Tax and the Living Standards Framework

Speech to the International Fiscal Association, Queenstown on 1 March 2019

Secretary to the Treasury, Gabriel Makhlouf

Good afternoon everyone.  Thank you for the welcome, and for inviting me back to IFA.  Today, as the agenda indicates, I’m going to talk to you about wellbeing and the Living Standards Framework (LSF) and how tax fits into that.

Tax: the context#

But first some general context on tax.

Taxation is a central element of a government’s fiscal strategy, alongside its decisions on expenditure and debt.  It is also a key economic instrument, partly because of its fiscal role but also because of its effects on incentives or on the costs of compliance by taxpayers, or the costs of administering the system. 

Tax policy and its administration play a role in the productivity of any country’s economy.  Choices around taxation – what is or is not taxed, how much is taxed and how tax is collected – affect decisions made by consumers, workers, and businesses on their spending, saving, and investment.  And just as tax policy settings are a key lever to support New Zealand meeting its fiscal and economic objectives, they can also be an indispensable tool for achieving environmental and social objectives.

We therefore need to think carefully about the signals and incentives generated by the tax system.  And of course we want to avoid a situation where the tax system inadvertently encourages investment into non-productive uses.

Tax, as a source of revenue for the public services that underpin our standard of living, is essentially about our collective wellbeing: our health, education, security, welfare, and environment, amongst others. 

The tax system – and to be clear, when I talk about a ‘tax system’, I include policy design, legislative provisions and their administration – is an important enabler of wellbeing and living standards. 

The Living Standards Framework (LSF)#

There are 5 things you need to know about the LSF.

First and foremost it is a framework.  It sets out what we believe is necessary to improve living standards and promote intergenerational wellbeing, the four capital stocks that together comprise our ‘economic capital’ or ‘comprehensive wealth’: human capital, natural capital, social capital, and financial/physical capital. 

The objective of public policy should be to grow these capital stocks by focusing on investments that increase the growth potential of the economy, that improve equity across society and generations, that sustain social cohesion, that enhance resilience to systemic risks, and that ensure the sustainability of wellbeing as people go about their daily business of living and improving their lives.

Second the LSF is a Treasury product, developed for the Treasury by the Treasury over the last few years in order to improve the quality of our advice to Ministers on the likely effects of their policy choices on New Zealanders’ living standards and on intergenerational wellbeing.

Third, the Government has chosen to use the LSF as a foundational pillar of its wellbeing agenda and, in particular, of the first Wellbeing Budget that it will deliver on 30 May.  Of course the Government’s Budget priorities – which you can read in the Budget Policy Statement published in December – have been influenced by more than just the LSF

Fourth, the LSF offers the opportunity of a paradigm shift in public policy-making as a whole and not just in improving the Treasury’s own capability.  We are aligning our stewardship of the public finance system with an intergenerational wellbeing approach and, in turn, the LSF can support government agencies become more cohesive, so that public policy on wellbeing, spending, and other government interventions is aligned to improving intergenerational wellbeing.  It also applies to tax.

In my view, the potential to reshape the way we think about the contribution of public policy to increasing intergenerational wellbeing is significant.  The LSF enables a comprehensive assessment of both tangible and intangible factors that impact people’s lives.  It is a way of bringing those factors into our thinking when we develop our policy advice.

Stocks and flows: intergenerational wellbeing#

Let me expand a bit on what the LSF is about. The basic idea underpinning this framework is quite simple: it’s about stocks and flows.

Traditionally, economists have focused their thinking on the factors of production, like and labour, and how they are combined to create goods and services.  In a way, the LSF is an adaptation of this notion: the four capitals on which the LSF are founded are the stocks which combine to generate flows of wellbeing.  It is quite orthodox, even as it lets us expand our understanding of a much broader range of economic relationships.

Weaving the LSF into public policy provides a significant opportunity for the Treasury and the wider policy community.  It is a leap of thinking, and we want to work with others to develop new frameworks that re-define how we design and deliver policy.

When we use the LSF to consider fiscal policy, it shows the important links between economic and social outcomes.  Income is affected by economic growth, the employment and skills of our workforce, and the way tax is used to raise revenue.  Expenditure is considered in terms of how we can use an investment approach to achieve a sustainable improvement in our collective wellbeing, how it enhances social inclusion, and whether money is being used efficiently and effectively.

Everything interconnects, and the tax system remains core to the effective management of not only the country’s fiscal challenges but also its wider economic objectives.

