Shining a light on unfairness in our tax system
Victoria University 26 April, 2022
Those coming here expecting announcements of new tax policy will be disappointed. None are being made. We have no secret plan to introduce a CGT nor a wealth tax or a deemed income tax, nor others. The IRD is not doing any work to even develop these or other options.
Today is none the less important, in that it sets out important new foundations for tax policy, and explains some of the work I have asked Inland Revenue to get underway so as to better understand the outcomes of our current tax system. Outcomes that are currently opaque.
Tax is not always exciting, but I’ll try to keep you awake.
It is no coincidence that wealthy countries perpetuating the virtuous cycle of high standards of living and peace have substantial government programmes funded by substantial tax revenues.
Taxes pay for services which make society more prosperous, fairer, and peaceful.
An educated population, with good health and longevity, the maintenance of the rule of law, and even the collection of reliable statistics to measure progress and problems, are all critical to the functioning of modern prosperous nations.
This is why I advocate for fair taxes – as little as possible but as much as is necessary.
New Zealand is not a highly taxed nation. We sit in the middle of the OECD pack for total taxes.
Our total taxes don’t change hugely as a percentage of GDP, and have ranged between 30 and 36% in recent decades.
Boom times and recessions often have a larger effect than government changes to tax policy.
Even now, after the trauma of the COVID pandemic, New Zealand’s taxes are about 32.2% of GDP, which is close to identical to the 31.6% of GDP under National in 2012 after the GFC.
Contrary to the heat generated by the debate over the last few percent, there is widespread support for taxation.
Voters cast their votes in support of taxes for a mixture of reasons.
Some are altruistic. The “golden rule” common to most religions is “do unto others as you would have them do unto you”. Caring for fellow members of society is a core value of people, whether or not their values are faith-based.
Voters overwhelmingly believe everyone is better off with an educated and healthy population, and they know both cost money. It’s about more than altruism. They accept the whole community is worse off economically and socially if education or health services cannot be provided to those who need them.
Taxes fund the justice system, including the police and the courts, needed to protect people and to uphold property rights.
Those with lots of wealth obviously want to protect what they have against the huge loss they can incur if society becomes so unequal and unfair that those left out rise up and refuse to recognise their property rights.
Short of that extreme, we prefer taxes to the crime and discontent which can fester when other people can’t get by.
Voters support tax policy doing more than just funding what government spends in a particular year. They accept that governments, like them, should put money away for that rainy day.
The fiscal effects of tax enable society to smooth out the highs and lows of the economic cycle. By running surpluses in good times, in the hard times education, health, benefits, the police and other public services can still be funded.
These so called “automatic stabilisers” bolster the economy in downturns, helping societies endure those recessions with less hardship while maintaining the social contract.
The COVID support payments in the last two years are the most obvious and successful example of this in decades. Our world leading health and economic response to the worst pandemic in a hundred years relied upon them.
So the dark cloud of Covid has had an unexpected silver lining. It engendered a greater sense of social cohesion, and moved the public and media attitude towards the importance of those occupations that have traditionally been relatively low paid. It underscored our reliance as a society on others - not only our nurses and doctors in our health services, but our supermarket workers, cleaners, farm workers. Those who provide essential infrastructure – border workers, rubbish collectors, and bus & truck drivers. Our reliance on each other was clear.
The assistance needed and given through wage subsidies for businesses affected by Covid and the lockdowns illustrated the importance of state support for individuals and enterprises facing adversity.
This has improved societal understanding that an important objective of taxes is to redistribute income, as well as the cost of public services, on a socially acceptable basis.
This objective extends into avoiding extreme concentrations of wealth, most often given voice in New Zealand via politicians concerned about decreases in home ownership rates.
Addressing and balancing all these objectives on a socially acceptable basis means a basis which voters support.
Most of us want the vulnerable protected from poverty, because we believe this is morally the proper thing to do.
We also recognise that but for good luck, any of us (or our loved ones) could be in need.
We don’t want to be like the USA where a leading cause of bankruptcy is unpaid health bills.
We want opportunities for advancement for ourselves, our families and our friends.
Voters clearly want a tax system which makes the economy stronger. It is more often than not the major theme of any election.
When asked what is the most important topic to voters at election time Bill Clinton’s campaign famously summed it up: “it’s the economy, stupid”.
Voters understand, at least at a general level, that the tax system shapes the economy.
Politicians, fourth estate commentators, unions, and business groups who advise voters all tell them that taxes affect not just their take home pay, but savings and consumption, investment, and the strength of our economy.
