Tax cuts delivered, but watch out student loan borrowers.
After what seems to have been an interminable dance of the seven veils, all has been revealed and we now know the final shape of the Government’s tax package. Nicola Willis has delivered on National’s manifesto and increased thresholds as promised.
That was unsurprising, although there’s a twist in that these changes will take effect from 31 July, four weeks later than expected. The delay is to enable payroll providers to update their systems.
The big surprise for me is the decision to increase the threshold for the Independent Earner Tax Credit (IETC) to $70,000. As I said in my Budget preview, I expected this to be cut to help pay for, or even increase, the threshold adjustments. Speaking on Breakfast TV, I expressed the hope that any threshold adjustments would focus on the group around the threshold where the tax rate jumps from 17.5% to 30%. The lift in that threshold to $53,500 together with the extension of the IETC will help, but more needs to be done in my view.
Giving with one hand, taking with the other…
The Government has also increased the in-work tax credit (IWTC) by $50 per fortnight, which is welcome. However, its effect will be mitigated by the fact that the $42,700 annual family income threshold above which the IWTC will be abated at a rate of 27 cents per dollar remains unchanged. The threshold has not been increased since 1 July 2018 which means that families with income above the threshold face an effective marginal tax rate of at least 46.1% (17.5% plus 27% abatement plus 1.6% ACC Earner Levy) which is higher than that of the Minister of Finance. It remains remarkable to me that this issue has been allowed to continue for so long, but when I raised the issue with the Minister of Finance her response was “I utterly reject the question”. (There were quite a few other questions also rejected with varying degrees of utterly).
Increased Inland Revenue funding
As also promised by New Zealand First in its manifesto, the Budget proposes an additional $29 million annually for increased compliance activities. Interestingly, the specific appropriation for investigation, audit and litigation activities will be increased from $106.2 million to $165.4 million. The Appropriation for Services to manage debt and unfiled returns will also rise from $83.5 million for the June 2024 year to $105.7 million in the coming year. Both increases indicate we should expect to see a significant rise in Inland Revenue investigation and debt management activity.
Student loans
Unlike my prediction about the IETC, my speculation that there would be some increases here was correct. The Government proposes increasing the interest rate on student loan debt payable by overseas based borrowers from 3.9% to 4.9% from 1 April 2025. Furthermore, the late payment interest for both overseas AND New Zealand based borrowers will increase by 1 percentage point.
However, as previously discussed, the amount of student loan debt has steadily increased and only 26% of overseas-based borrowers are making repayments. The Budget Appropriations include a provision for debt impairment of $633 million (up from $539 million) for the coming year.
As noted above Inland Revenue is boosting its compliance activities for student loan overseas-based borrowers, “including those returning to or visiting New Zealand”. We can therefore expect to see a few defaulters being detained at airports. It will be interesting to see if such moves result in significantly increased repayments.
Waste disposal levy changes
Elsewhere, the Government proposes increasing the level of Waste Disposal Levy but at a lower rate than initiated by the previous Government. It’s anticipated the Levy will raise a total of $1.195 billion over four years to 2027/28 which is split 50:50 with local government. The Government proposes amending the Waste Minimisation Act 2008 to expand the range of activities the levy can be used for, such as restoring freshwater catchments. This sort of recycling of environmental levies is to be supported but perhaps the split between local and central government should be shifted in favour of local government.
Calling Inland Revenue?
Wading through the detail of the Appropriation Estimates often reveals some interesting nuggets. The Vote Revenue Estimates included the following details about Inland Revenue’s expected performance when answering calls and responding to correspondence. It will be no surprise to many to note that the standard of answering calls within 4 ½ minutes was not met. Going forward Inland Revenue expects to answer 60% of all calls so I will check in next year to see how it performed.
Now what?
Having delivered on its campaign promises what next for the Government’s tax policy? The Finance Minister referenced the ACT Party’s proposals to flatten the tax scale but made no commitment as to when that might happen.
Willis also acknowledged Treasury’s advice of a structural deficit of about 1.5% of GDP (roughly $6 billion). This can only be addressed by spending cuts or tax increases and the expectation at present is for spending cuts to meet that gap. That means any future threshold adjustments are off the table, including the possibility of automatic indexation at some point. For the moment the Finance Minister will be happy to take the credit for the changes announced today. Let’s just hope it doesn’t take another 14 years for the next revisions.
Facebook New Zealand’s 2023 results show the scale of the advertising revenue going offshore.
Treasury’s blunt warning ahead of the Coalition Government’s December Mini-Budget.
The Australian budget was announced last Tuesday evening and although comparisons with Australia are not always constructive, there are several points of interest, not just in terms of how the tax systems operate, but also about initiatives which could replicated here.
The Treasurer is predicting a surplus for the period to June 2025, but after that, apparently things get a bit tougher. A little bit like Aotearoa-New Zealand in that regard. The key point with an election coming up, is the “Stage Three” tax cuts take effect from 1 July. As is well known and has been the subject of some commentary over time, Australia has a tax-free threshold of A$18,200. That threshold isn’t changing, but what is happening is that the tax rate for the next bracket between $18,200 and $45,000 is dropping from 19% to 16%. The big change is in the next tax bracket where the rate drops from 32.5% to 30% for income from A$45,000 all the way up to A$135,000 Australian. Quite apart from the rate change the bracket has been extended from A$120,000 to A$135,000. The 37% bracket remains in place and applies for income between A$135,000 and A$190,000. Over $190,000 the top rate of 45% kicks in.
We had record migration last year and a lot of those people are heading to Australia and no doubt these tax measures will make it more attractive. I’m in the camp that you can’t ever compete on tax cuts because there’s always someone better able to reduce tax rates further. Right now that’s Australia.
One of the interesting comments I’ve heard about the Australian budget, is that the Australian Treasury forecasts, are frequently incorrect sometimes resulting in unexpected surpluses. Apparently, the Australian Treasury consistently under-estimates forecast inflation and the iron ore price, which since Australia is such a huge minerals exporter, is quite critical. Generally, the Australian economy tends to perform better than Australian Treasury predictions.
Another strong Australian corporate tax result
Furthermore, as the Australian economy is performing so well, the Australian company tax take is now a significant proportion of the total tax revenue. For the coming year to June 2025 it’s predicted to be A$141.2. billion or just over 21%.
(Deloitte Australia)
That’s a substantial sum by world standards. For comparison, in the UK (a near comparatively sized economy) the proportion of the tax take that comes from companies is usually between 7% and 10%. We are also a country with a fairly high corporate tax take. In the year to June 2023, it was 16.1% of total tax revenue. However, one of the reasons the Government’s books are deteriorating is the decline in the company tax take which is expected to fall to 15.6% of the total tax revenue this year.
Australian cost of living initiatives
There were also a number of other direct cost of living initiatives, including a $300 energy bill rebate to all Australian households. Eligible small businesses will get a $325 rebate during the coming year to June 2025. The Australian Government will also provide A$1.9 billion Australian over five years to increase the Commonwealth Rent Assistance maximum rates by 10%. (This would appear to be the Australian equivalent of the Accommodation Supplement).
Over here we don’t know whether the Budget in two weeks’ time will contain specific cost of living responses similar to these Australian initiatives but that appears highly unlikely. Based on what we’ve heard so far, the Government is relying on the individual tax threshold adjustments to sort of deliver cost of living relief.
Beefing up the ATO
Australia has a capital gains tax and some changes are proposed around the application of capital gains tax to non-residents. These are intended to ensure from 1 July 2025 that foreign residents are caught within the rules in relation to disposals of land. That’s something people tend to forget, that non-residents are taxable on disposals of Australian property and these proposed rules are intended to strengthen that compliance.
