An overhaul of our low-rate broad-base tax system would go a long way to addressing our huge wealth gap. Let’s not squander the opportunity the election affords for a national debate, writes Susan St John.
Comment: As election year approaches, debate must be had about the unfairness of GST, the high income tax rates on low incomes, no tax-free bracket and virtually no taxes on wealth or capital gains.
Instead of congratulating ourselves on having a system often lauded as the most efficient and simple tax system in the OECD, we need to admit that the low-rate broad-base approach has failed us.
Not only has it failed on fairness grounds, but also in terms of economic efficiency because it was never implemented as intended. The result has been damaging inequality, speculative housing booms and homelessness, widespread hardship and crippling effective tax rates on low- and middle-income people.
The idea we have ‘low-rate broad-base’ tax is a mirage. We have failed spectacularly to include all income in the tax base, especially for the top 25 percent of New Zealanders who have become phenomenally wealthy through unearned untaxed gains and tax avoidance schemes. We were so in love with the efficiency of GST and the huge revenue source it provided, that we acquiesced as the rate was hiked to 15 percent.
The fact is, GST is no longer ‘low-rate’. Activist John Minto has already opened the debate for the coming election with an opinion piece in the NZ Herald ‘Tax cuts please but start with GST‘.
The inevitable demands for the removal of GST from basics to protect low- and middle-income families however would in turn make our system far less broad-based. Sadly, we would kill off the low-rate broad-base golden goose of maximum income at the least economic cost by the complexities that will be introduced by base narrowing.
We have two choices. Either we look to a rebalancing of the tax system via a very progressive income tax following the Australian approach – or we make our existing system better fit the low-rate broad-base model.
The first approach might mean, as in Australia, a 10 percent GST with basics exempted, an $18,000 exempt income tax bracket, a capital gains tax to get at wealth accumulation, and a top tax rate of 45 percent. The complexities of each part of this would be staggering. The lost GST and the cost of the first-tax free bracket would be a killer, while GST exemptions would be very complex to administer. We would also discover that a top 45 percent income tax rate and introducing a capital gains tax are not the solutions to the wealth divide.
The second, and more politically feasible approach, is to improve the low-rate, broad-base approach. To stave off the call for removal of GST on basics, we could return to a more manageable 10 percent rate. Unfortunately, a 10 percent GST rate would mean a loss of revenue of around $10 billion that would need to be made up by higher taxes elsewhere.
However, if we stick to a 15 percent GST, we need much more deliberate compensation for its regressiveness. This means more generous benefits and transfers such as Working for Families tax credits to compensate low-income people. Time for the debate to begin.
The narrative that Working for Families just cancels out income tax for low- and middle-income families is most unhelpful. Working for Families is primarily a recognition that all children need an adequate income, and a low-income wage is not enough to provide for children’s needs. In New Zealand we pay these tax-funded per-child per-week payments to low-income families so that the costs are shared by all. Even if GST was zero and income tax was lowered for low income workers we would still need these payments.
While more generous Working for Families payments are required to better share the costs of children, we should increase them even further to help compensate for the high-rate regressive GST and the high tax burden of our current flattish income tax system on low-income families.
Arguments for compensation also apply to low-income adults without children. Tax bracket adjustments, adult benefits, other transfers, accommodation assistance, in-kind provision, debt and student loan forgiveness are all mechanisms that can be used. These must not be viewed as handouts, but recognised as the price to be paid for our simple but regressive tax system.
As well as better compensation, the tax base must be broadened to include proper wealth taxation, and all income tax loopholes currently exploited by the high-income earners need closing. In theory, the low-rate broad-base approach would include all capital gains as they accrue, including on the family home. But even this would not address the large fortunes already accumulated from tax-free gains. We need to stop talking about capital gains tax and consider a broadening of the income tax base to include all income from owning wealth starting with real estate (along the lines set out Retirement Policy Research Centre paper on Fair Economic Return that I co-authored with Terry Baucher).
For parents with children struggling in low-paid work, our tax system is neither simple nor low-rate. Excessive effective marginal tax rates trap those on low incomes in the poverty cycle. Currently, income earned over low thresholds can be taxed at eye-watering rates: an extra dollar earned over $48,000 is taxed 30c, causes a loss of 27c of Working for Families, 25c loss of Accommodation Supplement, 12 cents repayment of student loans, and then there is ACC and KiwiSaver, leaving many with little more than 5-20 cents in the hand for the extra dollar earned.
This means if we do choose the low-rate broad based approach we should immediately reform these damaging overlapping abatement effects. To start, let’s embark on a student debt forgiveness programme, better financial assistance for housing, reduce the abatement of Working for Families to 20 percent and increase the threshold to $55,000 and index it annually.
There is no free lunch in tax reform, the current regressive system is not fit for purpose. Let’s not squander the opportunity the election affords for a national debate.