Wishing for the New Zealand tax code

It's easy to forget just how excellent the NZ tax system is relative to those in other countries. But we are the envy of the world. Two datapoints for this week:

Tim Harford wishes UK VAT reform would move to a system like New Zealand's, where everything attracts GST: we tax food. After listing the absurdities of the UK system, where Jaffa Cakes are tax advantaged over "chocolate digestives" and whether a sausage roll is taxed depends on whether it's been heated. Harford asks what should be done, then answers his own question:

The Mirrlees Review is an attempt to figure out what the UK tax system would look like in an ideal world, and I looked it up. The authors reckon that you could levy a uniform rate of VAT on almost everything, raise benefits, pensions and tax credits, increase the income tax threshold by £1,000, cut the basic rate of tax to 18 per cent and the higher rate to 38.5 per cent, and leave pretty much everyone better off – the government would have more revenue and citizens would be more likely to buy what they really wanted rather than what the tax system nudged them to buy.

Harford wants the VAT to apply to everything, not just to sausage rolls.

Other than the tax-free threshold, that sounds an awful lot like the New Zealand system, where GST applies comprehensively and where, in 2010, the National government reduced tax rates across the board while increasing the GST.

Item the second: Frances Woolley makes the case for taxing food in Canada. The only place where I'd quibble with Frances's analysis is here, and it's only a minor quibble. Frances writes:

When the case for taxing basic groceries is presented in these simple terms, the assumptions underlying the argument become apparent. The equation of choice with happiness rules out any paternalist arguments for exempting basic groceries from taxation. For example, at present soft drinks are subject to sales tax, but milk is not. A tax on milk would be expected to decrease milk consumption and increase soft drink consumption, all else being equal. Those who would argue for taxing basic groceries would respond in one of two ways: first, that we should respect people's choices whatever they are; second, so many of the basic goods exempted from sales tax at present are teeth rotting, IQ-lowering sugary junk anyways that the paternalist argument has little force.

All of this is true. But the current equilibrium also involves a government-enforced dairy cartel that forces up the price of milk relative to soft drinks. Abolish the dairy cartel while imposing GST equally across all food items and the price of milk would drop, not rise. Especially for a GST as low as Canada's, and a dairy cartel as noxious as Canada's.

Again, Frances wishes that Canada had a system that looked a lot more like New Zealand's.

It would be awfully nice if Labour and the Greens here stopped trying to score populist points by hacking on one of the world's best consumption taxes. Labour, in office, recognized the GST's advantages and refrained from wrecking it for a decade. Too much populist nonsense in Opposition might force their hand in a future government.

Do visit the GST tag for Seamus's excellent prior posts.

Easton vs Krugman on Earthquake Finance

Brian Easton argues for a 3% earthquake levy in The Listener.

Prudence suggests the Government should be developing a backup strategy. One possibility is a Canterbury earthquake levy, a surcharge of, say, 3% on each person’s income tax bill. The levy would be used to pay off the government’s earthquake expenses that couldn’t be recovered from insurance and the like. There would be a special account to which these expenses were charged (including those already incurred); proceeds from the levy would be credited to it as long as the account was in deficit – probably for at least 12 years.

This only makes sense if the government faces serious constraints on debt issuance. Again, here's Paul Krugman on how to handle natural disasters:

Now suppose a disaster strikes. What this does is raise the marginal benefit of spending on disaster relief. The appropriate response is to move all the marginals to get them in line: spend less on everything else, and also raise more in taxes. So even there it shouldn’t be all offsetting spending cuts.

But wait: even more important, the government can borrow (or, in principle, lend, if it pays off all its debt). So it should balance its budget in present discounted value terms, not year by year. This means that the tradeoffs should include future spending and taxes as well as this year’s spending and taxes. And a natural disaster, like a war, is a temporary event; it should be met largely through higher taxes and lower spending 
in the future rather than right away, which is another way of saying that it should be paid for in large part by a temporary increase in the deficit.

This isn’t some novel idea, by the way — it’s the standard theory of public finance during war, going all the way back to Ricardo. And the logic of wartime finance applies equally to natural disasters. [emphasis added]

Recall that the standard theory says that, if everything were optimal ex ante, you'd want to cut spending on non-earthquake stuff, issue debt, and raise future taxes. The equilibrium size of government is a bit higher in total but spending on non-earthquake things has dropped. If you think government was too small ex ante, you should push for smaller non-quake cuts, larger debt, and higher post-quake taxes; if you think it was too large ex ante, bigger cuts to non-quake services, less debt, and smaller post-quake tax hikes.