Another thing of note, which I think we will see something similar in our budget, is increased funding for various Australian Tax Office (the ATO) compliance programmes. The ATO has currently got three such programmes on the go, covering personal income tax, the shadow economy and tax avoidance (Tax Avoidance Taskforce). The Budget announced a new initiative countering fraud. In terms of dollar returns on these programmes, they range between four to one for the funding of the personal income tax down to a little two to one for the Tax Avoidance Taskforce.
Small businesses and ABUMS
The other thing that I think people would love to see here is the Instant Asset Write Off. This is where small businesses can purchase an asset up to $20,000 in value and claim an instant write off. This programme has been extended for another year. Apparently one of the reasons it has been extended is that the legislation which would have terminated that programme hasn’t yet been passed. Australian governments have a habit of announcing measures and then not getting around to passing the relevant legislation resulting in something with the delightful acronym ABUMS – Announced But Unacted Measures.
Overall, there was some interesting stuff in the Australian Budget including another measure I’m going to talk about next, which I also wonder whether we might see applied here.
Facebook’s results
Moving on, Facebook has now released its New Zealand financial statements for the year to 31 December 2023, and these are bound to generate some controversy. The official income reported for the year was $9.1 million and the profit before tax was $4.4 million, resulting in income tax of $1.3 million.
Like Google New Zealand details of the payments to related parties is the very interesting section to look at, together with the statement of cash flows because these give you a better clue of what the scale of Facebook’s activities within New Zealand are. Note 4 to the financial statements, which explains the revenue, sets out what is happening. “The company reports advertising reseller revenue and associated direct cost of sales for reseller activity on a net basis” This note explains that the gross amounts it received in the year to December 2023 from advertising and services was $163,567,786 and then a reseller expense was $157,428,667.
So, although Facebook is reporting income for income tax purposes of $9.1 million, the real scenario is that the revenue that’s passing through it, is substantially higher.
Another Australian example to follow?
Now it so happens there’s a case going through Australia at the moment involving what they call an embedded royalty. Basically the Australian Tax Office took a case against drinks company Coca-Cola in relation to what it perceived as an embedded royalty (and therefore subject to withholding tax) in payments for the right to brew Coca-Cola in Australia.
The Australian budget has a number of what’s termed Intangibles Integrity Measures. One of those it appears is a new provision, effective from 1 July 2026, where it applies a penalty to taxpayers who are part of a group with more than $1 billion in global turnover annually, that are found to have mischaracterised or undervalued royalty payments to which royalty withholding tax would otherwise fly.
Now that’s two years away from implementation, but it’s clearly a shot across the bow of companies such as Facebook or Meta, and Alphabet, the owner of Google, about these reseller services expense. So that’s something to watch how this develops.
And I just wonder whether we might see something similar here, because significant sums of money coming from advertising, are going overseas, and, as I’ve mentioned before, that has had a detrimental impact on our media landscape that it’s basically been starved of cash as a consequence. So, watch this space.
Treasury’s warning on structural reform
Finally, this week there was a budget information release from Treasury of papers relating to the Government’s mini budget in December. And one of the papers titled Implementing the fiscal strategy has attracted quite a great bit of interest.
In the paper Treasury sets out in fairly blunt terms that there is a requirement or need for structural reform of the tax system. The key paragraphs are 24,25 and 26. Paragraph 24 notes
“Structural reform of the tax system is the most effective way to ensure it is flexible and capable of raising additional revenue sustainably… Such reform would need to recognise that while revenue raising is the primary purpose of the tax system, its distributional and economic objectives are also important.”
Plenty of wry smiles here for those who listened to the Titans of Tax expand on this very point.
The problem with fiscal drag
Paragraph 25 then discusses the importance of fiscal drag
“Since 2010, fiscal drag…has played an important role in enabling successive governments to use the tax system to meet their revenue objectives. This has placed increased pressure on the tax system’s other objectives. If you wish to offset or end fiscal drag, through adjustment of personal income tax rates and thresholds the fiscal headroom which needs to be created will further increase”.
In other words, if you want to end fiscal drag, you really do need to rebalance and reshape the tax system,
I’ve seen some commentary that this was blunter advice than was provided to the previous government. I don’t actually subscribe to that view because in my view Treasury’s 2021 long-term fiscal insights briefing He Tirohanga Mokopuna was pretty clear that a fiscal crunch was coming. I just think that because there’s been a change in government, what Treasury has done here is taken the rather softly, softly approach in He Tirohanga Mokopuna and just made it very blunt so the new Government knows from the offset that there are challenges ahead. And to be fair to Finance Minister Nicola Willis and the Prime Minister, they have not denied that. But what they propose to do about it, of course, we’ll have to wait and see.
And on that note, that’s all for this week, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
And I reflect on 40 years in tax – what’s changed or not changed.
The Finance Minister Nicola Willis made the first of what is going to be a series of pre-Budget speeches to the Hutt Valley Chamber of Commerce, and in it she dropped a few clues as to the likely contents of the Budget.
In particular, she announced that the Budget’s “tax relief package will increase the take home pay of 83% of New Zealanders over the age of 15 and 94% of households.”
In case you’re wondering who is in the unlucky 17%, these are taxpayers with annual income currently below $14,000 or with no income at all. They therefore would not benefit from any increase in tax thresholds. According to Inland Revenue in the year to March 2022, there were over 800,000 taxpayers whose income is been between $1.00 and $14,000. There were another 210,000 or so who had no income at all during the 2022 tax year.
14 long years?
In her speech Nicola Willis noted that New Zealanders have not seen any changes to personal income tax rates and thresholds for 14 years. “Unlike most developed countries, New Zealand has made no adjustments to tax brackets to compensate for rampant inflation.” However, having highlighted this point, there wasn’t a commitment in her speech to regular indexation of thresholds, which is how we got 14 years without changes. I’ll have more commentary on that a little later.
The Finance Minister talked about “tax relief aimed at middle and lower-income workers” which is interesting because it hints that maybe threshold adjustments might be focused most on those earning below $70,000. The threshold which I think is most problematic, and Geof Nightingale, Sir Rob McLeod and Robin Oliver all agreed with this, is at $48,000 where the tax rate goes from 17.5% to 30%. There doesn’t appear to be any plans to adjust the tax rates there, but whether there is a bigger proportional increase around that threshold relative to the other thresholds, we’ll have to wait and see. We know by the way that the $180,0000 threshold at which the 39% tax rate kicks in is not likely to be increased.
The OECD joins the call for a capital gains tax
The Finance Minister’s speech came hot on the heels of the latest Organisation for Economic Cooperation and Development (OECD) Economic Survey on New Zealand, released on Monday. The big headline here from a tax perspective that the OECD joined the IMF in recommending a capital gains tax. What was interesting here is that when the IMF made this suggestion, Nicola Willis, dismissed it with a snippy comment following in the footsteps of her predecessor Sir Michael Cullen. This time around, there was no such snippy dismissal.
The report actually is quite sobering reading, not just around the tax side of it, but just generally about what it has to say about certain aspects of the New Zealand economy. Education was specifically mentioned as a point where attention needs to be focused on improving standards and therefore flowing through to greater productivity across the economy.
The OECD agreed with the Government’s proposed fiscal approach trying to squeeze spending and keep it under control. It had some criticisms about how budget operating allowances have been allowed to increase in recent years without any real explanation.
The OECD supports the broad-base, low rate approach, a capital gains tax, and tax reliefs for pension saving
But it also made the point that “any tax cuts should be fully funded by offsetting revenue or expenditure measures”, before going on to add “raising revenues should first be achieved through broadening the tax base and reducing distortions before raising rates of existing taxes.” That very much endorses the broad-base, low-rate approach Sir Rob MacLeod in particular espoused in a recent podcast.