For those who have been counting – and for those who haven’t – the fifth thing you need to know about the LSF is that there’s a lot of material on our website that you can read to learn more, including the dashboard of indicators we published at the end of last year.

Our approach to taxation#

New Zealand’s current approach to taxation has many strengths, raising revenue through a broad-based, low-rate approach.  As we know, most of the taxes levied in New Zealand have broad bases, meaning there are few ‘holes’ in the tax base.  After 30 years or so this approach still has widespread support.  It provides the government with the revenue it needs to meet its objectives, while minimising distortions in economic behaviour.

The BBLR approach is best exemplified by our GST system. The Treasury’s advice has been and will remain that this system should be protected from exemptions that would undermine it.

The BBLR approach and the Generic Tax Policy Process (GTPP) provide valuable stability and certainty.  Both have served us well and continue to shape the way we think about the tax system.

In my view, both can also be complemented by the LSF as it encourages us to think more broadly about the impacts of change, and helps us to identify opportunities where tax can play a positive role in enhancing wellbeing.

In assessing tax policies against the BBLR approach, we already use principles in the LSF.  For example, we think about the impact of tax policies on equity (and the redistributive effects of the system), on cohesion (and how we ensure that everyone pays their fair share and people don’t restructure their affairs in order that others have to pick up the load) and on resilience (and how tax can act as an automatic stabiliser in the economy).

Both the Treasury and Inland Revenue are committed to the tax policy process we have in place.  Both of us share strong and fairly conventional tax policy frameworks: in short, our common view is that taxes should distort behaviour as little as possible while achieving revenue objectives and contributing appropriately to wider policy goals.  The challenge is to identify those wider policy goals where tax can make a positive contribution and not introduce damaging distortions.

Tax as a policy tool#

As the Tax Working Group reminded us, tax has a role to play in supporting a wide set of policy objectives.  Perhaps the most obvious example is on environmental policy where the role of taxation offers, in my view at least, a lot of potential.

We must always, of course, first ask ourselves what the best policy lever may be to achieve a particular objective.  It may be through tax policy but it might also be through new or amended regulation or the re-prioritisation of existing spending or the introduction of user charges or something completely different.  We need to think comprehensively and creatively. 

For example, and as I’ve said in the past, in the case of delivering value for money in our transport infrastructure, one of the questions that it’s important to explore is whether we’re doing enough to manage transport demand effectively. Congestion charging or road pricing may indeed be an answer and enable the delivery of greater value for the public’s investment.  But we all notice the reduction in traffic congestion during the school holidays. 

Have we considered what the benefits may be of varying school or university starting times?  Would that free-up capital investment so that it could be used elsewhere?

And take another example, the call for ‘sugar taxes’ to help tackle obesity.  I remain very very sceptical about why a regressive tax would be a better option than simply regulating the amount of sugar that could be put into a fizzy drink.

Whatever lever we use, in whatever area, we need to ask ourselves: do we understand the incentives we would be creating so that we avoid unintended consequences?

Environmental taxes#

Taxation is one tool – alongside regulation and spending measures – that could guide the transition to a low emissions economy.  Tax and other economic instruments can be useful to improving environmental outcomes by ensuring we take account of the cost of our actions on the environment.

Apart from the need to raise revenue for government spending and transfers, there is another justification for taxes – aligning social cost with private cost to remove spillover effects to third parties.

The important thing is that we get the signals right.

From a tax perspective, the challenge is in designing a pricing mechanism that addresses the problem, is simple to understand and apply, and is set at the right level.  If the price is set too high, it can be as inefficient as having no price at all.

We anticipate that as environmental resources come under growing pressure and conflicts between competing users become more stark, there will be an increasing move to the use of economic instruments, including environmental taxes and trading schemes.

Of course other regulatory mechanisms will continue to be important, and we need to tailor each policy response for the environmental problem we want to tackle.  For example, the Emissions Trading Scheme is a good example of a tool that can promote the more productive use of resources.  Including agriculture within its scope, for example, would provide incentives for investment in research and development (R&D) or innovation in on-farm practices and improve productivity.

Tax and welfare#

Many people regard the relationship between tax and welfare as ‘tax paying for welfare’.  But the application of welfare benefits – and in particular their abatement – can act as effective taxes.  We need to provide the right level of support to people who need it, without creating punitive disincentives.

It’s important to get the balance right.