Taxes affect investment returns, and bad laws can distort investment into speculative asset classes rather than enhancing investment in the productive sectors that create jobs and earn exports.
Overall, voters want their tax system to be fair, and so do I.
The eternal challenge for politicians who want to improve the system is to convince voters that any proposed tax changes will be fair to them while making the economy stronger and society better.
If we fail to do that, beneficial changes to the tax system can be hi-jacked by those whose self-interest is adversely affected. They can squalk loudly.
This propensity to misrepresent tax changes is why “tax switch” language was used so forcefully, and effectively, by Bill English to defend the 2010 increase in GST and reductions in income taxes. While I did not agree with the proportion of that “tax switch” that went to higher income earners, the way he carried that debate was a master class in the politics of changing the tax mix.
Those opposing change sometimes fund campaigns via intermediaries, whose grasp of economic theory and settled tax principles at times evaporates when in conflict with the private interest of their funders.
While many leaders - Gareth Morgan and Sir Stephen Tindall are two brave examples in New Zealand - rise above their self-interest and advocate for improvements, some don’t.
Opponents to change can get away with wrongly alleging that changes are a tax grab rather than a change to the mix of taxes. This happens even if there is no change to the total tax collected and change is obviously needed.
Many in this room have been advocating for changes that meet the objectives I have described above. None has succeeded. We must ask ourselves - Why?
I believe the tax debate in New Zealand has become mired in unnecessary controversy, and I have some foundational work under way to address that.
We need to report actual outcomes against settled tax principles. Currently, sadly, we don’t.
Yes, there will always be political disagreement about the last few percent of taxation, and debates about how progressive the tax system should be. I am not trying to avoid nor blunt that.
I am enjoying the current political debate – with National promising to both cut taxes for those earning incomes above $180,000 and to reinstate investment-distorting tax breaks for landlords.
That’s right, those who already own multiple houses worth many, many millions of dollars would be rewarded by our opponents for returning to that old habit; using that tax advantage to leverage their properties even more - allowing them to buy another house by outbidding people who just want one home of their own.
National is proposing to return to what even the OECD has described as NZ tenants subsidising the taxes of their landlords.
Far from helping the “squeezed middle” that they claim to champion they are in fact squeezing them harder while cutting taxes for the better off.
We will win that debate.
Having made my political point, and highlighted our very different approach to that of the Opposition, I readily accept you can never take the politics out of tax.
We can, though, have a fact-based discussion.
Currently many people look at our headline personal income tax rates and see a system that charges higher rates on higher taxable income – and they assume that the system is progressive overall. It isn’t.
What’s hidden is that the effective marginal tax rate for middle income kiwis is generally higher than it is for their wealthier co-citizens. Indeed some of their wealthier Kiwi compatriots pay very low rates of tax on most of their income.
It is rare for the debate to properly factor in the effective rate of that regressive tax - GST - as a percentage of income, or for that debate to include economic income that is untaxed.
Statistics, statistics, damned lies and statistics.
In the absence of trusted facts it is little wonder that my political opponents can misrepresent simplistic concepts.
Yet, there remains a sense of unease, especially amongst younger New Zealanders who see their opportunities constrained by current inequities in the tax system.
Many believe those better off than themselves can structure their affairs to pay lower taxes. But can they prove it?
This is a worldwide problem, and that problem is compounding year upon year. Thomas Piketty has shown that it is certainly not the meek who are inheriting the earth.
Yet Elon Musk, Jeff Bezos and their ilk - fresh from blasting into space – effectively avoid scrutiny of the low tax rates they enjoy on this planet compared to the middle income people who work for them or buy their products.
This is not the politics of envy. It is the politics of fairness.
So how can voters assess who is right, and why can’t we prove it?
The Labour Government believes it is the responsibility of government to shine light, and we will.
Only IRD can gather the data needed, and now, for the first time in our history, they are.
I’ll first deal with the serious shortcomings of current data, and the major investigation, that is well under way, to fill those gaps.
Then I will turn to how we are grappling with reporting to the public, based on that research, in accordance with settled principles which I believe should endure.
So, first what are we doing about data inadequacies?
We have poor data on the distribution of wealth and capital income in New Zealand.
Via the census we gather information on home ownership, which is reliable.
We have very good data on the earnings of salary and wage earners. That data is collected every pay day and forwarded electronically to IRD.
Dividend and interest earnings are also well understood.
So far so good.
But we have two big gaps.
The smaller of the two relates to GST. It’s easier to solve and less significant, so I’ll cover that off quickly first.
We have good, largely automated systems underlying the GST payments that are due to IRD.
However we have much more limited understanding of how much different groups in our population pay.
