Plucking the goose or how to find a billion dollars a year without hissing

Terry Baucher details how the previous National-led government appears to have successfully raised at least $1 billion of extra revenue annually with little or no fanfare.

Louis XIV’s finance minister, Jean-Baptiste Colbert, famously declared that “the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”

What was true in the seventeenth century remains true today. And although Colbert might not recognise much of the modern economy and tax system, he would probably still appreciate some of the sleight of hand used by New Zealand finance ministers to raise funds without too much hissing. At a rough guess the last National government seems to have successfully plucked at least $1 billion of extra revenue annually with little or no fanfare. How?

We’re not talking about specific tax related measures often of a quite technical nature. These are a staple of every government’s budget.

A long-standing option used by governments of both hues is inflation, and in particular ‘fiscal drag’. This is when income tax rate thresholds are not inflation adjusted so wage growth lifts more earners on to higher marginal tax rates.

Income tax rates and thresholds were last adjusted in October 2010. At that time someone on the average wage had a marginal tax rate of 17.5%. According to the labour market statistics for the September 2018 quarter, average weekly earnings are $1,212.82 or $63,067 annually, well above the $48,000 threshold at which the 30% tax rate applies. Even median weekly earnings at $997 are also well above the $48,000 threshold.

So how much revenue does fiscal drag raise annually? The short answer would be “Heaps.” The Budget Economic and Fiscal Update released in May’s Budget estimated the effect of fiscal drag as $1.6 billion over the five years to 30 June 2022.

more detailed analysis of the issue was prepared for then Finance Minister Bill English in November 2016.

The aide-memoire noted that adjusting for inflation since October 2010, effective 1 April 2017, would cost $1 billion in the first year. Clearly, baulking at this “large cost,” the paper instead modelled adjustments to thresholds based on price inflation over a single year, from June 2017 to June 2018, and applying that inflation factor to current thresholds beginning 1 April 2017. This produced a cost of $220 million for the 2017-18 year rising to $720 million by 2019-20.

The paper concluded by noting “a downside to not annually indexing is that there is less transparency for taxpayers.” This is something that politicians of both hues will rather conveniently rely on when trumpeting “tax cuts.”

Although fiscal drag is a well known tactic, Bill English also employed variations of it elsewhere to raise revenue. In the 2011 Budget inflation adjustments to the student loan repayment threshold of $19,084 were frozen until 1 April 2015. This and other changes to the student loan scheme added up to $447 million in “savings” over five years. The freeze on the student loan threshold was later extended until 1 April 2017.

The 2012 Budget froze the parental income threshold for student allowances until 31 March 2016, a measure worth $12.7 million over four years. More controversially, the same Budget increased the repayment rate applying to income above the student loan repayment threshold from 10% to 12% – a defacto tax increase. This increase raised (sorry “saved”) $184.2 million in operating costs over four years.

The 2011 Budget saw changes which also stopped inflation adjustments of the threshold at which abatement of working for families tax credits applied. Instead, measures reducing the threshold over a four year period from $36,827 to $35,000 were introduced. A “slightly higher” abatement rate of 25 cents in the dollar instead of 20 cents in the dollar was also phased in over the same period. These measures were intended to realise savings of $448 million over four years. (The current government’s Families Package partly reversed these changes by raising the abatement threshold to $42,000 whilst lifting the abatement rate to 25 cents in the dollar from 1 July 2018).

The 2011 Budget also removed the exemption from employer superannuation contribution tax (ESCT) on employer contributions to KiwiSaver funds. This is probably the biggest single measure that increased the tax take outside of the rise in the rate of GST to 15% in October 2010.

The exemption was removed with effect from 1 April 2012 and the compulsory employer contribution was also increased from two to three percent from 1 April 2013.  These changes saw the annual ESCT collected rise by almost $400 million from $681 million in the June 2011 year (the last full year before the changes) to $1,078 million in the June 2014 year (the first full year of the changes).

Finally, there is the opportunity to increase various duties such as those on alcohol, petroleum and tobacco. For example, tobacco excise duty has been increased every year since January 2009 as part of the country’s Smokefree policy. As a result, the excise duty per cigarette has gone from 30.955 cents per cigarette in 2009 to 82.658 cents per cigarette as of 1 January 2018. During the year to June 2018 the government collected over $1.8 billion in tobacco excise duty.

All told, the combination of fiscal drag, ESCT increases and changes to student loans and working for families cumulatively represent at least $1 billion of additional revenue collected annually. Throw in the various excise duty increases, specific “base protection” tax measures such as changes to the thin capitalisation rules for foreign-owned banks or the the “Bright-line test” introduced in 2015, and the increased annual “tax” take is close to $1.5 billion.

