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Spend and Tax

Brian Easton

As a general rule, New Zealanders want more public spending. Surveys (such as the 2014 Election Survey) show consistent support for increases in spending, particularly in the areas of health, education, housing, law enforcement, public transport and the environment (in that descending order) as well as favouring reduced income inequality. However, it is not clear whether the public support higher taxation to fund the spending; one would like to think them realistic enough to accept this with such large public spending demands.

Government could borrow to increase spending temporarily but unless that spending was an investment which gave a direct return – very little of Core Crown Expenses are – then at a later stage the additional borrowing would have to be recouped through additional taxation. Basically a government spending more than its current revenue shifts the burden of taxation through time; it does not eliminate it. Note, however, that some government spending – most prominently on healthcare, education and child services – is a social investment any public return of which involves tax payments.

Assuming extra spending does not come from increasing debt, government income will have to rise. By international standards the burden of general government revenue in New Zealand relative to GDP among affluent economies is not high. The New Zealand rate of 39.7 percent of GDP is below the OECD country average (42.4 percent) in the 2013 year. If government spending were to increase by 1.6 percentage points of GDP ($4bn), New Zealand would still be below the OECD average and well below such luminaries as the Scandinavian economies, France and Germany.

Before considering the standard recipe of increasing income tax and/or GST rates, other possibilities should be considered. Obviously tax loopholes should be eliminated whatever. Here are some examples:

  • While trusts are an integral part of the management of property, they are also used for tax avoidance since their top tax rate (currently 30 percent) is below the top income tax rate on persons and corporations (33 percent). An obvious change would be to tax them in a manner similar to that for companies.
  • Tax all returns on capital to reduce distortions in investment decisions from the tax system. With some exceptions, capital gains are not currently taxed. Extend income tax to cover capital gains from share transactions and from all investment housing.
  • The failure to levy GST on low-valued imports of goods and services is partly an issue of compliance costs. Even so, the exemption threshold seems too high.

These changes might generate some useful revenue gains, in total they would be small in comparison to the size of the demands for additional government spending.

 

Options for Raising Taxes: New Taxes

Excise duties on tobacco and alcohol demonstrate that properly targeted, low-compliance-cost duties can contribute to improving the nation’s health. That does not mean that all such levies will be equally effective.

In recent years the New Zealand government has outlaid an average of $215m a year to purchase carbon credits. The amount is likely to increase as the world takes global warming increasingly seriously. It is not obvious that this should be paid out of general taxation, when a carbon tax would both cover the outlay and encourage reductions in carbon emissions.

There is a strong case for a Financial Transactions Tax. However, it would be pointless for New Zealand to introduce it by itself since it could be easily evaded by shifting the transactions offshore. Some members of the European Unions are currently exploring the imposition of an FTT. If it proceeds, New Zealand should be a fast follower, perhaps within a consortium of non-EU countries which would implement a jointly compatible one.

Most members of the 2009 Tax Working Group (TWG) supported the introduction of a low-rate land tax. The supply of land cannot change and it is not globally mobile. Therefore, a well-designed land tax will have a negligible distortionary effect on use incentives. Unfortunately, the value of land is deeply imbedded in a regime in which there is no land tax, and owners have made decisions on that basis, especially borrowing to purchase it. The initial impact of a land tax where there is heavy debt on the land is difficult to evaluate. For instance, the TWG acknowledges that the price of land will fall if a tax is imposed; that would raise the debt-to-land value, in some or many cases, to dangerously high levels. Given the central role that the farm industry plays in the New Zealand economy it seems wise to proceed with a land tax with caution.

The New Zealand government is already in receipt of some revenue from resource levies but it does not seem to have a comprehensive approach to them. For instance, most water usage is not levied.

In summary, there are a number of prudent ways that New Zealand government revenue could be increased by extending the tax regime. But collectively they would not contribute the sort of sums the public seems to require for its public spending ambitions.

 

Are There Spending Areas Which Can Be Cut Back?

It is easy, and therefore common, to propose cuts in existing government spending. Of course the government should seek to improve the efficiency of delivery of its services. It does; it has been doing so for as long as anyone can remember. There is no reason to believe it is less efficient than private sector equivalents.

But excessive downward pressure on some government spending programmes can compromise the quality of its delivery – especially in the long run. Additionally, it may raise transaction costs and/or increase effective inequality, especially when the effect is to shift costs onto households.

More relevant is cutting or greatly modifying spending programmes. This can be controversial for a programme valued by some may be resented by others. There may be a case for better targeting of some programmes. This will be easier if the overall system of redistribution is fairer, but there remains a danger of high effective marginal tax rates which will be a disincentive to people improving themselves. (They tend to be a burden especially on the poor.)

A widely held view is that the age of entitlement for New Zealand Superannuation should be raised above 65 years, reflecting the rising longevity of the elderly. Like the earlier increase from 60 to 65 the change should be well signalled and incremental. There would be some reduction in government spending from such a measure but because it would be phased in, the gains would not great in any immediate term.

 

The Fundamental Conclusion

Major increases in government spending cannot be solely financed by the above measures. Instead it would be necessary to increase the rates of GST or income taxes. An increase in the GST rate would not do much towards reducing income inequality – one of the major public concerns. In order to reduce inequality much of the additional funding needs to be raised by higher income tax rates. Reducing income inequality requires that the tax system be more progressive, that the rate hikes should be higher at the higher income end than at the low income end. Even though the rich would pay relatively more if the redistribution system of taxation and transfers is more progressive, much of the burden of additional revenue raised would be paid by those in the middle of the income distribution. For many of the increases in spending they will be the main beneficiaries – especially over their life cycle in areas such as health.

 

Note: a longer version of this discussion can be found here.

Brian Easton
About the author

Brian Easton

Economist

Brian Easton is one of New Zealand’s leading economists with a unique profile as an economic development practitioner, consultant, journalist and commentator. A former director of the New Zealand Institute of Economic Research and a one-time member of the Prime Minister’s Growth and Innovation Advisory Board Brian has numerous awards to his credit including being a distinguished Fellow of the New Zealand Association of Economists. Dr. Easton is an adjunct Professor of the Auckland University of Technology and is currently writing a history of New Zealand from an economic perspective, Not In Narrow Seas: A Political Economy of New Zealand’s History, to be published by Otago University Press.