Easton ruled out those options at the outset: spending cuts "could be politically and economically disastrous"; increased debt isn't on the table as he reckons it would make credit downgrades too likely.

But Easton also worries that the "loose fiscal stance" we'd have if we used debt to fund earthquake recovery would give RBNZ cause to tighten monetary policy. Maybe we're in some kind of knife-edge case where earthquake damage is sufficiently large that government cuts to other programmes sufficient to fund the earthquake reconstruction would be seriously damaging while debt issuance sufficient to fund the recovery would be a really large injection in need of partial offsetting; it's otherwise hard to reconcile his fear of big bad things happening with spending cuts and other big bad things happening with debt-funded spending. But standard theory says to fund things by both cutting current spending and increasing debt and future taxes rather than either alone.

And, it's hard to find much evidence of strong constraints on demand for our debt in the auction data; the last offering of government bonds found a weighted average successful yield of 3.8% on bonds maturing 2019. You can make a case for substantial tax increases if you think government is just way too small, but it's perhaps a bit mischievous to hang it on earthquakes.

But as Brian Easton was NZIER's Economist of the Year a couple of years ago, it's likely that I and Krugman and the standard theory of public finance going back to Ricardo are wrong on this one.

Optimal tax theory - contraception edition

Tyler points to some data on the price elasticity of demand for the Pill as contraception among college-aged American women. A price increase from $5-$10 per month to $30-$50 per month resulted in a 2 - 4 percent drop in use of the Pill. The paper says the price increase was "more than three-fold". If a 300% increase in the price of the Pill results in a 3% drop in demand, that's about the lowest price elasticity of demand I've ever seen - around 0.01.

Oh, the fun tax theory exam questions that could flow from this! Recall that the naive interpretation of Ramsey tax theory says that you want to tax more heavily those goods that are inelastic in demand: that way, deadweight costs are lower. But the more accurate interpretation of Ramsey (here too) is that you want to tax more heavily those goods that are complements to untaxed leisure in a world in which we can't tax leisure directly. Further, we have Pigovean reasons for taxing public bads and subsidizing public goods.

So, is the Pill a complement to leisure or to labour? Tyler points to some evidence from the paper's abstract:

Women who lack insurance and have sex infrequently appear to substitute toward emergency contraception; uninsured women who are frequent sex participants appear to substitute toward non-prescription forms of birth control. Additionally, we find small but significant decreases in frequency of intercourse and the number of sex partners, suggesting that some women may be substituting away from sexual behavior in general.

If intercourse is leisure rather than investment in work-related social capital, then we might have some Ramsey argument for taxing contraception. But it's not immediately clear in which direction any Pigovean argument might run. Neither is it even immediately clear in which direction any long-run Ramsey argument might run if you think through some general equilibrium arguments about sex, positional goods, and hypergamy; easy to imagine how it could go either way.

There's at least a short essay exam question in there on tax theory for anybody who's lecturing tax in public economics next year; it's a nice one where there are lots of clearly wrong answers but also many potentially right answers so long as the argument is reasonable.

Happy Valentine's Day!

Paraphrasing Robert Frank

Will Wilkinson points to the latest from Robert Frank. I'm going to change a couple words in the quote here; you tell me if it still makes sense. If it doesn't, why does it make sense if we switch it back to talking about forced income redistribution rather than forced kidney redistribution?

Each year as the April 15 health filing deadline draws near, healthy older libertarians mount the stump in high dudgeon to denounce the government for seizing kidneys that are rightfully theirs. They might do well to reflect briefly on the fact that no matter how much they've exercised, they wouldn't have had any kidneys to seize in the first place if they'd grown up in a country like Nepal or Somalia; they're already older than the average life expectancy in those countries. The infrastructure that made their health possible was built by those who today need kidneys. Much of that health is thus an unearned return on investments made by others.

Once we start viewing income in excess of that possible in the state of nature as a rent available for redistribution, I don't know what particularly stops the argument's extension over to forced kidney redistribution from those older than the typical life expectancy in the state of nature.

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.

