By Terry Baucher*
Louis XIV’s finance minister, Jean-Baptiste Colbert, famously declared that “the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”
What was true in the seventeenth century remains true today. And although Colbert might not recognise much of the modern economy and tax system, he would probably still appreciate some of the sleight of hand used by New Zealand finance ministers to raise funds without too much hissing. At a rough guess the last National government seems to have successfully plucked at least $1 billion of extra revenue annually with little or no fanfare. How?
We’re not talking about specific tax related measures often of a quite technical nature. These are a staple of every government’s budget.
A long-standing option used by governments of both hues is inflation, and in particular ‘fiscal drag’. This is when income tax rate thresholds are not inflation adjusted so wage growth lifts more earners on to higher marginal tax rates.
Income tax rates and thresholds were last adjusted in October 2010. At that time someone on the average wage had a marginal tax rate of 17.5%. According to the labour market statistics for the September 2018 quarter, average weekly earnings are $1,212.82 or $63,067 annually, well above the $48,000 threshold at which the 30% tax rate applies. Even median weekly earnings at $997 are also well above the $48,000 threshold.
So how much revenue does fiscal drag raise annually? The short answer would be “Heaps.” The Budget Economic and Fiscal Update released in May’s Budget estimated the effect of fiscal drag as $1.6 billion over the five years to 30 June 2022.
A more detailed analysis of the issue was prepared for then Finance Minister Bill English in November 2016.
The aide-memoire noted that adjusting for inflation since October 2010, effective 1 April 2017, would cost $1 billion in the first year. Clearly, baulking at this “large cost,” the paper instead modelled adjustments to thresholds based on price inflation over a single year, from June 2017 to June 2018, and applying that inflation factor to current thresholds beginning 1 April 2017. This produced a cost of $220 million for the 2017-18 year rising to $720 million by 2019-20.
The paper concluded by noting “a downside to not annually indexing is that there is less transparency for taxpayers.” This is something that politicians of both hues will rather conveniently rely on when trumpeting “tax cuts.”
Although fiscal drag is a well known tactic, Bill English also employed variations of it elsewhere to raise revenue. In the 2011 Budget inflation adjustments to the student loan repayment threshold of $19,084 were frozen until 1 April 2015. This and other changes to the student loan scheme added up to $447 million in “savings” over five years. The freeze on the student loan threshold was later extended until 1 April 2017.
The 2012 Budget froze the parental income threshold for student allowances until 31 March 2016, a measure worth $12.7 million over four years. More controversially, the same Budget increased the repayment rate applying to income above the student loan repayment threshold from 10% to 12% - a defacto tax increase. This increase raised (sorry “saved”) $184.2 million in operating costs over four years.
The 2011 Budget saw changes which also stopped inflation adjustments of the threshold at which abatement of working for families tax credits applied. Instead, measures reducing the threshold over a four year period from $36,827 to $35,000 were introduced. A “slightly higher” abatement rate of 25 cents in the dollar instead of 20 cents in the dollar was also phased in over the same period. These measures were intended to realise savings of $448 million over four years. (The current government’s Families Package partly reversed these changes by raising the abatement threshold to $42,000 whilst lifting the abatement rate to 25 cents in the dollar from 1 July 2018).
The 2011 Budget also removed the exemption from employer superannuation contribution tax (ESCT) on employer contributions to KiwiSaver funds. This is probably the biggest single measure that increased the tax take outside of the rise in the rate of GST to 15% in October 2010.
The exemption was removed with effect from 1 April 2012 and the compulsory employer contribution was also increased from two to three percent from 1 April 2013. These changes saw the annual ESCT collected rise by almost $400 million from $681 million in the June 2011 year (the last full year before the changes) to $1,078 million in the June 2014 year (the first full year of the changes).