These under the counter tax increases have happened with little fanfare under the guise of “savings”, or “better targeting of government programmes” (how the Budget 2011 changes were described). Colbert would no doubt approve of this efficient plucking of the goose with very little hissing.

Can do better – the state of Inland Revenue

Terry Baucher wades through a series recent IRD reports and concludes the taxman has room to improve

Whatever the final recommendations of the Tax Working Group are, Inland Revenue will be a key player in implementing and managing the changes to the tax system. But is it up to the task?

In the run-up to Labour Day weekend it released its 2017-18 annual report and two other reports. Collectively, these reports give a good insight into its current and future state which might be summarised as “Can do better.”

The first report released was the result of some follow up research on “strengthening stakeholder engagement.”

Undertaken by Wellington based research firm Litmus, the research targeted groups identified by Inland Revenue as having an important role in its billion-dollar Business Transformation process. The stakeholders surveyed included central and local government agencies, business representative groups, large enterprises, vendors and suppliers and tax agents/intermediaries.

Litmus surveyed 229 organisations and received 118 responses. Just seven of the mere 10 tax agents surveyed responded. Given there are 5,600 tax agents with over 2.7 million clients, tax agents represent a substantially under-represented demographic in the final survey’s results.

Significantly, the feedback from tax agents was less positive than from other stakeholders. According to the report, tax agents were “less supportive about how Inland Revenue is changing and its ability to deliver”, with only a third “confident Inland Revenue will successfully deliver the change.”

It might be tempting for Inland Revenue to argue the small sample size means the Litmus survey was not representative of tax agents. However, its customer satisfaction surveys show that those tax agents surveyed who were “very satisfied” with Inland Revenue declined from 77% in 2015-16 to 66% in 2017-18. This was the largest drop amongst any of the surveyed groups.

An explanation for the dissatisfaction of tax agents can be found in Inland Revenue’s 2017-18 annual report.

The upgrade of Inland Revenue’s secure online service myIR in April 2018 (“Release 2”) did not go smoothly. Users had problems logging on and some services became unavailable. Frustrated taxpayers and tax agents rang Inland Revenue for assistance only to find their call “capped” by Inland Revenue because call volume exceeded its capacity. As page 38 of the annual report explained:

“We capped 286,392 calls during June 2018 to manage the spike in demand. This is a 69% increase from 169,533 capped calls in June 2017.  This contributed to an 85% increase in complaints in April-June 2018 compared to the same three months in 2017. We received 3,541 customer complaints during this quarter, 1,623 of which were received in June 2018.”

Inland Revenue eventually resolved the problems encountered in Release 2, but it faces a much bigger test with Release 3 next April which will affect over a million taxpayers.

Its annual report has some fascinating details about how Inland Revenue is progressing with its Business Transformation programme. Its use of contractors and temporary staff has almost tripled in the past three years: increasing from $45.3 million in the June 2015 year to $124.1 million in the June 2018 year. Spending on contractors and temporary staff represented 22.8% of all Inland Revenue’s $545 million personnel costs for the June 2018 year.

The increase in the use of contractors and temporary staff is almost certainly down to implementing the Business Transformation programme. 11% of Inland Revenue’s 5,250 staff are now on fixed-term contracts compared with 2% in June 2014.  Despite this shift, the proportion of staff who are female has remained constant at 64% over the same period. However, the department has a gender pay gap of 19.4% as the difference in average salaries for men and women is $16,235.  As the report explains “Women only make up 43% of the people who earn over $100,000, while they make up 68% of the people who earn under $100,000.”

After four years of declining recruitment Inland Revenue made 604 new hires in 2017-18. However, during the year 938 staff left which is why Inland Revenue paid out over $21 million in termination benefits, a more than twenty-fold increase from the $919,000 paid during the 2016-17 year. The staff losses meant its staff turnover for 2017-18 was 15.4% overall, not exactly an encouraging sign of a healthy workplace. Curiously though, the average length of service of staff rose to 13.6 years. (Incidentally, the department paid $339,000 in bonuses during the year although it’s not clear to whom).

And yet, despite all these comings and goings, Inland Revenue’s personnel costs for the June 2018 year were lower than budget by over $87 million. According to the report:

“The majority of this variance reflects the change in both the phasing and delivery of the Business Transformation programme, and organisational change required to deliver the programme outcomes.”

All this points to an organisation in a state of flux with an unsettled workforce, hence the recent strikes. It’s one reason why I and many other tax agents are dissatisfied with Inland Revenue’s current performance and view the approaching Release 3 next year with some concern.

