By Jonathan Barrett*
It’s no secret that Revenue Minister David Parker has long been interested in tax reform in New Zealand. In 2022, he announced plans for legislation requiring future tax policy changes to be measured against a set of tax principles, notably fairness.
The Taxation Principles Reporting Bill, just released for public submissions, is the result of Parker’s ambition. But while it is reasonable to support a tax system that is fairer than the current system, I believe the bill is confusing, unnecessary and pointless.
Unlike the Tax Working Group, which clearly and adequately stated tax principles that most people could understand, the bill introduces highly technical ideas that could exclude ordinary people from the debate.
The bill also attempts to tie the hands of future governments by legislating principles that are not accepted across the political spectrum.
My main concern, then, is that the bill appears to close down democratic debate about taxation by claiming certain viewpoints are universally accepted. Secondly, the tax principles, as they are stated, are vague and poorly explained.
Horizontal equity
The bill introduces the concept of “horizontal equity” and defines this as meaning “people with similar levels of income should pay similar amounts of tax”.
But a more accurate way to explain horizontal equity would be to say “people who are in similar situations should be treated similarly”.
For instance, tax systems often view people with young children as being in a different situation from people with adult or no children. The Working for Families (WFF) programme is an example of such a distinction based on a political value judgment.
The principle of horizontal equity as outlined in the bill is incompatible with the Income Tax Act because people with similar levels of income won’t pay similar levels of tax due to programmes like WFF.
If the principle of horizontal equity needs to be stated, it should be that “taxpayers in similar circumstances should pay a similar amount of tax”.
Time and money
There is also no concept of income that everyone accepts. A standard tax textbook distinguishes between legal, accounting and economic conceptions of income.
According to the bill, “the time value of money matters when considering horizontal equity”. I presume the authors of the bill mean that some will get a tax benefit by deferring their tax liability when others with a similar income can’t.
But the phrasing in the bill makes it difficult to understand. A set of principles that affect everyone should be understandable by as many people as possible.
The bill also introduces the phrase “economic income”, but again a clear definition isn’t included.
The bill’s authors then appear to endorse a particular conception of comprehensive income – that is, the increase in economic capacity during the tax assessment period.
Understood broadly, this conception of income not only includes increases in wealth that a taxpayer hasn’t received (unrealised gains), but also capital gains and capital transfers. But New Zealand doesn’t currently tax capital gains or capital transfers.
This means there would be a significant gap between the ideas set down in the principles and how most people think of income.
The IRD tax study started with a speech entitled, Shining a light on unfairness in the tax system.
— Jo Moir (@jo_moir) April 26, 2023
“That light has now been shone,” David Parker says.
The question is, what is anyone going to do about it? https://t.co/yY3ygAWr9f
Vertical equity
The bill also states: “The tax system should be progressive. Tax is progressive if people with higher levels of economic income pay a higher proportion of that income in tax.” This is in line with the principle of “vertical equity”, which requires people in different circumstances to be treated differently.
It is not uncommon for countries to lock in the ability to pay tax, which traditionally includes both horizontal and vertical equity, within their constitutions. But the bill is not a constitutional document and represents the opinion of one government – and perhaps just one minister – at a particular point in time.
Using the word “economic” in the explanation of vertical equity is unnecessary. The OECD defines progression as meaning “an increasing proportion of income must be paid in tax as the income increases”.
The inclusion of “economic” in this context could be seen as an attempt to neutralise debate about a particular theory of income that isn’t universally accepted.
The bill doesn’t solve our tax problems
The bill then states: “A progressive tax system does not mean that every tax should be progressive (e.g. GST is regressive) but the overall system ought to be.”
This is a reasonable and pragmatic approach to including GST in the tax mix. But the following sentence is problematic: “In practice, wealthy people should at the very least pay no lower a rate of tax on their economic income than middle-income New Zealanders already do.”
Why “in practice” and not in principle? The income of so-called “middle-income New Zealanders” is most likely fully taxed under the current provisions of the Income Tax Act.
Certainly, some wealthy people may engage in arrangements to reduce their income tax liabilities. But most don’t pay “enough” tax because successive governments have lacked the courage to tax capital gains, wealth, and gifts and inheritances.
The Tax Principles Reporting Bill does nothing to remedy this.
*Jonathan Barrett, Associate Professor in Commercial Law and Taxation, Te Herenga Waka — Victoria University of Wellington. This article is republished from The Conversation under a Creative Commons license. Read the original article.
