Wealth tax or food GST exemption: Which could make our tax system fairer?

The spectre of tax is haunting our politics and the upcoming election. The policy complications of exempting foods from GST howl in the night, while wealth and capital gains taxes circle the Beehive like angry ghosts – despite successive prime ministers’ best attempts to exorcise them. Our politicians have spent 30 years assuring us that these apparitions are not real, hushing us back to sleep. But the current revenue system is moth-eaten and crumbling.

In April last year, then-revenue minister David Parker laid out the principles of a modern tax system. In a speech at Victoria University of Wellington, Parker cited Adam Smith, the 18th-century Scottish economist regarded as the intellectual architect of modern capitalism. In today’s terms, it should be equitable: those on equivalent incomes should pay the same amount of tax and those with more resources should pay more than those with fewer. It should be convenient, transparent and easy to navigate. And it should be efficient, avoiding economic distortions or damaging productivity.

While New Zealand had legislative frameworks around things like public finance, climate change and child poverty, there was no coherency around tax – “that most important of government functions”.

So, he was introducing legislation to fix this. The Taxation Principles Reporting Bill would require the Inland Revenue Department (IRD) to produce a report every year documenting the fairness, coherency and integrity of the tax system, which collected $113 billion from New Zealanders last year.

Parker went further. He’d also given his tax officials the power to investigate the assets, income and tax arrangements of our wealthiest households. Officials couldn’t determine whether the tax system was fair, he argued, if they didn’t even know how much the very wealthy earned, what they owned or how much tax they paid on it. Their study population consisted of 311 high-net-worth households. Those of a left-wing persuasion sometimes denounce the wealthiest 1% in New Zealand, but they enjoy an average net worth of only $7.6 million. Parker’s study would investigate the wealthiest 0.02%, with an average net worth of $276 million – a group never studied by the Treasury or IRD.

The results of the project were released in April, a year after Parker’s speech, and it revealed that the very wealthy paid low levels of tax – just as Parker had expected. The average member of the study group paid an effective tax rate of just 8.9% tax on their “economic” income (which includes salary and wages, investment earnings, capital gains and trust income). In comparison, the average annual income from salaries and wages for full-time-equivalent employees is $79,600, and if they don’t have any other sources of income they’ll effectively pay 22% of that in tax, according to the IRD’s tax calculator.

Missing the net

New Zealand clearly failed the fairness requirement of a modern tax system. Or did it? The subjects of the study were anonymous but one of them soon declared himself: former prime minister Sir John Key, now chairman of ANZ, the country’s largest bank. Key was highly indignant at the suggestion he didn’t pay enough tax and he went on a NZ Herald podcast with former Cabinet colleague Paula Bennett to criticise the report. “I know there’s a hell of a lot more wealthy people that are not on the list that are a lot wealthier than we are,” said Key. “But I know how much nominal tax I pay and the answer is a truckload. So, when 2% of people are paying a quarter of all personal tax and 25% … or 20% are paying about 70% of it, well, if that’s not enough, what is enough?”

Key is correct that high income earners pay most of the nation’s net income tax, though his figures were slightly astray. In 2019, a Treasury study estimated that the 3% of taxpayers earning more than $150,000 paid 24% of the total income tax take for that year. And the top 21% of earners paid 64% of total income tax revenue.

Another one bites the dust: David Parker resigned as revenue minister after the Prime Minister ruled out a wealth tax. Photo / Getty Images

How then, could Parker possibly claim that the rich didn’t pay enough tax? The trick is that Key was talking only about income tax levied on salaries, wages, investments, benefits and earnings through self-employment. For most of us, this, along with GST, is the tax system. But once you’ve reached the top 0.02% wealth status, you just don’t make much money this way, relatively speaking. This category of tax barely applies to you.

In 2018, the average total family income for the IRD study group was $8 million and only 7% of that on average – $560,000 – was earned in the form of taxable income. If you’d earned that in 2018, you’d have paid 31.7% tax on it: $175,720. But most of your total income came from your trust and additional property and financial holdings (an average of $5,360,000 for the study group). And the majority of this consisted of capital gains, which aren’t taxed at all.

Political suicide?

In 2006, tech entrepreneur Sam Morgan sold his Trade Me website to an Australian company for $700 million. This attracted controversy when Morgan revealed he paid no tax on the transaction, in which he personally made at least $227 million. He wasn’t deliberately evading tax, Morgan explained, he just didn’t have to pay any – a situation he found absurd. The finance minister at the time was Bill English: he suggested Morgan write him a cheque.