Stealth Taxes

Frances Woolley argues the case for hidden taxes:

Visible taxes can lead to bad policy choices when a tax's visible incidence is different from its actual incidence. The average tax payer will vote for a tax/benefit scheme that appears to be in his or her interests - for example, increased health care spending financed by increased corporate income taxes - not realizing that the burden of the corporate income taxes might be shifted forward onto customers or backwards onto employees - in other words, right back onto the average tax payer.

It's a nice second-best argument. And, consistent with one of my favourite papers in experimental economics (previously discussed here): Sausgruber and Tyran's finding that buyers in a double-auction will happily vote for inefficient redistribution programmes framed as a tax on sellers but will oppose it when framed as a tax on buyers, despite equivalent incidence.

I'm not sure that a tax's invisibility necessarily protects against stupidity. New Zealand's clean GST is built into consumer prices; there's still not unreasonable pressure to wreck it by exempting food. But, that Labour's only advocated the wrecking ball when safely away from the Treasury benches suggests something.

Frances continues:

A final argument for stealth taxation is that it facilitates budget balance.  People want good things from their governments, like health care and old age pensions. But they don't want to pay taxes. So the temptation is to vote for spending initiatives and vote against any tax increases. When taxes become more visible, people become more aware of the taxes that they are paying, and lobby harder for tax cuts. The result: future generations are burdened with debt and taxes.

Now the argument could be made that in fact invisible taxes contribute to government debt - if the average voter realized how little he benefited from the Bush (Bush-Obama?) tax cuts, how much those tax cuts benefitted the richest Americans, and just how mind-bogglingly rich the richest Americans are, perhaps he would have voted against them. I don't know of any decisive evidence on this point, so if you disagree, feel free to say so in the comments.

Some degree of visibility in taxation is desirable - without information how the tax system works, and who bears the burden of taxation, it is difficult to make good policy decisions.

This is a fun one to think through. Specify that voters are largely ignorant but will vote against anybody they think is to blame for bad outcomes. And, specify a Westminsterian system so they know who's to blame for bad outcomes. In that world, I'm not sure whether it matters a lot whether the taxes are hidden or visible. If taxes with too high of deadweight losses are used to fund services of too little value, incumbents get turfed. Maybe it takes slightly longer if policy has lagged effects. Retrospective economic voting then saves things. If there's no opacity, the ruling party has to balance losses from bad effects of policy against loss in popularity from running "works, but unpopular" policy. At least there's weight on the effects of policy despite voters not knowing a damned thing except what they see out the window.

In a political system where responsibility attribution is more difficult - either Parliamentary with PR and powerful committees or a Presidential system with strong division of power and a federalist structure - things are harder to work out and could then persist longer. Then there's rather less incentive to weigh the effects of policy; rather, you blame the President if you're Congress, blame the other party in Congress if you're the President, blame the State if you're local government. Blame gets spread and incentives for good policy are flattened.

I'm also not sure that complete opacity is as good an idea in a Brennan-Buchanan Leviathan taxation world than in a Musgrove benevolent despot one.

Frédéric Bastiat or Paul Henry?

Ah, the ups and downs in the life of a blogger. Just when I was feeling quite chuffed about being compared to Frédéric Bastiat, Eric points me to the comments section of the Labour Party’s blog, where I am compared to Paul Henry. Specifically, commenter bbfloyd described my comments on Labour’s tax policy as

a series of personal opinions based on a worldview that can only be described as the result of a privileged upbringing

followed by

update.. just checked seamus’ blog… he writes like paul henry with a university degree. similar degree of narcissism.

Eric says that bb has me about right, although it is not clear if when he checked the blog it was my posts or Eric’s much more numerous ones that he was looking at.
This is all good fun, but it is the “worldview … of a privileged upbringing” that puzzles me. I’d describe my upbringing and current socio-economic status as comfortably middle class, which is privileged, but hardly what one would normally associate with that term. For the record, I have an income well in excess of $5,000 per year, well below $150,000, no assets that would ever be subject to a capital gains tax, and am a vegetarian who spends an absurd fraction of his income on fresh fruit and vegetables. That is, like most comfortably middle class people, and probably more than most, I would stand to gain a lot from Labour’s proposed tax policy. Such is Director’s Law. How that is consistent with my worldview, I’m not so sure.