No surprises there, but the report continues:
“There is a need to reduce distortions to household choice of asset allocation. Shares, land and owner-occupied residential property are tax favoured. Most capital gains from shares, owner-occupied residential property and land are not taxed. To ensure the tax system is not overly distorting, saving and supporting broader growth, capital gains taxation reform should be done as part of a wider review of tax settings for saving. New Zealand’s tax settings remain an outlier in some respects in international comparison, and notably in offering no tax deduction for contributions and in taxing the returns pensions funds earned while they’re invested and prior to withdrawal at progressive rates, this likely distorts saving away from private pension saving.”
Robin Oliver made the point about over-investment in housing, but as mentioned last week Dr Andrew Coleman picked up on how our taxations of savings is unusual by world standards,
There’s a lot to digest in this 150-page report which is only available online. It’s probably no surprise that expanding the capital gains tax base is not likely to be very high on the agenda of the Coalition Government at the moment. But there’s plenty of food for thought in the report.
One of the other points of interest, and there has been some commentary about this, is the suggestion for an Independent Fiscal Institution, basically, a policy costing unit. The OECD picked up that there had been no independent costings of policies in the run up to last year’s election. This is something that could be done by an Independent Fiscal Institution. Some work was done on this under the last government and Nicola Willis seems open to revisiting the issue.
Following the Irish example?
The OECD survey suggested the Irish Fiscal Advisory Council (IFAC) https://www.fiscalcouncil.ie/as a model that could could be followed. Given Ireland has a similar population this seems a good idea. Personally, I think we ought to look very closely at countries of comparable size to ourselves. The IFAC has been mandated to independently assess the government’s fiscal stance and budgetary forecasts and monitor compliance with budgetary rules. As I mentioned earlier the OECD thinks that we need to review our budget rules.
According to the OECD survey about 80% of OECD have some form of Independent Fiscal Institution. The Congressional Budget Office in the United States which has 270 staff is a very well-known example. Over in Australia, the Parliamentary Budget Office, with 45 staff has this role. The Canadians have a similar Parliamentary Budget Office and over in the UK they have the Office for Budget Responsibility. There’s plenty of examples around the world to consider and it would be encouraging if we heard something in the Budget about this.
Small businesses and statistics
The OECD survey, noted that the business entry and exit rates are higher in international comparison although this means “business dynamism is vibrant” the OECE also noted that the “high share of the population working in micro, small and medium enterprises…hints at a difficulty for these firms to grow into larger businesses.”
One other thing I thought was very interesting was commentary around improving the timeliness of New Zealand’s macroeconomic statistics. I’ve long thought it was a weakness that we don’t see monthly GDP or inflation data, but I wasn’t aware we were, like Australia, very much in the minority within the OECD in not producing a monthly CPI index. As the OECD noted “Older and less frequent statistics increase the risk of costly policy mistakes”. I wonder what the OECD would have made of the news that all Stats NZ staff were offered voluntary redundancy?
Don’t look back in anger? Forty years in tax
This week, it is 40 years since I started working in tax. They say the past is a different country, we did things differently there and that’s true, but one thing that hasn’t changed over my time in the past 40 years is the behavioural impact of tax. When I started working in the UK, the top rate of income tax was 60% and I saw people very incentivised to make sure that they’re claiming all the possible deductions, maximising pension deductions and the like. The top rate in the UK now is 45%, but you still see the same behavioural impact.
For comparison in 1984 the top rate in New Zealand was officially 60% but a further 10% surcharge had been introduced in 1982 by Sir Robert Muldoon, the Prime Minister and Finance Minister at the time. The top rate was therefore 66% which applied to income above $64,000. Based on CPI since then that’s the equivalent of roughly $260,000 now. According to the Inland Revenue date for the March 2022 income year, just over 42,400 taxpayers earned more than $260,000. That’s a little bit under 1% of all taxpayers. But they had a substantial amount of income between them, close to $20 billion and therefore paid a sizeable amount of tax nearly $7 billion in total.
The effects of forty years of inflation – how New Zealand taxpayers appear to have lost out compared to their UK counterparts
In terms of inflation, it’s quite interesting to look back at the tax rates and the income bands which applied. In 1984 the lowest rate was 20% on the first $6,000 of income. That $6,000 in 1984 dollars would now be $24,350 so in terms of inflation adjustments, even when we see the current 10.5% tax threshold move from $14,000 to maybe $16,000 in the Budget you can see that maybe New Zealanders have been losing out. Consequently, because we aren’t adjusting thresholds regularly, fiscal drag means that inflation has affected the ordinary working New Zealanders quite substantially.
That becomes clearer when you swap notes with what’s gone on in the UK with the tax thresholds there over the same period. The UK has a tax-free personal allowance which Was £2,005 back in 1984 when I started working. It’s now £12,570, but if it had just kept in place in place with inflation, it would be only £6,300. In other words, the value of the tax-free personal allowance has doubled in the past 40 years.
Interestingly, the tax threshold after which the higher tax rates kick in was £15,400 back in 1984. Inflation adjusted that would £48,300 compared with the £50,000 where it actually takes effect. There is an additional rate of 45% in the UK on income over £100,000. Back in 1984 the highest 60% tax rate kicked in at £38,100 inflation adjusted that would be £120,000 now.
What you see looking at these numbers is broadly speaking average earners in the UK have been less affected by fiscal drag and inflation than New Zealand workers have been. And that is something that I think I’d like to see changed here for the better and we should be having regular inflationary adjustments as is required by the UK tax law. I think such a move would tie into the better fiscal discipline suggested by the OECD.
The behavioural impact of no capital gains tax
I’ve now worked for over 30 years in New Zealand, but I still remember my shock when I realised there wasn’t a general capital gains tax here. When I consider the behavioural impact of taxation, that’s where you see it apply most where people will be looking to turn something that could be taxable at 39% into a non-taxable gain. And so, there’s a distortionary effect there.
And just to circle back to discussions we’ve had previously on the podcast and what the OECD have just said, there is a tremendous amount of value in the broad-based low-rate approach. It’s not perfect, but one of the things it does deal with is this question of behavioural impact and distorting behaviour chasing tax benefits. My personal view is the absence of a general capital gains tax has had an effect on our productivity. If it’s better in investment returns to invest in residential property in which the returns are largely tax free, than investing in a business or in shares that are taxed, such as overseas shares under the Foreign Investment Fund regime, then that diverts investment into less productive assets. Whether that’s for the benefit of the wider economy as a whole, well, that is a matter for ongoing debate. My view is it’s not.
And on that note, that’s all for this week, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
A quiet week in the tax world – but is this the calm before the storm of this year’s Budget?
The latest OECD report on taxing wages shows the tax wedge rising in most countries including New Zealand.
It’s been a quiet week in the tax world, which, to be honest, is quite welcome. But there’s also a growing sense of a calm before the storm, that being the Coalition government’s first Budget on 30th May, I’ll offer up some speculation as to what I think will be in the budget closer to the time, but one thing we do know will be expected to happen, is adjustments to the flat tax thresholds, which as listeners will well be aware of, have not actually been adjusted since October 2010.
It so happened last week the Organisation for Economic Cooperation and Development (the OECD) released Taxing Wages 2024, its annual Taxing Wages report. This is a fascinating document which looks across the composition of wages and provides details of taxes paid on wages. This year, it’s also focusing on fiscal incentives for second earners in the OECD and how tax policy might contribute to gender outcome gaps and labour out market outcomes. It’s a big report which runs to 679 pages and is only available online.
Taxes are increasing thanks to inflation
One of the things that comes out of the Executive Summary was that in the words of the report tax systems in the OECD are not fully adjusting to inflation. Consequently,
“The average tax wedge for all eight household types covered in this report increased in the majority of countries between 2022. And 2023 driven in most cases by higher income tax. For the second consecutive year, more post tax incomes at the average wage level declined across the majority of all OECD countries now.”
