Government as a tax-collector (continued)
Other tax issues
As noted, the Taskforce does not believe that a higher rate of GST is necessary or desirable as a part of the structural tax reform needed to achieve the 2025 goal. GST is a very efficient tax, and were higher tax revenue ever to be required it would probably be the fallback option. But government spending has risen so much, and there is so much scope to cut the share of government spending in GDP over the coming years, that we do not believe that a higher rate of GST should be considered. Raising GST would tend to have the effect of validating ill-considered low-quality increases in government spending, shifting the focus from where it needs to be. The 1989 increase in GST should probably be best seen in this light, deferring necessary adjustment to spending. Of course, as income tax rates are cut, the mix of total taxation revenue would shift towards consumption taxes. That shift is certainly appropriate.
There has been public discussion and debate over recent months around two possible tax base broadening measures.
The case for a land tax - levying a small annual tax, of perhaps 1 percent, on the unimproved value of all land - is reasonably well made in the literature. Unimproved land is the ultimate immobile asset, and because of this a tax on land is, in principle, quite minimally distorting. Local authority rates are already either a house and land, or a pure land, tax (depending on whether a particular local authority uses land or capital value rating), and a land tax operates at a national level in Denmark. We do not favour the introduction of a national land tax here for several reasons:
- We do not have actual estimates of unimproved land values. Rural land values include the value of pasture, drainage etc, and hence a land tax would affect incentives to invest in improving the quality of the land.
- At best, even a 1 percent land tax, on all land, would raise revenue equal to around 1 percent of GDP. This is because land values at present are unsustainably high, and a land tax itself would materially further reduce long-term equilibrium real land prices. Current informal revenue estimates suggesting a greater revenue potential are almost certainly too high.
- History suggests[72] that the pressure to introduce carve-outs, differential rates and so on would be very difficult to resist, over time even if not initially. If so, that would seriously undermine the in-principle case for such a tax.
- The transitional issues for the agricultural sector in particular would be very substantial. Were there a pre-existing subsidy, we would have no hesitation in recommending its removal, but it is not obvious why, in the absence of such distortions, we would want to impose a large transitional burden on producers in the agricultural sector, especially in a period when the focus needs to be on catching Australian incomes.
We do not seeing a pressing need to extend the existing provisions of the Income Tax Act under which some capital gains are assessable as income for tax purposes.
Much of the recent debate around taxation of capital gains centres on house prices, and especially prices of investment rental properties. House prices have risen very substantially. At current levels, they are almost certainly unsustainable. We propose measures in a later chapter to reduce or remove regulatory barriers that impede the supply of new houses when prices rise. The Taskforce strongly favours dealing with distortions at source, not responding to symptoms with second-best instruments. Ongoing discussion around the possibility of a capital gains tax, on real capital gains, should be conducted on its own merits, as a matter of appropriate tax system design, not as substitute for fixing weaknesses in policy in other areas.
However, if New Zealand is to meet the 2025 goal, the focus of economic policymaking needs to be on creating a climate that encourages and rewards wealth creation. It is not clear how well taxing capital gains - whether on houses that provide valuable rental services to many, or on other business assets - fits that framework. The capital value of any asset only increases sustainably when the market attaches a greater value to the future income that the asset is expected to generate. When future profits or future rents actually rise, they are liable for tax as income, but there is no compelling reason to tax both the capital value and the expected future income that the increase in the capital value embodies. Doing so could be considered as, in effect, double-taxation. The parallel with labour should illuminate the point: when the wages of health professionals rise we tax the wages, not the capitalised value of the investment in human capital that makes it possible for those people to earn the higher wages. There are no costless windfalls on offer: taxing capital gains more heavily would raise more revenue but would be expected to reduce innovation and capital accumulation. Finally, actual working capital gains taxes are materially less attractive than textbook versions.
Tax reform and fiscal constraints
We consider that tax cuts and tax reform will be integral features of a successful strategy to meet the 2025 goal. We also believe that substantial tax reform will generate significant real economic gains, including significant increases in revenue over the longer-term.
Nonetheless, tax cuts and any material tax reform must be based on identified and implemented cuts in the ratio of government spending to GDP, and on realistic estimates of the likely short-run revenue costs of cutting average tax rates. The low level of public debt is one of the great strengths of the New Zealand economy. It should not be jeopardised by cutting tax rates in the hope that expenditure savings can be secured in the years to come. That sort of approach is usually a recipe for higher tax rates again before too long, while degrading the quality of core public services in the process.
Notes
- [72]New Zealand had a land tax system for many years, only finally abolished in the 1990 Budget.