Apart from collecting $73 billion of revenue during the year, Inland Revenue also did its bit for the government’s books by returning a surplus of more than $59 million to the Crown. This seems to be part of a deliberate policy – over the five years to 30 June 2018 the department recorded surpluses totalling more than $192 million.

The financial statements included in the report have some other interesting revelations: child support collections exceeded payments to caring parents by $181 million. Again, this is a long-standing policy: the corresponding amount for June 2017 was $184 million. Child support late payment penalties, which at 36% per annum in the first year are more than those payable for late payment of tax, effectively represent a backdoor tax on liable parents.

A serious review of child support debt is long overdue: despite writing off $594 million of debt during the year, the total child support debt at 30 June was $2,259 million. This is Inland Revenue’s largest single debtor type. By comparison the total of GST, PAYE and income tax outstanding at 30 June was $2,841 million. The $1,662 million of child support penalties owed is more than the $1,651 income tax outstanding, an absurd position.

Inland Revenue also collected $49.796 million of “other revenue” during the year. Unexplained in Inland Revenue’s annual report, it transpires that this is the total of penalties imposed in relation to late repayment of overpayments of working for families’ credits. I found the answer in note 3 to the government’s financial statements for June 2018, which includes $231 million of “Child support and working for families penalties” in its Sovereign Revenue for the year.

To put that total in context, it’s almost double the $118 million of court fines included as revenue in the government’s financial statements. Penalties on top of repaying overpaid working for families credits seems a harsh outcome for what is most likely to be the result of an error.

The annual report also details the vast amount of data sharing going on between Inland Revenue and other government agencies. During the year the department received 520,561 “contact records” from the Department of Internal Affairs. The Ministry of Social Development (MSD) provided details to Inland Revenue during the year relating to 94,378 child support cases. MSD also shared 7,041,500 student loan cases in what must have been a one-off information transfer. Inland Revenue in return shared details with MSD relating to 1,373,489 Community Service Card holders, 402,047 child support cases as well as proactive information sharing for 743,346 benefits and student cases.

Quite apart from data sharing with other government agencies, during the year Inland Revenue sent details of 128,930 persons to the Australian Tax Office as part of its Student Loan collection programme. This resulted in matches being found for 85,147 persons who will soon find they have not escaped their student loan repayment obligations.

The extent of data sharing currently going on between Inland Revenue and other agencies here and around the world is enormous yet goes largely unnoticed. It invariably comes as an unpleasant surprise to anyone caught up by the data exchanges. A data leak would surely represent one of the biggest risks for the department, but it’s not clear from the annual report whether the independent Risk and Assurance Committee has specifically considered the issue.

The other document released, Statement of Intent 2018-2022 (the SOI) is rather like a glossy corporate brochure packed full of buzz-words and corporate-speak.  The SOI never uses the word “taxpayer/taxpayers”, instead “customer/customers” appears 141 times in the 24-page document. This aversion to using the word “taxpayer” is also apparent in Inland Revenue’s Annual Report: it appears a mere 41 times in 224-pages compared with 708 mentions of “customer/customers” – more than 17 times more frequently.

The use of “customer” is well meant, but in my view is ultimately disingenuous. It implies a voluntary relationship which simply does not apply to an organisation extracting money with the full power and backing of the state. As anyone involved in a dispute with Inland Revenue will attest, its view is not “the customer is always right,” but “the taxpayer is guilty until proven innocent.” The alternatives to Inland Revenue are not a “competitor” tax agency, but either outright non-compliance or emigration. Inland Revenue would do better to more honestly recognise that for most people it is the “Bad Guy” and use its new “customer-centric” approach to ameliorate that reality.

In fairness, for all its earnest corporate-speak, the SOI recognises that Inland Revenue’s future success is dependent on trust. Page 11 of the SOI comments:

“[Trust] is vital for motivating people to pay their taxes and for the successful implementation of policy. This trust has been eroding in many countries. The situation is not yet clear in New Zealand, but longer term it may mean Inland Revenue cannot rely on operating in an environment of high trust. There are already differing levels of trust in Inland Revenue and the wider public sector between different ethnic, socio-economic, and demographic groups.”

Currently Inland Revenue will need to work hard to maintain trust in it, particularly amongst tax agents. The next stage of the Business Transformation programme (Release 3) in April 2019 is therefore both a threat to that trust yet also an excellent opportunity to reinforce the public’s trust in it. Inland Revenue is at present outwardly confident that Release 3 will succeed. We’ll have the first verdicts on whether that confidence was justified in under six months’ time. Watch this space.