Let us start with the big picture. In the year ended 30 June 2019, the entire GDP of New Zealand was exactly $300billion. That is the value of all the goods and services produced in the country that year. Out of that total, the Government drew revenue totalling almost $92billion, or approximately 30.6%. The government’s revenue was made up as follows:
| Direct income tax from individuals | $38.698 billion |
| Corporate Direct Tax | $15.99 billion |
| Other Direct Tax | $2.497 billion |
| Total Direct Tax | $56.394 billion |
| Goods & Services Tax | $21.862 billion |
| Petrol Tax | $1.982 billion |
| Tobacco Tax | $1.980 billion |
| Road User Charges | $1.673 billion |
| Alcohol Tax | $1.086 billion |
| Other Indirect Tax | $0.746billion |
| Total Indirect Tax | $29.329 billion |
| Total Tax Revenue | $85.723 billion |
| Miscellaneous other Sovereign Revenue | |
| ACC Levies | $3.014 billion |
| Other Sovereign revenue (Fire Service, EQC, Fines, etc) | $3.013 billion |
| Total Other Sovereign Revenue | $6.028 billion |
| TOTAL SOVEREIGN REVENUE | $91.751 billion |
As can be seen, of total government revenue in the 2019 year, 61.46% came from direct tax (on earnings) and 31.96% from indirect tax (on spending). Despite efforts for many years to spread the tax burden more evenly across sectors and across different taxes, government revenue remains heavily dependent on direct tax- especially from individuals.
TAX ANOMALIES ABOUND WITH NO POLITICAL WILL TO CORRECT THEM
Few topics create more difficulties in a democracy than tax. When one party proposes a change there will always be some people in society negatively impacted, even if it is by losing a perk they previously enjoyed. So in our adversarial political system the Opposition can be guaranteed to oppose the change and often will be successful in both gaining political favour at the expense of the Government and in blocking the tax change proposed.
The result: politicians leave what is already on the tax books unchanged. They are scared to open Pandora’s box and attempt any sensible amendments. So our tax system continues to be skewed unduly to direct tax. It remains a hotchpot of anomalies which Parliament finds too hard to try and change. A few simple examples:
- Gains from land transactions are only taxable if the property was originally bought with the object of on-sale at a profit. EVERYONE who buys a property has resale at a profit in the back of their minds as one of their objectives, yet few of such buyers pay tax when they sell.
- Australia and NZ have long failed to agree on withholding tax and imputation credits attaching to shares held by citizens of the other country when those shareholders file their tax returns in their home country. This results in double tax on share dividends.
- New Zealand and many Australian shares are taxed on a different basis from shares in the rest of the world, which are taxed in New Zealand on a ‘deemed 5% dividend regime’. Returns on overseas shares have fallen with the lower worldwide interest rates but the 5% deemed dividend remains- in effect a capital levy each year. The 2019 Annual Report of the NZ Super Fund says at page 125:
‘… in any given year if our return on global equities exceeds 5%, then our effective tax rate will be lower than 28%; and if our returns are less than 5%, then our effective rate will be higher than 28%. In 2015, the Fund paid 3% on the net income it made from its overseas shares. In 2016, it paid 96%. In 2018, it paid 8%.’
It would be difficult to imagine a bigger mess than the tax on overseas shares – yet it remains in the politically too hard basket
- Tax on currency gains and losses. If you hold any overseas currency then gains or losses calculated back to NZ$s (which occur by the minute) on that overseas currency bank account are returnable as part of your income. But if you use those overseas funds to buy overseas shares you pay nothing on gains in their share price.
- Taxing the NZ Super Fund, and Kiwisaver at normal income tax rates when it is clear New Zealand needs to grow its savings urgently. Many overseas countries allow savings for retirement, including super fund earnings, to be accumulated tax free or at low tax rates and taxed only when they are taken out of the fund.
- The absence of a capital gains or wealth tax in New Zealand.
I am sure accountants who work with the New Zealand tax system every day would be able to add several more pages of further anomalies without difficulty.
