Appendix 1 - Policy considerations


NEW ZEALAND’S TAX SYSTEM

1.1 Having a good overall tax system means having both good tax policies and good administrative systems. Both of these elements need to go hand in hand.

Costs associated with raising taxes

1.2 Taxes create costs. As well as the taxes themselves, there are additional costs that are sometimes referred to as 'deadweight costs'. These include compliance costs to customers and administrative costs to Inland Revenue, and also distortionary costs due to the way that taxes influence behaviour. For example, they can discourage people from working, saving, starting a business or increasing their skills. Taxes can bias the ways in which people work or save. Taxes can also discourage firms from investing or cause them to invest in inefficient ways. It is important to keep the overall costs of raising tax to a minimum.

1.3 Reducing compliance costs for businesses, in particular small and medium enterprises (SMEs), is an important goal for the Government. Although there is evidence that tax compliance costs for New Zealand individuals and SMEs are likely to be low by international standards , given the large number of SMEs operating in New Zealand, overall tax compliance costs for this group as a whole are likely to represent a significant cost to the economy. In 2009, compliance costs for SMEs alone were estimated at $2.5 billion which was more than 1% of GDP. Total compliance costs in the United States have been estimated as 10% of tax collections which in New Zealand would amount to 3-4% of GDP. It is therefore very important that we continue to contain tax compliance costs.

New Zealand’s tax policies

1.4 The aim of New Zealand’s tax policies is to tax as broad a range of income and expenditure as practicable at rates that are as low as possible. Known as the broad-base, low-rate (BBLR) approach, this provides a coherent and robust revenue base and promotes equity and fairness, economic efficiency and growth, and revenue integrity.

1.5 It also helps keep administration and compliance costs low. It is a much more coherent way of levying tax compared with most OECD countries.

Endorsement of New Zealand's tax policies

1.6 New Zealand’s tax policies work well and are held in high regard internationally.[1] A number of independent domestic reviews of the tax system have also been undertaken in recent years, and have fundamentally supported New Zealand's underlying tax system and BBLR framework. [2]

Future challenges

1.7 There are long-term fiscal pressures that future Governments will need to consider. An ageing population, coupled with the increasing demand for world class healthcare and other services, will contribute to these pressures.

1.8 We should do everything possible to ensure high levels of compliance with the tax system to manage these fiscal pressures. Boosting levels of compliance is an important part of the Government's review of tax administration.

Inland Revenue’s tax administrative framework

1.9 Inland Revenue aims to make it as easy as possible for people to comply with the tax system and to access their social policy entitlements delivered through the tax system. It also aims to make it hard for people not to comply. The goal is to provide services that are value-for-money while maintaining the integrity of the tax system.

1.10 The way that Inland Revenue currently operates administratively largely reflects a set of sensible decisions on how to make marginal improvements or take on new tasks given the legacy of the systems that are already in place. The Government has not, until now, stood back and had a fundamental look at how tax might best be administered if it were starting from scratch.

INLAND REVENUE’S BUSINESS TRANSFORMATION PROGRAMME

1.11 Inland Revenue is embarking on a once-in-a-generation opportunity to make changes to New Zealand’s tax administration system to meet current and future needs. The Government has agreed in principle to a long-term business transformation programme to look at different ways of delivering tax and social policy. This includes re-shaping the way Inland Revenue works with taxpayers, and looking at possible changes to, amongst other pieces of legislation, the Tax Administration Act 1994.

1.12 This is far more than just updating a computing system. Rather, it is a chance to have a fundamental look at tax administration in New Zealand and see what changes need to be made as Inland Revenue moves further into the 21st century.

1.13 The world is changing, with huge improvements in ways of doing business. Ways of doing business that were acceptable 10 or 20 years ago will no longer meet the demands of customers. This also has wider implications beyond Inland Revenue – appropriate information sharing between Government agencies is also important to deliver efficient outcomes for New Zealanders.

1.14 It is therefore vital that Government and Inland Revenue establish the sort of tax administration services that taxpayers, third parties, advisors, and users of social policy services actually want and require, and which minimise the additional effort required to meet tax obligations and receive payments.

1.15 Any future tax administration system should also be effectively enforced and produce high levels of voluntary compliance. We want to achieve this while reducing the administration and compliance costs associated with raising tax.

1.16 Tax administration requires integrity and coherence – customers need to believe in the value of the system and feel as if there is a level playing field for all concerned, with people who do not comply being treated effectively and consistently.

1.17 New Zealand’s very simple policy framework sets a sound base for such a transition, and should help ensure a much simpler tax administration than is required in other countries.

CURRENT PROBLEMS AND ISSUES TO CONSIDER

Systems and processes

1.18 The current revenue system is under increasing pressure. Major tax and social policy initiatives are difficult to implement given core technology and business processes. These demands have resulted in various system modifications, manual interventions and workarounds that have produced layers of complexity and cost for government and taxpayers.

