Morgan and Guthrie’s Modest Taxation Proposal

Gareth Morgan and Susan Guthrie have proposed a radical shake-up of New Zealand’s tax and welfare system, summarised in this article in the Herald last week. The main features are as follows:

• an “unconditional basic income” (UBI) of $11,000 for every adult, applying to everyone and replacing all other benefits including superannuation;
• a flat income tax rate of 30% applying to all income earned by individuals, trusts, or companies; and
• a “comprehensive capital tax” (CCT), which effectively imposes a minimum tax on all capital excluding financial assets equal to the tax that would apply if the capital earned a rate of return of 6%.

I assume also that they assume maintenance of a broad-based GST, and full dividend imputation of corporate tax.

Some things in their proposal I like. Having a single system implementing transfers and income taxes is long overdue. I wouldn’t go so far as to have a single minimum income that is the same for every adult, irrespective of need, as the level that would be needed to guarantee an acceptable income to the most needy would be unaffordably high if given to all. An integrated tax and transfer system, however, needn’t be as hands off as in their proposal; there could still be a role for a body like WINZ to adjudicate on levels of benefits according to need, and provide other support services; the most important thing is to integrate the systems so that the impacts of policy changes on horizontal equity and effective marginal tax rates are transparent.

Aligning the corporate tax rate, tax rates on trusts, and the marginal rate of income tax for the majority of taxpayers is also long overdue. I wouldn’t have a single rate all the way down to zero income, in order to allow differences in the guaranteed minimum income based on need to be phased out at higher incomes. Again, the point of difference here is small relative to the main point. A system in which there was a common rate applying to corporate income, trusts, and the income above, say, $30,000 would probably achieve almost all of the benefits of a single rate in terms of eliminating the distortions and compliance costs that multiple rates can bring.

On the other hand, the comprehensive capital tax has me flabbergasted, for a number of reasons:

First, the contrasting motivations for the UBI and CCT seem incongruous. Under the UBI, an able-bodied pre-retirement adult with no dependents would be entitled to choose to not work and still receive the UBI, and pay no tax. Their justification for this is that “[w]e are a rich society so to compel people to opt for paid work or face the stigma of qualifying for a benefit has no logic.” At the same time, however, their CCT does not regard it as a matter of personal choice how people should invest their savings; instead it implies a moral imperative to earn a return of at least 6%. There seems to be an underlying value judgement that earning a high return on capital is a social obligation, but one that only applies to those who choose to save at all.

Second, an effective minimum tax represents a massive deviation from the admirable principle of having a common rate of tax on all income, and brings with it the distorting effects of multiple rates. As an illustrative example, consider someone choosing whether to invest in an asset with a guaranteed return of 6%, or one with even odds of returning either 0% or 15%. The risky asset has a higher expected return to the economy, but under the non-linear tax system it would have a lower expected after-tax return. This is a strange incentive structure for a proposal designed to better allocate capital.

Third, a CCT seems likely to have some quite insidious properties. The proposal calls for the CCT to be applied to all non-financial assets including the family home. They don’t specify in the article how the capital value of the asset is to be determined. Is it the purchase price or the current market value? If it is the purchase price, then the tax would create the same sort of distortion as a capital gains tax applying only to realised gains—an incentive to hold on to appreciated assets in order to avoid the tax rather than choosing a portfolio because of their underlying value. If it is on the market value, then homeowners would be subject to large fluctuations in their tax liabilities from year to year independent of their income streams, at the whim of property valuers. This, of course, is already an issue with local-body rates, but the amount levied in rates each year is trivial compared to a 30% tax on 6% of the valuation of a house.

Finally, a CCT would bring about a one-off capital loss on the value of houses, as future purchasers would have to consider their ability to pay the tax when calculating how large a mortgage they could afford. That is, the shift to the proposed tax system from the status quo would start with a massive takings from property owners. This needs to be borne in mind when thinking about the benefits of a system with a high UGI and low marginal tax rate: Of course, we can have low taxes and generous benefits, if the government can fund its activities from an initial property theft. But I’d rather have a clunky and inefficient tax system coupled with a respect for property rights.