Executive summary

As Minister of Revenue you are accountable for the overall working of New Zealand's tax system and for the Inland Revenue Department. In addition, tax policy decisions are made jointly by yourself and the Minister of Finance.

Our key advice is that New Zealand’s tax system is in a good place. The tax bases are broad, robust and provide reliable sources of revenue to fund Government programmes. The broad tax bases and the relatively low tax rates make the tax system among the most coherent in the OECD. This helps in ensuring that the tax system is relatively efficient and fair. As well as having a coherent tax policy the tax administration functions well – as demonstrated by the conclusions of various external reviews. This underlines the main point that a good tax system is not just about good policy. Both tax policy and tax administration must be working well for us to have a good tax system.

Key issues and challenges

While the tax system is in good shape there are a number of key issues and challenges that will need to be considered in the short- to medium-term. These are summarised below and covered in more detail in later chapters.

Fitting the tax policy work programme into the Government’s broader economic objectives

Inland Revenue and the Treasury agree upon the tax policy work programme with the Minister of Revenue and the Minister of Finance. A key challenge will be to ensure that the tax policy work programme fits into the Government’s broader economic objectives. Early next year officials from Inland Revenue and the Treasury will discuss the tax policy work programme with Ministers to ensure that this happens. This is discussed further in chapter 1.

The tax system and abating social assistance

Given fiscal constraints, reform of Working for Families and other forms of social assistance that abate with income is likely to be a key issue for this and future governments. When evaluating reform in these areas it is important to consider how tax fits in.

There are a number of competing goals in this area that cannot be easily reconciled. For example, Working for Families tax credits provide substantial assistance to many low and middle-income families. However, to keep this assistance affordable it is necessary to abate the assistance as income increases. This increases the effective marginal tax rate of recipients and, therefore, inevitably affects work incentives.

In a fiscally constrained environment there is no clear solution to this problem. Any reform will require a trade-off between the level of assistance, who it is targeted to and work incentives. These are difficult tradeoffs which will need to be worked through in making any changes in this area. This is discussed further in chapter 2.

Maintaining a coherent tax system

The broad-base, low-rate framework that underpins New Zealand’s tax system is one of the most coherent in the OECD. There are some major benefits in having a coherent framework. Maintaining such a framework means ensuring that changes to specific parts of the tax system are evaluated according to their effect on the tax system as an integrated whole.

New Zealand’s broad-base, low-rate framework is not the only coherent tax system. Different governments with differing distributional objectives might reasonably choose different frameworks. But a priority is in ensuring that any framework is coherent and that taxpayers cannot avoid paying their fair share of tax.

Two alternative coherent systems that could be adopted have been considered in various reviews. These are a Nordic system (currently in place in Norway) or a system that incorporates an allowance for corporate equity (ACE) and a rate of return allowance (RRA), as suggested by the recent Mirrlees Review in the United Kingdom. Common to both of these alternative systems is a significant reduction in the taxation of capital relative to labour.

There are pros and cons to all three coherent approaches, and which one is most appropriate for a country will, to a large extent, depend on the special characteristics of that country. Inland Revenue considers that the current broad-base, low-rate framework is the best available coherent tax framework for New Zealand. But this system works less well if the top personal tax rate is too much higher than the company rate. While arguments can be made for adopting a Nordic or an ACE/RRA system, a large onus of proof should be shifted before moving to either of these approaches. It is important for the Government to make a choice on the framework that should apply because, until this is done, it is difficult to evaluate the pros and cons of more specific tax changes. This is discussed further in chapter 3.

Inland Revenue in a digital age

Inland Revenue’s IT systems are based around FIRST – a system developed specifically for Inland Revenue in the early 1990s. Since then, the functions of Inland Revenue have grown and are now much broader than simply collecting taxes. They include administration of Working for Families and KiwiSaver, and the collection of student loans and child support.

The growth in the ambit of Inland Revenue’s functions and changes in public expectations have resulted in FIRST becoming a significant constraint on the department’s operations. Inland Revenue has a strategy to address this which it will implement progressively over the next 10 years. This is a substantial investment (with estimated spending between $1.0 and $1.5 billion). An important priority is ensuring that this new investment programme works well. Over the next few years before the programme is fully implemented, Inland Revenue’s ability to deliver policy changes with complex system implications will be constrained. This is discussed further in chapter 4.

Delivery of core functions in a constrained fiscal environment

The Government’s fiscal position is likely to be under significant pressure for some time. To assist in managing this, departments (including Inland Revenue) can be expected to deliver more for less. Inland Revenue has already been able to identify and deliver considerable savings over the past few years, while continuing to deliver against our performance measures but this has become progressively more difficult.

Inland Revenue’s future baselines will require us to provide significant efficiency savings. Some of this can be achieved by making existing policy and operational frameworks more efficient. Nevertheless, the level of efficiencies necessary to stay within our future baselines is likely to require some difficult tradeoffs. We will face pressures to reduce service levels or make changes in some policies. Some of this will involve capitalising on the efficiency opportunities that technology change provides such as dealing with customers and intermediaries electronically rather than over-the-counter, by telephone or by letter. The efficiency benefits that can be achieved through increased electronic contact are significant but they will be reduced or even eliminated if existing communication channels remain at current levels. We face some difficult challenges in this area. Some legislative or policy changes may be required and these are likely to be controversial. This is also discussed in chapter 4.