While GST is collected by businesses, they pass that cash-cost on. The actual cost is borne by those who buy GST-inclusive goods and services. Thus GST is really paid out of our earnings when we spend them. In economic terms GST is mainly a tax on labour income. Who bears that cost?
Data is limited on the effective overall GST rate paid by New Zealanders. We don’t really know this by either income or wealth decile.
I have asked IRD to remedy this. I expect we’ll be using the best data we have, rather than collecting more.
Statistics New Zealand gathers some spending data via the Household Economic survey. Analysis of that data will help. Perfect analysis is complicated by life time income, savings and consumption patterns, which differ by age more for some deciles than others.
Nevertheless I expect it will show trends by income and wealth, which we maybe we can extrapolate for higher income and wealth groups that are not well measured in the survey.
This is a bigger issue for New Zealand than most countries because, under our broad GST system, we have one of the highest proportions of consumption tax as a proportion of total taxes in the world.
I support our GST system, but it is regressive. While not all taxes need to be progressive, the system overall should be. We can’t properly assess our tax system without knowing what effective GST rates are for different cohorts in New Zealand.
So we will better analyse this.
The second gap is the larger and more serious one.
We have virtually no idea what rate of tax is paid by the very wealthy.
As wealth concentrates into the hands of an ever smaller cohort at the very top, more and more of their income, and a greater proportion of national income, is represented by returns on capital.
How much this amounts to, and how much of it is taxed or untaxed, is currently unknown in New Zealand.
Our statistics are worse than Australia’s & Europe’s.
Our rough measure of net assets suggest that outside the family home, 65% of all wealth is held by the top 10%. In fact, it could be that more than 2/3rds of all financial assets are held by the top 5%, with most of that concentrated in the top few per cent.
I said the 65% held by the top 10% is a rough measure, because it is undoubtedly an underestimate based on the Household Economic Survey, which has severe limitations at the top end.
Until recent years most people thought the HES was pretty reliable. In fact it is close to useless in disclosing the wealth or income of the top few percent.
In Capital in the 21st Century, Thomas Piketty made the point that countries that rely on surveys and don’t actively monitor the affairs of the very wealthy have greater wealth inequality.
He explained that survey measures of wealth don’t work at the top end because survey questions are too general to burrow into the multiple and complex discretionary trust and private company legal structures used by the very wealthy.
Questions don’t delve into capital income.
Valuation methodologies are inconsistent.
And at the top end there is a propensity to understate when making disclosures to government agencies.
When I delved into our survey measure, we proved that the highest net wealth ever surveyed in the Household Economic Survey was $20 million dollars.
That’s right. The NBR rich list is a better data set than the official statistics.
I was not surprised, but I was still shocked. A $20 million max. Really?
How come, in a country with billionaires, our data set used for policy purposes effectively ignored the wealthiest? It’s not out by a factor of ten – that would be huge in itself. But that maximum is out by a factor of hundreds.
The Tax Working Group did not have the power to find the truth, but they did record the problem in their reports.
Further, when I became Revenue Minister I was told that the intermediaries holding data on the 1%, who have duties of confidence to their clients, did not provide information to IRD not needed for tax administration. They could say “all taxes properly payable are paid, so bugger off”.
It beggars belief that we currently don’t know what rate of tax is paid by the top cohort in New Zealand on their economic income. We do know the rate paid by wage and salary earners, and by small business owners.
I was advised that the UK Revenue department has an information gathering power for policy purposes. Other countries already collect the information because they ordinarily tax capital income in some way. I concluded we were an outlier.
Cabinet agreed. That’s why, in last year’s Budget, we moved to address this data gap.
Parliament conferred this much needed information-gathering power on the Commissioner of Inland Revenue here, and Inland Revenue was allocated funds to conduct research relating to the tax paid by the wealthiest New Zealanders relative to their economic income.
I am pleased to advise this is now under way.
It has attracted ill-informed speculation on the Government’s motives, which is why I emphasised at the start that the Government is not secretly working on new taxes.
Rather, this research is about improving the evidence base about how the current tax system actually operates. This information will inform future tax policy advice and so it may feed into future tax policy development.
The project is not targeted at specific individuals, and no individualised information will be published.
Inland Revenue has put many safeguards in place to protect individuals’ privacy.
The information collected will be securely held separately from Inland Revenue’s other systems.
Only officials working on the project will have access to the individualised information, which will be destroyed at the end of the Project.
Information gathered will not be used in assessments either for current or future taxable income.
What it will do is allow any future tax policy development to be based on solid evidence.
