Alternative Options

Personal tax changes

A number of alternative options were canvassed to deal with the aforementioned problems of high and inconsistent tax rates. From the evidence presented above, raising taxes in order to remove disparities clearly runs contrary to a BBLR framework and the aim of improving incentives for participation, labour productivity and migration. Therefore only options including tax rate reductions are considered suitable.

In deciding upon the magnitude of tax rate cuts and threshold changes, the government is constrained by the fiscal and macroeconomic implications. The fiscal responsibility provisions of the Public Finance Act 1989, coupled with the most recent macroeconomic forecasts, puts constraints around the level of tax rate reductions and threshold changes that would be sustainable, particularly given the requirement to maintain prudent levels of total Crown debt. A package of smaller tax reductions is not considered adequate to sufficiently improve labour productivity, participation, and migration incentives or provide the necessary fiscal stimulus given existing macroeconomic conditions. Although tax rate reductions below the preferred option are possible, the suggested tax changes represent a balance between medium term goals and the current fiscal and macroeconomic constraints.

To meet the objective of improving labour participation through a decrease in effective ATRs, alternative options to the IETC are available. An alternative way of providing an improvement to participation incentives is through a different set of tax rate and threshold changes. However, this alternative was rejected as it is fiscally expensive and it is not well targeted at encouraging an important group within society to enter the workforce.

In the context of a targeted credit, two alternative mechanisms of providing the credit were considered. These were delivery through the PAYE system as income is earned, or through an end-of-year rebate (or potentially somewhere in between). An end-of-year rebate mechanism is cheaper to administer and is likely to be more accurate (given that the total income and circumstances of each applicant will be known after the end of the tax year). However, the receipt of the tax credit as income is earned provides superior work incentives as the credit is received sooner. Given the objectives of the reform, and the relatively minor difference in delivery costs, the rebate mechanism is not the preferred option.

In order to facilitate the changes to personal tax rates, various options for funding the changes were considered. Increasing other tax types to pay for the reduction in personal taxes runs contrary to the principle of increasing New Zealand's international attractiveness, and is inconsistent with the BBLR approach to taxation. Another option considered was not offsetting the reduction in tax revenues through the removal and modification of other areas in the tax system. However, not funding the changes was deemed too fiscally costly given the already large projected future deficits. The table below shows the fiscal cost of making the personal tax changes without offsetting the cost through other tax system changes:

Fiscal cost of personal tax changes with no offsetting gains

Options for reducing government expenditure include expenditure within the tax system, or from other areas of general expenditure, including core Crown expenditure. By implication the BBLR approach provides that less growth-enhancing tax mechanisms are recycled into tax rate and threshold changes. Consequently, in terms of tax system efficiency (and keeping administration costs low) the savings should initially come from less growth-enhancing areas within the tax system. Two areas of spending have been identified from within the current tax system - the R&D tax credit, and modification of the KiwiSaver scheme.