Equity and fairness key to tax considerations
Equity and fairness will guide the Government's consideration of the Tax Working Group's options for changes to the tax system, Finance Minister Bill English said today.
"The benefits must clearly outweigh any potential difficulties to warrant significant changes," he said in a speech to the Institute of Chartered Accountants in Auckland. "Equity and fairness will be key considerations, alongside benefits for the economy and for households."
The Tax Working Group, led by Victoria University's Centre for Accounting, Governance and Taxation Research, is taking a first principles look at the tax system. It is also considering how tax can contribute to economic growth based on exports, investment and sustainable jobs.
"The group is looking at proposals that, when taken together, are fiscally neutral," Mr English said. "The Government has a strong preference not to increase taxes to close the budget deficit. We prefer more efficient taxes over higher taxes.
"And, unlike other many other countries, we have no desire to increase the tax take."
The Tax Working Group is due to report in December and its options will be considered by the Government early next year, Mr English said.
New Zealand would also need to be mindful of international developments – particularly the Henry tax review in Australia.
"Australia is our largest trading partner, the source of much of our foreign investment and a destination that lures large numbers of Kiwi workers abroad, so we are keeping a close eye on developments.
"If the Henry Review results in Australia moving to lower its taxes, our own review will leave us well placed to consider options that maintain our international competitiveness."
Media contact: Craig Howie 04 817 9895 or 027 755 5809
Speech to New Zealand Institute of Chartered Accountants
Rendezvous Hotel, Auckland
Saturday, October 17, 2009
Good afternoon and thank you. It is a pleasure to be here.
It's great to have the opportunity to explain the Government's economic plan and lay out some of the challenges we face - along with the role tax policy will play.
The Government has a very clear plan to increase our productivity, grow our exports and start narrowing the income gap with our trading partners. We're focused on what matters: jobs and growth.
Since the election, the economy has been the Government's top priority.
One of the main effects of the recession has been a big fall in forecast tax, putting pressure on Government spending and limiting policy options.
We are not alone. Governments around the world are facing the same
Wrestling debt under control will be the fate of many Western countries as they emerge from the current crisis. They will end up with smaller public services, lower pensions or increased taxes as a result.
New Zealand is better placed than many countries in determining how it responds.
We don't want to go down the route of raising taxes. We are committed to a tax system that contributes to economic growth, is competitive internationally and helps New Zealand families get ahead.
As we emerge from the recession it is worth pausing to reflect on whether our tax system is as simple, fair, efficient and robust as it can be.
The fiscal and economic challenge
But first, it's important to understand the wider economic and fiscal environment in which we are considering our tax policy options.
Our current economic and fiscal challenges are more significant than we have seen for two or three generations.
The Government inherited a New Zealand economy that had gone into recession in early 2008 and was under considerable stress from imbalances built up over the past decade.
It's now clear that our economy started to get out of balance around 2003 - and it has since got progressively worse. Here's what I mean:
- Bank credit and household debt started blowing out
- Non-tradeables inflation took off and remained high at around 4 per cent
- Government spending ballooned - increasing by 50 per cent in the past five years - double the rate of economic growth and government revenue
- And since 2003, our productivity has sunk to a 25-year low.
Let me set out two indicators of our lopsided economy:
First the tradeables sector - that's exporters or industries competing with imports - has actually been in recession for five years, contracting by about 10 per cent in that time.
Even more staggering, there have been almost no net jobs created in the tradeables side of the economy for the past 10 years.
By contrast, the non-tradeables sector - domestic industries not competing with exports, including the Government - has grown by 15 per cent in the past five years.
The second symptom of New Zealand's unbalanced growth is the red ink in the Government's accounts - the result of fast-rising spending and falling revenue.
The Crown accounts for the year to June 30, 2009, released this week, illustrate the problems we face.
Revenue was $2 billion lower than in 2008, spending jumped by $7 billion and the operating deficit stretched to $10.5 billion - an almost $13 billion turnaround from the $2.4 billion surplus 2008.