The tax wedge is described as the difference between the labour costs to an employer and the corresponding net take home pay of the employee. It represents the sum of the total personal income tax and Social Security contributions paid by employees and employers. Less any cash benefits that the employee might receive.
New Zealand has consistently scored well in this measure because we don’t have Social Security taxes and we’ll talk a little bit more about that later. But notwithstanding that, the average take home wage for New Zealand employees has been declining over the past few years.
The report has an appendix showing the evolution of effective tax rates on labour since 2000 with a number of separate measurements based on single persons, single parents, or married couple with two children. It looks at what the tax wedge for each group is based on 67% of average wage, 100% of average wage and 167% of the average wage.
Now, whatever measure you take, you can see that the tax burden for New Zealand employees has been rising steadily since 2010, but you can see it start to accelerate in the last three to four years. So, for a single person at 167% of the average wage, their tax burden has gone from 23.9% in 2017 to 25.8% in 2024. Now you might think 2 percentage points isn’t much, but it becomes more noticeable as it accumulates over time. For a single person at 100% of the average wage the tax burden has gone from 18.3% to 21.1% over the same period.
This OECD report reinforces what we’ve been saying for some time that tax adjustments to the thresholds are long overdue. Now those who listened in to last week’s podcast with Sir Rob, Rob McLeod, Robin Oliver and Geof Nightingale will have noted pretty much everyone was of the view that the threshold where the 30% tax rate kicks in, that’s $48,000 was a major problem in our tax system. Geof was particularly insistent on this point. This OECD data reinforces that point. So, it will be interesting to see what moves are made in that space in the Budget at the end of the month.
Social security taxes – time for a rethink?
Moving on, thanks to everyone who’s commented or given feedback here and across the various social media platforms about last week’s podcast. It’s always great to have some engagement. I do read all the comments even if I don’t always respond.
There were some particularly interesting comments from Dr Andrew Coleman of the University of Otago about Social Security taxes and the absence of them in New Zealand. As he noted, New Zealand is an outlier in world terms in this respect.
Now, as I mentioned in the podcast, Social Security contributions were once quite a significant factor of the New Zealand tax system from the 1930s until the 1960s. But what happened over time was that the contributions weren’t hypothecated and applied only to Social Security payments, but in fact just became treated as part of taxation generally until in April 1964, the Social Security Fund was merged into the Consolidated Fund
Ultimately, the then Finance Minister Robert Muldoon decided in 1968 that separate Social Security contributions were no longer required and merged everything formally into income tax. Since then period, income tax has used to pay for Social Security such as welfare and superannuation.
That’s more than 50 years ago, but as Doctor Coleman pointed out many other countries have Social Security taxes. So, is that something we should consider in more detail? Well, I hope to explore that point in a separate podcast.
Sir Rob McLeod, Robin Oliver and Geof Nightingale on expanding the tax base
[In this part of the podcast I asked Sir Rob, Robin and Geof about the strains New Zealand’s Broad Base Low-Rate approach is experiencing and if a government wanted to raise how would it do so- through a wealth tax, capital gains tax, stamp duties or estate duties, whatever].
Sir Rob Mcleod (RM) Well, if I can kick off, I’m a huge fan of Broad Base Low-Rate (BBLR). I think it’s got a very simple thrust. It’s as much about pragmatism as it is about technical. I think we need to be careful in my experience with the debate and understanding that a Broad Base Low-Rate system is not one characterised by a myriad of taxes. Some people interpret a myriad of taxes as achieving breadth and therefore fitting with Broad Base Low-Rate. No, my definition of Broad Base Low-Rate is a few taxes with a broad reach. That’s where you get the simplicity. And the income tax and the GST covers most of GDP in the nation.
What does it not touch is the question to ask. You can talk about wealth tax and CGT, capital gains tax, but they’re actually part of the income tax. There’s an overlap between wealth tax, capital gains tax and the income tax. I don’t believe that that gap justifies the kind of emphasis that’s being given to wealth tax and CGT.
Sure, we’ve got some capital gains not taxed, most of them actually are taxed already in the system. The comprehensive capital gains tax I think in that sense is a bit of a misnomer because we do not have comprehensive taxation in the New Zealand system. And if you go and then put wealth taxes on, whether it be land or wealth in general, you are actually doubling up on the income tax. You’ve got an element of double tax in doing that and that takes us back to the starting point, that Broad Base Low-Rate is about identifying the gaps. And there’s bugger all gaps actually left by a broadly designed GST and income tax such as New Zealand has.
And when we go into the debates on specifics around the margins of that base, there are good reasons for arguing about why we shouldn’t have them. So that’s why I think BBLR is there. If you want to get more out of what we’ve got than the broad base of income tax and GST, you’ve got to justify it and you’ve got to start with what percentage of the GDP should be taxed in the first place. With balanced budgets, government spending equals taxation. With a balanced budget, which is kind of where the world wants to be these days.
So, I think recognise that the tax rate for the nation is government spending divided by GDP. And there’s a hell of a lot of benefit from there. So, if you want a tax cut, you’ve got to cut the government spending. It’s the only way to do it. Those various elements I think are very interconnected in the debate around Broad Base Low-Rates.
Geof Nightingale (GN) I think your question was where would you go to for another 1% of GDP? And I would agree with Rob that it feels to me that 30% of GDP or Government expenditure to GDP at roughly 30% has (that’s our long-run average, it spikes up and down for pandemics and earthquakes and recessions and things) that’s a constraint that I would be quite personally happy for our economy to operate against.
The question is then how you raise that revenue. And I totally support Broad Base Low-Rate. I think it’s effective in practise and 30 years of experience. I think the missing bit still there is our income tax is not as Broad Based as it should be, and I think we do need to extend it into further realised capital gains. So, whether you do that as a separate comprehensive capital gains tax like other countries, or you just change the definition of income, that’s a design feature.
Philosophically, it’s the same thing. It’s just how you get there. Taxing more income through realised capital gains, and then I would recycle that revenue into tax cuts, reductions, initially in the lower marginal rates because that’s where our problems come with high effective marginal tax rates in conjunction with welfare, which leads to productivity and incentives to work and all of that. So I would extend the taxation of capital, recycle the revenue and like Rob aim for 30% government expenditure over GDP.
TB Robin, you were part of the tax working group, you were one of the three dissenters in 2019. I that still your opinion?
Robin Oliver (RO) As Rob said and Geof echoed, it’s not a black and white issue. Do you tax capital gains or not? I mean, Michael Cullen kept on trying to make the point, talking about taxing capital income, not capital gains. Everybody ignored it, but he had a point that we do tax capital gains in certain cases and it’s all part of our income tax system and GST anyway. Are there holes in the system where you can efficiently raise more money at low cost? And the big hole, the gap in our system, it came out in the tax working group and all other reports is land.
We are a growing economy, growing population, land rises/increases systematically in value and that produces a lot of income and overall, we don’t tax it. You look at all the data, you know, higher wealth people, predominantly own land. Not all, but predominantly. So OK, should we be taxing land in one form or another? And I’ve got sympathy for that, but you’re going down to the workability. No government will ever tax home ownership. If it does, it will cease to be a government pretty quickly and someone sensible will come in and abolish that tax. So that’s a big hole in any land base. And then you’ve got issues about iwi and their relationship with land. You’ve got farmers.
We used to have a land tax. We had a comprehensive tax in the 1890s and we ended up with a tax just on Queen St commercial property. Everybody else got exemptions over time. I have some sympathy for taxing the increase in the value of land or land in some form which is not taxed now, but the housing, the home ownership stuff. You know, David Caygill, he proposed taxing homeowners. And he got told to back off.