The complicating factor here is the effective marginal tax rate on an individual. If we look at tax without looking at welfare, we ignore the potential for policy to create poverty traps, where people see no reward for working to get ahead.

Whether it is an explicit tax rate or an implicit benefit abatement, at the end of the day people know how much extra money they’ll get from starting a job, changing to full-time from part-time, working longer hours or getting a promotion. We have got to make those calculations stack up.

And this is not just in the narrow fiscal sense of making sure people have a financial incentive to get ahead.  That is important.  But it is also important to make sure there is a pathway for people to get more involved in society, in work, and in their community.  We know that these measures are fundamental to subjective wellbeing.

International (and digital)#

Globalisation, technological change and the rise of the digital economy are challenging the current international tax framework.  This audience knows all there is to know about BEPS so I won’t spend too much time on it.  Our response to BEPS is broadly consistent with the OECD/G20 Action Plan, although the specific proposals are tailored for the New Zealand environment. In some instances our existing tax laws are already consistent with OECD recommendations. In other cases, however, tax treaty and domestic law changes are required to address BEPS.

Perhaps the more significant current issue is the way the existing international tax framework handles companies that can derive significant income from a country without having a permanent establishment or physical presence there.  Social media companies are the best example.

The OECD is trying to produce an internationally agreed solution to the issue.  In the meantime, a number of countries, including our own, have also been looking at interim solutions, such as a digital services tax, or DST.  Australia has been consulting on options for taxing the digital economy. The UK has proposed a DST that would apply from April 2020, unless a multilateral solution is reached by the OECD before then.  The Government has announced that it will consult on ways to tax the digital economy and will release a discussion document in the next few months on the topic.

A key point for me is that the international rules-based order is as much about tax as it is about trade so a solution here will need us to work very closely with our international partners.


I should add that I’m also sceptical about the value of hypothecated taxes.  When it comes to introducing new taxes to provide hypothecated funding for a particular area of spending, the benefits can be questionable.  In general, taking a broader view might lead us to the conclusion that funding should be distributed according to the principles of value-for-money and need, rather than tied to a particular revenue stream.

Tax Working Group#

I’m going to limit myself to three things when it comes to the Tax Working Group.

First, on the topic du jour, extending the taxation of capital income, I hope it will surprise no one when I tell you that the Treasury supports the thrust of the TWG’s conclusions.  Six months ago when I was last speaking in Queenstown, I said that the Treasury believed there was a real case to extend the taxation of capital income and we haven’t changed our view.  I recognise that this would come with its own risks, including higher compliance and administration costs. But there are interventions available to address these risks.  The extent to which the impacts are realised – whether positive or negative – will depend significantly on the design of policy. 

Second, I have no doubt that you’ve read all of the TWG’s outputs but if you haven’t I encourage you to read all three volumes, including the interim report.  I also encourage you to tell your friends and their friends to take the time and read those three volumes, to reflect on what the TWG is saying and to ask questions where they don’t understand.  Most of all, you should encourage them to look very sceptically at the noise that’s been generated in the 10 days since the report was published.  An issue like this deserves careful consideration and not the rushed hyperbole I’ve read in the media.

The third and final thing I want to say about the TWG report is how proud I am of the joint Treasury and IRD team that formed the Secretariat.  They’ve done a terrific job.

Business Transformation#

As I said earlier, the ‘tax system’ is about more than just policy and in my view the most important issue in the tax system right now is not capital gains tax, it’s not environmental taxes or congestion charging or bed taxes or new levies.  It’s IRD’s Business Transformation.  BT’s biggest release in its implementation takes place next month.  The changes will result in a fundamental shift in how New Zealanders interact with the tax system and my best wishes go to everyone involved in this significant project.


Let me draw this speech to a close by touching briefly on the development of He Ara Waiora and the TWG’s consideration of te ao Māori perspectives.  The TWG has made an important contribution towards encapsulating a wellbeing framework within this broader world view and the Treasury is now considering how He Ara Waiora could inform the ongoing evolution of our Living Standards Framework. 

We all have a lot to gain from incorporating te ao Māori into our world view.  We are ambitious for New Zealand and for the intergenerational wellbeing of New Zealanders.  The LSF offers a significant opportunity for both the Treasury and the wider policy community to change the paradigm of public policy-making.  This applies to tax as much as it does to health and education and any other policy. 

I look forward to your ongoing engagement on this important issue and am very happy to take questions.