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.