I was working with him on capital gains tax proposal and we officials recommended including home ownership. And we were gobsmacked, totally bewildered when he accepted our recommendation. We expected him not to. And he went off to lose that next election, but probably not for that reason.
Workability matters. Home ownership is off the table. Our problem as a country is we take our savings, we invest it in land, we borrow from Australia, we invest in more land, bid up the price of land. We end up with the same amount of land as we began with – because that doesn’t increase – and heavily in debt to Australian banks. Solving that problem is not easy.
The problem with overinvestment in housing
TB Yes, it’s a behavioural impact. I had this conversation with an American client yesterday, who because of the fact they have to file U.S. tax returns, they’re subject to capital gains tax. But the FIF regime, he looked at that, and said, well, I can’t invest in stocks so I’m going to look at residential investment property here. That’s really a case of an unintended consequence of a tax.
On the family home, I fully grasp all of that, but is there an argument for saying that there is a limit? Because we build some of the biggest houses in the world. New Zealand houses – new houses, were until quite recently – are the third largest in the OECD. They were nearly getting on for close to 200 square metres.
RO We like our houses.
TB So could you say above two and a half million dollars or $5 million, the gain above that – some pro rata, we’re getting into technical details, but there is this thing that you’ve just espoused it perfectly, Robin. That at present we’re encouraged to invest in land and more land and borrow. So, there’s a loss of productivity, that 20% dead weight. There’s got to be a lot of lost productivity because capital is diverted into land rather than elsewhere.
RO The current group did look at something like that, although it was outside our terms of reference. We were not allowed to even consider the home or the land underneath the home or the sky above the. In terms of reference that we did look at that. The trouble is, a $2,000,000 house is not all that much in Auckland, as Michael Cullen kept on putting out, it was a hell of a lot in Whakatane.
TB There are 77,000 homes in Auckland worth more than $2,000,000, according to an OIA I got.
RO Probably one in Whakatane.
GN There’s a technical solution. If you were going to put all realised capital gains into the tax pot, you give every New Zealander a lifetime exemption, regardless of asset class or description, and that might be $5,000,000 or more, less but and that then shouldn’t distort behaviour. It’s arguably equitable and from a compliance and administration perspective, it would take probably 95% of us out of the of the loop.
RO And with that 95% of revenue.
GN Yes, well, maybe not because the assets are weighted towards the top. But anyway, the argument against that was always administrative. It’s very difficult to administer. But with current digitisation and things, I’m not sure those administration and compliance arguments – the integration of the land registers and share registers and things – as strong as it used to be. So, there are theoretical solutions there, but they’re hard to get to the public.
RO The idea of taxing the person with over $5 million has got a lot of appeal, but it’s not realistic. I always give the example of the idea you can freely tax all these very high wealth individual/ medium wealth individual people. Well, some of those are your medical specialists, your surgeon, your oncologist. And they can go to Australia.
You whack this $5,000,000 tax on their income over a lifetime and off they go to Sydney. So you’re sitting here in New Zealand, you’ve got cancer or something like that, and we’ve got a more equal society, but we have no treatment for cancer. Off to a hospice you go.
GN That might be the case with a wealth tax, but with an income tax I’m not convinced, Robin. I mean, Rob might be able to comment with direct experience of working in Australia. But labour and consumption taxes in Australia on high earners, medical professionals, they’re pretty tough compared to New Zealand. (TB 45% top rate plus 2% Medicare).I would have thought, but I don’t know what your experience is Rob.
RM it’s not just Australia, we’re becoming more global, aren’t we? So almost every country is a neighbour of one sort or another these days. The other thing is these people are incentivised to find these loopholes. And having lived, having operated and worked in Australia for six years, they’ve seen wealthy people find loopholes there too. So that that won’t go away.
TB It’s our job to find them, to be frank.
RM Yes.
RO The government legislates for them. You get tax free superannuation in Australia, or 15%. We’ve got to get away from this idea we can tax our wealth. Our problem is, as we’re next to Australia, is Australia becoming wealthier than we are. It’s attracting our nurses, our doctors, our policemen, our police persons and what have you through higher wages. We’ve got to increase our wage level and our productivity, and we don’t do that by sitting around and inventing new taxes.
TB But do we change the incidence of tax, so that capital gets diverted into more productive areas?
RO I give you the example of houses. I agree with that.
GN Our effective marginal tax rates, in those doctors, nurses and policemen, if you go across to Australia and look at those, yes, the incomes are definitely higher 30 or 40%. But I think there’s a tax dynamic in there as well for those people. Because we’re sweating our labour incomes, particularly in those low ends.
Robin has often said this, the worst tax rate we’ve got in New Zealand is the 30% rate at $48,000. Which is huge, it kicks in below the median income. So, I think there’s a tax dynamic in those migrations of doctors, nurses and police as well.
What about inheritance taxes?
TB The $48,000 threshold is a shocker. A final point on this housing. I think you’re right, politically a capital gains that incorporates the family home is impossible. You’re not even a one term government with that. But does that perhaps point to the need – and this is where the IMF come in – is that maybe that’s picked up through an inheritance tax at a separate point. Inheritance taxes, estate duty used to be quite significant. It was 5% of government revenue way back when in 1949, and they were one of the first taxes we introduced here. But they’ve declined over time around the world, but now there seems to be particularly with this, the wealthiest generation in history – and I think all of us are members of the Boomers – are starting to pass away, and there’s a huge transfer of wealth about to happen. And governments are looking at that.
RM Can I bring the conversation back to where I was about what percentage of GDP should tax be.
Because we are straight into, in essence, the tapestry of taxes. And what lurks underneath the motive for that conversation is really redistribution. Because a lot of the motive in the conversation that we’re having is about getting feathers off particular geese, and about certain thresholds and the rest of it.
The starting point ultimately is what does the country need by way of revenue as a percentage of GDP now? Now, if you’re arguing that actually New Zealand’s got a big problem of injustice or inequity because the rich are basically getting away with it, is a bit of a different to back from where we came from and earlier on in our conversation. Geof, to be fair, has identified redistribution as a goal. So he’s been consistent in that regard.
But I think this demonstrates why it’s so important to first of all ask yourself what you’re trying to do with your tax system, and if it is about revenue and getting a particular percentage of the GDP, then I think that these debates about estate duty and wealth tax and land tax are red herrings.
The 1% of GDP, for example, Geof, that you’ve mentioned in the question we’re asked to consider through a new tax, does not undermine my general principle of the broad reach and impact of GST and income tax. In fact, you guys (Robin and Geof) were both on the Cullen Review and you actually, in the report that came out, compared a 1% increase in GST with the capital gains tax and it kind of blew it away. That demonstrates my point that the Broad Base reach of GST and income tax can do everything that you’re trying to get out of these, peripheral and miscellaneous taxes. The only thing that’s left standing as to why you want to do it, is redistribution.
RO I’m OK with that, obviously. But getting on to death duties, estate duties, they have an interesting history. Other countries have them. People have different ideas about bequests and motivation. You know, how important it is to give money to the children. You’ve got Warren Buffett, who honestly gave each of his children 10 million and that’s it. Well, 10 million seems like a nice little nest egg, but in Warren Buffett’s terms, that’s just rounding. Bugger all in bequest terms, Other people will die for it. Literally, they will fight. It is enormously powerful. They will do anything to avoid death duties.
When we used to have them, that was the area of massive tax planning. It was the beginning of it all – avoiding death duties was a massive industry. And you think it’d be easy to do. Well, you’ve got to have gift duties as well, otherwise people just give it away to the kids. And you end up with Inland Revenue, as it used to do, roaring around, stamping every gift that’s made in the country, every Christmas and what have you, and determining they’re not subject to gift duty.
Massive amounts of bureaucracy involved. They are not easy taxes and I’ll just finish with the history of the end of death duties in New Zealand.