We now face cash deficits of between $10 billion and $12 billion for each of the next four years. On current projections, we will not be back in budget surplus for a decade.
The recession has had a significant impact on the Government's books.
Over the four years from 2008, our total GDP will be permanently $50 billion lower than if the global financial crisis had not occurred. That means the Government will collect about $16 billion less tax revenue.
With expenses continuing to grow regardless, we will double government debt by 2014 - borrowing an average rate of $250 million every week for the next four years.
One of the consequences of issuing all of this debt is that the Government's finance costs will increase markedly.
In recent years, these costs have sat around $2.5 billion a year. Budget 2009 forecast finance costs to double to more than $5 billion a year by 2014 - roughly the combined amount spent on law and order and defence.
So these finance costs will compete directly with spending on more worthwhile public services.
It was entirely appropriate for the Government to increase its borrowing to cushion New Zealanders from the worst effects of the recession. We are doing this to maintain public services, preserve entitlements and prepare the economy for sustainable productive growth.
However, additional borrowing on this scale cannot continue indefinitely and the Government has taken steps to ensure the rising tide of debt is turned back.
Let me stress here that public finance cycles are long.
Net government debt rose steadily from the early 1970s and peaked at over 50 per cent of GDP in 1992. It then took another 16 years of near continuous growth to get it down and almost eliminate it by 2008.
So we can now expect it to take 20 to 30 years for the Government's finances to recover from the impact of this recession.
The Government's economic programme
Before I discuss our thinking about tax policy in more detail, I'd like to set out the Government's plan for dealing with these challenges and increasing New Zealand's economic performance.
It's important that tax policy is seen within this wider context.
We have identified six key drivers of our economic programme over the next three to five years:
The first area is reforming the regulatory environment and cutting away red tape getting in the way of business and productive investment.
Regulatory Reform Minister Rodney Hide has been extremely busy working with the Government to get this significant two-year review programme underway.
It includes the Overseas Investment Act, the Resource Management Act, the Building Act, the Holidays Act, electricity and telecommunications rules, and the emissions trading legislation.
The Government's second policy driver is significantly lifting the performance of the public sector, while reducing the rate of spending increases.
You will have heard a little about this from Revenue Minister Peter Dunne yesterday when he spoke about work being done to "Transform IR".
The public sector represents about 30 per cent of the economy, so it's ssential that it plays its part, particularly with the Government's finances under pressure.
We've made it clear that we will improve both the efficiency and effectiveness of spending, while limiting the negative impacts of public policies on private enterprise.
The next area is investing in productive infrastructure.
The challenge here is quite simple. It is to ensure that the right level of investment is made in the right places by organisations with the knowledge and incentives to invest.
Earlier this year, we established the National Infrastructure Unit. One of its roles is producing the first National Infrastructure Plan by early next year - a stock take of current demands and investment programmes which will become the focal point for industry co-operation.
The impact of the Government's programme on infrastructure investment is already evident. We are investing $7.5 billion over the next five years to build and upgrade schools, roads, housing, hospitals and telecommunications.
The Government's fourth policy driver is education and skills. There are several parts to the Government's focus in this important area.
The first is literacy and numeracy at primary schools, driven by National Standards, which will set clear expectations, measure children's progress against those expectations and report their progress to parents in plain English.
The second area is providing options for secondary-age students outside the traditional school system.
The Government's fifth policy driver is innovation and business assistance. This covers government and business investment in research and development, in innovation, and in developing new markets and products.
Our considerable investment in this area will help firms connect with overseas markets and consumers; as well as help them develop new ideas to create new and higher value products and services.
Those goals will help drive productivity growth and investment in the tradeables sector, and improve our export performance.
Finally, let me turn to taxation - the sixth focus of the Government's economic policy agenda for the next three to five years - and no doubt the area you are keen to hear about today.
Taxation is one of our six policy drivers because of the pervasive influence it has on both the economy at large and on decisions made by individuals.
As we have said, New Zealand needs to lift its economic growth.
That's all the more important with 60,000 people now on the unemployment benefit and with unemployment likely to continue rising well into next year.