There was consultation with the Privacy Commissioner on the ground rules for the information collection, and an advisory group has been formed to help refine the methodology to be applied.
Compliance costs are being managed appropriately. Some information is already held and new valuation information is not being sought.
Following a screening round of consultation, the IRD has now sent out a request for information on the very large number of legal entities owned by individuals in the research group.
I thank those who are cooperating with this research.
I admire the creativity and energy of our successful business people. I have worked with many of them over the decades and I respect the role they play.
But I believe we should all pay our fair share.
While we already have evidence that the wealthy pay lower rates of tax than middle income earners, no one can tell you how much lower their effective tax rate is.
Currently it really is a stab in the dark.
Until we have a more accurate picture about how much tax the very wealthy pay, relative to their full “economic income”, we can’t honestly say that our tax system is fair.
I think the gap will shock some people, but whether my instincts are right or wrong will be proven by the data.
It will mean that in the future, our tax policy advice is better informed – whatever the political stripe of the Government of the day.
This leads to the second leg of the double. How should we use this better data? Put another way, what principles should we assess tax policy against?
A Tax Principles Act
I believe we need a route to enable improvements in our tax system.
A Tax Principles Act will help.
It surprises some who witness the heat of tax debates that there is widespread agreement about core tax principles. These are long settled.
Adam Smith in his 1776 book The Wealth of Nations laid out four maxims that still hold sway.
Successive tax enquiries over many decades in New Zealand and similar countries overseas have all enunciated similar principles.
In NZ the 1982 McCaw review, the 2001 McLeod review, and the more recent 2019 Report of the Tax Working Group.
In Australia the 2010 Henry tax review. And in the UK the 2011 Merrlees report.
They all endorse the same principles, based in that most core value of New Zealand - fairness.
The main settled principles are:
- Horizontal equity, so that those in equivalent economic positions should pay the same amount of tax
- Vertical equity, including some degree of overall progressivity in the rate of tax paid
- Administrative efficiency, for both taxpayers and Inland Revenue
- The minimisation of tax induced distortions to investment and the economy.
New Zealand is renowned for our fiscal responsibility legislation and reporting framework - now in the Public Finance Act. It has served us well.
So do reporting frameworks for child poverty and climate change.
In all these areas, we know what direction our country is headed, enabling voters to judge against promises made.
I find it anomalous that for the most core of government functions, the collection of tax, we have no equivalent.
Little wonder our tax debate is so easily side-tracked by opinion and conjecture.
Political parties will genuinely disagree as to how best to apply tax principles. Voters need to assess their proposals. A reporting framework will help both.
Our proposal is to require Officials to periodically report to Ministers about the operation of the tax system, using the principles as the basis for their reporting.
As to how these, or other, principles are expressed, we seek something that New Zealanders of all stripes see value in retaining and protecting.
They need them to be clear enough to avoid ambiguity, without determining outcomes which are political.
In New Zealand we have the advantage of a number of previous tax inquiries. The advice they prepared can be drawn upon as to what could be widely accepted tax principles for New Zealand.
Lots of people have strong views on what tax policy should seek to uphold. Many hold opposing views. The trick will be to find that higher level, common ground from which information can be reported and the debate can be had.
Currently, the project is in its early stages. I am discussing this with officials in the Treasury and IRD.
An important stage of the project will be wide public consultation on the proposed principles and reporting framework. We’ll be going that around the middle of the year, and hope you will share your views,
While the Public Finance and Child Poverty Reduction Acts require the Government and officials to report on specific issues within a legislative framework, the approaches which they take differ.
Where the PFA requires the Government to prepare financial information according to widely accepted accounting measures (which develop over time), the CPRA’s reporting measures are closely prescribed within the legislation itself.
In the context of a tax principles statutory reporting framework, this could mean a set of high-level, general principles in legislation, with a legislated requirement for the government to issue a guiding statement setting out its views on the development of tax policy. Tax policy officials would be required to independently report information relevant to those tax principles.
It could also entail more detailed principles and defined measures in legislation with officials reporting according to those defined criteria with a focus on the data controversies of the day. For example, it could require officials to report on the progressivity of the tax system.
I will be working closely with officials to develop an appropriate methodology.
A Bill will then be introduced to bring these into effect and set up the reporting requirements.
I would like to see these principles enacted in a Bill before the end of the current Parliamentary term.
If Parliament passes it, the Tax Principles Act will take its place alongside the Tax Administration Act and other revenue Acts to create the tax system that New Zealanders can understand and be proud of.
I believe these two projects are important.
They will result in stronger economy, a fairer tax system, and a better New Zealand.
I really appreciate you taking the time to be here today.