It started off with Australia. Death duties were limited to the state governments. When Queensland got rid of its death duties Victoria and New South Wales and the rest of Australia followed suit. We followed thereafter. Because anybody was going to go to the country which didn’t have it.
Death duties have got some appeal to people, I understand the issues. It’s very appealing when people don’t have any bequest, motive to actually tax a windfall gain. The only reason they are working, building their business is for the children and grandchildren. These people will react massively to its reintroduction.
[This is an edited part of the full podcast which readers are encouraged to download and listen to at the link at the top of this page.]
On that note, that’s all for this week, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
What makes a good tax system and where does New Zealand presently sit?
The current broad-base, low rate approach is under strain. How do we address that? What can we do to keep/ preserve that as far as possible? And more.
Terry Baucher: It is my very great privilege this week to be joined by three of the titans of tax in New Zealand, Rob McLeod, Robin Oliver and Geof Nightingale.
Rob, or more correctly Sir Robert McLeod, KNZM is one of THE gurus of New Zealand tax, has been involved in tax policy at the highest levels since the 1980s. A former chair of EY, he was chair of the 2001 McLeod Tax Review and was also a member of the 2010 Victoria University of Wellington Tax Working Group. He’s currently a consultant, although still very much involved in the tax policy world. He was knighted in 2019 for services to business and Māori. Kia Ora, thank you for joining us.
Robin Oliver, another of the gurus of New Zealand tax, until he retired from Inland Revenue, was Deputy Commissioner of Inland Revenue and head of Tax Policy where he advised the 2001 and 2010 tax working groups. He is now a partner in tax consultancy Oliver Shaw and was a member of the last Tax Working Group. Robin was made a member of the New Zealand Order of Merit in 2009.
Geof Nightingale recently retired from PwC, and when he’s not cycling the length of the South Island, is an independent tax consultant. He was a member of both the 2010 and 2019 tax working groups. Thank you again to all of you for joining us.
What makes a good tax system and where does New Zealand presently sit?
We’ll begin with what was asked at this year’s International Fiscal Association Conference. The three of you spoke on the topic of what makes a good tax system. What does make a good tax system and where does New Zealand presently sit? Rob, would you like to lead off?
Rob Mcleod (RM) Thanks, Terry. Well, I think at its core tax is mainly about raising revenue to finance government programmes. It’s true that tax has peripheral tasks as well, like you know, correcting for market failure. If we think about carbon taxes, the primary purpose of that kind of tax is really to moderate adverse behaviour in the economy, which is not is not really a revenue raising objective. Some would also argue that taxes are there to achieve redistribution goals, transfer income to those that are in need. That too is not so much a revenue raising goal.
“At its core tax is mainly about raising revenue to finance government programmes”
But if you go to the real reason why income tax exists in countries, it’s actually to raise revenue for governments. If governments didn’t need revenue, you wouldn’t have taxes. And chances are you wouldn’t have such a major regime doing these other two things, like corrective taxation, like carbon taxes, or trying to redistribute income without the agenda of raising revenue. I would argue that we wouldn’t have tax systems on the scale that we have them doing those other things. So, I believe that raising revenue is the primary goal of a good tax system and doing it at least cost would be my formulation.
Robin Oliver (RO) I agree with Rob, even more so, that a good tax system is one that works. It raises money for the government. That may seem obvious to people, but you can’t have taxes which fail to raise money. Margaret Thatcher’s poll tax failed to raise money. It was a failure.
“You’ve got to really focus on raising money at least cost”
So it has to raise money at least cost to society and that’s admin costs, compliance costs, but overall economic costs. The cost of disincentivising people from work and savings and so forth. People think that’s “blah blah blah blah” but the estimates in New Zealand and Australia, and used by the Australian Treasury, is that twenty cents in every dollar of tax is lost in economic costs. In other words, not quite, but basically lost output, lost wealth for the country. So, you’ve got to really focus on raising money at least cost.
Rob mentioned redistribution. I think redistribution’s got nothing to do with a good tax system. Government raises money to do good things – health, education, welfare. We’ve lost focus on what tax is about. We’ve got diverted into all sorts of ideas that it could be used for. No, it’s about raising money, at least cost. Every tax proposal should be looked at “Is this the way we could raise some money, effectively, at least the cost to society.”
TB Thanks, Robin. Geof, I think you have a slightly different take on the redistribution issue and I note that the IMF was talking about redistribution in one of its papers recently
Geof Nightingale (GN) Well, Terry, I’d largely, and violently agree with Rob and Robin that the primary function of a good tax system is to raise the revenue that government needs. But it’s how it goes about that where I might differ.
There’s a couple of backgrounds, opening points I’d like to make, and the first is I think it seems, really uncontroversial that our modern democratic states with tax systems and, you know, rule of law-based things. They’ve done more than anything that’s ever been tried to lift living standards. So, broadly, I think they are a good thing that the tax status policy people might call it is a good thing.
“You can only tax by consent”
The second point is, that in those democracies, it’s really important for tax policy people to acknowledge that you can only tax by consent. I mean we impose taxation through the rule of law and through enforcement. But in the end people vote on taxes and people vote governments in and out and tax is often a key election thing. So you can really only tax by consent.
So, whatever the theory may tell you, you have to – I’ve learned over many years now – bring the public with you. That’s the job of the politicians, not the policy people. The policy people have to accept. That general consent point is really important when you start talking about the future of tax in New Zealand.
And then the third thing is there’s no such thing as a perfect tax system and as Robin pointed out, we navigate it, every tax policy choice is a bunch of trade-offs, and we navigate those trade-offs with some well-established principles. You know, equity efficiency, administration etcetera. And those principles can never be applied scientifically. In the end, they come down to, in my view anyway, value judgments at the margin, and that’s where the politics comes into the tax system as it as it should be.
So what is a good tax system? Well as Rob and Robin said, primarily one that raises revenue with the least cost to society. And there are secondary objectives, and those are the distributional impacts. I think those are important for policymakers to take into account. And I think they feedback around into the consent of citizens to be taxed and and the fundamental democratic process actually. and. Most OECD countries, in fact all I think, have progressive tax systems by and large and general voting patterns suggest that that’s the majority view of life across OECD democracies.
The problem with behavioural taxes
Other secondary objectives that Rob and Robin mentioned with behavioural changes, carbon taxes and things and those are very specific instruments of public policy, and they might raise some short term revenues. But they shouldn’t be relied on for long term revenues and it’s almost a different category of taxation to the general tax system because if they work – those behavioural taxes – the revenues will often dry up, will be reallocated into the areas that they’re trying to change.
TB That’s something we’re actually seeing with the tobacco excise duty. It worked and now revenues are falling and now that’s sort of a hole in the finances.
RO But if that works, yeah, it’s the same as environmental taxes. You know you have taxes on degradation of the environment. And if you don’t degrade the environment, you get no money. And it’s perfectly fine. They work, but back to Geof’s point. I totally disagree that redistributions got anything about it. You clearly have to have a democracy; in a democracy you have to have consent. I agree with that. You have to have consent to make the tax system work because of voluntary compliance and all that.
Poll taxes – efficient but unworkable?
But the purpose of tax is to raise the money in the most cost-effective way. And I give the example of that is the poll tax, Margaret Thatcher’s poll tax. I mean poll taxes are loved by economists because it’s thought of as being efficient. But it doesn’t work. I mean if you want to raise New Zealand’s government revenue by poll tax you’ve got to raise about $30,000 per individual. You’re not going to go out to people in South Auckland, a family household, and demand $100,000 from them please. I mean, they don’t have it. And there’s no point in demanding money, which people just don’t have.