We also need to increase household incomes so they can save, repay debt and, from the Government's perspective, so it can get back to budget surpluses sooner.
This Government sees a simple, fair and efficient tax system that encourages New Zealand families to get ahead under their own steam as one of the key drivers of economic growth.
Ideally, the tax system should impose the minimum cost necessary to get the revenue needed for vital frontline services and to support the most vulnerable.
That means it should be simple to administer, easy to comply with and not drive behaviour and investment decisions.
It should also provide the right incentives - allowing people to keep more of their own money encourages them to invest time and effort into improving their skills so they can earn more. This also has a productivity benefit for the economy.
In addition, the system should be fair - most forms of income should be covered and where possible loopholes that allow the sheltering of income to avoid tax should be closed.
Lastly, our tax system must be internationally competitive - New Zealand with its small population and capital markets needs to attract skilled workers and encourage people to invest here.
And if our economy is to thrive, we need to ensure our best and brightest have good reasons to stay.
It is no secret we have one of the most internationally mobile labour forces in the OECD, with huge numbers of Kiwis living overseas, the second highest proportion of expats after Ireland and strong migrant flows.
In short, we rely on high levels of inward migration and investment.
The tax system should help New Zealand attract and retain the people, businesses and investment it needs.
Until recently, the relative simplicity of the New Zealand tax system was one of its strengths. However, it has become increasingly complicated.
Tax Working Group
Earlier this year, the Minister of Revenue and I announced the establishment of a Tax Working Group, led by Victoria University's Centre for Accounting, Governance and Taxation Research to review our tax system.
The aim was to take a first principles look at the system and see how it could be improved - and in recent months the working group has set out some of its ideas in a series of public papers.
The working group is looking at proposals that, when taken together, are fiscally neutral. The Government has a strong preference not to increase taxes to close the deficit. We prefer more efficient taxes over higher taxes.
And, unlike many other countries, we have no desire to increase the tax take.
Some of the challenges the Tax Working Group is considering are:
- Whether the efficiency and integrity of the tax system could be improved through changes to the tax mix. This will include consideration of the Government's 30/30/30 tax goal, and challenges associated with this in the current environment.
- Whether the tax base could be broadened so we are less reliant on personal and corporate tax.
- Whether changes to the tax mix could tilt the playing field away from borrowing and spending towards exports, investment and sustainable jobs.
- How we could simplify the tax system to reduce compliance costs and make it as easy as possible to administer.
I'd like to take this opportunity to commend the Tax Working Group's work to date. The calibre of its experts - drawn from government, academia and the private sector - is extremely high. So far it has tackled its brief with clarity and rigour.
The group's work is also extremely timely. Across the Tasman the Australians are conducting a review of their own tax system, led by the Secretary to the Treasury, Ken Henry.
Australia is our largest trading partner, the source of much of our foreign investment and a destination that lures large numbers of Kiwi workers abroad, so we are keeping a close eye on developments.
If the Henry review results in Australia moving to lower its taxes, our own review will leave us well placed to consider options that maintain our international competitiveness.
So I look forward to receiving the Tax Working Group's report in December. We will consider its findings in the New Year and any changes will be signalled in Budget 2010.
The benefits must clearly outweigh any potential difficulties to warrant significant changes.
Let me be clear, equity and fairness will be key considerations, alongside benefits for the economy and for households.
The Tax Working Group's papers on property-related taxes have generated a lot of public debate.
And so too has the idea of increasing GST to provide revenue for personal tax cuts. The main issue here is fairness - low income earners, in particular, would have to be compensated for any increase in GST.
There are arguments for and against these ideas and I'm happy for the working group to consider them. As a Government, we welcome debate, but we must be practical and realistic.
As Prime Minister John Key and I have both stated previously: the Tax Working Group will have to come up with some fairly compelling reasons to convince us of the overall benefits of further property-related taxes or an increase in GST.
High marginal tax rates
The working group has raised a number of issues in its papers released so far. One of them is our internationally high marginal tax rates.
