Keynote Address to IFA Annual Conference
9.15am, Friday 15 March 2013
It is a great pleasure for me to once again address an IFA conference and to have this opportunity to share my thoughts on taxation issues with you.
This is the eighth time I have had this privilege, and certainly I regard this annual event as an important opportunity to outline the taxation work programme and government thinking for the year ahead and beyond.
And I always look forward to learning about your thoughts.
Before I begin, let me say that there is much to learn from the experience and thinking of other countries.
It is why New Zealand has always sought the advice and commentary of outside experts in tax policy.
And we are truly fortunate to have the presence of one such expert, Professor Alan Auerbach, who will also be addressing this conference.
I look forward to hearing about the views he expresses.
Let me also take this opportunity to step back and make some observations about tax policy in New Zealand as someone who has been a privileged participant in the policy process for almost three decades.
I would like to reflect a bit upon where we have been, some factors which make New Zealand special, where we are now and also provide some thoughts on future directions.
In Budget 2010, the Government put in place the most important set of tax changes in twenty years.
The changes were substantially influenced by the deliberations of the Tax Working Group which drew together tax practitioners, academics and tax officials.
For the Tax Working Group, everything was on the table, and I would have to say that a massive amount of very high quality work was produced.
More recently there has been an internal government savings and investment review.
What I would like to do today is summarise what the Government has concluded from these tax reviews and the implications for our tax system in the medium term.
The most important conclusion from these reviews is that the current broad-base/low-rate or BBLR approach to taxation will be maintained.
While we must always be open to change to meet evolving circumstances, the BBLR approach provides significant advantages.
These conclusions been reflected in the revenue strategy adopted by the Government which confirms the BBLR approach.
At the same time, there is continued pressure to lift government revenues to meet our long-term fiscal challenges.
The tax work programme, therefore, contains a number of projects designed to broaden the tax base in economically efficient ways; that is, in a manner that is consistent with the BBLR approach.
As you will have seen in recent times, we are also prepared to react vigorously to combat potential erosion of our tax base.
In that context, I would like to comment a little on an issue that has occasioned much media interest around international tax planning and the work being undertaken at the OECD on Base-Erosion and Profit-Shifting, the so called BEPS project.
I think this is an area where New Zealand has been ahead of the curve; and I would like to put our efforts in this area, domestically and at the OECD, into context.
We have not arrived at our current tax settings by accident.
Since the mid-1980s, we have undertaken a series of intensive reviews of our tax system.
Over those same years, New Zealand has also learned the benefits of consultation, although there were times in the early 1990s when consultation did not work well.
Since 1995 under the Generic Tax Policy Process, consultation with interested parties has been an explicit and indispensable part of tax reviews.
GTPP formalised the best of consultation of the previous ten years.
It is worth recalling what tax policy was like in the bad old days.
Our tax system shared the experience of many other countries.
Tax rates were generally high and the tax base was perforated at best, with many special tax breaks.
Personal tax rates went all the way up to 66%.
The company tax rate was 45% and income earned through companies was subject to double taxation.
That is, if the income was in fact subject to tax in the first place.
We had export incentives and a huge number of special breaks for particular activities.
We had no tax on Fringe Benefits.
Not only was the tax system inefficient, but to complete the double whammy, it was very unfair.
The tax breaks, of course, were all well-intentioned.
But the road to anarchy – if not hell – is paved with good intentions.
Tax breaks were brought in to encourage “good things” to happen.
But once you have tax breaks for certain good things, the question arises, why not for other good things as well?
Or, if it is ok to use the tax system for good activities, how far down the path do you want to go of using the tax system to discourage bad things?
We already have certain elements of that, principally for understandable public health reasons, but we are far properly more wary about applying that concept too broadly.
One might think with the high tax rates being levied that the government of the day would have been awash with cash.
But the government was running a deficit of 9% of GDP.
It was like collecting water with a sieve.
Amazingly, sales taxation was probably in an even worse mess than the income tax.
