Tax churn money-go-round puts high cost on society

Dr Bryce Wilkinson
The National Business Review
21 February, 2014

It is often said that tax is the price we pay for a civilised society.

Indeed, taxes are necessary to fund key public services, including defence, law and order, the courts, border controls, civil defence, foreign affairs, public administration generally, and a contestably lengthy list of other potentially worthy activities of a collective nature.

So how much do such services cost?  The answer for central government is around 5.5% of gross domestic product (GDP), according to Statistics New Zealand’s latest estimates.  This has not changed much during the last 100 years. For example, back in 1913-14, reported central government current spending, excluding financing costs, was 5.0% of GDP.

Similarly, local government spending on collective activities was 1.9% of GDP in 2012-13, whereas 100 years ago local government spending, including public works spending, but excluding interest was 3.1% of GDP.

Adding this up, if being taxed to pay for collective activities is the price for a civilised society, the quantum could be appreciably below 7-8 % of GDP, after allowing for additional contributions from user charges and specific levies.

Sure enough, 100 years ago, in 1913-14, central government tax revenue was 3.3% of GDP and local government revenue from rates was 1.1% of GDP. That would put the price for a civilised society at around 4-5% of GDP.

On this basis the price for a civilised society has skyrocketed.  In 2012-13, general government tax revenue was 30% of GDP, comprising 28% for central government taxes and 2% for local government rates. 

Why has it skyrocketed for central government but not for local government? In terms of key historical events, central government used two world wars and the 1930s depression to permanently ratchet up revenue from income tax, along with spending on income transfers. 

Another big expansion of both occurred from the 1960s, particularly with the introduction of the domestic purposes benefit and unfunded national superannuation in the 1970s. In contrast, local government could not tax income. More recently, central government has greatly increased indirect taxation (GST) and kept the proceeds to itself.

In a nutshell, taxes on work and savings were vastly increased to subsidise non-work and consumption.

The upshot is that the prime financial activity of central government is to tax New Zealanders with one hand, while giving back even more in cash and in-kind benefits with the other. Those benefits have become entitlements.  That net tax deficit has become a burden.

To illustrate, in 2013-14, New Zealanders are projected to pay $44 billion in individual income tax and GST. In the same year the government plans to give us back $51 billion as benefits in cash (social security and welfare), or in kind (education and health). The finance minister has to cover the deficit through some combination of borrowing, corporate tax, other indirect tax and user charges.

Overall, individual income tax and GST is insufficient to fund the collective goods that characterise civil society; instead the taxes are paid in the expectation the government will pay us back even more. 

A major daily’s editorial this week illustrated the entrenched nature of that ‘free lunch’ expectation.  With particular reference to paid parental leave, it welcomed the start of election-year spending promises, and asserted that voters have “done their penance” in the form of past budget stringency, so “a modest pay-off is in order”.  Really, at whose expense and with or without their consent?

The system has induced many New Zealanders to take costly measures to reduce their taxable income and/or increase their eligibility for hand-outs. The many options include reducing working hours, not seeking promotion, hiring accountants and tax lawyers, setting up family trusts, preferring tax sheltered investments, feigning sickness or disability and changing family composition.

Economists have been unable to estimate these costs precisely. They tend to increase with the square of the effective marginal tax rate, which differs across the community and can be high indeed for those on income-tested benefits. 

A Treasury guideline suggests government analysts assume that each additional dollar of government spending from taxes be counted as costing the community $1.20. This is at the modest end of the range of estimates in the professional literature. An Australian economist, Winton Bates, has estimated a reduction in the churning of taxpayers’ money through the tax-benefit system of 10 per cent of GDP could lift GDP per capita by 5%.

The army of tax and welfare professionals who earn their living from churning individuals’ incomes through the government’s accounts has a pecuniary incentive to argue the current redistributional aspect of the tax/benefit system represents an inadequate contribution to building civil society.  More redistribution is always better than less.

Naturally, many of those perceiving themselves as gaining the most from the tax/benefit system will agree. That combination looks like a substantial political majority.

Detailed estimates by Treasury officials and others for 2009-10 indicate that the bottom 60% of households by income received $20 billion more in benefits than they paid in individual income tax and GST, whereas the top 40% paid around $13 billion more in taxes relative to benefits. The net fiscal cost of $7 billion happens to be the same as for the 2013-14 projections.

Such a politically entrenched and economically unsustainable configuration would challenge any minister of finance.

Yet the problem is not intractable. The widespread burden of low incomes arises fundamentally from lack of access to jobs and low productivity, partly due to deficient levels of numeracy and literacy. Those problems can be reduced, given the will and the time. 

Moreover, taxing the rich is not the free lunch that these figures suggest, or many opportunistically pretend. The burden of the enormous amounts paid in income tax is likely to be quite widely spread through higher pre-tax wages and thereby higher consumer prices for everyone. 

Nor is the situation the static ‘them’ versus ‘us’ situation that these figures depict. Young people in low income households who envisage becoming professional earners in high income households can afford to take a longer-term, life-cycle, view of these distributional issues. Many young mothers may fall into this category.

Moreover, the waste in churning the income of the top 40% of households through the tax system is material. The government collected $24.6 billion in taxes in 2009-10 from this group, only to return $11.2 billion to it in benefits in cash and in kind. How necessary was that?

None of this is to make a case against assistance in genuine cases of need. How well a society looks after children and adults who are mentally or physically incapable is indeed a test of its civility. 

But the debate in New Zealand today is about entitlements, not disabling incapacity. Are some entitled to parental leave or living wages, independent of productivity and paid for by others whether they consent or not? Advocating entitlements is one thing, advocating a more civil society is another.

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