Tax Bracket Creep - The Definitive New Zealand Guide
Discover everything you need to know about bracket creep and how it affects your personal finances in our comprehensive guide. Learn about the causes, consequences, and solutions to this complex tax issue.
Updated 18 February 2023
Summary
To help you understand bracket creep, our guide covers:
Summary
- You've probably heard the term "bracket creep" before but may not know what it means. In short, bracket creep is when inflation causes people to move into higher tax brackets even though their 'real' incomes haven’t increased.
- This shift results in people paying more tax than they otherwise would have. With the ongoing cost of living crisis, bracket creep can be a silent killer that whittles away the purchasing power of many Kiwis.
- While bracket creep may not appear a big deal at first glance, it can significantly impact Kiwi taxpayers, especially those on low and middle incomes.
- Bracket creep can significantly impact your tax bill, so it's important to be aware of how inflation can push you into higher tax brackets and how this can affect the amount of tax you pay.
- While there may not be much you can do at the policy level to address bracket creep, it's important to be aware of it and plan around it.
To help you understand bracket creep, our guide covers:
What is Bracket Creep? How Does it Work Mechanically?
Bracket creep occurs when taxpayers are pushed into higher tax brackets due to inflation. Even though their incomes have not increased on an objective basis (after adjusting for inflation), higher income results in people paying a higher overall tax rate but ending up with lower purchasing power, making it harder to meet living costs.
To further elaborate on key definitions relevant to bracket creep:
To further elaborate on key definitions relevant to bracket creep:
- Inflation is defined as the sustained increase in the cost of goods/services over time. So, for example, when inflation increases, the prices of groceries and petrol also go up.
- Bracket creep is defined as the instance where wages or incomes go up (that pushes people into higher tax brackets). Still, the cost of living (inflation) increases at the same or a faster rate than wage growth, meaning real purchasing power has fallen after considering increased taxes and cost of living.
Why does bracket creep occur?
- In New Zealand, tax brackets are not adjusted for inflation each year. This situation means that as prices rise, incomes (after factoring in inflation - known as the "real income") stay the same.
- Still, people are pushed into higher tax brackets because their incomes grow (even though their purchasing power has stayed the same). So, while a person's nominal (not factoring inflation) income may not have risen, their effective income—after taxes—may have decreased significantly due to bracket creep.
- As incomes rise, Kiwis get put into the next tax brackets and pay a higher proportion of tax on their total incomes. While this might not seem like a significant change initially, inflation's effect can be significant over time.
- For example, a loaf of bread might cost $2 a decade ago but $4 today. That means that the purchasing power of the New Zealand dollar has decreased by 50% over those ten years.
Why is bracket creep so bad, and why should I care about it?
Bracket creep can have a significant impact on your tax bill. While bracket creep sounds slow and insignificant to many Kiwis, it can be a major challenge for many households. You'll pay more on your income if you're pushed into a higher tax bracket. In addition, this shift can leave you with less money to save or spend as you please.
Bracket creep should be front-of-mind for many New Zealanders as it disproportionately influences lower-income people. Typically, Kiwis on low and middle incomes spend a bigger proportion of their income on consumer staples like food and rent. This spending pattern means that any decrease in their disposable income (as a result of bracket creep or inflation) can make it difficult to make ends meet.
Bracket creep should be front-of-mind for many New Zealanders as it disproportionately influences lower-income people. Typically, Kiwis on low and middle incomes spend a bigger proportion of their income on consumer staples like food and rent. This spending pattern means that any decrease in their disposable income (as a result of bracket creep or inflation) can make it difficult to make ends meet.
Must-Know Facts about Bracket Creep
1. While bracket creep is perceived as a negative thing for Kiwis, bracket creep generates a significant amount of additional tax for the government.
- While bracket creep can cause headaches for many Kiwi households, it may not be as urgent of an issue for the government. This lack of priority happens because as Kiwi incomes creep up and get pushed into higher tax brackets, more tax revenue is generated for the government.
- This money is either used to provide more support to those in need (like providing unemployment benefits or jobseeker benefits) or for critical infrastructure to cities and regions that need it.
- While bracket creep can be addressed and avoided by adjusting tax brackets for inflation each year, this would almost certainly result in less tax revenue for the New Zealand government. Therefore, the government does not have a strong incentive to address bracket creep compared to other issues they have to deal with.