We had an anachronistic wholesale sales tax with multiple rates, ranging from 10 to 60% on different goods.
It applied to only about 27% of household consumption, largely confined to durable items such as motor vehicles and home appliances.
Around one-third of the tax was on business inputs, hobbling New Zealand businesses’ ability to compete on world markets.
As a consequence, the tax system intruded in a hit-or-miss manner on business decision-making.
Tax revenues were subject to unexpected shortfalls.
Tax losses were openly marketed.
As a consequence frequent and unexpected changes were made to the rules.
Both the government and private industry were increasingly blind to the effects of the tax system, with many unintended negative consequences.
The policy process was a mess.
Government and the private sector operated in different silos.
Change happened without warning, making rational, prudent business planning impossible.
It was no way to run a railroad, let alone the single most pervasive lever of government policy.
In saying all this, we were not alone.
By the 1980s many other tax systems internationally were in a similar position.
A wave of reform toward lower tax rates and broader tax bases swept tax systems in developed countries.
New Zealand was in a mood for change and joined the trend with enthusiasm.
I think that it is fair to say we went further and accomplished more than most other countries.
New Zealand tax policy and tax policy making since the 1990s has been driven by two key things.
The first is the broad-base, low-rate (BBLR) tax policy framework.
The second is GTPP.
The tax system that emerged from the reforms of the second half of the 1980s had dramatically lower tax rates and broader tax bases.
Income earned through companies was taxed only once with the introduction of the imputation system.
The wholesale sales tax was swept away and replaced with the GST, which remains one of the most comprehensive and comprehensible sales taxes operating in the world today.
The many problems besetting New Zealand at the time necessitated strong and decisive action.
It is fair to say that the changes were revolutionary.
But revolutions are generally not created by committee and consensus.
Eventually the revolutionary fever resulted in changes that went too far; that did not take proper account of practical real world issues and concerns.
And so, in reaction, the GTPP was introduced in 1995.
GTPP marries good process with the good policy that had opened the decade, but helps to avoid some of the excesses that can occur when reform does not have due regard of practical constraints.
The essence of the GTPP is consultation and dialogue in order to achieve practical and effective outcomes.
Governments must still govern, but the result is certainly better if proposed changes are subject to scrutiny and debate – an issue that some recent political dealings have highlighted! I could not possibly comment!
GTPP recognises the fact that neither tax officials, taxpayers nor their advisors, nor unfortunately even Government Ministers, have a monopoly on wisdom on tax reform.
GTPP also helps ensure that tax reform is suited to New Zealand’s particular situation.
What makes New Zealand special?
Any tax system must take into account the economic and institutional situation of the country in question.
And aside from having the best rugby team in the world, New Zealand really is special in a number of ways that are relevant to the development of its tax policy.
Unlike most other OECD countries, the top personal tax rate is close to the company tax rate.
When this is combined with our imputation system, New Zealand is able to avoid the structural pressures to recharacterise income that arise when the rates diverge.
This allows immense simplification of the tax system and this is a huge advantage.
Moreover, New Zealand’s tax system strongly achieves its primary purpose.
It brings in the money in a way that is efficient and generally seen as fair.
The top tax rate in New Zealand is one of the lowest in the OECD.
As a consequence the top rate of tax applied to savings income in New Zealand is similar to the “’low’ flat tax rates on capital income found in Nordic countries.
And we have achieved the result without the need for complex systems separating income from capital and labour.
It is interesting to note that since 1985, the total share of personal income taxes as a percentage of tax has fallen from 60% to 37%, while the share of consumption taxes has increased from about 21% to 38%.
Thus there has been considerable rebalancing between the taxation of income and consumption.
New Zealand is geographically isolated and most FDI into New Zealand is in sectors that supply domestic demand.
Accordingly, pressures on our tax system from international factors are likely to be different than for other countries facing regional competition for mobile investments.
Finally, not only capital, but labour can move internationally, and we have certainly seen that in recent years, most notably with the number of New Zealanders now living in Australia.