Capital gains taxes are, oddly enough, a neoliberal policy tool. One of the mantras of that economic revolution was “broad base, low rate” taxation, and as neoliberal governments swept to power around the world in the 1980s, they lowered income and company tax while introducing or increasing taxes on capital gains and consumption. New Zealand introduced a consumption tax, GST, in 1986. But we are almost unique among OECD nations in our lack of a capital gains tax. In the 1980s, prime minister David Lange insisted that introducing one would have been political suicide, “likely to lose you not merely the next election, but the next three” (which is precisely the number of elections Labour lost in the 1990s, after the Lange-led neoliberal-reform regime imploded).

The impossibility of taxing capital gains became conventional wisdom in Wellington. In 2000, when an OECD report argued that this gap in the tax system was damaging the economy, finance minister Michael Cullen replied that taxing capital gains was “extreme, socially unacceptable and economically unnecessary”, adding, “Basically, it is political suicide in New Zealand.”

But by 2011, the ice was thawing. This was partly due to an endless parade of economists complaining about the incoherency of the tax regime, and partly because high-profile cases such as Morgan’s suggested to the public that the economists might be right. That year, Labour, led by Phil Goff with David Parker in an associate finance role, campaigned on a tax switch: a tax-free threshold of $5000 paid for by a capital gains tax. The policy was fairly popular – 40.9% support in one poll. But Labour was not. They lost that election. And the next.

In 2017, Labour glimpsed a chance at victory when Jacinda Ardern replaced Andrew Little as leader just weeks before the election. But Ardern’s early dazzle faded when National hammered her party on its tax policy. Capital gains was still popular – 35% supported it versus 26% against in a 1News poll. But Labour felt it was dragging them down, so Ardern declared she would not introduce a capital gains tax. Instead, if elected, Labour would convene a tax working group and take its recommendations to the public in the subsequent election.

National had convened its own tax working group when in power in 2010. Its findings were highly critical of the existing regime, concluding: “The tax system lacks coherence, integrity and fairness … There is a major hole in the tax base for the taxation of capital, which is manifest, for example, in high investment and low taxable returns in the property market.”

John Key’s administration rejected a land tax. Photo / Getty Images

National’s working group considered a capital gains tax but instead recommended a tax on land, which the Key government quickly ruled out.

Labour’s 2017 tax working group was headed by Cullen (who’d left Parliament in 2009). It reported back in early 2019, recommending a capital gains tax exempting family homes. Cullen’s views had shifted since his time as a finance minister, he explained, citing Keynes’ famous adage, “When the facts change, I change my mind.”

He encouraged the nation to have a conversation about capital gains and it did, briefly, before Ardern ruled the tax out, not just for that term (in which she lacked a majority in Parliament to introduce one) but for as long as she remained prime minister, “not because I don’t believe in it, but because I don’t believe New Zealand does”.

Gasps of horror

Economists prize simplicity, especially when it comes to tax, because complex systems favour the wealthy, who can hire accountants and lawyers to navigate them. But a simple capital gains tax would tax family homes along with shares and other assets held in KiwiSaver accounts.

Cullen’s model exempted family homes but not shares, meaning the companies managing your KiwiSaver fund would have been eligible. And there were gasps of horror the length and breadth of the nation when he included farmland. He’d let you pass your farm on as an inheritance but if you sold it for a profit, the government would tax you.

National’s leader at the time, Simon Bridges, had enormous fun denouncing Cullen, Ardern and Finance Minister Grant Robertson and their malevolent plot to destroy the Kiwi way of life.

Labour's then Finance Minister Dr Michael Cullen eventually warmed to a capital gains tax. Photo / Getty Images

The worst part, from a political perspective, was that introducing a capital gains tax would be complicated and controversial but wouldn’t bring in very much money: less than half a billion a year in the first year.

Parker’s wealth study found that the very rich are making millions in capital gains but, his critics pointed out, most of those gains were unrealised. If the estimated value of your bach increases by $100,000 over one year but you don’t sell it, can that really be counted as income? What happens if it declines in value the next year ‒ do they give you a refund?

In Cullen’s model, the government would tax gains only when they were realised, and it would start counting the gains only from when the tax was introduced.

The Cullen report estimated that a capital gains tax would eventually raise 1.2% of GDP per annum in revenue – about $5.5 billion at current settings. But it would take at least a decade to get there. Cullen was telling Ardern and Robertson to spend political capital to introduce a new tax but some future government would get to spend all the money it raised.