Finally, there is the opportunity to increase various duties such as those on alcohol, petroleum and tobacco. For example, tobacco excise duty has been increased every year since January 2009 as part of the country’s Smokefree policy. As a result, the excise duty per cigarette has gone from 30.955 cents per cigarette in 2009 to 82.658 cents per cigarette as of 1 January 2018. During the year to June 2018 the government collected over $1.8 billion in tobacco excise duty.
All told, the combination of fiscal drag, ESCT increases and changes to student loans and working for families cumulatively represent at least $1 billion of additional revenue collected annually. Throw in the various excise duty increases, specific “base protection” tax measures such as changes to the thin capitalisation rules for foreign-owned banks or the the “Bright-line test” introduced in 2015, and the increased annual “tax” take is close to $1.5 billion.
These under the counter tax increases have happened with little fanfare under the guise of “savings”, or “better targeting of government programmes” (how the Budget 2011 changes were described). Colbert would no doubt approve of this efficient plucking of the goose with very little hissing.
*Terry Baucher is a tax consultant and director of Baucher Consulting Limited a specialist tax consultancy. He is the co-author with Deborah Russell MP of Tax and Fairness published in 2017 by Bridget Williams Books.
52 Comments
I like how "saving" is put in inverted commas - as if acknowledging the reality that a sovereign government that can issue its own currency at the stroke of a keypad never needs to "save" before it can spend. The ongoing, ill advised surpluses our governments are ideologically driven to run (at the expense of aggregate demand and full employment) just represent the dis-saving of the private domestic sector (given a current account deficit) - we are taxed more than we are given by government spending. What is more wasteful than the high labour underutilisation rate we have had for years? So many people can't get enough hours of living wage employment. This government should be running a sensible deficit -either via tax cuts and increased welfare payments for the bottom earners or via increased spending on public services and infrastructure. Not "saving" - sucking money and demand out of the economy. But they think that by "saving" they somehow have more money to spend in a downturn. Wrong, the ongoing surpluses push the private domestic sector into more and more debt which eventually causes the downturn. It is self-defeating. Alas, they insist on seeing a government like a household.
Hi cs, in relation to your second to last sentence, why does governments ongoing surpluses push the public into debt? Traditionally the more money there is being added to circulation the more debt the public takes on (correct me if I’m wrong)?
On a side note, in follow up to our sound money discussion a while back I’ve found this video and I think it knocks the explanation out of the park all while giving a nod to your rightly pointed out concerns about sound money:
https://m.youtube.com/watch?v=fjhLp8AHAYc
I would love to know what you think if you have the time to check it out.
I will watch when I get a chance!
You need to have a look at sectoral balances.
Basically in a given period, by accounting definition (not assumption or theory) a government surplus= a non-government deficit. So if the government surplus is 2% of GDP, the private sector (domestic and foreign) must be in deficit by 2% of GDP (i.e. not saving).
That is why when you look at the history of public and private balances the public balance is the exact mirror image of the private balance. So when the NZ government is in surplus, the private sector MUST be in deficit.
G-T= S-I -(X-M)
Put simply, if the government is running a surplus and the foreign sector is running a surplus (saving in our currency via the current account deficit) then in order to maintain national income levels the private domestic sector must go into debt (it must be in deficit).
Government deficits allow the private sector to save. They accommodate the savings desires of the private sector.
If you are referring to the money multiplier idea - that is a myth to disabuse yourself of. More reserves does not mean more lending.....
Randy Wray on sectoral balances
https://www.youtube.com/watch?v=zxDVRISfsls
Another nice explainer
https://www.youtube.com/watch?v=x2Jx5hDm-sk
Thanks cs for the explination and links, I believe I have the gist. On a slight tangent, is public and private debt that different as with public debt essentially the private sector (taxpayers) end up paying for it eventually anyway. Isn't it just an outside entity borrowing for you? Private debt by proxy?
