Raising taxes to fund health and pensions in an ageing New Zealand – Alternative labour tax progressivity

New Zealand, like many advanced economies, faces long-term fiscal pressures arising from population ageing. Over coming decades, demographic change is projected to increase government expenditure on New Zealand Superannuation and public health care relative to the size of the economy. Addressing these pressures will require policy choices about how government revenue, expenditure, and public debt evolve over time. This Analytical Note is one of a series of background papers that informed the Treasury’s 2025 Long-term Fiscal Statement (LTFS). The LTFS considers a wide range of possible responses to long-term fiscal pressures, including changes to revenue, expenditure, and the design of major government programmes. The background papers supporting the LTFS provide more technical detail on particular modelling approaches and policy scenarios, complementing the more accessible analysis presented in the LTFS itself. In this paper we use the Treasury’s overlapping generations (OLG) model to describe the macroeconomic, fiscal, and distributional effects of strategies that adjust tax policies to ensure fiscal sustainability in the face of rising pension and health expenditure. The scenarios presented are hypothetical analytical exercises designed to illustrate the mechanisms at play within the model rather than represent specific policy proposals. New Zealand raises the bulk of its tax revenue from labour income, consumption expenditure, and capital income, with source deductions on labour income representing the largest source of tax revenue. In this paper we meet expenditure pressures by deploying labour income tax strategies that vary in their degree of progressivity. In all scenarios, tax rates adjust over time to fund projected increases in pension and health spending and to stabilise the government debt-to-GDP ratio. The paper compares four stylised tax strategies: a Baseline strategy where marginal tax rates increase by the same percentage point amounts across all income brackets; a Current progressivity strategy that broadly preserves the current degree of progressivity in the tax system (as represented by the ratios of labour tax rates); an Increased progressivity strategy where the lowest tax rate is held constant while higher tax brackets increase; and a Reduced progressivity adjustment where relatively larger increases occur in lower tax brackets. The modelling highlights several mechanisms relevant to long-term fiscal policy. In particular, the distribution of income across tax brackets affects the size of the tax bases available to fund increased expenditure. The model indicates that changes to labour taxes could suffice to meet expenditure pressures arising from an ageing population, but that tax increases would need to be shared across tax brackets because the share of labour income in the highest two tax brackets is not large enough to fund the entire projected increase in expenditure. The alternative tax strategies explored in the paper result in different macroeconomic and fiscal outcomes. The model suggests that more progressive increases in marginal tax rates on labour income tend to be more distortionary, leading to larger reductions in labour supply, capital accumulation, and economic activity than strategies that spread tax increases more broadly across the labour income tax base. In the model, less progressive tax increases generate higher effective labour supply, higher per capita capital, and higher aggregate income and consumption in the long run. While the model highlights the efficiency implications of different tax structures, there are also other well-established reasons why governments may choose to maintain progressive tax systems, including redistribution or equity considerations, and the role progressive taxation can play in providing insurance against income risk. These considerations are important but are not the primary focus of the analysis presented in this note. The OLG framework also enables us to examine how alternative tax strategies affect people with different lifetime income profiles and those born in different years. The results illustrate that different households respond differently to the tax strategies considered, and that the strategies have different consequences for their wellbeing across generations. Importantly, the scenarios examined in this paper consider only one dimension of the broader set of policy choices discussed in the LTFS. Governments have a range of potential tools available to address long-term fiscal pressures, including changes to spending programmes, eligibility settings, the mix of taxes used to raise revenue, and policies that influence economic growth and labour force participation. The purpose of this note is therefore to provide technical insight into how different labour income tax structures interact with demographic change within our modelling framework. Together with the other background papers released alongside the LTFS, this analysis contributes to the evidence base supporting public discussion of New Zealand’s long-term fiscal sustainability.