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Part B - broad choices

5 What role could tax play?

  • Current tax revenue is not sufficient to cover the current level of spending.
  • Left unchanged, the income tax system will raise more revenue by pushing more and more taxpayers into higher income tax brackets – an average wage earner is projected to earn more than $70,000 by around 2023, and so face the top rate of 38%.
  • Although increased tax revenue could help achieve a more sustainable long-term fiscal position, higher taxes are likely to result in slower economic growth and lower incomes for New Zealanders.
  • There are serious issues around the current design of the tax system: the effect of different taxes on economic growth; international competition for people and capital; and the coherence and fairness of the tax system.

The tax system is a critical part of any discussion of the long-term fiscal situation because taxes provide the bulk of the revenue used for government spending.

Currently, we do not raise enough tax to cover spending - which produces budget deficits - and this has to be covered by government borrowing. Although a portion of the deficits and resultant borrowing is attributable to the downturn in GDP, the key fiscal issue is the persistent gap between government expenditure and revenue. If New Zealand does not want increasing debt, then increased taxes could play a role. But just as high public debt is recognised as unsustainable, because it becomes an increasing economic burden, higher taxes also come at a significant cost.

The largest of these costs is that higher taxes limit economic growth. There is not a large amount of empirical evidence on the effects of taxation in New Zealand, but a recent study in the United States shows that increasing tax revenue by 1% of GDP could result in 3% lower GDP after three years.[6] The long-term effects of higher taxes on growth are unlikely to be this large in New Zealand – perhaps around a tenth of this – particularly if other countries are also raising taxes to address their long-term fiscal outlooks. However, in a world competing for skills and investment, tax rates are also important factors in whether New Zealand will keep or attract the skilled people, capital and businesses it needs. And tax rates can drive people's domestic behaviour – for example, in choices around whether they innovate and invest, save or spend, improve their skills and work harder or invest in a business, equities or property.

Current issues

At the end of the 1980s, New Zealand was seen as having a well-designed tax system, built around a broad base and low rates, and an income tax system that was the least distortionary in the OECD. This is no longer the case.

From an economic growth perspective, New Zealand's tax mix is unhelpful. Income taxes (both corporate and personal) have a detrimental impact on growth, while consumption taxes like GST, or property taxes have a less adverse impact. The GST rate of 12.5% is low by international standards and in comparison to our income tax rates. There are no central-government property taxes, nor is there a comprehensive capital gains tax.

We have the third-highest proportion of tax revenue raised from company tax in the OECD and our company tax rate of 30% is higher than the average of 26% for small OECD countries. Our top personal tax rate begins at the relatively low level of NZ$70,000. Australia, for example, has a higher top tax rate, although it does not start until someone earns AU$180,000. Under the existing personal income tax regimes in both countries, Australians pay less tax than their New Zealand counterparts until they reach an annual income of $210,000. Fewer than 1% of New Zealanders are at this income level or higher.

New Zealand has a higher percentage of its skilled workforce living overseas than any other country in the OECD - nearly one in four highly skilled Kiwis is offshore.[7] Relatively higher wages in Australia for many jobs makes migration there a particular issue for New Zealand. The competition for people, companies and business investment means we need to be sensitive to how salaries and profits are taxed elsewhere. The extent to which we can close the income gap with Australia, and how each country taxes its workers, could be important in people's decisions to stay in New Zealand – and pay tax here. Similarly, our attractiveness to new immigrants will be influenced by our tax rates.

The tax system

Total tax revenue is the product of what is taxed (the tax base) and the rate at which taxes are levied on that base. New Zealand's main taxes are:

  • personal income tax, levied using a progressive rate structure (raised $28.5 billion in 2009, 53% of the tax take)
  • GST, levied at 12.5% on virtually all domestic consumption (raised $11.6 billion in 2009, 21% of the tax take)
  • company tax, levied at a flat rate of 30% (raised $9.3 billion in 2009, 17% of the tax take), and
  • a range of excises on petroleum, tobacco and alcoholic products, some tariffs on imports, road-user charges and stamp duties (raised $4.8 billion in 2009, 9% of the tax take).

Issues with the tax system include:

  • Households (with children) in the bottom half of the income distribution effectively pay no income tax or receive tax credits, because of the interaction with the income support system.
  • The top 10% of income earners (those earning more than $70,000) pay more than 40% of all income tax revenues and about 20% of GST revenue.

Changes over the past 20 years have created some important linkages between the tax system and benefits. For example, low-to-middle-income families in New Zealand typically face high effective marginal tax rates on their incomes, relative to those in many other OECD countries, due to the combined effect of income taxes and the Working for Families tax credit system.

There has also been substantial growth in tax avoidance behaviour.[8] This reflects that the amount of tax people pay varies according to how they make their money. For someone earning more than $70,000 a year, if their income is earned from working it will be taxed at the personal income tax rates of up to 38% (and any savings will be taxed at the same rate), but if it is derived from selling property or shares at a capital gain, it will normally attract no tax at all. Where the self-employed can operate under a company structure, or receive income through a trust, marginal tax rates can be reduced from a top rate of 38% to 33% or 30%.

Trends towards this type of tax avoidance have increased over the last decade, with a large rise in the number of companies and trusts - and a dramatic slowing in the number of high-income salary earners.

Notes

  • [6]Romer, Christina D, and David H Romer (2009) "The macroeconomic effects of tax changes: estimates based on a new measure of fiscal shocks." University of California, Berkeley, April 2009.
  • [7]Dumont, Jean-Christophe and Georges Lemaitre (2005) “Counting immigrants and expatriates in OECD countries: a new perspective.” OECD Social, Employment and Migration Working Papers No.25, Paris, OECD. http://www.oecd.org/dataoecd/34/59/35043046.pdf
  • [8]Inland Revenue Department (2008) Briefing for the incoming Minister of Revenue - 2008. Wellington, Inland Revenue Department, November 2008. http://www.ird.govt.nz/aboutir/reports/briefing/
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