Plucking the goose

For all these reasons, capital gains taxation has declined in popularity over recent years. Now, the affections of left-wing policy experts have drifted to wealth taxes, which avoid all these complications. Instead, the government sets a wealth threshold: all households with a net worth of over $10 million, say. Then it taxes a proportion of their net value every year. So, on a 1% wealth tax, a family worth $276 million would pay $2.76 million every year.

Simple! But the wealthy inevitably expatriate as much wealth out of the country as possible to avoid paying this, and the problem of “capital flight” means this form of taxation is declining in popularity around the world.

Louis XIV’s finance minister, Jean-Baptiste Colbert, 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”.

New Zealand’s finance ministers have become masters of this craft, steadily increasing taxes without being seen to do so. They accomplish this through the subtle art of bracket creep.

Our income is taxed at different levels. At present your income up to $14,000 a year is taxed at 10.5%; additional income between $14,000 and $48,000 at 17.5%; it keeps going up until you hit the top rate of 39% at $180,000.

These brackets haven’t shifted since 2010, with the exception of the top rate, which was introduced in 2021.

Inflation since 2010 totals 38%, according to the Reserve Bank’s inflation calculator. If your income has kept up with inflation, your wages or salary are 38% higher in nominal terms, but your purchasing power hasn’t changed. You aren’t any better off – over the past three years, many households have gone backwards in real terms – but the government nevertheless takes more in tax as your income creeps up into higher brackets.

Income tax distribution in NZ. Photo / New Zealand Treasury

The Treasury refers to this as “fiscal drag”, and in July, it released a series of budget documents revealing that the wheels were finally coming off the current tax system. For the past 13 years, governments had relied on fiscal drag to pay for increased state spending, it said. This was now threatening the integrity and progressivity of the tax system, because low-income earners were paying middle-income tax rates while middle-income earners were drifting into the higher brackets. Continuing to raise revenue through this mechanism would incur growing economic costs and call the fairness of the system into question. So Treasury recommended that the government consider broadening the tax base.

Grant Robertson and David Parker had already set about doing just this, exploring both a wealth tax and a capital gains tax for the 2023 Budget.

All the stars for meaningful tax reform seemed to have aligned: the current system was falling apart; Ardern had promised never to introduce such taxes but was gone; Parker’s new wealth report was evidence that tax-free gains on the scale of Sam Morgan’s were the norm among the very rich rather than the exception. National had indicated they’d deliver tax cuts by adjusting the income brackets and linking them to inflation, so Labour needed a competitive policy to campaign on.

Robertson and Parker landed on a wealth tax of 1.5% on fortunes greater than $5 million. This would bring in enough money to pay for a tax-free threshold of $7000 on incomes, subsequently increasing to $10,000. It delivered higher tax cuts to lower- and middle-income earners than National’s package.

It was everything Parker had been working towards. But Prime Minister Chris Hipkins cancelled the package 10 weeks before the Budget, and when news of the scheme emerged, he ruled out wealth and capital gains taxes for as long as he was in charge.

GST and food

What if the government removed GST from food? Or just fresh fruit and vegetables? Wouldn’t cheaper healthy food be the perfect tax policy for struggling families? This idea is very popular with the public: 76% support in a 2022 Newshub Reid Research poll. New Zealand First has promised GST exemption for “supermarket basics”, while Te Pāti Māori wants kai exempted from GST.

It’s hard to find an economist who doesn’t loathe this idea. Cullen’s report dismissed it as “complex, poorly targeted for achieving distributional goals and [generating] significant compliance costs. Furthermore, it is not clear whether the benefit of specific GST exceptions are passed on to consumers.”

There’s a risk that a GST exemption would merely function as a vast wealth transfer to the very profitable supermarket duopoly. The Herald’s deputy political editor, Thomas Coughlan, noted on Twitter: “If anyone thinks any government can force retailers to somehow pass on the GST cost …” and cited Labour’s inability to crack down on paywave surcharges.

That’s not the only problem. Cullen’s report estimated that removing GST from all food and drink could result in $14.58 a week in savings for low-income families but $53.03 per week for those on the highest incomes. And it’s expensive: $2.6 billion a year in 2018; around $3.15 billion at today’s prices. If the government wanted to help people buy food, the report concluded, it should just give them money.

