Fiscal drag in Treasury crystal ball

By Brian Fallow

Tax bracket creep and rise in GST two options for country's long-term future

Taxing capital gains at the same rate as other income would raise around 1 per cent of GDP. Photo / Chris Gorman
Taxing capital gains at the same rate as other income would raise around 1 per cent of GDP. Photo / Chris Gorman

Allowing more fiscal drag - where nominal income growth pushes people into higher tax brackets unless the thresholds are adjusted - is one of the options sketched in the Treasury's long-term fiscal statement, released yesterday.

The statement projects the widening deficits and ultimately insupportable debt burden which would result over the next 50 years if tax is held at 29 per cent of gross domestic product and government spending grows at historic rates.

As well as looking at ways of reining in growth in the big-ticket spending items, especially health and superannuation, it highlights a couple of options that would raise the tax take as a share of GDP.

One is to raise tax bracket thresholds to compensate for consumer price inflation but not for real wage growth. The other is to lift the GST rate.

The options are only intended to be illustrative of the challenges and trade-offs in meeting the long-term fiscal challenge, and are not policy recommendations.

"Collecting, say, 2 per cent of GDP more in tax would go a long way to meeting future spending pressures and would also not be particularly out of step with historical trends," the document said.

Over the past 40 years the tax-to-GDP ratio has averaged just under 30 per cent and over the past 10 years just under 29 per cent.

"The idea that people might move into higher income tax brackets as their [real] incomes rise is one that people might be able to accept," the Treasury says.

On the other hand having almost everyone eventually move into a higher tax bracket would make the tax system less progressive than if the thresholds were adjusted to reflect real wage growth as well as inflation.

Finance Minister Bill English, in a speech on Wednesday, emphasised the highly redistributive nature of the tax and transfers system.

In the current tax year households earning over $150,000 a year, 12 per cent of all households, were expected to pay 46 per cent of the income tax collected, he said.

At the same time households earning less than $60,000 a year - around half of all households - would pay 11 per cent of the income tax or $2.7 billion, while collectively receiving $8.1 billion in various forms of income support. The Treasury estimates raising the GST rate to 17.5 per cent would raise the tax to GDP ratio by one percentage point.

But it would still leave the lion's share of the projected gap between revenue and spending to be dealt with by other measures.

It would take a larger share of the incomes of people with lower incomes, and probably result in pressure for exemptions, which would reduce the efficiency of the tax. Among the background papers accompanying the statement is one that explores other tax options as well.

Increasing company tax would reduce incentives to invest, it says.

"In practice the company tax rate could not be raised much higher than it is currently due to raising incentives for multinational companies to structure profits away."

Taxing capital gains at the same rate as other income would, like a GST hike, raise around 1 per cent of GDP.

A capitals gains tax is complicated to design and implement, the Treasury says, and would have an efficiency cost inasmuch as it increases the tax on capital overall. But it could also improve the allocation of savings by encouraging less investment in real property and more in other forms such as financial assets.

A payroll tax would be regressive - hitting those on lower incomes more.

Raising income tax rates is considered very inefficient because of the adverse effect on incentives to work, save and invest.

By contrast a well designed land tax, based on the value of unimproved land and with no exemptions based on land use, would be very efficient, but it would be unfair to current landowners as its introduction would cause land values to fall.

Environmental taxes are primarily intended to affect behaviour rather than raise revenue. Muddling those two objectives can lead to poorly designed and inefficient taxes, the Treasury says.

- NZ Herald

© Copyright 2014, APN New Zealand Limited

Assembled by: (static) on red akl_a5 at 30 Aug 2014 18:34:25 Processing Time: 654ms