TAX INCONSISTENCIES HAVE A COST
There is a further consequence. No one likes paying tax. But if the overall tax system is sensible, internally consistent and reasonable, people are more inclined to live with it. If the tax system is full of anomalies and inconsistencies people view it far less favourably. The sort of question which taxpayers then routinely ask is, ‘Why am I paying all this tax on my gains, when Fred over there pays no tax on his different gains?’ A poorly structured tax system helps generate a poor perception of the tax system generally and it is far more tempting to evade a tax system you see as full of holes and making little sense. There is surely an indirect reputational cost our tax system sustains because politicians avoid working and improving it.
BETTER OVERALL STRUCTURE NOT DIFFICULT
The most frustrating aspect of this entire position: an overall sensible Tax regime is actually quite simple in theory; and would be easy to implement. Here is my solution:
A good tax system needs three basic taxes: direct income tax; indirect GST and a capital gains/wealth tax. As a rough suggestion, let’s say the country aimed for 45% from direct tax, 30% from indirect tax and 15% from a tax on capital. (That leaves 10% for other sovereign revenue and miscellaneous government revenues). Try to keep all three at low rates so the incentive to avoid any one of them is limited. Then if a taxpayer avoids or evades one of these three taxes (say on their income) they still get caught by either GST and/or capital gains tax when they spend that untaxed income. Similarly, if you manage to avoid one of the other taxes like capital gains, you get caught with income tax or GST.
The one problem with this basic three-tax system: you can’t trust politicians. When Gladstone (the famous Victorian UK finance minister and Prime Minister, who was ironically on record at the time as opposing income tax) introduced income tax to the UK in 1853, it was at seven pence in the pound, phasing out over seven years. Somehow that phase-out never happened and Gladstone’s initial rate of 2.9% of income has increased by far more than 10 times since. GST was introduced in NZ at 10% and has now become 15%. The initial reductions in NZ income tax which were part of a package when GST was introduced, have crept back up again. Give politicians a new tax such as a capital gains or a wealth tax and there is nothing surer – it will be introduced at a low rate, and creep up over the years. So the populace sensibly takes the view – oppose all new taxes, to minimise the opportunities for political creep.
How to prevent this creep of taxation rates? The only way I can suggest is to entrench in legislation a fiscal rule that would require a parliamentary ‘super-majority’ (see my final chapter on Democracy) to change it. The rule could state the total tax take of the New Zealand Government cannot exceed, say, 33% of GDP averaged over, say, any three year period. That would allow expenditure above the permissible ceiling when a Covid or a Christchurch earthquake causes a major economic ripple. But the objective would be to prevent governments steadily pushing up their expenditures over the years and letting tax rates creep up to fund those expenditures. With a ceiling tied to a percentage of GDP, tax revenues could grow- but only as the economy grew.
You would need Treasury supervision to ensure the upper limit or amount of tax collected by the Government each year, kept within this overall ceiling. The politicians could still play their traditional political games and change the tax rates on each of the three taxes, (so long as the total did not exceed 33% of GDP), to benefit their own supporters. The Left might lower income tax rates on low incomes, the Right might lower rates of capital gains or wealth taxes. However, there would need to be a requirement that changes to the rates at which each of the three types of taxes is levied must not exceed certain limits, so the essential framework of three principal taxes is maintained.
To pass an entrenched fiscal rule such as this, National and Labour would need to get together, agree on the overall legislation and then both vote for it. This is easy to say, but very difficult to achieve politically. Labour would want the percentage of GDP taken as tax to be high, National would want it low. Labour would want a higher capital gains or wealth tax, National would try to minimise this. There would be endless political argument. But if both parties sat down and genuinely tried to work out a tax system for the long term benefit of the country for a change, it would be very possible. Yes, the minor political parties would try to curry political favour around the edges and oppose it, but hopefully the public would see them as political opportunists and the two main parties could push this through.
If you had such a system of three key taxes, with an overall ceiling percentage of GDP which taxes in total could not exceed each year, income tax could be brought down significantly from its present levels and the revenue lost on that account could be recouped from capital gains or wealth tax. It has always seemed wrong to tax income earned from productive work (which will usually be of benefit to the community, producing as it does, goods and services for others to buy) while leaving capital gains (which contribute little or no benefit to the rest of the population) completely tax free.
