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Progressive tax rates and our withholding system

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Individuals are taxed at progressive rates. This means that lower levels of income are taxed at a lower rate than higher level of income. All individuals have their lower levels of income taxed at these lower rates, regardless of their level of total income.

This is explained in the following diagram.

For a person's main source of employment income, the PAYE deductions made by their employer reflect this range of tax rates which can apply to one person’s income. Other forms of income – such as interest – have tax withheld from them using simple systems where a single rate is chosen. Generally that rate should be the same as the highest rate the person expects to apply to their annual income from all sources - their “marginal tax rate”. So, if Roxy in the above diagram had a term deposit on which she expected to receive $500 of interest in a year, she should advise the bank to withhold from that interest at her marginal rate of 30%.

This approach of dealing with progressive rates through PAYE on a person's main source of employment income and using a single rate on their other sources of income works well most of the time, but does not work so well when income from the main source varies significantly through the year or when income from other source takes their total income over an income tax rate threshold (as would happen if Roxy had other income of more than $20,000, which would bring her into the 33% band at over $70,000 of total income). These under- and over-payments of tax are currently addressed when annual tax returns are filed, but in the future greater use of digital technology improve the ability to make interventions during the year.

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