Indeed, New Zealand has one of the largest percentages of its population working abroad.
Tax Working Group, Budget 2010 and the Savings and Investment Review
The Tax Working Group work canvassed a wide range of topics and enlisted a cadre of the top tax academics and professionals from around New Zealand and abroad.
In concert with officials from Inland Revenue and the Treasury, detailed papers were prepared, conferences held and a final report summarising the work was released.
And the report certainly was not allowed to gather dust.
The working group identified serious problems that had accumulated in the New Zealand income tax system due to the misalignment of the company, trust and top personal tax rates.
In response, as noted above, Budget 2010 moved to better align tax rates and to shift the burden of tax away from income and toward consumption.
Differences among the company, trust and top personal tax rates were substantially reduced to decrease pressures that had existed under the previous rate schedules.
Income tax rates were reduced across the board.
At the same time, the GST rate was raised to tilt the tax take away from income and toward consumption.
The working group also expressed concerns about light taxation of investment in property, accelerated depreciation for equipment as a result of the 20 percent loading, and lax thin-capitalisation provisions.
Budget 2010 also responded to these concerns by a set of measures which helped pay for income tax cuts in a way which was fair.
Treasury has estimated that the overall package of changes was broadly distributionally neutral.
The top third, middle third and bottom third of taxpayers gained similar amounts.
The working group also examined the overall structure of the tax system.
It saw much to commend the New Zealand tax BBLR paradigm, and argued that it should continue to be an underlying framework for the New Zealand tax system.
A further review question that arose was whether New Zealand should pursue reforms in the direction of reducing taxation of capital relative to labour.
There is a lot of support in the academic literature for reforms in this direction, and both the Henry Review in Australia and Mirrlees Review in the UK were sympathetic to that.
This latter question was taken up by the review of savings and investment.
The Government has looked carefully at whether it should initiate a fundamental reform of the tax system in the direction of reduced taxation of capital.
On balance, the Government’s conclusion has been to reconfirm its support for the broad-base/low-rate tax system, which has served New Zealand so well for the last two decades.
A broad definition of income is taxed.
As an important supplement we have a very broad-based and neutral GST.
The Minister of Finance will also discuss the savings and investment work in his speech to this conference tomorrow.
The reaffirmation of our current tax settings does not mean we should rest on our laurels.
We will continue to monitor international developments and be willing to respond as necessary.
We will continue to pursue changes to the tax system consistent with the broad-base/low-rate framework.
That is, we will explore changes that make the tax system fairer and more efficient.
All of which leads naturally to a discussion of the current tax policy work programme.
The Work Programme
The programme, which was released last year, reflects the BBLR approach and supports the Government’s priorities.
The Government has announced four key priorities:
- responsibly managing its finances;
- building a more productive and competitive economy;
- delivering better public services; and
- rebuilding Christchurch and the surrounding areas.
Responsibly managing the Government’s finances is obviously central to any tax system.
The key goal of the tax system is to raise tax revenue as fairly and efficiently as possible to finance government spending.
Taxation is one of the Government’s biggest interventions in the economy and in the lives of its citizens.
Economic efficiency in the way tax is collected is central to the Government’s second priority of building a more productive and competitive economy.
The BBLR approach is designed to respond to both of these priorities.
Tax systems with broad tax bases and low tax rates have proven internationally to be the most robust and secure systems for raising tax revenues.
They are much less prone to unexpected shortfalls of revenues.
A BBLR system is also designed to minimise distortions from taxation in the economy.
The pattern of activity is essentially driven by market forces, rather than maximisation of tax benefits.
Over the next ten years there will also be considerable work in Inland Revenue’s Business Transformation space.
The aims include delivering better public services by:
- reducing systems risk;
- reducing the time cost of policy change;
- reducing costs to taxpayers and better delivering the services they want; and
- by making the administration of the tax system more cost effective.
An important part of this is collaboration across government departments to make the government sector as a whole provide best value for money.
That is no small undertaking, but it is a very important one.
