Tax tinkering behind a façade of boldness
Fri 21 May 2010 by Gareth Kiernan in Government

Firstly, credit where credit’s due.  The government has been brave enough to embark on the most significant changes to the tax system in 20 years.  Having identified a disproportionately large reliance on personal income tax for its revenue, the government has widened its tax base by shifting some of the burden onto GST instead.  A less concentrated tax system reduces the incentive and ability for tax avoidance to take place.

Related to this point is that the government has taken notice of some of the obvious loopholes that had been exploited in the tax system over the last decade.  These loopholes had come tithe fore primarily as a result of Labour’s decision to introduce the "rich prick" 39% tax rate in 2000.  Using trust and company structures to minimise one’s tax bills, or investing in rental properties with a negative cash-flow on the basis of future capital gains windfalls, had become de rigueur.

Swamping these glimpses of boldness, however, is the inescapable feeling that National has missed some golden opportunities to make more far-reaching changes to the government’s role in the economy. Last year, the global financial crisis and burgeoning fiscal deficit gave the government an ideal excuse to trim the fat from departments that had known little funding restraint over the previous nine years.  Yes, funding allocations and employment levels for many departments have been frozen, there has been some rationalisation of back-room jobs, and spending has been reallocated away from "low quality" areas.  But the government has simply used its "savings “to pump even more money into education and health – areas of spending that have grown between 50% and 70% faster than the economy since 2000.

This year, one could easily point to a lack of genuine spending restraint again.  But the government’s biggest missed opportunity with the 2010 budget has been to take a more substantive change to the benefit system and its interaction with the tax system.  The monolithic Working for Families system and the independent earner tax credit (IETC) both deserve to be scrapped.  These policies are guilty of unnecessarily complicating the tax system and skewing the incentives to work.

I don’t want to downplay the political obstacles to making such a wholesale change to the benefit system.  But in formulating policy, it is imperative to clearly identify the problems that need to be addressed, and then design the policy to meet those objectives in the most efficient way.

Part of the problem with Working for Families is that it has multiple aims, with the later segments of the package no more than blatant election bribes.  But let’s assume that Working for Families‘ primary objective is to provide assistance for people with children.  If that’s the case, we should bring back the universal Family Benefit and increase tax rates across the board to fund it.  That system is far cleaner than the high effective marginal tax rates that people earning between $37,000 and $90,000pa face as Working for Families benefits are abated.  Effective marginal tax rates 20% above the legislated rate are common, so the disincentive to work additional hours is not trivial.

The IETC, which provides a rebate to earners in the $24,000-$44,000pa range, seems to imply that tax rates in this bracket are too high.  If that’s the case, we should simply lower the rates, rather than muddying the waters and creating extra hoops for self-employed people to jump through.  And the IETC effectively imposes a marginal tax rates for workers earning between $44,000 and $48,000 of 30.5%, rather than the legislated 17.5%.

Even in trying to address the perceived problems with property speculation, National has adopted a piecemeal policy approach.  It is unsurprising that property investors feel unfairly singled out when the depreciation rules are changed for them and no one else.  The government has failed to address the broader discrepancies in wealth obtained through capital gains and wealth accumulated through wages and salaries.  Make money from your day job and you’ll be taxed.  Make money through rising house prices or by growing and selling a small business, and you won’t be.  The old adage that "you have to have money to make money" is only exaggerated by the tax wedge between working income and capital gains.  Property investment is only a symptom of the problem, and the government has missed the fact that the underlying issue is much broader than a bunch of landlords seemingly exploiting the system.

The tax and benefit systems are nowhere near the mess of rebates and exemptions that existed in the early 1980s, but they are gradually heading in the same direction.  It is a natural progression for constant tinkering with tax and benefit policy to result in more complicated systems over time, and this week’s budget has done almost nothing to reverse that trend.

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