The effects of the Government’s tax cut package will this year begin to wear off for a group of 2943 low-income families after the Government decided not to adjust a little-known tax credit threshold — effectively freezing their incomes for a year.
Of the families affected, 86% are single-parent families, according to an IRD paper released with the decision, which was made last December.
The change will not mean a family’s income, comprised of money from work and tax credits, reduces. Instead, it will mean that it does not increase this year, as usual remaining at about $679 a week after tax for most affected families, who must work at least 20 hours a week to qualify.
This means the value they received from last year’s tax cut package will partly erode, before picking up in 2026 and the families’ incomes will erode in real terms.
Families will still be “better off” than prior to the tax package — just not by as much as they would have been had the Government decided to stick to what it agreed in the Budget and increase the threshold each year. Freezing the threshold this year will save the Government a paltry $970,000 a year. The only way to avoid the trap would be to take on far more hours, or to be paid a far higher hourly rate, earning one’s way out of the threshold trap.
The issue comes from one of the Working for Families (WFF) tax credits, the Minimum Family Tax Credit (MFTC). One goal of the Working for Families system is to ensure that someone working will always be better off than someone on a benefit by making sure that parents who work 20 hours a week or more (30 hours for couples) will get a guaranteed level of income higher than being on a benefit.
To hit this guaranteed minimum income, the MFTC “tops up” a person’s work income to the point where it is higher than it would have been if they were receiving a benefit. Historically, what IRD calls the “guaranteed amount” is adjusted upwards each year to ensure, in the words of IRD officials, those families remain “marginally better off” than were they on a benefit.
There is no agreement on how much better off these families are required to be to achieve the policy’s aims. An IRD paper noted that in theory, the MFTC could be set to ensure families were $1 better off each year than were they on a benefit — just less than 2 cents a week. Typically, however, it is set at $1 above the weekly level of income a sole parent beneficiary could receive.
In 2021, the Labour Government decided to set the MFTC threshold so that on an annual basis, a sole parent would be better off working and receiving the MFTC than they would be receiving a main benefit, which included also receiving the winter energy payment.
In 2024, the new National-led Government decided that the small number of MFTC recipients should also benefit from their tax cuts and tax credit changes (mainly the $25 a week increase to the in-work tax credit), which also helped to increase the gap between a benefit and work.
As a result of this, the IRD calculated the MFTC is $25 a week higher than it needed to be to simply mean a person would be “better off” working than on a benefit.
At the time, the Government decided those changes should pass through to recipients of the MFTC. As a result of Cabinet decisions made last year, that decision has been reversed. This means that this year, the gap between a benefit and work will shrink slightly.
An analysis from IRD officials said that recipients’ “nominal incomes will not be negatively impacted by the decisions in this paper because their total income in hand will not decrease”.
Officials added that, “[at] the same time, their total income in hand will not increase until the Minimum Family Tax Credit threshold is increased again”.
“This means that in real terms, their incomes will decline with annual wage growth”.
The purpose of the MFTC is to encourage people into work — a philosophy that is at the heart of the current Government’s plan to encourage people off a benefit into work.
Revenue Minister Simon Watts told the Herald that these changes would not undermine that effort.
“The MFTC is typically increased annually to match increases to main benefits – this is to ensure MFTC recipients remain at least $1 better off per week in work than they would be on benefit.
“Typically, the MFTC is increased at the end of the year [by December 1]. However, Budget 2024 tax changes means that the MFTC threshold is now at least $25 higher than it needs to be to ensure recipients are better off in work than they would be on benefit,” he said.
Watts said the change he made was to have the threshold “held for the year” because the “decision to increase it was brought forward as part of Budget 2024 [and increased substantially more than it needed to be]”.
IRD proposed an even harsher change, which would have frozen the MFTC until the $25 a week benefit from the 2024 tax package had effectively worn off entirely, saving about $6m over the forecast period.
Labour’s social development spokeswoman Carmel Sepuloni told the Herald the change was “disappointing”.
“A large proportion of those who get the credit are actually the sole parents and because of the fact that it’s going to effectively be frozen, they’re going to fall behind in terms of their income,” Sepuloni said.
Sepuloni said that the last Labour Government had put the whole WFF system under review. She wanted reforms that would simplify the system which has come under fire for its complexity.
“We know that so many people don’t even understand how Working for Families works. Many are claiming it, but they don’t necessarily understand the interactions and so there is a need to simplify it.”
The MFTC is one of the most frequently criticised WFF tax credits. The main criticism is that it disincentivises work – the opposite to what it is meant to encourage. IRD advice shows that someone receiving the credit and working 20 hours a week will get about $679. If that person increased their hours to 30 a week, they would still receive $679, giving them no incentive to take on more work. They only start to get “better off” again when they work 35 or more hours a week. This is because the credit abates at a very steep rate.
Another criticism of the credit is that it makes an arbitrary distinction between children with parents on a benefit and those who work.
Auckland University Associate Professor Susan St John has criticised the system on this basis.
St John told the Herald said the MFTC was “the worst disincentive imaginable”.
“It is designed to be slightly more attractive to be on than a part benefit. But it is just another government payment, administered by the IRD, to replace the part benefit,” she said.
“The MFTC is supposed to be a work incentive, but once a sole parent is on it, every extra dollar from a wage rise or extra hours worked actually costs the sole parent a dollar plus 1.6% ACC. This fundamentally contradicts its aim of making work pay. It is very difficult to police the hours of work, and families can inadvertently earn more and get a big debt to IRD.”
St John said, “Far too much time and money has gone into reviewing this obscure tax credit to the neglect of the bigger picture of how the Working for Families fails our struggling families.”
The decision appears to have been prompted by a warning from IRD that the abatement threshold for the MFTC (the point at which someone earns enough to begin withdrawing the credit) would soon overlap with the abatement threshold of another WFF abatement threshold, the In-Work Tax Credit.
Officials reckoned that on the current trajectory, this would occur in 2027, and would mean some families facing effective marginal tax rates of 128% — in other words, for every additional dollar a person earned, that person would be taxed that entire dollar, plus 28 cents more, meaning the more someone earned, the more their overall income would reduce.
Just 60 families would face these rates initially, according to IRD officials, but the number would rise as years went on. The Government’s decision will defer that crossover year.
This problem would have been fixed by adjusting the abatement threshold upwards, a policy Labour and National pledged on the campaign trail, but which National u-turned on it formed a government.
Thomas Coughlan is Deputy Political Editor and covers politics from Parliament. He has worked for the Herald since 2021 and has worked in the press gallery since 2018.
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