40 Comments
Good article. As much as I am a proponent of a FTT as the 'fairest of them all', I really chafe at 'progressive' tax. Though, I've also thought if the progressive tax was much more graduated, instead of piecemeal shelves we have, would be an improvement. People working across the tax boundaries are excessively rewarded (erm, increased tax bill) for doing so.
A flat tax would be better than a progressive one. Consumption taxes are regressive - a flat tax, everyone pays their fair share (assuming no dodging via fancy accounting - but they don't pay their fair share anyway, so no difference).
The government should be able to function on the amount of tax they would receive if everyone was earning minimum wage. Any more is, by and large, excess expenditure. So, perhaps a higher minimum wage, and a much lower expenditure would be a good place to startt.
I also support the idea of a tax cap.
The government is the currency issuer and not a currency user and it cannot tax us before it has spent its currency. Taxation only deletes the governments currency and doesn't finance it. We need the government to be running deficits so as to finance our net savings and our current account deficits. (Sectoral Balances).
https://theconversation.com/how-government-deficits-fund-private-saving…
Totally disagree.
1) In a capitalist society there will always be a pyramid of wealth. It is fiction that everyone can climb to the top of the pyramid.
2) The rich don’t make their wealth in a vacuum but are totally dependent on the existence of the rest of society.
A progressive tax system is the only fair and equitable way of taxation and ideally this would be an income+wealth based % consumption tax.
If you disagree I suggest you go to Venus by yourself and make your fortune there.
A progressive tax system is the only fair and equitable way of taxation and ideally this would be an income+wealth based % consumption tax.
A blanket statement with no basis. 'fair and equitable' are in the eye of the beholder.
We differ in view, that's fine - but there's no need to be rude about it. Just remember, anything that exists due to legislation can be changed - it's not set in stone, and can be changed at will.
Flat taxes simply don’t work. They don’t generate sufficient revenue and the socially optimal outcome is not achieved. Ie services get cut to the bone and we end up in the mess we are in now with massive social and environmental deficits.
There are studies that have been down that show the optimal maximum tax rate is about 60%, far more akin to the tax rates before deregulation. Neoliberalism is a failure through and through.
Whilst I say this I’m also not opposed to every dollar of government spending going through cost benefit analysis to ensure it is productively spent.
Well now, hold on there. A flat tax is possible, but only if it is applied to all forms of wealth generation.
So a middle-income earner on $150,000 pays 15%, or $22,500, per year in tax.
If they had a savings account with $15,000 in it that nets then 3% interest, or $450, for the year pays 15%, or $67.5, per year in tax.
If they had $1,500 in shares that nets them 10% dividend, or $150, a year then they pay $22.5 in tax.
If they had a house that they bought for $1,000,000 and sold it for $1,500,000, they pay $75,000 in tax on that sale. 15%.
If they were also a business owner, with that business being valued at $10,000,000 and it was bought by some investment company for $20,000,000 then they pay $1,500,000 in tax, assuming they had 100% ownership.
Essentially, tax should be applied to any increase in value of an asset at the time the asset is liquidated, or any form of monetary gain.
But as mentioned in the article, pretty much any wealth generation outside of PAYE and interest on savings/investments is either not taxed at all, or taxed at a lower rate for the same amount of "income".
Some of these are easily available, such as PIE Term Deposit versus regular Term Deposit which can reduce the tax you pay on your interest earned when you're in the 30%, 33% or 39% income tax bracket.
It is also why property investors are happy to run cash negative - making no profit at all on their rentals - and thereby not paying any tax, while waiting for an opportunity to sell for a tidy profit in the future that also requires no tax being paid. It's also why some of our rental stock is in poor condition, as those investors don't have the necessary cash reserves to make the repairs or improvements.
However, there is an entire culture of tax reduction in play, with many businesses whose sole reason for existing is to reduce the tax people pay by massaging the numbers on one side of the equation and leveraging the "rules" to their customers benefit.
At the end of the day no tax will ever be "fair" because people are involved, and for the billions of us that exist, there's only a very small number that are entirely selfless.
Maybe we should let an AI determine what tax system should be used? But for that to work it would need to have independent thought, which is a scary prospect.
The Bill appears to specifically rule out CGT & imputed rents on the family home.
Claiming that the "principle" of Vertical Equity is generally accepted is standard socialist envy dogma..
And of course:
Te Tiriti o Waitangi obligations apply
This Act must be applied consistent with the public service’s obligations in relation to Te Tiriti o Waitangi.
