Public poorly served by ‘wartime’ policy responses

Dr Eric Crampton
30 March, 2021

One year ago, in a desperate rush, the government launched the wage subsidy scheme. It had to be done in a hurry; every other option was worse. The country was going into lockdown and everyone faced radical uncertainty about what might hold on the other side. Mass layoffs were a genuine possibility.

The scheme worked. It is easy to imagine better versions of the wage subsidy scheme. And New Zealand’s scheme did undergo a few rapid changes as holes were found and patched. But it would have been impossible for a better version to have been developed and rolled out with the necessary speed. Delay was too costly in the crisis. The world was moving, and policy had to keep up.

Unfortunately, too much policy has been circumventing proper process. What is necessary and least bad in a crisis does not make for good policymaking in normal times.

This past week has not been among Wellington’s more crowning achievements.

A suite of poorly thought-through housing policies was announced, with part of the housing package legislated the next day. And the Climate Commission brought its submissions process to a close without releasing all of the information necessary for properly evaluating its recommendations.

In both cases, the public has been poorly served.

And, in both cases, we see the problems inherent in rushing through policy to deal with longstanding issues. Crisis-framing short-circuits proper policy development.

Tax policy generally follows New Zealand’s Generic Tax Policy Process, which requires strong consultation, and support from the private sector, tax officials, and government ministers. Tax Working Groups consisting of experts in accounting, law, economics and taxation will work through options.

Last week’s changes to taxes on housing followed a rather different process, with little room for expert or other advice.

Changes to the bright-line rule on investment properties amount to a very poorly designed capital gains tax on those properties.

A decent capital gains regime is comprehensive across sectors and allows a balancing of gains and losses. And almost all capital gain tax regimes impose a tax rate far lower than marginal income tax rates.

While New Zealand has not had a capital gains tax, the tax system has evolved over decades to ensure that people do not disguise taxable income as a capital gain. The first incarnation of the bright-line rule, with a two-year window, worked to that end. It ensured that those who made a living buying and selling houses could not dodge paying income tax.

But a ten-year rule is a capital gains tax, as almost every economist surveyed by The Spinoff agreed.

Announced changes to the tax treatment of interest expenses are more worrying.

New Zealand’s tax system has had a coherence to it. Businesses were generally treated alike. A business’s taxable income is revenue less the expense of running the business.

The changes announced last week, but not yet legislated, disallow the largest expense for one business segment.

There is no principled basis for the change in tax policy, but rather a repeated suggestion that property investment is not really a business, and a sense that the Government needed to be seen to be doing something about rapidly escalating house prices.

If the change to the treatment of interest costs was intended to encourage investors to sell their properties to first-home buyers, it may be stymied by the concurrent changes to the bright-line rule.

And while the Government signalled that new builds would be exempt from the change, convincing investors that their new developments won’t roll into the punitive tax regime in a few years may prove difficult.

Treasury had not yet thoroughly analysed the likely consequences at the time of the policy announcement. It advised only that the policy be delayed until they had had time to assess it more thoroughly. Announcing policy before the bureaus had a chance to offer initial advice brings risk. The Government may be less than keen on receiving official advice that the policy is a bad idea if it has already publicly committed to enacting it. When officials are contantly choosing which battles to pick, this one may not prove worth the effort regardless of the policy’s flaws.

And there will be more than a few areas where Members of Parliament might well wish they had the benefit of frank advice from officials. How will the changes affect rents? Will they discourage new investment? Should interest on debt taken on for renovations be an allowed expense? If not, should we expect the quality of rental properties to decline? Might some residential properties convert to commercial spaces if the latter is tax advantaged? And how should we think about the regime uncertainty caused by unpredictable changes to tax policy?

While the eventual Bill is likely to come with more extensive official advice and opportunity for submission, the process remains seriously at odds with established tax policy process. It brings substantial risk of poor outcomes and unintended consequences. Worse, it builds uncertainty about the foundations of tax policy. If one sector can be targeted for punitive tax treatment today, which is next? Hasty reactive policy makes for unpredictability.

But housing was not the only policy area suffering from a bit of haste.

Submissions on the Climate Change Commission’s draft report closed this past week as well.

Haste is well warranted in reducing emissions, but New Zealand policy begins from a decent position. Last year’s changes to the Emissions Trading Scheme [ETS] brought a binding cap on net emissions. The cap on net emissions is scheduled to come down in line with New Zealand’s commitments. And carbon prices in the ETS have doubled over the past couple of years.

The Climate Commission is charged with producing carbon budgets. The legislative process has imposed some tight time constraints; the Commission will be providing its final report to Parliament in May.

But because the ETS already has a cap scheduled to decline, emissions will still come down even if we take a bit of time to get things right in carbon budgeting. The path to 2050 is set by how quickly the ETS cap declines over time, not by the speed of the Climate Commission’s reporting.

Good institutions buy time to make good decisions. And the Commission’s model shows that current policies will get us to net zero. That finding should itself suggest we have time to get the details right.

Because the Commission’s draft report was produced in a bit of haste, and because the task before its modelling team was substantial, important parts of the modelling were not ready for public release. In a podcast interview released on Saturday, Dr Rod Carr, Chair of the Climate Commission, said that the Commission needed a bit more time to document its work before release.

Details in the modelling matter. The economists at Sense Partners are well versed in the kinds of economic modelling used by the Commission. They suggest that while release of the model would be important for transparency, more detail on the assumptions fed into the model and the effects of those assumptions could have been released.

For example, if the Commission’s modelling assumed that global carbon prices were higher than prices in New Zealand, there would be no risk of businesses here put at a disadvantage. If carbon prices here exceeded prices abroad, the economic effects could be different. Because the Commission has not yet released its model, it is hard to tell how sensitive outcomes are to the chosen assumptions.

The Commission will be making recommendations setting out a path for the next thirty years. Since the cap on net emissions will be dropping regardless of whether the Commission’s process takes a couple more months, the extra time would not delay climate action. It would instead help in ensuring that the next three decades starts on the right foot. For all of the worries threaded through the Commission’s report about the risks of stranded assets if market participants do not weigh rising ETS prices, the Commission pays too little heed to the risk of locking in the wrong policies.

There was no reasonable alternative to hasty legislation in March of 2020. When the world moves quickly and dramatically, policy has to be nimble. The costs of policy being less than perfect were rather smaller than the costs of failing to act.

But too much of policy since then has continued on that same near-wartime footing. It is an approach that will not serve us well.

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