• 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.