KEY POINTS:
Taxes play a fundamental role in determining the sort of society in which we live. They can influence investment flows, where we live, what we eat and drink, how we save, our transport choices.
As we move into election season, tax - in particular personal tax cuts -
is very much on the agenda.
The Minister of Finance, Michael Cullen, has made clear his criteria for personal tax cuts: no borrowing to pay for them; no service cuts; no exacerbating inflationary pressures; no creating greater inequalities in our society.
This list invites a broader question: what is a good tax? The following are generally accepted characteristics of good tax policy:
Fairness: Taxpayers in similar situations should be taxed similarly.
Certainty: The rules should state when and how taxes should be paid and how to calculate the amount owed.
Convenience: Payment should be easy for the taxpayer, and should fit in with normal business practice.
Simplicity: Tax laws should be easy to understand and compliance costs should be minimised.
Transparency: Taxpayers should understand the taxation process and how and why policy changes are made.
Neutrality: A taxpayer's financial and business decisions should not be motivated by tax outcomes, or special treatment.
But when it comes to defining just what constitutes these characteristics, things start to get tricky.
Fairness demands that two taxpayers with equal abilities to pay should pay the same amount of tax. However, whether it is fair for higher profits or higher salaries to be taxed at a higher rate is open to wide debate.
In general, progressive taxes are the norm for personal income; flat taxes the norm for businesses. Those with higher incomes will pay more under both progressive and flat tax systems. The relative fairness of either system - or, for that matter, of a regressive system, where less tax is paid on the last dollar earned than on the first - is a matter of opinion.
The current system, with tax rates of 30 per cent, 33 per cent, and up to 39 per cent for companies, trusts and individuals respectively, simply makes no sense - different taxpayers are paying significantly different amounts of tax on similar income-earning activities.
Certainty generally comes from clear laws and timely guidance being readily available to taxpayers.
Convenience is desirable because the more difficult a tax is to pay the more likely it will be unpaid. Being able to complete tax returns online has also greatly increased convenience. For a small business owner, however, tax (GST, PAYE, FBT [fringe benefit], etc) is still a real headache.
Simplicity and transparency are important as complex rules lead to errors and disrespect for the system. The simpler the system, the lower the associated administrative and compliance costs - which has obvious benefits for taxpayers and for Inland Revenue.
Penalties are also more likely to be understood if a system is simple, certain and clear. Many would cite the use of interest rates as a penalty as a "bad" tax - especially since they are not able to be remitted, even in deserving circumstances.
Neutrality. Taxes should be neutral so that individuals and businesses can make economic decisions on economic grounds. However, the temptation to use tax incentives to counterbalance market failure (to encourage investment in important infrastructure perhaps) and even human behaviour (a high tariff on cigarettes or alcopops, for example) is ever present - and may produce desirable social outcomes.
Government interference with investment decisions implies that the Government knows best.
Perhaps it is right on occasion - but any system which prefers some taxpayers over others must undermine the confidence of all taxpayers.
Taxes are not simply a matter of redistributing wealth. They are signposts as to which direction governments and would-be governments believe our country should be heading.
We are in an election year, and already hearing a lot about taxes.
Rather than just weighing up which proposed tax regime will leave more money in your back pocket, it's worth thinking about tax policy as a sign of an underlying philosophy.
As the tax debate starts to heat up, take time to consider how any proposed or announced changes score in the checklist above.
* Neil Russ is a tax partner in the Auckland office of national law firm, Buddle Findlay.