A microsimulation analysis of marginal welfare-improving income tax reforms for New Zealand

This paper examines the direction of welfare-improving income tax reforms in the context of New Zealand, which recently reduced its top marginal income tax rate to one of the lowest in the OECD. A behavioural microsimulation model is used, in which social welfare functions are defined in terms of either money metric utility or net income. The model allows for labour supply responses to tax changes, in which a high degree of population heterogeneity is represented along with the details of the highly complex income tax and transfer system. The implications of the results for specific combinations of tax rate or threshold changes that are both revenue neutral and welfare improving are explored in detail, recognising the role of distributional value judgements. Results suggest, under a wide range of parameter values and assumptions, that raising the highest income tax rate and/or threshold would be part of a welfare-improving reform package.