Tax - continued

Options for collecting more than 29% of GDP in tax revenue

In terms of avoiding legislative changes, the simplest way for the Government to collect more tax is just to allow fiscal drag. The effect of people being pushed into higher tax brackets would mean that most of our future financial pressures could be paid for that way. However, although straightforward in some ways, governments may not view letting people drift into higher tax brackets as a viable long-term solution to future financial pressures. For one thing, fiscal drag is not very transparent. For another, as explained earlier, it ultimately would mean that even people with low incomes relative to the rest of the population would be paying the top tax rate on some of their income. Our tax system would become less progressive, relative to our current system. Also, rising marginal tax rates would decrease work incentives.

An intermediate option would be to index tax brackets to inflation, so the tax system compensates for inflation but not for real wage growth. Section G of this Statement considered this option.[88] This approach would still mean that people are pushed into higher tax brackets as they experience real wage growth, but it would not be as dramatic as "full" fiscal drag. This approach would still push lower income people into higher tax brackets, and would decrease work incentives, but not to the same extent as "full" fiscal drag.

However, governments have many options to increase tax beyond allowing fiscal drag (or a version of it) to run. We might broadly classify the different options as:

• increasing the rates of an existing tax
• extending the base to which an existing tax applies, and
• introducing a new tax.

Could we increase the rates of an existing tax?

Three existing taxes might be candidates for increases in their rates: personal income tax, corporate income tax, and GST.

If we raised each personal income tax rate by 2 percentage points, we could raise extra revenue of around 1% of GDP. However, raising personal tax rates would probably be very inefficient, discouraging people both from working, and from saving or investing. The effects of people working, saving, and investing less could mean that we do not collect as much extra tax as we thought. Changing the personal tax rate scale could potentially be either progressive or regressive - it depends on the new rates.

If we raised the company tax rate from 28% to 35%, we could raise around another 1% of GDP.[89] Note, however, that this estimation assumes that raising company tax involves no behavioural responses, which is unlikely to be correct. Raising company income tax would have adverse efficiency effects because it would reduce incentives for investment. In practice the company tax rate could not be raised much because it would incentivise multinational companies to structure profits away from New Zealand. This might have implications for the New Zealand economy more generally, beyond just how much tax we can collect. Furthermore, the size of the increase in the company tax rate necessary to collect an extra 1% of GDP is much larger than the corresponding increase required for other taxes.

GST is the final major existing tax base that we would increase the rate of in order to collect more tax. Section G of this Statement analysed the impacts of increasing the rate of GST to 17.5%.

Could we broaden the income tax base by including different kinds of income?

If we started taxing income in the form of capital gains at the same rate we tax other forms of personal income, we would raise around 1% of GDP of extra tax revenue (this number varies depending on exactly what kinds of capital gain income are included). Introducing a capital gains tax has an efficiency cost in terms of increasing the tax on capital overall. But it could improve the allocation of savings by altering incentives so less investment would be made in real property and more in other forms, such as financial assets. Depending on the precise base the tax is applied to, it could also increase the progressivity of the tax system, as better-off people tend to hold more investment assets. It would probably also cause real property prices to be lower than they otherwise would be, which might reduce international vulnerabilities by reducing the demand for foreign borrowing. Capital gains taxes are complicated to design and implement, with many design options and second-order efficiency issues that would need to be considered.

Could we introduce a new kind of tax?

We could introduce a national land tax, that is, a tax on the value of land (as opposed to a tax on the increase in the value of land), similar to our system of local body rates. A land tax of 0.7% of the value of unimproved land could raise around 1% of GDP in the first year. Land taxes are generally considered to be very efficient, causing little reduction in economic performance. The main disadvantage of a land tax is that its introduction would cause land values to fall, meaning that people owning land at the time would experience a one-off loss. It is questionable whether a land tax would be sustainable over time, as experience suggests that there would likely be pressure to exempt certain kinds of land from its ambit.

There is no perfect revenue-raising option

All possible ways of increasing our tax take have trade-offs, and different governments will think that different aspects are more important. Some governments, for example, might be willing to sacrifice some efficiency for a tax system that is overall more progressive. Increasing revenue could certainly be an option for addressing future pressures in different spending areas, but - just like options for reducing growth in spending - all the possible options have trade-offs.