Finally, an on-going task that appears well in hand is ensuring that the tax system is fit for purpose in the Government’s final key priority of rebuilding Christchurch and the surrounding areas.
Government Revenue Strategy
The Government’s revenue strategy expands on the implication of these priorities on tax policy in New Zealand.
It states: “The Government supports a broad-base, low-rate tax system that minimises economic distortions.
The Government considers these goals are best supported by a tax system that:
- maintains revenue flows to pay for valued public services and reduce debt;
- responds to New Zealand’s medium term needs in a planned and coherent way
- biases economic decisions as little as possible – which allows people to work, save, spend or invest in ways that they believe are best for them
- rewards effort and individuals’ investment in their own skills
- has low compliance costs and low administrative costs
- minimises opportunities for tax avoidance and evasion, and
- shares the tax burden as fairly as possible.
The Government’s revenue strategy is to raise revenue in ways that meet these objectives.”
The tax policy work programme is driven by this revenue strategy.
Revenue raising options
In principle, there are many tax reforms that could be used to support the Government in its goal of responsibly managing the government’s finances.
Tax rates could be increased or new tax bases introduced.
However, rather than increase tax rates or introduce new tax bases, the Government has focused in recent years on revenue raising options consistent with the overall BBLR framework in order to support fairness and economic efficiency.
Measures have included changes in treatment for mixed use assets, salary sacrifice arrangements, specified minerals and livestock valuation.
Measures supporting fairness, efficiency and a more productive and competitive economy
It is important to understand the tax system’s role in promoting a more productive and competitive economy.
Normally taxes will detract from economic performance.
Good tax policy is like good medicine – first do no harm.
Taxes can harm economic performance in many ways, for example:
- by discouraging investment which would earn more than it costs, or
- by encouraging people to invest in inefficient ways,
- by discouraging people from saving or encouraging them to save in inefficient ways,
- by discouraging people from working, up-skilling or from working as long or as hard as they would ideally like or
- by making New Zealand a less attractive place to base a business.
The problem is that tax reforms which improve things on one margin can often make things worse on another.
Trade-offs are inevitable.
But development of good policy minimises our vulnerability to the law of unintended consequences.
And it is in that light that you will have heard recent concerns around fringe benefit tax and car parks.
I would like to start with the question: what are we trying to do here?
The answer is simple: we are trying to create a fairer and more equal tax system.
We are doing that with issues as diverse as making sure graduates overseas pay back their student loans, and the current work with the OECD on making multinationals pay their fair share of tax.
It is all about fairness.
That has been our approach as a government.
And that has been how we have looked at the tax treatment of car parks.
When all the noise quietens down, the proposed taxing of car parks provided to employees, predominantly in Auckland and Wellington CBDs, under the fringe benefit tax rules is actually about getting a fairer, more equal, way of treating those who receive non-cash benefits and those who just get wages or salary.
That is the reasoning.
Now – as it should be – it is being tested by the Finance and Expenditure Select Committee.
And that committee will look at compliance costs.
It will look at the impact on nightshift workers.
That is a vigorous process and I will work with the outcome of the select committee’s deliberations, just as I have already worked with last year’s consultation process.
You would not know it from the media coverage, but this is not actually a new initiative.
It was the subject of an issues paper last year and submissions were made, but interestingly the concerns now being raised by some elements of the business community were not made during the consultation process.
While I am always open to looking at issues and potential pitfalls associated with any tax change – and I will look seriously at the concerns now being raised – I am nevertheless deeply wary of eleventh hour lobbying campaigns from vested interests being taken as a sound basis on which to construct policy.
We all need to look at the pros and the cons; the costs and the benefits.
Back to the broader context, so much of the tax policy work programme is aimed at supporting fairness and economic efficiency and building a more productive and competitive economy.
Work on taxing foreign retirement savings, extending the active income exemption to branches, GST for cross-border issues and mutual recognition falls into this area.
Much of this work will involve ensuring that the tax system remains fit for purpose in a changing world.
If the tax system needs to be examined to ensure it is fit for purpose, the same is certainly true for the tax administration.
