The technocrat’s tax

New Zealand facesa number of fiscal policy challenges over the near term.   Tax revenue isfalling, government spending may well need to rise, and the country’s creditrating is under threat.  

There is one way that the government can ensurethat it provides an appropriate stimulus and maintains New Zealand’s sovereign debt rating – give an independent body (akin to the RBNZ) theability to set tax rates.

A good fiscal stimulus is said to havethree elements.   It must be timely, temporary, and targeted.

How would an independent body setting taxrates provide these elements?  

Essentially, the government would sign apolicy targets agreement with an independent body.   The agreement would statethat this organisation has the over-riding goal of ensuring that the government’sbudget is balanced in the medium term – but there would also be scope for theorganisation to allow deficits or surpluses in the short-term depending onwhere we are in the economic cycle.  

This type of policy would ensure that anyfiscal stimulus is temporary.   Without the potential for the government to digitself into a hole of debt, credit rating agencies would be more comfortable inkeeping a high rating for New Zealand sovereign debt in the face of risingshort-term debt.

Furthermore, with this central bodysetting tax rates, the fiscal response to a recession would be immediate – withthe central body able to immediately lower taxes if the environment requires it.  This ensures that the fiscal stimulus would be timely.

However, it is not immediately clear thatsuch a policy would fit into the category of a "targeted stimulus".   In orderto see how this policy would at least be no worse than current policy in termsof targeting we have to think about how it interacts with government spending.

Given that the government still controlsspending, it determines where any stimulus will be targeted in the end.   As aresult, the final stimulus to the domestic economy will be just as targeted asin the case when taxes are not set by an independent authority.

As well as satisfying the temporary,timely, and (too some degree) targeted criteria for any short-term stimulus,the independent determination of tax rates would also have medium termbenefits:

  • Greater transparency surrounding the cost of government policy,
  • A greater level of intergenerational equity – as current generationsare forced to take on the cost of their own spending,
  • Increased certainty surrounding the medium term level of taxes.

However, there are issues with such ascheme.   Beyond the potential operational concerns (which may be substantial),there are three primary issues which would need to be thought through:

  • The doctrine of no taxation without representation,
  • The issue of "which" tax rates could be centrally determined,
  • The question of the appropriate "timing" when raising this taxrevenue over the medium term.

Although I strongly believe in theconcept of no taxation without representation, I do not think that theindependent determination of taxes betrays this principle.  

Over the medium term, tax rates will beset solely in response to government spending.   As government spending isdetermined by elected officials, the tax burden is still implicitly set by arepresentative body.

The issue of what type of tax rates thecentral body would control is more difficult to deal with.  

Although having an independent body settingdistortionary taxes (income taxes, consumption taxes) may make sense, itdoesn’t necessarily follow that other taxes should be set centrally (eg petrolor cigarette taxes), or that the structure of the tax system should be setindependently.

The solution to this issue would be tohave all tax rates tied to a single "choice rate" of the central authority,according to a policy targets agreement between the authority and thegovernment.  

Such an agreement would ensure that theunderlying equity and externality argument for the structure of tax system isstill controlled by government – leaving the central authority with only onerate to choose when trying to balance the budget.

The final question of timing is alsoessential.   In an environment where taxes are determined outside of government,the independent body would want to time tax increases differently when extraspending is investment than when it is consumption.  

This implies that in order to implementthis policy, we need a clearer distinction between government consumption andgovernment investment – a distinction that would provide the added bonus of increasedtransparency in government spending.

Although there are important issues to beironed out, the concept of centrally set tax rates has a lot of merit – both interms of our short term and longer term requirements of society.

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