- Additionally, these tax issues can become increasingly political, meaning some political parties may be reluctant to make bold changes to the current tax bracket structure out of fear of public backlash.
2. Bracket creep affects all taxpayers but is especially problematic for those on low and middle incomes.
- Bracket creep can make a big difference depending on your income level. For example, if you were earning $70,000 and paying a 30% marginal tax rate and then subsequently had your salary pushed up to $80,000, your marginal tax rate would only increase to 33%, a 3% increase.
- However, If you were earning $45,000 and were in the 17.5% marginal tax bracket, your salary would subsequently increase to $50,000, and you would move to the 30% tax bracket. This shift in the marginal tax rate is a significant increase (almost doubling the tax you would need to pay).
- Additionally, a person on a $45,000 income is much more likely to feel the pain of a tax increase than someone on $70,000 as they start from a much lower starting salary. Bracket creep can pose a serious issue for those on lower incomes versus those on higher incomes that are somewhat insulated from drastic increases in the tax rate.
Frequently Asked Questions about Bracket Creep
Why does bracket creep occur? What are some examples of bracket creep in New Zealand?
Bracket creep will occur when income and costs increase, but the New Zealand government does not adjust tax brackets to account for this inflation each year, leading to a higher proportion of income being paid as tax. Wages have gradually risen, but the core tax brackets have not shifted in many years. That means that New Zealanders on lower incomes have crept into what used to be excessive income tax brackets. Examples include:
1. Being pushed into a new tax bracket
For example, there were significantly fewer Kiwis decades ago that were in the 30% tax rate bracket (which kicks in on all income earned over $48,000 a year) than there are now, given the current minimum wage is around $44,000 and the median income in New Zealand is around $60,000. As a result, the average Kiwi on a standard salary a few decades ago will have been pushed into the next tax bracket over the last decade.
Additionally, due to natural wage increases, Kiwis get pushed from relatively low-income tax brackets to much higher tax brackets without having a substantial increase in their earnings power. For example, going from a 17.5% marginal tax rate (on incomes from $14,000 to $48,000) into a 30% marginal tax rate is significant. For many New Zealanders, bracket creep has resulted in this occurring over the last ten years.
2. Introduction of new taxes
The increase in GST in 2010 to 15% (from 12.5%) caused many goods and services to increase, effectively reducing the purchasing power of many New Zealanders.
1. Being pushed into a new tax bracket
For example, there were significantly fewer Kiwis decades ago that were in the 30% tax rate bracket (which kicks in on all income earned over $48,000 a year) than there are now, given the current minimum wage is around $44,000 and the median income in New Zealand is around $60,000. As a result, the average Kiwi on a standard salary a few decades ago will have been pushed into the next tax bracket over the last decade.
Additionally, due to natural wage increases, Kiwis get pushed from relatively low-income tax brackets to much higher tax brackets without having a substantial increase in their earnings power. For example, going from a 17.5% marginal tax rate (on incomes from $14,000 to $48,000) into a 30% marginal tax rate is significant. For many New Zealanders, bracket creep has resulted in this occurring over the last ten years.
2. Introduction of new taxes
The increase in GST in 2010 to 15% (from 12.5%) caused many goods and services to increase, effectively reducing the purchasing power of many New Zealanders.
How does bracket creep impact taxpayers?
Bracket creep can significantly impact taxpayers, especially those on low and middle incomes. Higher marginal taxes can leave these households with less money to save or spend on essentials like food or rent.
How can bracket creep be avoided?
While bracket creep is unavoidable at the individual level, bracket creep can be negated by adjusting tax brackets for inflation each year. This adjustment would ensure that taxpayers are not pushed into higher brackets simply due to the rising cost of living. Again, however, this will usually need to take place at the government policy level rather than at the individual taxpayer level.
What can I do to minimise the impact of Bracket Creep?
The best advice for minimising the impact of bracket creep is to understand the implications of bracket creep on your income, budgets and taxes and then plan around it. For example, suppose you know that your purchasing power is likely to drop due to bracket creep. In that case, you can either try to pick up side hustles to increase your income and counteract the decrease in purchasing power or cut down on non-essential spending.
While PAYE should automatically adjust and recalculate the appropriate taxes you owe each year, it can pay to understand the implications of moving up a tax bracket to ensure you don’t underpay your tax.
While PAYE should automatically adjust and recalculate the appropriate taxes you owe each year, it can pay to understand the implications of moving up a tax bracket to ensure you don’t underpay your tax.