Schedule 1Taxation principles
s 4
Taxation principle Description
Horizontal equity People with similar levels of income should pay similar amounts of tax. The time value of money matters when considering horizontal equity. The tax system should generally recognise the economic effect of income, not its name, while acknowledging there are important areas where exemptions to taxing economic income are justified in the pursuit of wider societal outcomes (eg. not taxing the imputed rent or gains on an owner-occupied home).
EfficiencyTax revenue should be raised in ways that minimise distortions to the economy and the use of resources.
Vertical equity The tax system should be progressive. Tax is progressive if people with higher levels of economic income pay a higher proportion of that income in tax. A progressive tax system does not mean that every tax should be progressive (eg. GST is regressive) but the overall system ought to be. In practice, wealthy people should at the very least pay no lower a rate of tax on their economic income than middle income New Zealanders already do.
Revenue integrity The revenue system should be sustainable over time and minimise opportunities for tax avoidance and tax evasion.
Compliance and administrative costs Compliance and administrative costs for taxpayers and the Government should be reasonable, but this is not justification for substantial unfairness in the tax system.
Certainty and predictability People should be able to determine their tax obligations before they are due.
Flexibility and adaptability The tax system should keep pace with changes in society, in particular technological and commercial developments, and changes in inequality.
I'm always very skeptical of any legislation being proposed that says it must align with the treaty, for no other reason than it can be interpreted in different ways and argued in court under different lenses. Unless it is clear cut and specific, I don't feel this is a viable option.
No new laws are perfect. All are step in the (generally) right direction. This one is no different.
I wonder if Johnathan has heard of the quote: Perfect is the enemy of good
Or perhaps he's concerned that such a law might have him paying more tax? We don't know. And he doesn't say.
Not just them. Our household pays ~$10k per annum more tax than some others of similar income due to how heavily skewed our personal income tax rates are. There's a continuum from equal to skewed, and we're right at the very end of skewed.
Don't get any handouts, but we do benefit from the taxes spent on social goods such schools, roads and the justice system - same as everyone else. We just pay more proportionally for it than most.
I believe it's the difference in net income, although that's not all tax. For example, assuming a 3% KiwiSaver contribution:
- Two people each earning $70,000 have a combined net annual income of $105,618 ($52,809 each).
- A single person earning $140,000 has a net annual income of $96,547.
That's a $9,000 difference, but two people likely spend more per annum than one, so that "benefit" is going to be eaten into by their higher combined costs.
How about we consider income to be solely a single persons for tax purposes (ie your income tax rate), but then consider this same income to be the family income when assessing spousal eligibility for benefits?
In other countries with a single income earner in the family the income can be split across persons for tax purposes. That would be fair and consistent if we use it to assess benefits.
Johnathan, I take issue with this bit!
The bill introduces the concept of “horizontal equity” and defines this as meaning “people with similar levels of income should pay similar amounts of tax”.
But a more accurate way to explain horizontal equity would be to say “people who are in similar situations should be treated similarly”.
For instance, tax systems often view people with young children as being in a different situation from people with adult or no children. The Working for Families (WFF) programme is an example of such a distinction based on a political value judgment.
WFF - while delivered through the tax system - in not anything to do with tax. It is a redistribution based upon a family's situation. I.e. any political party can change WFF while leaving the tax system untouched.
Perhaps you need to find a new example as this one does not show what you want it too?
Nice try at muddying the waters.
Understood broadly, this conception of income not only includes increases in wealth that a taxpayer hasn’t received (unrealised gains), but also capital gains and capital transfers. But New Zealand doesn’t currently tax capital gains or capital transfers.
if they tax based on this idea, that's fine with me as long as they will also do tax returns based on capital losses (realized or unrealized), it'll only fair it works on both ways.
Another observation I have is that, whenever there is an issue, be that a housing issue, poverty issue, the Labor-Greens will just tax it, then pretend problem solved.
Think about it, the Labour government has been in government for two terms now, they invented a new tax bracket, refused to adjust tax bracket even when inflation gone through the roof, taxed on fuel, removed interest deductability (which actually created a tax on rent), moved bright-line test to 10 years (which is creating a version of CGT). but what have they achieved? Kids are still hungry, and the poor is still poor.
Labours entire policies are built on the principle of blaming "rich pr**ks" for everything to retain their dependency demographic voter constituencies.
They'd be history if NZ had a sound economic basis to enrich the majority of its citizens now that the only historical wealth creating option of housing has failed for the foreseeable future.
if you really understand Labour's policy on landlords, you'd find it will "make institutional landlords great again", and consequences of that is not exactly to help everyday kiwis, or renters.
and I should point out that, it's labour's tax policy taxing the working class more than it should. Hence this article is talking about 'definition of income'.