1.19 As a result, current systems and processes pose significant challenges and risks. These include:

  • inability to provide the services that customers are and will increasingly demand in a future digital age;
  • inability to fully support the delivery of business initiatives across the wider public sector;
  • inability to benefit fully from information and expertise used across the wider public sector;
  • operational failure, potentially impacting the Government’s revenue collection and distribution; and
  • ability to implement the Government’s tax and social policy initiatives in a timely and efficient manner.

1.20 Business transformation affords Inland Revenue the opportunity to address these issues.

Compliance and administration costs

1.21 As part of the trade-offs considered in any changes, it is crucial not to fall into the trap of merely shifting costs away from government onto taxpayers. Reforms will not be successful if they cut administration costs but these are more than offset by additional compliance costs on the private sector.

1.22 Nor should measures be considered that reduce administration or compliance costs but lead to higher overall costs as a result of greater distortionary costs. Some simplistic options that may reduce compliance costs (for example, a turnover tax) might have relatively low administration and compliance costs but extremely high distortionary costs.

1.23 Although it is likely that New Zealand SMEs individually have low compliance costs by international standards, given the large number of such firms in New Zealand, aggregate compliance costs for these firms are large. It is important to focus on containing these costs.

1.24 This does not mean that tax concessions should be introduced for SMEs, however, as tax costs and tax compliance costs should not be confused. Tax breaks for a particular sector are likely to reduce economic efficiency and growth by encouraging resources to flow into less productive activities. They are counter to the BBLR philosophy. It may, however, be possible to make some changes that result in tax simplification measures that reduce compliance costs for SMEs without a substantial fiscal impact.

1.25 There are also reasons to be wary of creating too much choice. Compliance costs tend to rise in countries that give SMEs too many options for paying tax. This can encourage SMEs to calculate their tax liability a number of ways to find which involves the lowest tax payments (perversely, at the cost of increased compliance).

1.26 Also, as much as possible, it is undesirable to have rules that create difficult boundaries and disincentives for successful firms increasing in size.

1.27 In addition to core policy changes, there will be other opportunities for simplifying the tax system by more effective reliance on technology and existing business systems (see Appendix 2 for more details).

Facilitating compliance

1.28 Effective tax systems rely on facilitating compliance by customers. Addressing errors or mistakes after the event imposes significant costs on both Inland Revenue and the customer. It is more effective and efficient to consider what can be done to facilitate compliance and enable customers to file tax returns and make entitlement claims that are correct, for example, to get it right from the start.

1.29 The elements of an approach that facilitates compliance include:

  • designing a tax system which makes it easy to comply and difficult not to;
  • directing attention to the pre-filing stage and proactively targeting high risk areas and segments; and
  • where possible, incorporating tax and social policy processes within a customer's everyday life – that is, designing systems that align or build off the customer's own processes and lifecycle.

1.30 To effectively facilitate compliance, Inland Revenue must continue to build its understanding of different groups of customers, their environments, and the factors that drive their behaviour (capability, motivation and opportunity). This will help shape the necessary actions that Inland Revenue needs to take to help promote compliance.

Increased use of effective withholding regimes

1.31 International studies have found very high levels of compliance for certain forms of tax (in particular, for withholding taxes, such as PAYE) and considerably lower rates of compliance for others, such as self-declared income. This suggests that greater use of withholding schemes, wherever possible (and appropriate) should be encouraged.

1.32 The effectiveness of withholding at source is reflected in the fact that the current New Zealand tax administration system generally works well for individuals whose income is derived solely from salary and wages that are subject to tax withholding regimes. This is consistent with the experiences faced by other modern tax systems. In operating withholding taxes, governments recognise the reliance placed on businesses that operate the withholding in question.

1.33 The system works less well, however, in other circumstances – in particular, when tax on investment or other income is either not withheld or withheld at the incorrect rate. This can lead to costly square-ups when returns are filed, or unfairness and inefficiencies if they are not. This particular problem, if not addressed, is likely to grow with the onset of an ageing population where more people earn a larger proportion of their income from capital sources.

Filing obligations

1.34 The current tax obligations on individuals vary, based on historic distinctions made. A policy decision was made previously to try and remove the requirement to file income tax returns from as many individuals as possible. This resulted in relatively few salary and wage-earners in New Zealand filing income tax returns compared with other countries.

1.35 This, over time, created a tension in the tax administration system between customers who are not required to file and those who are. As a customer’s circumstances change, their filing obligations can also change, for example, becoming eligible for Working for Families tax credits.

1.36 In addition, significant numbers of individuals are now either required to file or are, in certain circumstances, given the option to do so in favourable circumstances.

1.37 Individuals earning foreign income, rental income or business income, or who are receiving Working for Families tax credits, are required to file tax returns. Others are not required to do so. These differences in filing requirements may result in some being completely unaware that they may not be complying with their obligations.