Lisa Marriott points to the UK for reasons to avoid tax exemptions on food. Photo / Supplied

When the Listener asked Lisa Marriott, professor of taxation at Victoria University of Wellington, about the complexity of exemption regimes, she sent a paper on the UK tax system showing the different rates for VAT (the UK version of GST) across different food types. It showed that, among other things, gingerbread men decorated with chocolate are taxed, unless the chocolate consists only of two dots for eyes, in which case gingerbread men were exempt. Marks & Spencer spent 13 years fighting in court to determine whether its teacakes were cakes or biscuits for tax purposes.

It’s complicated

While the minor parties are promising significant tax policy tweaks this election, Labour and National keep delaying their announcements amid whispers of internal divisions and deteriorating revenue. Labour’s announcement was understood to be imminent as the Listener went to press. On July 27, National’s deputy leader and shadow finance minister, Nicola Willis, claimed she’d been leaked the details: Labour planned to make fresh fruit and vegetables GST exempt. Economists took to the media to denounce the policy. Political journalists noted ominously that it focus-grouped well and fitted nicely on a billboard.

Eric Crampton, the economist who exposed the improvised nature of the fuel tax exemption, is very critical of GST exemptions, as well as capital gains taxes. Asked what he made of this new development, he said: “It is always surprising when New Zealand’s Left, which wants government to do more things, supports breaking the clean tax system that would enable it [to do more]. … Every populist imposition on the tax system makes it run less well. That increases the cost to the government of raising revenue and reduces the scope for government to pursue programmes that it thinks are beneficial.”

Hipkins refused to rule the GST policy out, and his junior ministers made enthusiastic noises when questioned about it. But when journalists approached Parker for comment, he just walked away. He’d resigned as revenue minister three days earlier.

‘Dumb’ cuts

On March 10 last year, TVNZ’s influential 1News poll returned an unexpected result: Jacinda Ardern’s government was behind the National opposition for the first time since the pandemic. This was just three months after Christopher Luxon became opposition leader, and it was the early days of the cost-of-living crisis: an inflationary surge that the Reserve Bank assured us was temporary.

But people were clearly unhappy. Four days after the poll, Ardern announced a temporary reduction in fuel-excise tax and road-user charges.

Eric Crampton, an economist at the conservative New Zealand Initiative, wondered just how much work had gone into this suspiciously timed policy, so he requested documentation from the Ministry of Transport. He learnt officials had been notified just before 3pm on Sunday afternoon, three days after the poll and one day before Ardern’s announcement. They were instructed to give costings and advice for a Cabinet paper for the Transport Minister by 11am the next day.

Inflation proved less temporary than anyone hoped, so the fuel- and road-user tax exemptions were extended twice before expiring at the end of June this year, at a total cost of about $2 billion. Most economists hated this policy – Brad Olsen, CEO of Infometrics, described it as “extremely dumb”. Modelling demonstrated that it was a tax cut that primarily benefited the wealthy. And the government was also spending billions trying to reduce carbon emissions – $486 million this year alone to keep the price of carbon in its Emissions Trading Scheme artificially low. So for 15 months, the government was burning taxpayer money in an almost literal sense.

It was popular, though – drawing 71% support in a Taxpayers Union/Curia poll. The question is, if the government can improvise a $2 billion tax change over the weekend – a change that most economic commentators agree made no rational sense – how much coherency is there to the overall system?

Taxation policies announced so far:

Greens

• Tax-free threshold of $10,000
• Wealth tax of 2.5% on individual assets over $2 million (over $4 million for couples).
• 1.5% tax on trust assets.
• Increases in higher tax-bracket rates. Income over $75,000 will be taxed at 33%; over $120,000 at 39%; over $180,000 at 45%.
• Increase corporate tax rate from 28% to 33%.

Te Pāti Māori

• Kai exempt from GST.
• 0% tax on income up to $30,000.
• 42% tax on income from $180,000-$300,000; 48% on income above $300,000.
• Wealth tax: 2% on net wealth over $2 million; 4% on net wealth over $5m; 8% on wealth over $10m.
• Increase company tax from 28% to 33%.
• Foreign company tax: 2% tax on financial transfers overseas.
• Vacancy and land banking tax: 33% tax on the value of properties that remain empty for six months or more; 33% tax on value increases for land that remains undeveloped after four years of sale, with Māori land exempted.

Act

• Simplify the brackets on income tax: 17.5% up to $75,000; 28% above $75,000.
• Tax credit for low- and middle-income households.
• Carbon tax refund paid out of the Emissions Trading Scheme.