An average wage earner with children loses over half of every extra dollar they earn, once our high top tax rates and the abatement of Working for Families tax credits are taken into account.
This puts us in the bottom half of the 30 OECD countries on this measure. In the UK, France and Japan, the same worker would get to keep far more of every extra dollar earned.
Getting to keep less than half of what they earn is hardly an incentive for people to aspire to higher incomes.
In New Zealand the top rate of 38c starts at just $70,000 - about 1.5 times the average wage. This is much lower than the OECD average, which is about 2.4 times the average wage.
In Australia the top rate at 45c is higher but you need to earn over A$180,000 to pay it, while in the US the top rate is about 40 per cent, but you need to earn about NZ$340,000 before you pay it.
Differential tax rates and income support like Working for Families and student allowances create big incentives for people to minimise their "taxable income".
This is amply illustrated by the 9700 high-income families with rental properties, who last year claimed tax losses, enhancing their eligibility for Working for Families payments.
A case can also be made that a wide gap between the corporate and the top personal rates provides incentives to use the company structure to avoid the top personal rates.
A key issue here is the overall credibility of the system. Large scale legitimate avoidance behaviour by higher income earners undermines the goodwill of lower income earners.
It's quite telling that there has been virtually no growth in the number of people paying tax on $1 million of annual income since the 39 cent top personal tax rate was introduced 10 years ago.
We don't want people spending their time and resources trying to avoid tax. Equally we also don't want IRD devoting all its time to chasing tax and compliance issues.
As a country, we want families, businesses, accountants and lawyers looking at how to unlock greater income and productivity, not working out how to minimise their tax.
I'm pleased to see the New Zealand Institute of Chartered Accountants and Tax Management New Zealand proactively looking at how the tax system for small businesses could be simplified to reduce compliance costs.
They have set out two proposals:
One is for micro businesses earning under $60,000 a year and not registered for GST to pay a final tax of 15 per cent based on turnover.
The other proposal is for businesses with annual turnover of less than $1.2 million to have their income tax calculated on a cash basis, based on their GST return.
I understand that a final report will be submitted to the Government next year for our consideration, after consultation with the SME sector.
I believe these proposals have merit and they will not be dismissed out of hand. Tax policy officials will engage with the Institute on them.
Examining the tax mix
Another area the Tax Working Group is considering is the tax mix.
As a country, New Zealand relies heavily on the taxes that are most damaging to growth - income and corporate taxes. Nearly 60 per cent of our revenue comes from these two sources.
Here are some facts worth considering:
- In 2000 around 5 per cent of wage earners paid the top personal tax rate. In 2009 this has climbed to 9 per cent and it is expected to reach 25 per cent in 10 years.
- We collect the third highest ratio of corporate tax to GDP in the OECD.
At the same time, distortions are created by the things we do not tax.
Most people would see it as unfair, for example, that speculators can reap large tax-free gains while low and middle income workers are taxed on every dollar they earn.
Inland Revenue has published data showing that last year the losses claimed by people with rental properties were $575 million more than the income declared from residential rentals.
The net reduction in Government revenue was approximately $150 million, while the capital value of this asset class roughly doubled.
This is a recent trend. In 1999 rental properties generated over $600 million in taxable income.
Industries like farming, manufacturing and tourism, are vital to providing sustainable jobs as we come out of the recession.
However, in recent years, large increases in property values have contributed to high interest rates for these sectors.
Those higher interest rates, in turn, push up our dollar, reducing exporters' margins and making it more expensive for businesses to borrow. Again, this cycle harms our productive industries.
Can I finish by reiterating that the Government is clear about what needs to be done to turn this economy around. We have a balanced, targeted and effective plan to achieve that.
However we need to make sure we get the kind of recovery we want - one that will create sustainable jobs and growth.
Despite our considerable economic challenges, I'm confident about New Zealand's prospects because of the resilience demonstrated by many New Zealanders. We are seeing early signs of recovery, which I welcome.
By backing ourselves as a country, we have a real opportunity to emerge from the recession stronger and more competitive than other countries.