There are a number of other issues which would also need consideration if a system such as this was attempted. Government charges are the flipside of tax. If you levy people with the same amount of tax from year 1 to year 2, but in year 2 put up the charges which people have to pay to acquire a Government service, the financial effect is the same as a tax increase in year 2. So revenue from Government charges somehow has to be subject to the overall ceiling as well.
I have suggested some specific tax changes in other chapters – changes to income tax as it applies to houses, stamp duty on house sales and purchases, waiving GST on private health and private education where they save the Government the cost of providing those services. I have questioned the excessive tax burden placed on the less well-off parts of our society, leading to wealth disparity. I don’t comment further on those suggested tax modifications except to say, ideally there would need to be a full review of all Government taxes, charges, and duties, as part of an overall reassessment, to come up with overall sensible tax outcomes right across the board.
As to a possible capital gains or wealth tax, this MUST include owner-occupied housing (otherwise it will have little effect in reigning in the prices of our overvalued houses). New Zealanders are generally asset rich and cash poor. A tax on wealth must face the fact that many may own a home worth $1million but have no spare cash to pay to the government each year in a wealth tax. So generally taxes on capital are imposed when the asset is sold and cash becomes available. But that means such a tax potentially takes years to start producing meaningful revenue. A wealth tax, where you pay, say, 1% of the value of your capital assets each year, starts producing revenue from the day it is implemented. I have not studied these taxes in detail. Rates are a wealth tax, imposed on the value of real estate, whether the owners have cash to pay it at the time it is levied or not. I wonder if it would be possible to have a tax on capital which is an either/or. You could get a discount, if you pay the tax every year or pay a higher tax when you sell. However such a tax is formulated, I do feel we need a tax on capital in some form to go with direct tax and indirect tax. At the moment, the New Zealand economy is seriously skewed towards capital gains which are unproductive for the country. If there was a wealth tax, putting a cost on holding capital assets, that would hopefully incentivise people to invest into productive, income-producing assets.
THAT’S OUR MONEY YOU ARE SPENDING
There is another issue with tax reform. Politicians have successfully severed the link between tax paid and Government spending. If you asked the average Kiwi how much tax and other levies they pay to the Government each year they would have no idea. Tax is removed at source from their income. They no longer even need file a tax return. Tax (on top of GST) is levied when they buy petrol, alcohol or cigarettes. Politicians are incentivised to disguise the real tax burden and hide from voters how much tax they are actually being levied. Then, with the public not really thinking it is ‘their money ‘ which is being used, the politicians can truly act as Santa Clause and bestow gifts from on high (gaining significant political credit in the process) when they announce new government spending. Incredibly, a large majority of voters do not make the connection that it is their money being spent back on them (with politicians claiming the credit for the spending). If we created circumstances which made it clearer to every voter, that it is always their money being thrown about, perhaps the insatiable need of politicians to try and win elections by outspending the other politicians would be lessened.
How to do this? Require a statement issued to every single taxpayer each year, estimating how much tax and other government levies they have paid that year. We five million New Zealanders (many of whom don’t work) on average paid $18,350 each to the Government in 2019. For people of working age the amount would be much higher. Ideally those voters should also be told on regular occasions: ‘this amount you paid in tax last year will need to go up next year if Government spending increases.’ (I am not holding my breath that politicians will ever agree to do that).
One final thought. Why does the IRD never send a letter of thanks to taxpayers? Have the IRD tell taxpayers that the country cannot operate without tax. Thank them for paying their share on time. Such letters would cost little. At the moment you hear from the IRD only when they want a payment. A better image, and some appreciation expressed for taxpayers who do play by the rules would surely do no harm.
Well, this paper was surprisingly easy to write. Fixing tax is not difficult in theory (undoubtedly the devil would be in the detail – but if there was a will to improve tax, much could be done). Is it remotely possible that what I have proposed will ever happen? Answer: at the moment, overall sensible change is exceptionally unlikely to happen.
Unfortunately the more you think about tax, the more you realise that before you can fix tax you need to fix Democracy. Will that ever happen? I have attempted to suggest how it may be possible, in the final chapter 16 of this book.
Covid – Catalyst for Change 