- introduce prescription taxes
You mean reverse the previous removal of them
- over tax wage and income earners
Arguably we are already being overtaxed due to bracket creep
For the record, I'm no fan of Labour or National this election. NZ needs more lateral thinking and diversity in parliament to represent the variety of different views.
It would be a better instinctive response form people to think more broadly when hearing about either Labour or National than simply reverting to bagging the other. There are more options to vote for folks, let's break the traditional mentality and mix it up in parliament
You don't see any moral hazard associated with allowing capital losses to be clawed back?
I see moral hazard. But I see also some seriously anti-competitive behaviors by businesses knowing full well a project is going to fail but as it stuffs the competition, they do it anyway - and the CGT tax system makes it less of a loss. (Sure, this is done already but over much shorter terms which don't really allow the business to pick a time when the CGT loss is recognised.)
I can't understand, being a simple fellow, why we always seem to be debating major changes to our taxation system. It has been what, about 35 years since the introduction of a consumption tax, with parallel simplification of the rest of the system.
It seems to have operated reasonably well. What drives all the excitement about further radical change. Yes, I understand socialists will never get enough tax dollars for all their favourite schemes to eliminate poverty, crime, and Santa Claus. And yes, I get that economists just like to play with new ideas.
But let's face it. Our system works reasonably well with reasonable simplicity.
We already have a capital gains tax on property sales which could be administered with more clarity and certainty. And there is a good arguement to index tax rates to reflect inflation and perhaps to serve as a disincentive against imprudent government.
It seems from my reading of these sort of articles, and responses thereto, most of the debate is about a belief someone is getting away with not "paying their fair share". The latest debates prompted by a very incorrect, but possibly deliberate misreading of the recent IRD study. The reporting of same has been atrocious by our mainstream media, but Minister Parker has the headlines every big spending socialist could desire!
It will be interesting to see what happens with the tax system announcements by different parties as if they index tax brackets they will lose a large volume of tax revenue, and when they have blown the budget so spectacularly over their two terms while increasing their tax take by a good margin also, it is hard to fathom how the country can keep functioning effectively if they lose out on a sizeable chunk of this.
The NZ government is now collecting 55 percent more income tax off its citizens than it did in 2017.
Does anyone else think that this is outrageous given that just about every public service has gone backwards from the quality of roads, hospital waiting lists, education standards, mental health, crime, massive blow out in government debt, emergency housing, you name it.
The price of food rising at 12 percent per annum.
And yet they want more?
Get your own house in order and stop trying to fool us with vaguely worded, deceptive tax reform.
Sod off.
Thanks for a great article, Jonathon. If you don't mind, can I use it in a tax course I teach later in the month?
Your definition of the meaning of horizontal equity “people who are in similar situations should be treated similarly” is very important, and I think it nicely catches what is wrong in the definition proposed by the bill. Horizontal equity has never meant that people with similar income should be taxed the same amount: this seems to have been a New Zealand invented paraphrase, with no support from the academic literature whatsoever. It is particularly noticeable that most OECD countries deliberately structure their tax systems to comply with “people who are in similar situations should be treated similarly” while allowing people with the same income to be taxed differently. On the whole they do this by taxing labour and capital incomes at different rates, in accordance with standard tax arguments, largely through the use of social security taxes. Most Scandinavian countries push the point even further, deliberately reducing the tax on capital income below the tax on labour income to ensure that they have a high capital, high wage economy. No such "luck" for New Zealanders - this bill proposes we spurn the tax systems used in most high income OECD countries for a homegrown version developed from poorly stated principles.
Please keep contributing - there needs to be more analysis of whether New Zealand's very unusual tax system is actually delivering good results, or whether the "New Zealand way" has been undermining the country's economic performance for the last 40 - 50 years.
Yeah its kind of a stupid article, because it doesnt even look at the true definition of Progressive Tax.
Because people with higher incomes pay progressively more tax by just earning more.
Tax on 20k versus tax on 40k at even a flat rate, they 40k earners are paying double the tax.
It is progressively unfair, to then tax them at a higher rate as that is an "Exponentially Progressive Tax".
For equality you should either have a flat tax "Rate" or a flat tax "Amount" that everyone should pay as citizens of the country.
How about not having a progressive system by how much you earn, but by what your real share of the cost of govt is.
Say 20k or 30k for every person to live in NZ, anything over that you get to keep, whether its 5k or 200k.
That is a user pays fair system.
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