Delivering better public services
The Commissioner of Inland Revenue will speak more about her department’s business transformation programme so I will keep my comments on this to a minimum.
An important starting point is the reality that Inland Revenue’s work is markedly different today from twenty years ago.
Then, the department was solely a tax collection agency.
Today it is the government agency most people deal with on matters from child support to Working for Families, to KiwiSaver and student loans repayments, as well as their tax affairs.
In addition, in response to taxpayers’ service expectations, a growing number of those interactions occur online.
In my view, IRD continues to discharge its duties efficiently and effectively, but I know that these factors have combined to put pressure on the department’s computer system, FIRST, which in turn is becoming a significant constraint on the department’s operations.
To illustrate this, I am told that it is taking longer to implement the current changes to the child support scheme than it took to implement the original scheme in FIRST in 1991.
We need to change the revenue system through business process re-engineering supported by new technology.
An important part of the business transformation programme is to make interactions with Inland Revenue as simple as possible.
Delivering this programme will inevitably take time.
This means that over the next few years, Inland Revenue’s ability to deliver policy changes quickly will be especially constrained by complex systems implications.
That is not great - but it is the reality we are faced with.
Unless there are overwhelming other reasons, tax policy will generally try to ensure that tax rules are as simple and consistent as possible and minimise “special cases”.
The Cabinet will consider the department’s business case for the overall direction of its transformation programme later this month.
I will be making more announcements on this in the weeks to come.
In discussing delivering better public services, there is one policy area I will touch on that needs to change significantly and quickly.
That is how Inland Revenue engages with the wider public service. Central to this is the ongoing reconsideration of tax secrecy.
I am committed to maintaining confidentiality of information provided by taxpayers but I also want Inland Revenue using the skills and information it has to support other agencies in achieving their roles.
In the middle of that is a practical and sensible balance that can be struck.
Work to date has resulted in Inland Revenue working more closely with, and providing more information, to the Ministry of Social Development.
Work is currently progressing well on how Inland Revenue can contribute to preventing serious crime.
The focus is also on how Inland Revenue can support the Government’s business outcome goals.
Much of this work will be service-focused but will also consider how tax information can support business regulatory agencies achieve their goals.
OECD Base-Erosion, Profit-Shifting Initiative
Shifting further afield, an area which is much in the news these days is international tax avoidance.
The OECD has recently launched a project on so-called Base-Erosion and Profit-Shifting, known by the slightly melodic acronym of BEPS.
Let me begin by saying that the issues addressed in BEPS are not new.
Tax systems have increasingly grappled with issues of international tax avoidance over the last two decades, as production and distribution systems have become globalised and multinational.
Media discussion, however, has involved, and sometimes confused, two related issues.
The first is that arrangements by multinational firms can sometimes lead to a situation where income escapes taxation entirely.
That is, there can be double non-taxation of some income.
The second, is that changes to the way international business operates, for example in the digital economy, can cause a strain around the edges of how countries tax businesses operating across borders.
The Government has a two-pronged approach to this issue.
Domestically it is continuing to respond vigorously against international tax arrangements designed to reduce New Zealand’s domestic tax base.
Second, it is an active participant in the OECD’s BEPS work, to keep informed of international trends and to shape the policy development.
With regard to the first issue, New Zealand has always sought to protect its taxation rights.
Some people in this audience might even think that we have been too enthusiastic.
But I will not apologise for that.
Taxes from companies as a percentage of total taxes in New Zealand are among the highest in the OECD.
This is simultaneously a sign of both our success and our vulnerability.
The Government has acted both through changes to tax policy and through tax administration.
On the policy side, actions include introducing the bank minimum equity rules, recharacterisation of stapled stock, elimination of conduit, and tightening the thin capitalisation rules.
And we continue to propose changes where necessary, as with the recently released Officials’ Issues Paper on thin capitalisation.
On the administrative side, Inland Revenue has successfully pursued avoidance cases related to international tax arrangements.