Labour’s Tax Policy:

There were few surprises in the policy announced Thursday, as much of it had already been announced or clearly foreshadowed. The key policies are

• zero income tax on the first $5,000 of income;
• an increase in the top marginal tax rate to 39% for incomes over $150,000;
• exempting fresh fruit and vegetables from the GST (technically, zero rating them);
• a 15% capital gains tax.

I would stand to benefit quite nicely from these changes, but I still don’t like the policy. Let’s take each item in turn.

 

In principle, I don't mind the $5,000 tax-free policy. There are fixed costs to working compared to not working, which are not recognised when one has to pay tax from the first dollar earned. I could see a tax-free bracket having a non-trivial effect on decisions on whether to enter the workforce part time or not at all, particularly if the tax-free threshold could be lifted over time. A tax-free bracket is also a much more moral way of ensuring that workers receive a living wage than would be an increase in the minimum wage. I find it difficult to believe, however, that the other policies in the package could make up for the cost of exempting the first $5,000 of income from tax for every taxpayer. This is the unpleasant arithmetic of tax policy: Tax cuts at a particular income level only have an efficiency-relevant impact on the behaviour of those taxpayers whose marginal income is at that level, but they give a tax reduction to anyone whose income is at that level of higher; cuts in tax rates at the lower end, therefore come at a large fiscal cost for a only a small change in reduced disincentives.

 

The proposed increase in the top rate is silly. There is such a small proportion of the country’s income earned at those levels that the policy can hardly be expected to bring in a significant amount of revenue, but will surely lead to the usual tax avoidance games. It is hard to escape the conclusion that this is a purely symbolic policy designed to make people with incomes less than $150,000 feel good that those with more income are being taxed more. If so, it is appealing to a rather ugly side of human nature.

 

The zero-rating of fresh fruit and veg might just about be the most appallingly cynical election bribe the country has ever seen. I am not saying that it would be the most costly election-bribe policy enacted; that mantle would have to go to either National Superannuation or interest-free student loans. Rather, I suspect that this policy would have the highest cost relative to benefits, with benefits defined according to a policy’s proponents’ underlying preferences. Consider first the costs of the exemption: of relatively small importance is the lost revenue that will need to be made up elsewhere. More important, is the additional transactions costs in compliance, enforcement, and definitions that the policy would introduce. Much worse, is the erasing of the line in the sand that currently stands between a clean GST and one with messy exceptions; once we start on this slippery slope, there will be no clear line left to defend against creeping exemptions and tweaking of the GST system likely to be proposed in the future. Against this, are two putative benefits. First is the idea that the exemption will make the GST more progressive. I haven’t seen any data on this, but I would extremely surprised if taxing fresh fruit and were not a progressive tax; if one wanted to use the tax system to redistribute from poor to rich, I suspect the proposed exemption would rank second only to high cigarette taxes as a method for achieving that objective. The second supposed benefit is the health benefits from eating more fresh fruit and veg. The trouble is that nutritionists tell us there is no nutritional advantage to fresh over frozen or canned, so unless someone can show some convincing data giving a significant elasticity of demand for fresh fruit and veg that does not result from a substitution away from preserved fruit and veg, we would need to dismiss this benefit as well.

 

Finally, there is the proposed capital gains tax. I have never been a fan of taxing capital gains, but this is a complicated area that needs its own post. There are certainly good economic arguments on both sides. I do hope, however, that media commentators are careful to check the devil in the details. Just because famous economist X is in favour of a capital gains tax, calibrated in a particular way, does not mean that he or she is in favour of any capital gains tax. Neither statements like (“Treasury is in favour”) or government responses made before the details are known (“dagger through the heart of growth”) will move the debate along very far here.

 

Offering the other kid’s bat.

“Offering the other kid’s bat” is a metaphor I use in my welfare economics class for a certain type of government policy. The reference is to an experience I had way back when I was in Standard 3 (translation for younger New Zealanders, Year 5; translation for North Americans, 4th grade). We used to play schoolyard cricket at lunchtimes. The two key things to understand about our version was that, like real cricket, there were two players batting at any one time, and that, unlike real cricket, the way you get to bat was by being the person who made the decisive move in getting a batsman out, by taking a catch, effecting a run-out, or bowling the ball that hit the stumps. In this meritocracy, those of us who were not well endowed with sporting talent rarely got to enjoy the sought-after activity of batting. But I did get my chance one day when a ball got hit irretrievably onto a classroom roof and one of the boys who was batting at the time offered to let me bat if I let them use a ball I had brought to school that day. There was no cost to me from this trade, so I thought it more a generous act of social welfare from the boy making the offer rather than a market trade. To my horror, however, he promptly went over to the other boy who was batting, wrenched the bat out of his hand gave it to me and continued batting himself. (To my embarrassment, I have to admit that I accepted the stolen property.)

