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Inland Revenue

Tax Policy

Chapter 5 - Assessing income splitting against the criteria

5.1 This chapter assesses the idea of income splitting against the criteria outlined in chapter 1.


5.2 The decision to tax on a family basis by allowing income splitting may increase perceived fairness in some areas at the expense of others. Whether taxing on a family basis is a good thing depends on the relative weightings given to different goals.

5.3 With individual taxation, as at present, a one-earner family will pay more tax than a two-earner family when the two have the same total family income. In fact, whenever one partner contributes more to total family income than the other, the tax system will impose at least as high and generally a greater burden than if they both contributed the same incomes. This may be seen as unfair, particularly when considered in light of the Working for Families package.

5.4 Working for Families uses the family, rather than the individual, as its basis for determining the appropriate level of assistance for families. As such, it provides equal support to families in similar circumstances that have the same total family income (and the same number, and age, of children). However, while those families are treated equally for Working for Families purposes, some will still end up worse off than others because of the individual basis of the tax system. Allowing income splitting for families would ensure that such families are treated consistently.

5.5 Furthermore, limiting income splitting to families with children would also ensure that a couple with a child would pay less tax than a couple without a child when both had the same aggregate income.

5.6 It is also arguable that income splitting recognises the contribution of stay-at-home parents, when the current individual system of taxation does not.

5.7 On the other hand, it is arguable that family income does not always accurately capture a family’s ability to pay tax, and so is not the fairest means of determining tax liability. This is because family income does not take account of the hours worked by family members. While it may be considered unfair for different couples working full-time with the same aggregate income to face different tax burdens, if one partner in a family is not in paid employment he or she will have additional time available for valuable activities at home, such as childcare.

5.8 Compare the following two families: Family 1 has both partners working full-time for 40 hours a week, earning $50,000 each. Family 2 has one partner working full-time for 40 hours a week and earning $100,000, with the other partner not in paid employment. Family income is the same, so income splitting would allow these two families to pay the same amount of tax. But do these families have similar abilities to pay tax? If both families have young children needing to be cared for, Family 1 may need to employ childcare as both parents work full-time, whereas Family 2 may not need to do so. Individual taxation places a higher burden on the single-income family and so it may possibly be argued to be fairer in this situation.

5.9 It may also be perceived as unfair that the benefit from income splitting increases as primary income increases, providing more benefit to families with higher incomes.

Providing choice to families

5.10 The government is also committed to providing real choices to parents and carers in combining their work with their caring roles through the government’s “Choices for Living, Caring and Working” ten-year action plan.

5.11 Parents raising children often face the choice between both parents working (and employing childcare), or one parent staying at home or working part-time to care for a dependent child or children.

5.12 In some cases, both parents in a two-parent family may wish to work but may be deterred by the cost of childcare, as may a sole parent who wishes to work. The government has acknowledged this concern, and the childcare and Out of School Care and Recreation (OSCAR) subsidies, along with the recently introduced free Early Childhood Education programme, are ways of alleviating this concern.

5.13 In other cases, one parent may wish to stay at home and care for dependent children but may not see this as a viable option because of financial considerations. At present, there are no government measures specifically designed to make staying at home or working part-time a more viable option in this situation, although Working for Families does implicitly aid this goal by providing financial support to families.

5.14 Income splitting may enhance the choices available to parents by making it easier for a partner to stay home to care for dependant children, if he or she wishes to, as single earner families would benefit the most from 50/50 income splitting.

5.15 Even so, income splitting may not target support very well if this is the goal to be achieved. As Figure 1 shows, the greatest benefit from income splitting goes to families on higher incomes, and these families may not necessarily be the families who most need assistance.

5.16 For families with lower incomes, for whom the financial constraints may be greater, income splitting would provide only small amounts of support. For example, a one-earner family receiving $40,000 would gain only $600 a year from income splitting.


5.17 The impact on economic efficiency of income splitting is not immediately obvious because effective marginal tax rates (EMTRs) increase for some people (secondary earners) and decrease for others (primary earners).

5.18 Taxation of labour income will distort price signals and alter people’s work decisions, leading to an inefficient allocation of resources. This inefficiency increases the higher the tax rate is, and the more responsive people are to the imposition of the tax. Therefore the reduction in primary earner EMTRs will increase efficiency, while the rise in secondary earner EMTRs will decrease efficiency.

5.19 The average decrease in primary earner EMTRs and the increase in secondary earner EMTRs is roughly the same, so the efficiency gains from the reduction of higher primary earner EMTRs would appear likely to outweigh the negative effect of the increases in lower secondary earner EMTRs. However, if labour supply responsiveness differs between these groups, this may not be the case.

5.20 Empirical evidence[5] suggests that secondary earners, especially women, are far more responsive to changes in the return to labour than primary workers. Consequently, the negative impact on efficiency of an increase in secondary earner EMTRs may outweigh the positive impact of the reduction in primary earner EMTRs. For example, a full-time worker may decide to continue working full-time under any circumstances, whereas a part-time worker is more likely to reduce hours of work or leave the workforce altogether if EMTRs become too high.

5.21 Even in the absence of income splitting, EMTRs can be high for many people as a result of the abatement of the Working for Families package, the ACC earner premium, student loan repayments and child support obligations. As such, the efficiency impact of a further change in EMTRs as a result of income splitting would be greater for such people than for those with a lower pre-income splitting EMTR.

5.22 There may also be further efficiency impacts beyond those directly relating to the tax system. The lower EMTRs on primary income earners are likely to provide greater incentives for them to acquire new skills and move to better remunerated jobs, which, by itself, is likely to boost labour productivity. However, the higher EMTRs for secondary earners create incentives to reduce hours of work, or to leave the workforce temporarily, which may adversely affect labour productivity. Evidence suggests[6] that once people have been outside the workforce for more than a year their skills may begin to atrophy, resulting, in the long term, in a less productive workforce, which may have an impact on economic growth.


5.23 By implementing income splitting through the existing Working for Families tax credits system, income splitting is likely to be relatively simple for people to comply with. If they were able to use a special tax code to receive the tax benefit from income splitting during the year, there would be some increase in compliance costs. That is because they would need to estimate their correct tax rate having regard for the impact of their partner’s income on their tax liability.

5.24 If the income splitting benefit were paid out after the end of the tax year the only families who might face a significant increase in compliance costs would be those who were eligible to split their income but who were not eligible for Working for Families tax credits. The reason is that they may not previously have been required to file a tax return, but might now have to do so in order to receive the tax benefit from income splitting.

Administrative costs

5.25 Income splitting would be very expensive to implement and administer irrespective of the specific design. However, it might be possible to implement it through the current Working for Families tax credits system, which would restrict costs to an extent.


5 See, for example, Blundell, R. and McCurdy, T. (1999) “Labour supply: A review of alternative approaches”, in O Ashenfelter and D Card (eds.), “Handbook of Labour Economics”, Volume 3, North Holland, Amsterdam.

6 See, for example, Jaumotte, F., (2003) “Female labour force participation: past trends and main determinants in OECD countries”, OECD Economics Department working papers No. 376; Fagan, C. and Walthery, P. “The role and effectiveness of time policies for reconciliation of care responsibilities”, paper presented to the OECD Conference on Life Risks, Life Course and Social Policy, Paris, 31 May – 1 June 2007.