The key difference is that private debt can be defaulted on. Households are constrained by what their revenue and borrowing potential allows. They are users of the currency. Sovereign governments are issuers of the currency and do not need to worry about revenue constraining spending. Their cheques will never bounce and in a myriad of ways they never have to tax to pay off debt. See Japan where boj owns large chunk of its own government's debt. "A government cannot become insolvent with respect to obligations in its own currency.A fiat money system, such as we have today, can produce claims without limit"...said by that well known modern monetary theorist Alan Greenspan 1997. This power can be abused of course but I would argue it can be put to good use for public purpose.
I agree they could technically not default. The issue however is they would inflate their currency to a point of uselessness domestically and abroad. Would you agree with that?
Japan is now also stuck in a system here they can practically never raise interest rates and they get issues associated with low interest rates, zombie companies etc.
I still feel the piper needs to be paid, it’s just in what form is the question.
Deficit spending can always cause inflation if done at full employment and in sectors of the economy that are at full capacity. I agree. So can spending from any sector (investment, exports, consumer spending). But it is very hard to inflate a currency to the "point of uselessness" and this has happened very rarely and usually is accompanied by war, political turmoil and the decimation of the productive sector of your economy (Weimar, Zimbabwe). Then printing money really does chase a lack of supply and you get hyperinflation. Hyperinflations are rare. If deficit spending always and everywhere caused inflation you would think Japan with a 250% government dept to gdp would have strong inflation right? And yet ... no.....
Hi cs. Thanks again for the reply. Inflating the currency to uselessness was my MMT equivalent for defaulting, not suggesting it was a likely conclusion.
There’s a lot I need to wrap my head around to understand how printing can be ongoing with minimal to no consequences if it can at all. I think time will shine a light on the issues MMT will cause. Currently I can see inflation and ever increasing debt servicing costs plied onto the citizenry.
I will be curious to see how things play out especially as we are in the first period in a long long time where there is no sound currency anywhere in the world. Nothing highlights issues like a contrast which unfortunately we don’t have at the moment.
It's been a while since I've done any Macro, but I'm sure the Fisher Effect would definitely imply so.
I dunno what cs's background is, but I think he's definitely missing something in his open economy macro understanding. He's right about what he is saying about sectoral balances, but I don't see how the notion that sovereign nations can print money without impunity in the medium to long run in an open economy.
Sure potentially with obligations in own currency, but not in obligations issued in foreign currency.
Nymad, I leave you with a wonderful long consideration of open economy issues from a Modern Monetary Theory perspective from economist Bill Mitchell. http://bilbo.economicoutlook.net/blog/?p=40433&cpage=1. Enjoy.
Mainstream macro has got things spectacularly wrong for a long time: QE will increase lending, monetary policy can do things on its own, seeing money as a veil over barter, money multipliers, crowding out, financial deregulation is harmless, fiscal austerity will cause expansions, Ricardian equivalence, rational expectations, loanable funds, NAIRU, .... I believe MMT is far better as a lens through which to view macro given these failings. Indeed a new undergrad textbook is coming out next year to compete with the Mankiw version of econ 101. Interesting times. https://www.macmillanihe.com/page/detail/Macroeconomics/?K=9781137610669
Cool story bro.
But just tell me how the Fisher Effect can be ignored and an issuer can ad infinitum print money to pay it's obligations with impunity. Like I said, this is potentially the case with obligations in own currency, but for obligations in other currencies this isn't possible.
It's the important distinction here. Hence why all of the macro guys you have quoted emphasize this fact.
Debt in foreign currency is never good when your currency depreciates. That is very true. Sovereign governments should try to avoid borrowing in foreign currency. Banks etc hedge if possible. But sensible deficits that offset private savings desires need not be inflationary or cause depreciation. See Japan. Governments cannot spend ad infinitum with impunity. There are real constraints.
cs,
But governments can and do default on debt-Argentina has done so on several occasions and Russia did so in the late 90s. According to Moody's,at least 16 sovereign bond issues have defaulted-this includes Pakistan,Ukraine,Ivory Coast,Uruguay and of course,Greece. Germany has defaulted 4 times since 1800.
