Household structure, economic units, and income splitting

There is talk in the air that the New Zealand government may one day look at “income splitting” as a form of providing tax relief.

Income splitting changes the fundamental economic unit that is taxed from the individual to the household. The most likely form of income splitting we could see in New Zealand would see the gross income of the main income earner and their partner (either through marriage, civil union, or some other definition) aggregated and then split evenly between the two partners before being taxed at the individual tax level. As tax rates increase with income, this would lower the tax liability of all two-person households.

However, is this policy fair, or even sensible?

The concept of income splitting comes from the idea that the appropriately measured social unit is the household. Our benefit system is built on the same premise, with individuals unable to receive the benefit if their partner is earning a reasonable income. However, this whole system seems a bit silly to me given that individuals are paid their wage based on their own incentive to supply labour.

I agree that the household can be viewed as an economic arrangement, where two individuals agree to specialise in different roles and receive benefits from this specialisation. However, the fundamental economic unit is the individual. It is the individual that makes choices and decides what household structure they would like to enter into.

If we then view individuals as the appropriate economic unit, income splitting seems un-equitable. By allowing income splitting we are giving a tax advantage to those in a relationship versus those that are not (include solo-parents!) – something we should only be willing to entertain if there is a positive externality associated with that household structure.

However, if there are positive externalities associated with this type of household structure then perhaps we should quantify it and then target it directly, rather than further muddying the income tax system.

  • CPW

    I already spent about ten minutes ranting about this earlier this morning, but I’ll limit my many objections to just one. Income splitting only makes sense if you are desperate for the tax system to encourage one particular family structure: namely a high-income single earner with a stay-at-home spouse. If you’re agnostic about your preferred family structure it is just not a sensible policy.

    Didn’t we just finish instituting a $2bn program of income support for families all of a year ago? What was that for again?

  • http://tvhe.co.nz Matt Nolan

    “I already spent about ten minutes ranting about this earlier this morning”

    Sorry to troll on my own post- but who were you ranting too? (Its like economist gossip!).

    “If you’re agnostic about your preferred family structure it is just not a sensible policy”

    Agreed

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  • http:///100wordblog.wordpress.com Richard

    If you were going to income split, and use the household as the basic unit, why stop at the non-earning spouse? Surely you’d want to avoid the wee kiddies paying the higher tax rate on their share of the household incomes as well:)

  • http://goNZoFreakpower.blogspot.com Will de Cleene

    Income splitting is best left to divorce lawyers.

  • http://tvhe.co.nz Matt Nolan

    Wow you guys all seem to agree that income splitting is silly – I thought I was being contentious with this post. Shows what I know :P

  • http://www.tvhe.co.nz agnitio

    well I wasn’t at all surprsed to see that it was Peter Dunne’s policy. This policy defintiely fits in with Puter Dunne’s idea of the ideal family unit.

    Nice quote from Patrick Nolan, I hear he’s a smart guy;)

    I wonder if since it’s united future policy it doesn’t apply to same sex couples?

  • http://tvhe.co.nz Matt Nolan

    “I wonder if since it’s united future policy it doesn’t apply to same sex couples?”

    The “future” element has gone now – I think that United is still conservative, but they probably won’t exclude same sex couples now.

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  • dracotb

    I wonder if since it’s united future policy it doesn’t apply to same sex couples?

    I wonder how much he would support the idea if there was 1 high earner and 6 wifes/husbands involved :D

    Silly idea as it effectively penalizes singles.

  • http://tvhe.co.nz Matt Nolan

    “Silly idea as it effectively penalizes singles.”

    I’m not a fan of the income splitting idea either – the economists I know seem torn though.

    Ultimately, the debate between economists is about whether we view the household (however we define it :P ) or the individual as the economic unit.

  • http://www.tvhe.co.nz agnitio

    interesting point, I wonder if the side people take on that is related to whether they a predominantly supply side or demand side economists (if such things exist anymore!)

    presumeably if you think the supply side is important than individuals are the relevant economic unit since they supply labor (mum and dad do, kids don’t which I guess makes them pretty useless economic units here!), where as when you look at the demand side you have consumption coming from the entire household and thus you might argue that it is the household.

    interesting stuff, not really sure where I stand on the issue.

  • http://tvhe.co.nz Matt Nolan

    “presumeably if you think the supply side is important than individuals are the relevant economic unit since they supply labor (mum and dad do, kids don’t which I guess makes them pretty useless economic units here!), where as when you look at the demand side you have consumption coming from the entire household and thus you might argue that it is the household.”

    That was a really good summary of the issue, I completely agree :)

    Ultimately, I am falling on the individual side because of the structural changes we are experiencing with what constitutes “a household”.

    Furthermore, if we want to promote household structure, or pay them for externalities associated with forming that sort of social structure it seems more efficient to do it directly, rather than mess around with the structure of taxes.

  • http://www.squidoo.com/paid-blogging paid blogging

    Sure doesn’t seem very sensible to me. Shouldn’t we being do what’s best for the tax payer? Good post.