The use of anti-avoidance rules can raise potential concerns.
One of the goals of our tax policy and administration is to provide certainty for businesses in making business decisions.
This means that as much as possible, tax consequences should be set out in the legislation rather than be resolved through litigation and anti-avoidance provisions.
But we do not live in an ideal world.
The complexity of business arrangements and New Zealand’s tax system, especially as it interacts with the tax systems of other countries, means that it is impossible to develop rules which deliver the full intention of government policy in all cases.
With BEPS, these efforts move to the international scene.
This has a potential upside and also a potential downside.
It is in no one’s interest to have double non-taxation resulting from a more or less random application of taxation on international transactions.
New Zealand has moved to address this issue in its domestic law. Some other countries have been less effective in doing so.
An international focus on eliminating double non-taxation is supported by this Government.
Accordingly, we are very active in OECD discussions on this issue.
On the other hand, there is a risk that the public discussion gets ahead of both the nature of the problem and the ability to achieve practical solutions.
We all want to avoid hasty, poorly targeted knee-jerk reactions to alarmist reports.
Looking at no media in particular!
But at the same time, as we have shown, we are prepared to act if necessary.
Some issues can be addressed unilaterally.
Others however, raise complex issues, such as which country gets to tax what income.
These issues require multilateral changes, where different countries will have different economic interests in the outcome.
Such multilateral issues will be much more difficult to progress.
Work will likely proceed on a number of fronts.
Many of the areas being examined are intended to help countries more effectively exercise their taxing rights.
For example, ensuring that CFC rules apply appropriately to prevent the offshoring of domestic income is important.
Special provisions, such as effective thin capitalisation rules can protect the domestic tax base.
The OECD could have a role in helping to identify and promote international best practice in these areas.
Other areas, such as taxing the digital economy, raise fundamental issues.
It has been a cornerstone of international taxation that simply exporting goods to a country should not expose a company to income taxation by the importing state.
On the other hand, in some cases it could be argued that a firm is effectively carrying on a business in a country and should be taxed.
On a similar note, the growth of online shopping is also beginning to affect New Zealand’s GST base.
Although fundamentally many people agree that goods and services purchased online from off-shore retailers should attract GST, a system that collects this revenue efficiently and effectively is difficult to attain.
Nevertheless I have asked officials to consider the options.
This is hard stuff.
They are big and complex issues with no easy solutions or quick fixes.
But we must be prepared to think outside the box in coming to solutions.
One area that has been raised in Australia and abroad is publishing the tax paid by companies operating in a country.
Obviously, there are many complex issues involving taxpayer confidentiality that would need to be carefully examined before we were to go down this path.
And the amount of taxes paid, on its own, would provide a misleading picture of a company’s affairs within a country.
Taxes may be high or low for many reasons completely unrelated to international tax avoidance.
On the other hand, compliant companies might find it advantageous to promote their image as good corporate citizens by spontaneous release of this information.
This is an area where caution is important.
We will continue to follow developments abroad with considerable interest.
I would also be most interested in your views on the issues that this approach would raise.
In conclusion, I would like to thank you again for this chance to address you.
I believe that it is important that you have an opportunity to hear some background on the underpinnings of our tax policy.
But I also believe it is equally important that I hear from you.
Good policy, as ever, will lie in the middle.
Over the last few years there has been a considerable amount of soul-searching, both inside and outside of government on the best direction for tax policy.
I think that the conclusion that we should stick with our BBLR framework reflects an appropriate and pragmatic balancing of the many issues which underlie tax system design.
I hope that this also allows you to see the work programme in its broader context, rather than simply as an ad hoc grab bag of issues.
It most certainly is not that. I can assure you that there is method in the madness!
Finally, as always I invite your questions and comments to prove it! Thank you.
Mark Stewart | Press Secretary | Office of Hon Peter Dunne
Minister of Revenue | Associate Minister of Health |
Associate Minister of Conservation | Member for Ohariu
DDI +64 4 817 6985 | Mb +64 21 243 698