The future path of government spending and tax

Tax

Taxes fund the services the Government provides. Taxation is a constraint on what the Government is practically able to provide: governments cannot increase taxes indefinitely without hurting economic growth or discouraging people from living in New Zealand.

The discussion in this section draws on the Treasury (2013). The Role of Tax in Maintaining a Sustainable Fiscal Position. Background paper prepared for the 2013 Statement on the Long-Term Fiscal Position. Available at www.treasury.govt.nz/government/longterm/fiscalposition/2013.

Taxes make up a significant proportion of the revenue the Government receives. In the 2011/12 fiscal year, over 90% of core Crown revenue was tax revenue.

Our tax system comprises income, consumption, and excise taxes. Income taxes include personal and company income tax, as well as taxes on certain other specific entities. Their generally broad coverage provides a large amount of revenue at a low tax rate. GST, a tax on consumption, is also broad-based, applying to almost all goods and services at a single rate. Excise taxes, such as those on petrol, tobacco, and alcohol, have specific purposes such as funding our roads or discouraging consumption of goods that have high social costs.

Figure 16 shows the high-level breakdown of the different kinds of taxes the Government receives.

Figure 16 Core Crown Tax Revenue in 2011/12 fiscal year - major categories

Our projections in the "Resume Historic Cost Growth" scenario hold tax revenue constant at 29% of GDP until 2060. That is roughly consistent with the average tax take in the recent past, although in the last few years our tax take has been somewhat less than that average, as tax revenues can be very sensitive to economic downturns.

Perhaps counter-intuitively, holding tax revenue constant as a proportion of GDP actually involves assuming that governments will make some changes to personal income tax. People's pay rises over time, through the combined effect of inflation and real wage increases through economic growth. And as that happens, their tax rate rises, as they will move into higher tax brackets. For example, currently we pay income tax of:

• 10.5% on income up to $14,000
• 17.5% on $14,001 to $48,000
• 30% on $48,001 to $70,000, and
• 33% above $70,000.

As people move into higher tax brackets owing to price inflation and real wage growth, governments collect more money. People sometimes call this effect "fiscal drag" or "bracket creep".

Our "Resume Historic Cost Growth scenario" projections, which have the tax take remaining as a constant percentage of GDP out to 2060, implicitly assume that governments will continue to make periodic adjustments to compensate for fiscal drag. If they did not, the tax take would rise as a share of GDP over time.

The 29% of GDP level is not intended to be a prediction. Rather, it is a modelling device to show the increasing gap between revenue and expenses. In the future, governments may wish to collect more tax revenue than 29% of GDP. Collecting, say, 2% of GDP more in tax would go a long way to meeting future spending pressures and also would not be particularly out of step with historical trends. Figure 17 shows that the ratio of tax to GDP has fluctuated over time.

Figure 17 Ratio of tax revenue to GDP in history

Just because we could meet future financial pressures by increasing taxes does not mean we should. Higher taxes would have drawbacks:

• People would have less income to spend on things for themselves. This could cause real hardship for people already on low incomes. For that reason, tax increases in the past have often been accompanied by some sort of compensating measure for people on low incomes.
• Whether tax increases are intergenerationally fair depends on where the taxes come from and what they are used for. The costs of personal tax increases, for example, would fall mainly on working-age people. If those tax increases were used to fund benefits that go primarily to older people, that would raise questions of intergenerational fairness. Other taxes are different - GST, for example, tends to be paid by people of all ages, as everyone has to buy things. And there are several services that go to people of all ages such as policing.
• Taxes tend to have economic costs, although these costs vary by kind of tax. For example, personal tax increases may discourage people from working. Corporate taxes also have efficiency costs. But other taxes might not have such significant economic costs, depending on how they are designed. Taxes on the value of land, for example, are considered to be very efficient compared with other options.