How you tax changes people’s behaviour

I’d like to think I’m handy with a hammer, and sincebecoming a home owner there have been plenty of projects to keep me occupied.  Like most DIYers, a big part of my motivation is saving money.   On occasionI’ve even taken time off work to finish projects, but does this make financialsense?

The short answer is yes, it can make very good sense.   Eventhough I no doubt work slower than a qualified builder or tradesperson and Idon’t get trade rates on materials, it can still make sense for me to take timeof the job I’m qualified to do and work in an area I’m less efficient at.   Howyou ask?   Due to life’s other certainty: taxes

When you purchase a tradesperson’s time, they have to add15% GST onto the bill.   They also pay income tax, which affects the price theyare willing to work for (at least the honest ones do).  

Depending on their marginal tax rate, full-time workers getto keep as little as two thirds of every extra dollar they earn.   So by thetime I pay that builder to re-gib the living room, I’ve lost almost half of theprice of the transaction to income tax and GST.

The government can’t tax leisure.   If I build somethingmyself, I don’t pay a cent in tax (apart from GST on the materials I mightuse).   If I go to work that day, then pay someone else to build it for me I paya truckload of tax.

I recently got a quote for a wooden deck, but decided tobuild it myself.   I saved over $2,000, even though the deck I built was biggerthan what was quoted.   It took me the equivalent of around four eight-hour daysto build.   My return on the time I invested was $500 after-tax a day – not abad daily rate for most of us.

This issue is not confined to the building sector.   Tax actslike a wedge in markets between what suppliers are willing to charge andconsumers are willing to pay.   Higher tax rates lead to larger distortions.  Next time you toss up whether to buy that $1,000 flat-screen television, try tothink about what it might cost without GST (as low as $870) or what youactually have to earn before-tax to buy it (probably around $1,200 or more).

Of course we need to pay tax to pay for roads, schools,hospitals, our welfare system, interest-free student loans, working forfamilies, and well you get the picture.   I don’t lose any sleep at nightbecause society has voted in governments who spend and tax at a level Ipersonally think is excessive.   But if there is one thing I want people tounderstand it’s this: the money has to be raised somehow – preferably asefficiently as possible.   Be aware that there is a cost to collecting tax andthat cost makes society poorer.

A timely example is the debate around taking GST off freshfood, which even the Clark-Cullen administration maintained was a very bad Idea.  Taking GST off some food, but not other goods, would raise compliance costs tobusinesses and dilute our simple GST system.   It could even boost supermarketsprofits and no-doubt their CEO pay.   If Labour seriously thinks thesupermarkets would pass on the entire GST cut then they have another thingcoming. But perhaps the most important issue is that the forgone tax would haveto be raised in other ways.

Another inconsistent tax policy is Labour’s proposed $5,000tax-free threshold. On the surface it might look like this policy is targetedat low-income earners, but even John Key would receive the full value of thetax cut as the first $5,000 of his income will be tax free.   Again this revenuewill need to be raised in other ways, unless spending is cut (which would havebeen unlikely if Labour and the Greens had formed the current government).

National’s approach to tax is also far from consistent.  After all, it was National that introduced the independent earner tax credit ata time when they claimed to be simplifying the tax system. Overtaxing us andthen making us jump through hoops to get the money back was Labour’s bread andbutter, but National is moving into this territory too.   And for every taxthere is a cost, fewer TV’s, fewer tradespeople in work, or fewer employment opportunitiesin our economy.

Tax should be seen as a means to raise revenue and not as away to deliver welfare or meet political objectives. With the economy still inrelatively poor shape, having a simple, efficient, low rate and broad-based taxsystem is more important now than ever.

Enjoyed this article?

You might like to subscribe to our newsletter and receive the latest news from Infometrics in your inbox. It’s free and we won’t ever spam you.