The key difference is that private debt can be defaulted on. Households are constrained by what their revenue and borrowing potential allows. They are users of the currency. Sovereign governments are issuers of the currency and do not need to worry about revenue constraining spending. Their cheques will never bounce and in a myriad of ways they never have to tax to pay off debt. See Japan where boj owns large chunk of its own government's debt. "A government cannot become insolvent with respect to obligations in its own currency.A fiat money system, such as we have today, can produce claims without limit"...said by that well known modern monetary theorist Alan Greenspan 1997. This power can be abused of course but I would argue it can be put to good use for public purpose.
Nice one cs. Oddly enough I tried to point that out to my local MP when asked for thoughts about Bill English's budget 18 months before the election. I don't think he understood my argument even though he is a fairly bright chap. Few people can. Instead of my somewhat muddled argument, I should have been more blunt in pointing out that a tax at that time would help the economy run sweetly by the time of the election. They preferred to run at 45kph in a 50kph area because they wos worried about the debt. The poor dears.
How to explain that Cullen paid off $30 billion of government debt by encouraging an extra $100 billion of household debt that doubled NZ house prices and National just did the same?
Exactly. The graph showing public surpluses as the mirror image of private debt should be more widely understood.
The potentially functional nature of deficits (in sovereign currency nations with floating exchange rates and debt in own currency) should also be more widely understood. These surpluses are unnecessary and do not change the government's ability to spend in a recession. The NZ government ALWAYS has that ability (as long as it doesn't join the Eurozone).
My take was they should give generous tax cuts when times are hard as people will then be able to use the money in the best way possible, each according to their situation. Fiscal drag will solve the problem of tax revenue when, and only when, things pick up. For some reason there is a widespread belief that it is better for governments to spend big in a recession rather than cut taxes. Beats me why that is, all you get is money wasted bigtime on dopey low productivity projects (eg Shane Jones' "vote bribery fund").
While tax reduction can give in a recession and take in a bubble it doesn’t because, I think, no Government is going to get back in power if it increases taxes no matter how sensible that logic is. Personally I think a Government should spend in a recession because it can help big time. I would imagine that the people in Northland rather like Shane Jones’ ‘vote bribery fund’.
R W,
You might want to argue that with J M Keynes. However,I don't disagree about Shane Jones's slush fund. Some infrastructure projects are good and some rather less so.
I would much rather see that money spent/invested in better water/sewage management schemes for example. I want better public transport,but roads such as the Tauranga-Katikati highway project should get the go ahead now.
Agreed Roger - magic discussion CS. I got wound up by the Clark Labour government's surpluses, and positively despised Cullen's smug arrogance about them but could never explain why. i just instinctively knew it was wrong, and put it down to an ideological attitude that said the Government should make a profit. Now I understand at least some of the reason.
My question though is should the Government be aiming at balance, rather than surplus or deficit? Financing a deficit has a cost too?
Financing a deficit means tapping keys and spending, transferring money into bank accounts. The reserve add can then be reserve drained by selling bonds to maintain a target interest rate. But this is not necessary. It provides risk free returns to savers and the financial sector. Governments can never default on it. Unless they choose to. Government debt is simply money deficit spent that hasn't been taxed back. If a bond issue failed to be covered by willing savers the reserve bank could just buy the bonds with a tap of the keyboard....see Japan. Deficits are just accounting records. They are neither good nor bad. It depends on the state of the economy. If you have underutilized capacity and a private sector wanting to deleverage and low inflation you need a deficit. That is if you don't strike oil or something that increases exports
Deficits are just accounting records. They are neither good nor bad. It depends on the state of the economy. If you have underutilized capacity and a private sector wanting to deleverage and low inflation you need a deficit. That is if you don't strike oil or something that increases exports
Right, but this is where it gets interesting. The Japanese public debt may be more sustainable because of their huge industrial might and export orientation (the Japanese private sector has largely deleveraged after all this time since their bubble burst). Countries like NZ are not really in the same league.