Many years later, I noticed how often public-policy rhetoric, particularly in election years, plays out essentially the same exercise of offering the other kid's bat: Group A are asked to demonstrate their commitment to social justice by agreeing to take from Group B to give to Group C.
I am reminded of this whenever I see calls for a higher minimum wage. Forget the debate about whether the minimum wage is an effective anti-poverty measure (probably not), or whether there are offsetting employment effects (probably true, but probably generally small), what is the morality of placing the burden of anti-poverty measures only on employers?
And I see echoes of offering the other kid’s bat today in the Labour Party’s tax policy, which according their leader is “bold”, will allow the government to “keep our assets, pay off debt, and create a stronger economy”, and yet will see “the overwhelming majority of kiwis paying less tax not more”. As far as I can see, this combination is not the result of a rosy scenario projection of the impact of the policy on growth, but rather an indication of the expected tax increases on the underwhelming minority.
Note that this is not a comment on Labour’s tax policy per se. I happen to think the policy is awful (more on that in later posts), but each of the component pieces can be reasonably debated on its merits. It is the packaging of the policy with the word “bold” while saying that the majority are getting a tax cut with no downside that is grating on me. And to be fair to Labour, the offering the other kid’s bat rhetoric is not unique to them but is a universal feature of political discourse. But it still makes me grumpy. (So grumpy that I am reduced to starting consecutive sentences with a conjunction!)

Where my taxes go

I like the visualisation over at Where My Taxes Go. In addition to giving the Budget 2011 breakdown by sector, they also give the per capita tax receipt. Here are some of the big ticket items.

• The set of DHBs (Health). 12.4% of total, $2298 per capita.
• New Zealand Superannuation. 11.7% of total, $2174 per capita
• Debt servicing. 4.5% of total, $829 per capita.
• New Zealand Defence Force. 3.8% of total, $700 per capita (though recall that almost none of this is spent on any actual deployment)
• Primary education. $620 per capita
• Secondary education. $456 per capita
• Tertiary education. $512 per capita
• Family tax credit. $492 per capita
• Domestic Purposes Benefit. $430 per capita.
• National land transport programme (highways). $407 per capita
• Student loans. $361 per capita. [Am mildly shocked that the per capita spend on student loans is this high; we must net from it though the $165 per capita in student loan receipts and the $109 in interest on impaired student loans.]

Collectively, transfers through Ministry of Social Development, the health system and education take up about sixty percent of the budget. It would be tough to run a serious attempt at getting the deficit down without taking on some of the bigger ticket items.

A payroll tax increase? Now?

The Prime Minister signals cuts to come in government spending on KiwiSaver, the tax-preferred retirement savings vehicle. The government currently subsidises KiwiSaver contribution with a one-off $1000 deposit into new KiwiSaver accounts and matches employee KiwiSaver contributions up to about $1040 per year. Employers are required to kick in contributions equivalent to 2% of your pay if you're eligible to join.

This has proven somewhat expensive for the government; consequently, John Key's signalled a halving of the government's contribution, with minimum employer and employee contributions to rise.

I hope that Key doesn't go for any large or quick increases in mandatory employer contributions. Tax incidence says it doesn't matter whether the employer or the employee bears the statutory cost, but if nominal wages are downwards sticky - and I can't believe that wage cuts consequent to mandated employer side contribution increases wouldn't get the employer into hot water - employers will react similarly to other payroll taxes. If it's done through a slow ratchet, employers can more easily compensate by varying the proportion of the total compensation bundle going to employees via cash and retirement funds.

And now I'm mildly curious whether StatsNZ data on hourly wages include effective payments made to employees by employers through KiwiSaver. I doubt that it does. Nominal wage data will then understate the growth in full employee compensation. [Update: One series includes it, another doesn't. I'll have to watch next time to see which is the one quoted in media reports. See here and here. Thanks Scott!]

Next week's budget will be interesting.