KEY POINTS:
In these times when it has become popular to look for tax breaks as a cure for whatever ails us, the idea of income splitting to relieve some pressure on families with children may appeal. But it would be a third-best solution.
It is telling that it has
taken 2 1/2 years for Inland Revenue to get something so dear to the heart of its own minister, Peter Dunne, even to discussion document stage.
Broadly speaking, the left is not keen because it is not well targeted at relieving child poverty, the extent of which the Child Poverty Action Group's report this week makes clear.
Income splitting is no use at all to single parents, who have the hardest row to hoe.
And it is seen as favouring a 1950s model of the family - with mum at home baking biscuits and looking after the children - that bears little relation to the realities of modern times.
At the same time, the right isn't keen because of the opportunity cost: like any other targeted tax relief, it reduces how much would be left for across-the-board tax cuts.
Nevertheless, if Dunne is in a position of influence after the election, it might have legs after all.
So what is income splitting and why might you want to do it?
There are several ways to design an income splitting regime, but the simplest one is to combine both partners' incomes and apportion it equally between them. This will usually reduce their combined tax bill.
That is because of the progressive nature of the income tax system: people on higher incomes pay more of their incomes in tax.
So the obvious question - too political for an official discussion document - is why not address the problem by flattening the tax scale?
Pricewaterhouse Coopers chairman John Shewan says the lion's share of the benefits of income splitting would be delivered in any event if we were to get rid of the 39c tax bracket and bring it back to 33c or 30c.
Having worked as a tax accountant in the United States, he says the complexity of income splitting is huge, with associated compliance and administrative costs.
The Government already has levers it can adjust to boost the incomes of families with children: Working for Families' tax credits, childcare subsidies and the accommodation supplement.
The discussion document suggests another objective, however. "By helping single-earner families, income splitting may enhance the choices available to parents by helping to ensure that it is a viable option for one parent to stay at home or work part-time to care for their dependent children," it says.
The fiscal cost might not be prohibitive but it is not trivial either.
Suppose you wanted to allow 50/50 income splitting for families with dependent children under 18.
Officials estimate the cost in forgone revenue at $370 million a year.
As it happens that is only slightly less than the estimated cost of dropping the 33 per cent income tax rate to 30 per cent.
If confined to families with children under 5, the cost would drop to $160 million.
Who would benefit?
The most populous part of the income distribution among couples consists of families whose main breadwinner earns between $50,000 and $60,000 and his or her partner up to $40,000.
About 70,000 families fall into that group and they would stand to gain between $1000 and $3000 a year.
The largest gains, however, would be among couples with larger incomes.
The biggest gain, nearly $9000 a year, goes to a couple where one partner earns $120,00 a year and the other earns nothing.
But in the great majority of families with dependent children, both partners have jobs.
For every level of secondary earner income up to $60,000 the benefit is higher, the higher the primary earner's income is.
But when both earn about the same, or when the secondary earner is on $60,000 a year or more, there is no net benefit from income splitting.
By the end of last year, 360,000 families were receiving assistance through Working for Families, to the tune of $5600 a year on average. And its eligibility criteria are based on the family unit not individual taxpayers.
One of the drawbacks of the regime, however, compared with the universal child benefit of old, is that its targeting provisions create forbidding effective marginal tax rates when family incomes reach the zone where entitlements are scaled back.
The effective marginal tax rate (EMTR) is how much of any extra dollar of income is lost as a result of taxation, the abatement of benefits or tax credits, and other income-related obligations like ACC levies and child-support payments.
With income splitting, some primary earners, although a minority, would see their EMTRs fall, most commonly by 12c in the dollar. But a similar number of secondary earners would face higher EMTRs.
And secondary earners, especially women, are far more sensitive to changes in the return to labour than primary workers are. So the net effect from an economic efficiency standpoint might well be negative.
But is there a case for it on fairness grounds? Why should two couples with the same income face different tax bills?
First, it is proposed to permit income splitting only for couples who have dependent children - unlike most other jurisdictions which allow it. So there is already an equity issue there.
It is arguable, the document says, that income splitting recognises the contribution of stay-at-home parents when the current system does not.
But it is also arguable that two families with the same income do not necessarily have the same ability to pay tax. One couple might have to clock up a lot more hours to earn that income, and face childcare costs.
Like the call to scrap GST on food, or even to have a special tax break to keep star All Blacks in the country, the concept of income splitting is a further retreat from the principle that the broader the tax base is, the lower tax rates can be, all else equal.
A tax concession for one group helps keep taxes higher than they might be for everyone else.
And they can have perverse or downright calamitous side effects, like the US tax credit for ethanol from corn. Not only is it a wicked waste of food (for little or no environmental gain), it is bad tax policy.
Many families are under pressure, no question. But income splitting only benefits some of them and only because of the structure of the income tax scale. Either flatten it or put more resources in Working for Families. But spare us any more complexity in the tax laws.