How do you define "sustainable" J C?
Perhaps you are referring to external constraints? Trade deficits expanding with deficits causing currency depreciation and inflation pass through?
I think this article by Randy Wray is interesting in this respect. MMT doesn't deny these aren't possibilities. But it says that full employment should not be sacrificed and external issues should be dealt with in other ways.
http://neweconomicperspectives.org/2014/02/mmt-external-constraints.html
"MMT principles apply to all sovereign countries. Yes, they can have full employment at home. Yes, that could lead to trade deficits. Yes that could (possibly) lead to currency depreciation. Yes that could lead to inflation pass-through. But they have lots of policy options available if they do not like those results. Import controls and capital controls are examples of policy options. Directed employment, directed investment, and targeted development are also policy options.”
Your folly is assumming the national mp had a brain in their head and was capable of free thought, which we all know tories aren't because their PR firm tells them what to say and do every step of the way. Frankly I have been disappointed in Nationals track record in the tax arena, they did some quite mean grabby things that I think were not very well thought out or...well spent either.
Yes, well, my take on that issue is as follows. Applying Pareto's ideas to politicians, probably only 10 to 20% of them are up to the job, the rest are overpromoted to their level of incompetence (the Peter principle). That leaves 10 to 24 competent politicians in the House of Reperesentatives at any one time...
I read a release from Positive Money that said neither Robertson nor Cullen at a public meeting would admit that private banks create money when lending.
https://most0010122.expert.services/includes/download.ashx?ID=149173
One does wonder....
Hi Roger, thanks for the comment. It's a good point. I didn't include it because it was part of the "re-balancing" 2010 Budget which I took as the baseline for my article. What was taken in removed depreciation was passed back in income tax cuts. You may have noticed that the Tax Working Group has had a look at whether
depreciation for some buildings should be reintroduced.
Thanks for all the comments everyone, much appreciated.
An 'honest' (i.e., genuine with respect to making NZ Smoke Free) government would increase the age of purchase for cigarettes and tobacco by one year every year if the aim of the policy was really to become Smoke Free (as opposed to increase the tax take). In thirty years time you'd need to be 48 years of age to purchase smokes. Hence, youth would never start and no new "recruits" would get hooked. For my grandchildren's sake, I so wish some government would do this.
Where do you live Kate ?
NZ has extremely high marijuana use for a start forget nicotine for a moment
Drug dealers all over Auckland selling everything from weed on up
My own children’s decile 10 schools had dealers selling behind the local McDonalds
I myself witnessed the black bummer with the guy waiting by the boot of his car on one occasion
Weed is legal in Canada now and still a third of people buy from illegal dealers and its only been a few months
US weed legal in many states and both US & Canada have an appalling illegal nicotine cigarette problem too
Good luck though
I'm a reluctant nicotine addict, still smoking. My generation is farked, but thankfully the changes during my later years have proved beneficial for the next generation. Except now the young ones skip tobacco n straight for the nicotine vapes, flavoured like lollies. Nanny state to increase purchase age over 18 IMO. The population just need to be less selfish "all about the profit" and shift the paradigm. I'm quite ashamed to belong to the human plague on itself, and the parasite of earth. Let's hv another world war, to encourage youth to begin to contemplate etc :)
If I was a sadistic misanthropic person and wanted to increase inequality in New Zealand then I'd increase tobacco excise, raise GST and decrease assisted living payments. For just a modest increase in tax take, say 500m, you could really drive inequality through the roof.
Yet for all their cleverness the Nats allowed foreigners who never set foot on NZ soil to freely speculate in buying & selling Auckland homes free of any taxation and free to repatriate their profits.
Worse they allowed this to continue for many years
Yet John Key happily loaded up GST to 15% from 12.5% along with a extra fuel tax even after stating in one election “No new taxes”
Bill English also claimed a housing allowance he later admitted he shouldn’t have taken from. Something so easily discovered it was crazy he tried it.
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