1.38 It may now be more appropriate, and fair, to treat individual customers more consistently than at present. Modern technology could provide scope for a dramatic reduction in the costs of interacting with the tax system, and allow for an efficient squaring-up of refunds or liabilities where required.

1.39 Appendix 5 will explore the possibility of whether Inland Revenue can provide more extensive pre-populated information on tax returns available to individual taxpayers. For those with simple affairs and without business, rental or foreign income, filling a tax return might be no more complex than confirming whether the sources of income that Inland Revenue identifies are the only sources of income.

1.40 A practical difficulty is in getting effective withholding rates in place, and minimising the costs involved in squaring up liabilities and refunds when tax has been withheld at rates that do not reflect the true end-of-year tax position. The trade-off with trying to make withholding tax more accurate is the potential increase in compliance costs for the withholder and administrative costs for
Inland Revenue.

1.41 Again, technology may help this by making square-ups much less costly. This Green paper will also be exploring whether it is possible to simplify square-ups with automatic bank transfers to those who have paid too much and higher rates of future withholding on those who have paid too little. Automatic square-ups could reduce pressure points around 'secondary tax', along with improvements to the rates at which secondary tax is withheld.

Other issues

1.42 Other issues to consider include problems relating to the provision of information. There are currently problems with the sufficiency and timeliness of collection of information, and the accuracy of that information.

1.43 When information is inaccurate there are also downstream problems with the timeliness of intervention or correction of that information.

1.44 Parallel questions arise around whether other features of the current tax system are really what customers expect in the 21st century. These include:

  • the Employer Monthly Schedule and other withholding systems – are they required to be updated to meet employers’ needs;
  • whether businesses, in particularly those with complex tax affairs, are afforded the right level of certainty to effectively manage their tax affairs in a timely and efficient manner;
  • the way that businesses are required to pay tax, including the estimation of provisional tax;
  • whether compliance with FBT can be simplified; and
  • are the interactions between tax and social assistance overly complex.

KEY BENEFITS ARISING

1.45 Some of the benefits that the potential changes discussed in this Green paper, when taken as a whole, should ideally achieve include:

  • Making it easier for customers to see their overall tax and social policy position, and to pay tax and meet social policy obligations.
  • Increasing predictability for customers, by:
    • providing easy digital access to their accounts (and alternatives for those without such access);
    • providing earlier and simpler transactions;
    • providing effective and timely solutions to their pressing issues and problems (for example, when providing binding rulings);
    • access to the right information and help at the right time;
    • using a business's normal business processes and systems to meet tax obligations;
    • having a low cost of contact;
    • being designed for a digital world, not a paper world;
    • improving response times; and
    • improving the collection, accuracy and timeliness of information to simplify and better tailor interactions.
  • Making it harder for customers to fall into debt in the first place, and also making it easier for them to correct if they do.
  • Reducing compliance and administration costs.
  • Supporting broader 'all-of-government' goals and providing value-for-money for the Government.
  • Ensuring the on-going surety and integrity of the tax and social policy system.
  • Making it easier and less expensive for customers to get it right and meet their obligations (and harder for them to get it wrong).
  • Providing sufficient information so that key policy concerns and audit risks can be identified easily.
  • Providing flexibility to cater for future changes.
  • Having an increased customer-focussed approach.

1.46 In short, Inland Revenue’s tax and social policy systems should be simple and make it easy to get right and hard to get wrong, be quick and low effort to use, provide more certainty, and should not require duplication of effort by customers or associated third parties. The systems should help customers to get things right from the start. They must also be flexible enough to move with technology developments.

1.47 This will not be an easy shift to make, or a quick one, but it is absolutely necessary for change to happen.

KEY ASSUMPTIONS

1.48 Some key assumptions have been made during the early development of the policy issues that are likely to underpin Inland Revenue’s business transformation. These include:

  • Key tax bases will remain substantially in place and New Zealand will continue with its BBLR approach. There are no fundamental changes currently planned to either income tax (individuals and corporates) or GST. Previous comprehensive tax reviews, most recently by the 2010 Tax Working Group , provide a high degree of support for this assumption.
  • Social policy and other non-tax functions currently administered by Inland Revenue (for example, in relation to Working for Families, Child Support, Student Loans repayments and KiwiSaver) will continue to be a key part of Inland Revenue’s portfolio of work.
 

1 See, for example:
- Deloitte’s 2014 Asia Pacific Tax Complexity Survey Report (http://www2.deloitte.com/content/dam/Deloitte/global/Documents/Tax/dttl-tax-ap-2014-tax-complexity-survey.pdf)
- Washington DC Tax Foundation’s 2014 international tax competitiveness index (see http://taxfoundation.org/article/2014-international-tax-competitiveness-index)

2 For example the McLeod Review in 2001 and, more recently, the Tax Working Group in 2010