It doesn't seem fair that bracket creep means people are paying more taxes. How is this legal?
- While bracket creep may seem negative for Kiwis, there are some instances where it can suggest things are better than they seem.
- For example, bracket creep results in higher tax revenue for the New Zealand government, leading, in an idealistic situation, to better infrastructure and essential services (such as hospitals, roads or wage subsidies) for Kiwis who need them. However with any government's spending priorities often questioned by their opposition, it's not clear what benefits additional tax revenue is providing to those who pay it.
- Additionally, while purchasing power may decrease from bracket creep due to inflation, this may not always be the case. There are instances where income increases can outpace the cost of living, meaning Kiwis will be better off than if they didn't experience inflation.
- Also, higher inflation is usually associated with a stronger economy and lower overall unemployment, which can be seen as a good thing. Furthermore, a hot job market means you’re more likely to be able to get salary hikes when you move jobs.
- To conclude, bracket creep may get a lot of negative press in the media, but the causes of bracket creep can indicate that things are better than they appear. This article from interest.co.nz explains the situation further.
What is marginal tax? How does bracket creep impact marginal tax?
Marginal tax is the tax rate you pay on the incremental last dollar earned. You'll move into a new tax bracket when you earn above a certain level, meaning your marginal tax rate goes up. This shift in the marginal tax rate differs from your effective tax rate, the total tax amount you pay on your entire income, not just for the last dollar you've earned.
While your marginal tax rate may be high, your normalised tax rate on your total salary will not be this high. For example, if you earn $75,000, your marginal tax rate for the last dollar will be 33%. However, this 33% rate only applies to money above $70,000, so your effective tax rate will likely be much lower than 33%.
While your marginal tax rate may be high, your normalised tax rate on your total salary will not be this high. For example, if you earn $75,000, your marginal tax rate for the last dollar will be 33%. However, this 33% rate only applies to money above $70,000, so your effective tax rate will likely be much lower than 33%.
When were the major tax brackets changed last?
The last time the New Zealand government adjusted tax brackets was in early 2021, with the introduction of the 39% tax bracket. However, the lower tax rates were unaffected by this change. For more information on income tax rates and historical changes, check out the New Zealand Parliament's breakdown.
Individual income tax rates and thresholds from 1 April 2021
Income level |
Marginal income tax rates |
$0 - $14,000 |
10.5% |
$14,000 - $48,000 |
17.5% |
$48,000 - $70,000 |
30% |
$70,000 - $180,000 |
33% |
Over $180,000 |
39% |
How does the new 39% tax bracket impact Kiwis? Will bracket creep exist there?
With the new 39% tax bracket applying from 2021 onwards, this tax bracket solely impacts those with incomes greater than $180,000. Therefore, this tax change will likely impact a small minority of Kiwis (around 2%) and will not impact Kiwis' earnings below this level.
Bracket creep still applies, even to those on higher incomes. So, for example, if you were earning $170,000 and got a 10% pay rise, but inflation was 12%, your income would grow to $187,000, meaning you'll be paying 39% on the last $7,000 of income, but your purchasing power will have decreased (as your 10% pay rise has grown slower than the 12% growth in the cost of living).
Bracket creep still applies, even to those on higher incomes. So, for example, if you were earning $170,000 and got a 10% pay rise, but inflation was 12%, your income would grow to $187,000, meaning you'll be paying 39% on the last $7,000 of income, but your purchasing power will have decreased (as your 10% pay rise has grown slower than the 12% growth in the cost of living).
How does bracket creep impact the government? Do they benefit from bracket creep?
Generally, bracket creep leads to more tax revenue earned for the government. This increase in tax revenue directly benefits the government and provides more money to spend on their yearly budgets. Still, it has the indirect risk of reducing the purchasing power of New Zealand households (especially those on low and middle incomes). This unintended consequence will mean that more targeted initiatives will need to be drafted to support these groups. Overall, it's up for debate whether bracket creep benefits New Zealand overall.
Where can I find more information on bracket creep?
You can find more information on bracket creep from the New Zealand government’s official website publication.
How does Bracket Creep impact New Zealanders?
Bracket creep impacts the amount of tax you pay. The amount of tax you pay can be affected by bracket creep in two key ways:
- You may be pushed into a higher tax bracket and pay more on your income.
- The government may raise taxes (such as GST) to offset the effects of inflation. This adjustment means you will pay more tax on the goods and services you purchase.
