Taxation: Finding a New Zealand solution
This paper is a backgrounder on National's thinking on tax. Obviously, our tax policy is in its formative, rather than final, stages. I expect that the McLeod Tax Review's interim and final reports will contribute to our tax policy development process. As always, all comments are welcome. Annabel Young MP
Finding a New Zealand solution to the New Zealand problem
The amount available for government expenditure is the result of decisions about the levels and mix of tax and debt. Tax is not an end in itself. It is one of the ways that government expenditure is funded.
Inevitably, decisions about tax types and levels flow into every part of society, including the economy. Sometimes these effects are intended but often they are unintended. The one certainty is that taxes change behaviour because people will seek to maximise the benefit from tax breaks and minimise the effect of tax burdens. This is normal and legal behaviour.
The compliance burden generates real costs that are a tax in themselves. These burdens are disproportionately heavy on small businesses, relative to the level of the business activity. Many government initiatives to simplify taxes have the effect of imposing new and greater decisions upon small business.
Tax in history and where do we stand in the world
New Zealand’s tax ( excluding local govt taxes) to GDP ratio peaked at around 38% of GDP in the late 1980’s/early 1990’s. On the back of firm expenditure control and the ability to reduce personal income tax, this ratio declined to 32% by 1999/2000. This is still high by international standards.
In terms of the outlook, while the nominal dollar increase in tax revenue forecast over the Government’s Budget forecasts is large, the percentage of GDP remains relatively stable.
At the same time that our tax take stabilises, much of the rest of the world is managing to lower taxes on the back of strong economic growth and controlled expenditure increases. Germany has just announced a round of tax reductions.
Having said that, it is notoriously hard to compare the individual tax burdens in different tax jurisdictions. Comparisons of averages or total tax takes can also be very misleading.
In general, it can be said that New Zealand has a relatively simple tax system but that does not mean that we have a system that is actually simple. Our problem in this area is that the system is becoming more complex (especially because of the extra 6% tax) while other jurisdictions are trending towards simplicity.
Tax and it’s impact on the economy
All decisions about tax must bear in mind the full cost of taxation. These include the direct cost of the taxes themselves and also the cost of compliance. Complexity in the tax system imposes a cost in addition to the value of the tax collected but without providing any additional government revenue. Thus complexity is a drain on the taxpayers and the tax-gatherers, which does not provide any benefit.
Complexity also has an effect on the stress of the people who are interacting with the tax system. It increases the risks and the time involved.
There are various estimates of how much it costs to produce a dollar, which can be spent by the Government. A reasonable figure might be around $1.30 per dollar raised. It is unlikely that the taxpayer receives anywhere near a commensurate benefit from marginal spending programmes.
Taxation impacts on:
- willingness to work
- choices amongst consumption goods
- willingness to save
- the pattern of saving
- the production pattern in society
- the use of inputs by particular industries
- the pattern of investment
In the 1990’s we followed some core basic principles with regard to tax which are still relevant. These were that an ideal tax system has the following values:
- even rates
- low total take
A good tax system is one that trends towards these values.
How do we simplify taxes?
- By keeping spending low and targetted on those activities where the Government can make a difference.
- By flattening the rates and simplifing the planning options
- By considereing the compliance costs of any proposal.
- By understanding that the issue is complexity for the taxpayer as well as complexity for the tax gatherer. We have not solved the problem if we have shifted the burden of compliance without reducing it. We have achieved very little if the cost of compliance has reduced for the government but has increased for the taxpayer.
- By looking at systematic problems which raise compliance costs. A good example of this is the problems that Cullen has jumped into by increasing the income tax rate. This has increased the complexity and cost of compliance for income tax, FBT, withholding taxes, employment decisions, structuring decisions etc.
How do we make taxes more honest?
- By having a transparent process for evaluating the cost/benefit of tax proposals in terms of tax costs, compliance costs and human costs.
- By clearly identifying proposals that shift costs but do not reduce them.
Why make the tax rates even?
Evenness (or flatness) refers to the variations of rates and also to the differences between different types of taxpayers or income. Variations in rates between individuals, companies, trusts (and different classes of beneficiaries), unincorporated societies, superannuation schemes, types of income, etc raises opportunities for arbitrage which we must assume will be utilised.
The deadweight costs of taxes rises more than proportianately as the marginal cost of tax increases.It follows that by lowering the high marginal rates of tax the biggest effieiency gain can generally be obtained for any given loss of revenue.
Levelling out the tax rates is important because
- this allow us to simplify the system
- Even rates increase the value of the dollars collected because they reduce the collection costs
- Even rates reduce the anti-avoidance activity and therefor increase the dollars collected
Any levelling of the system will produce these benefits. It does not have to be absolutely flat. Prior to the last election we had a flattish system with an extra low rate for people who fitted certain social/financial criteria,
How do we lower taxes?
Personal income tax: The greatest problem with the Cullen Increase is that they broke the belief that rates would trend down. This triggered attitude changes to tax planning as people are now planning for tax increases, i.e., it makes tax avoidance more worthwhile.
We need to re-establish the faith that we will join the world trend to lowering taxes. This does not need to be in one lump but we need to demonstrate that the trend is down.
Company tax: Company tax needs to be in line with the top personal tax rate. It also needs to be competitive so it needs to be trending down.
How low can you go?
- The tax rate is a consequence of decisions about expenditure and debt.
- Changes to the top tax rate of personal income tax have less effect on revenue, as there are fewer people on the top rates.
Should taxes be used to encourage social goals?
We already do this with special tax rules for low-income earners and families. Should we expand this to other non-tax goals?
- It is impossible to accurately cost in advance amounts of revenue given away in tax breaks. This information only becomes available after all the tax returns have been processed.
- There is a history in New Zealand of incentives having a perverse effect so that incentivised activity does not increase but it appears to increase because the incentives are claimed. This can be minimised by a direct grant system. An increase in the claims for an incentive does not mean that more of that activity is occurring. This is similar to the problem of counting sheep during the SMP regime.
- The de-linking of rebates from the tax system does mean that a limited amount of "tax breaks" can be delivered without increasing the tax complexity.
What about non-income taxes?
Excise taxes (fuel, alcohol, tobacco) are the main non-income tax. Others include gift duty, road charges and gambling taxes.
Taxes on smoking are the most regressive taxes imaginable. They are clearly taxes on the poor because most smokers have low incomes. It is possible that taxes on alcohol also impact on the poor more because of the greater ability of the affluent to access duty-free goods.
There is a particular complaint that these taxes fund general expenditure, rather than being related to the costs arising from the dutiable item (e.g., tobacco taxes/health or road taxes/roads. This is a complex argument as you need to factor in the indirect costs e.g. adding the heath costs of road accidents to the cost of roading.
Excise tax is simple for the government to collect. It looks like an easy tax to give away but there is no added bonus of reducing complexity.
Changes to GST
Rate increases to GST have to be huge to compensate for reductions in income taxes. For example, you would need to shift to about 45% GST to compensate for a reduction in the income tax rate to 20%. This is partly because any increase in GST would have to be matched by an increase in benefits and also allow for an increase in the number of beneficiaries.
The Tax Take
Withholding Tax 1,672
Total Income Tax 23,192
Other Direct Tax 2
Total Direct Tax 23,193
Other Direct 1,699
Total Indirect Tax 12,920
Total Tax 36,113 (32.5% of GDP)
NB: Total tax take (central govt taxes) is expected to remain relatively stable, rising to 32.7% of GDP in 2003/2004. The nominal dollar value at that time will be $41,534m.