And that’s why even an efficient tax system, inevitably given the level of government expenditure we have, will need to be progressive. Because you know the lower income earners just don’t have money to pay the tax that the government needs. But again, the point is, you’re really trying to raise money to spend on health, education and welfare and you want to do it at least cost. And forget about trying to have a secondary objective of redistributing income, that just leads you into bad taxes. And that’s led us from having a good tax system to one which is now pretty awful or going that way.
TB It’s a hell of a topic that. I mean, there is always a redistributive effect of tax, and the recent Treasury paper on the fiscal incidence of taxation was quite interesting in that regard.
RO Yes, good paper.
What about ring-fencing taxes for certain objectives?
TB The Treasury paper showed health and education benefits going to different deciles. They’re essentially redistributed within the system. So just a quick thought about these behavioural taxes Do you actually see much of a role for ring fencing? Tax takes such as, for example, environmental taxation that we raise these, we’re trying to encourage better behaviour, but the funds don’t go into the general pool but are used to mitigate the impact of climate change. Is there a role for that Rob?
RM Yes, I think I think there is. We call this hypothecation and we’ve had hypothecation in the area of fuel taxes for example, which are put on road users and then reinvested back on to roads at various times. But over time, you know, I think that money was ultimately then sent to the consolidated fund.
RO I mean, money is fungible. And therefore, putting it in one pot versus many pots, you can have an argument about whether that’s effective. I think ultimately if governments ensure there is a correlation between how they apply the funds and the taxes they raise, and hypothecation is a solid principle to get that correlation. But I think that the more recent view of governments has been that they can be relied on to effectively finance it all out of a consolidated pot. So yes, hypothecation is certainly there, and we’ve got examples of it.
Economists hate hypothecated taxes, because it ends up government spending money wastefully and low priority areas, because that’s where the money is. But it does serve a purpose, it provides the right incentives. There’s a case for it you know road user charges, Rob said was a good case in point. And you can make other cases like how do we control the level of health expenditure? Well, you could hypothecate GST to health and if people want to spend more on health, GST goes up and everybody has to pay it, so you can end up with arguments for hypothecated taxes. But the economists really hate them.
GN At the risk bringing distributional effects back onto the table, hypothecated taxes can also be highly regressive, so yes, I’ll just leave that there.
TB Yes, a common hypothecated tax around the world, which we don’t now have but once did, was Social Security. You see that many other jurisdictions had that and we’d had that until the late 60s. I think it was Rob Muldoon who decided stuff this we’ll just get rid of it because it was, as Rob described, was just going into the consolidated fund. But looking way back, it was a quite significant part of tax revenues if you look track the history of tax.
The problem with social security taxes
RO And very important in Europe in particular, and the United States of America. And we are very lucky not to have them. Australia and New Zealand, one of the few OECD type countries not to have Social Security payroll taxes, which are linked with the benefits. The reason for that is it results in peoples’ old age pensions, or whatever you call them – New Zealand super being linked with past earnings.
And that means that the poor are really poor, when they are elderly. And that’s the case in the UK. Everybody gets the same in New Zealand which in my view is absolutely a much better system than using your tax system to provide benefits linked with wages. Which means particularly women who are not always in the workforce, but child rearing, skills get really done over. I think we’ve got a much more equitable system of expenditure on welfare because we don’t have that.
The incidence of tax – who is actually bearing the tax burden?
RM Terry, can I just perhaps take us back to redistribution, I think there’s one important point about redistribution which unfortunately is a bit of a technical point. But it’s one that is overlooked not only by lay persons, you know, people not familiar with technical stuff, but also the tax profession itself. Which is the issue of incidence.
So if you just start with the GST as an example, most New Zealanders wouldn’t accept, and rightly, that the GST is not imposed on them. And yet, if you have a look at who pays the GST, they don’t pay it. The consumers do not send cheques to Inland Revenue. The tax is actually imposed on businesses. As a matter of imposition. When we talk about redistribution, we’re inclined to assume that the tax impact is where the law imposes it, but the key principle that’s demonstrated by the GST example is the market actually takes that tax and spreads it around, arguably like margarine, to all of the stakeholders and sometimes non stakeholders, and the and the contract to be affected.
These are such things as gross ups, if you go and slap a tax on somebody and they’ve got market power, they’ll put the price up of what they’re supplying to others. And in so doing, they’ll pass that tax burden on to others. And this is completely ignored in my view, when people are talking about redistribution, because there’s the assumption that the taxes that are actually imposed by the government, is actually borne by the people who send cheques to Inland Revenue Department, is utterly false. And if you try and unravel that mathematically and work out who actually is bearing the tax, the best you can get to on most of it is estimates including the dead weight loss of the 20% that Robin is talking about, it’s there’s a lot of estimation going on to get to those numbers.
There’s no argument that that economic effect is real, and for me that’s a big undercut of why I don’t buy all the redistribution argument, because it tends to proceed on the assumption that the way the government’s levying the tax will ultimately shape and determine the burden of it.
RO We don’t know a lot about the incidence of tax. But what we do know, it’s almost never born entirely by the person paying it. So, you end up with these studies, like the awful IRD study on high wealth, totally ignoring this fact, just totally ignoring it.
And the classic example of economics in the United States is that you have local body bonds, the interest rate is tax free. It’s a subsidy to like City Councils or what, and the federal government doesn’t tax them.
The high wealth individual – the person on the very high rates – ends up owning all these municipal bonds. They don’t pay any tax. But they’re getting a lower interest rate because they’re bidding up the price of these bonds, which is what’s intended and the local City Council get cheap money. And then along comes a bunch of officials measuring their tax burden and finding it zero. Disastrous. Horrible. Well, in fact, they’re paying it through the lower interest rates on it.
And this happens all the time, all through the tax system. You put taxes up on foreigners, that’s a good idea. Foreigners we don’t like, they’re not voting, and we put big tax on foreigners. They just simply demand a higher rate of return or don’t invest here. We end up with lower productivity, lower wages and the economics is absolutely clear. Put your tax on your non-resident investor, it ends up coming out in lower wages. And that’s exactly Rob’s point. The incidence is always shifting and yet we totally ignore this. The political debate just assumes the world is not what it is.
TB Robin, I think we’re going to see more and more of that. Sorry, Geof, you were about to say something.
GN I totally agree with Robin and Rob on incidence, it’s critical. But it comes back to my opening point that you can only tax through consent, eventually. If incidence is not well understood, policymakers – and it’s very hard and very slippery getting your hands on the concept – but policymakers need to think about it. But if you can’t convey that to voters, then it becomes kind of irrelevant.
I remember Sir Rob’s MacLeod committee and the $1,000,000 tax cap for individuals. I thought was a was a great idea because of that sort of argument that we’d be better off with $1,000,000 than not. But that policy is too easy to attack politically from an equity and a sort of a fairness sense. And that’s what happens in the real world as we all know and that’s why we end up in political arguments around the secondary purposes of the tax system, as opposed to really discussing the primary purpose of the tax system Which is least cost revenue raising for government policy. So, I agree with their incidence comments, but it works both ways, I think.
RM Can I just jump in on that one and just observe that in the McLeod Review where we did recommend that to be honest, I think it’s politicians that say that say no to those sorts of things than not, as opposed to public sentiment. Muldoon made the famous quote that Joe Blog, the average person on the street, wouldn’t know fiscal deficit if he tripped over one. And I think that’s a long way back and things weren’t as sophisticated then as perhaps they are now.
But if you think about the complexities of tax and you think about the extent to which the public is actually engaged with that complexity, I think that you are apt to over egg that interaction. Because ultimately politicians and officials and people like ourselves, there is a leadership role we play and the public follows that leadership.
I think you can observe that in history. The differences between countries and the qualities of their tax system often reflect the differential qualities of officials, politicians, et cetera, that’s going on in those countries. So, while I agree that in the concept of democracy, there’s a public underbelly in debate and voting terms, there’s one hell of a space for leadership and tax policy. Otherwise, we might as well pack our bags and go home. And I think that that is very influential and that’s why these debates and these principles of incidence and so on are important and need to be approached in the way we’re doing it.
