ECONOMICS: Taxation Reform Shouldn’t Be So Taxing

It’s (probably) impossible to come up with tax system that will please everybody. Not surprisingly, therefore, fault was quickly found with raft of options and proposals contained in the Taxation Working Group’s report to the Government two months back.
Property investors bridled at the prospect of being stung by property taxes; farmers baulked at proposals for land tax; and, retailers predicted customer backlash if GST was raised to 15 percent. Not surprisingly, most everyone welcomed proposals to cut personal and company tax rates.
But the fundamental findings of the TWG are indisputable and cry out for adoption as policy. Our tax system is not designed to minimise impediments to economic growth; it is grossly unfair to many people; it is not sustainable. The report suggested systematic framework for tackling these issues.
Because international literature considers high personal and corporate tax rates damaging to economic growth, it proffered portfolio of options aimed at reducing the state’s reliance on them. The balance should be shifted towards more taxation of spending (GST), accompanied by appropriate compensatory measures, particularly for those on lower incomes. The tax base should be broadened by more appropriate property taxes. The Group suggested range of possibilities including capital gains taxes, more targeted measures such as risk-free return method on rental property, land tax and, more effective tax treatment of depreciation rules.
A land tax obviously would discriminate against those wealthy in land assets and also against industries that use land extensively, such as farmers and horticulturists. The report did, however, suggest ways of ameliorating economically helpful income-generating anomalies. For example, value-per-hectare threshold could be introduced, below which productive landowners would not be taxed.
A capital gains tax is more comprehensive instrument. Some members of the TWG favoured this approach while others favoured targeting. Several were concerned about the transaction costs of capital gains tax.
But the package should be considered as whole, and the debate should not focus on any one element. Farmers or orchardists hit by the land tax might be better off overall because of the reductions in personal and corporate tax rates.
Some critics complained the TWG failed to advocate reduced government spending to finance lower income taxes. They pointed to the report by the task force led by former Reserve Bank Governor Don Brash which said lopping government spending to 30 percent of GDP would allow the government to cut personal, company and trust taxes to 20 percent. But if the first condition isn’t met, suggesting the second is waste of time.
Anyway, government spending can improve the quality of our lives – pouring billion or so into ridding the city of its traffic congestion, let’s say, would make Auckland much more attractive place in which to live. Incomes alone don’t determine whether people want to live and work in this country.
But the TWG wasn’t asked to do look at that. Moreover, as TWG head Bob Buckle insists, it’s good discipline to design tax system suitable for range of levels of government spending. It’s easy to call for cuts in government spending to finance tax cuts, but what happens when the electorate wants government that doesn’t reduce government spending?
In the upshot, the Government has accepted the need for tax reform and the broad sweep of the TWG’s proposals, particularly the need for fairer tax system focused on economic growth. It has accepted the advice to reduce tax rates across the board and has signalled its readiness to tax consumer spending by considering moderate increase in GST.
Prime Minister John Key has taken some items off the table – we can forget about land tax or comprehensive capital gains tax. Cabinet turned against land tax partly because it would erode the local body tax base and partly because politicians did not want to buy scrap with their main support base.
But the Key Cabinet few months ago would not have contemplated some measures it has not yet ruled out, such as increased GST. That measure was first introduced by the Lange Labour government of the mid 1980s to tax consumption rather than income. But the climate of public opinion is probably now better conditioned to accept an increase, along with other taxation reforms, than when GST was first imposed with very little debate.

Bob Edlin is leading economic commentator and NZ Management’s regular economic columnist.

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