RO We can see that with GST. We’ve got a flat rate, a good GST system, world class.
I remember back in the 80s Sir Robert Muldoon, the proposals was put to him about that. And he said, “You mean we’re going to tax water?” And he chuckled, “No way.” We put GST on doctor’s bills. People overseas think that’s just totally astonishing. Yet there’s broad support for what we have in GST, a non-progressive tax. Bizarrely we legislated to make it regressive, but it does meet those economic principles and it’s got widespread support. I mean, politicians keep on arguing for GST on no food, but those proposals get put up and get rejected every time.
Rob McLeod’s suggested alternative to a capital gains tax
TB Rob in your review, you raised the possibility of the risk-free rate of return method (RFRM) as an alternative to a capital gains tax. And we’ve seen that in the Foreign Investment Fund regime. Are you still keen on the idea?
RM The RFRM, the McLeod Review, came largely out of the debate around taxing housing. And this was in a discussion document, by the way. It wasn’t the final recommendation; it was abandoned because of what Robin said. Michael Cullen’s switchboard was blown up by the complaints of from telephone callers and we knew that was a pretty strong signal that no government was ever going to support it.
So, we pulled the plug. But basically, the problem with taxing assets that produce, that give sort of imputed income like your motor car or your house or your washing machine, there’s no cash flow to really measure the income. It’s economic income, but it’s hard to measure. And so, the beauty of the RFRM is that you calculate it effectively as a wealth tax, which is applying a percentage, I think we had 4%, against the market value of the of the equity in the asset. It’s quite important. That’s one feature of the RFRM is you’ve got to work out what you’re going to do with debt, debt funding of the asset. And we came to the conclusion we’re best to deal with that by narrowing the tax onto the equity, which is the total value of the asset minus debt associated with it. Which brings in problems because people then start to plan with where they load their debt, right?
But it was simplicity. If we could have made the income tax work on that kind of asset that’s a superior way of going, if you can make it work. I think the only reason you go to RFRM in substitution is there’s easier compliance and administration for taxpayers and the Inland Revenue. The F|IF regime I think Terry came out of the international regime As the child of the CV, the mark-to-market option.
I think you’re thinking of the FDR [fair dividend rate] in today’s terms is probably the most relevant analogy. Fixed dividend rate which I think did come from a an RFRM logic, although it’s a bit screwy because FDR, the RFRM tax principle is you should apply it at the riskless rate of return, and not at the risky rate of return, which is the way FDR works. And also, no deductions which FDR doesn’t abide by in its various option formats. So the concept is much the same but quite different in detail.
What’s surprising in the tax world now?
TB Is there anything in the tax world that surprises you right now?
RO I would say the wealth tax coming on the table, totally unworkable. According to the papers the last government almost legislated for a wealth tax in the last budget, ??? funding and massive reductions in income tax rates. And that wealth tax was completely unworkable and would never get off the ground. It was a total nuclear bomb on our tax system. The fact that people are seriously talking about totally impractical things is a serious concern.
We’ve got to be adults here. There is no fairies at the bottom of the garden. There is no pot of gold at the end of the rainbow. Grow up. Taxes have to be pragmatic and have to be workable, and trying to measure everybody’s wealth on a comprehensive basis every year is not.
GN I remain surprised by the continued acceptance by middle New Zealand of what I consider to be really high effective tax rates on labour income through the combination of GST and [tax] rates. And I remain surprised when you look at their voting patterns, their general resistance to extending taxation into capital income to address that, so not raising taxes as a percentage of GDP, but recycling revenue, shifting the instance of where slightly where that tax is paid, and it continues to surprise me. I think that message came through the high net worth survey that came out last year, but it was obfuscated by the complexity and some of the methodology problems and the way that survey was done. That’s what I’m still surprised at.
TB I think there’s a general lack of awareness of what effective marginal tax rates are and how they interact and how high they are at relatively low incomes. The 30% rate, $48,000 is a real problem threshold.
RM I suppose I am a bit surprised that the fundamental features of what’s been great for the New Zealand tax system, reappear as controversies, in the political realm particularly. Like the high tax rate. The problem is that Europe’s got high tax rates and Australia’s got high tax rates. New Zealand trying to wave the flag in favour of the low tax rate component of the BBLR has been a challenge. And I think it’s actually been because our neighbour has high marginal rates. And Europe has been very influential on people like Robertson and so on in my opinion in the sense that they buy into the idea that we can have government spending and taxes at 50% plus of the GDP. I should say that I’m therefore not surprised by it. But I think that’s been the big disappointment, that our rates structure has been allowed to sort of get up, and in a sense it’s part of narrow base, high rate [NBHR] thinking. They don’t realise that with those high rates comes the NBHR concept.
The other thing I just touched on is I kind of worry about the international – the OECD and the EU – devices through which large countries bully other countries. And the treaty networks and the BEPS regime and all that sort of stuff is typically a mask for powerful big countries grabbing money off other countries. And the more that happens, that’s a source of corruption and cancer for me and can ripple down and reach these national tax systems. And we’ve had more of that in the last five years than we’ve ever had before.
RO The OECD stuff is probably more two big elephants fighting, the US versus Europe and we get squashed in the middle.
TB I think that’s why the Global South is pushing back and trying to get the UN involved led by Nigeria and Pakistan which are small economies globally, but giant populations, you’re talking over 400 million people between them. They’re not buying into Pillar two. There seems to be pressure building in that area.
What one proposal from your respective tax working groups would you like to see implemented?
RM That’s a that’s a good question. Sorry to be boring, but I think I came back to the broad-based low rate. For Geof and Robin who know me well, I am a bit of a bore-a-thon drum beater on base principles, and the thing that I’ve seen is the base principle lose a bit of its grip in New Zealand in the last decade. We’ve taken our personal and our trust rate to 39%, which I do not like.
It’s the fiscal stuff that’s that this government is arguing that I don’t accept that it’s necessary for that, but that’s another big debate point about understanding how balance sheet management in government needs to be separated from profit and loss account management. I don’t think that those two aspects of the debate are properly worked through. We should take the longer road and the longer term to fix our debt issues, obviously try and avoid them from happening in the first place. But debt is not necessarily needed to be paid immediately. And not to be factored immediately into tax rate design in my opinion, which is a mistake that we’re currently going through.
GN I’ll be boringly repetitive, but I think the extension of income tax to more realised capital gains on a realisation basis and then using that revenue to recycle, I think that’s got equity efficiency benefits. And I also think it helps in some ways to resolve those high effective marginal tax rates around our productive sector of our economy, labour productivity. So that’s still what I would do if we were able to do one thing.
RO Oh, I still like Rob’s RFRM on residential rental and get rid of all these bright lines, interest deductions and ring-fencing rules. The other one Geof raised was seriously considered by the Labour government under Michael Cullen, was that you pay a million bucks worth of tax and you’ve done your bit and go away. An anathema now, times have changed. That was acceptable then it seems, but not now.
It was seriously considered by the caucus at the time. The idea is you get someone come and live in New Zealand and pay a million bucks and fund a Children’s Hospital. Doesn’t seem to me to be a bad idea.
RM Like a hypothecated tax, Robin?
RO I wouldn’t mind if it was hypothecated for good healthcare for children. I think that would be good.
TB Well, I think we’ll leave it there. I want to thank my guests this week, Sir Robert McLeod, Robin Oliver and Geof Nightingale. It’s been fantastic talking with you all. Thank you so much for being part of this.
[This is an edited part of the full podcast which readers are encouraged to download and listen to at the link at the top of this page.]
On that note, that’s all for this week, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
