The Tax Working Group’s scope must include the welfare system – broadly defined
Under a new centre-left government, we’re now about to start an eighth review of our taxation system. What can we learn from the history of this process?
17 November 2017
Over the last century, New Zealand has run seven major policy reviews of our taxation system. Two reviews were undertaken in quick succession in 1922 and 1924, and another commissioned in 1951.
A fourth, the Ross Report, was produced in 1967, the McCaw Report was published in 1982, and the McLeod Report was released in 2001. The most recent report was that of the Tax Working Group in 2010, and now we are about to start an eighth review.
Well, thus far none of the reviews of the tax system have undertaken any comprehensive integrated review of the welfare system. It is not surprising that this was the case for the earliest reviews, since there was relatively little welfare to consider. But for the post-World War Two reviews, there certainly was a significant welfare system.
The need for an integrated consideration can be understood using the old metaphor of two sides of the same coin. A welfare benefit is simply a negative tax. Alternatively, a tax is a negative welfare benefit. Welfare benefits are about achieving efficiency and equity goals as efficaciously as possible. So are taxes. In other words, two sides of the same coin. Imagine designing two entirely separate one-sided dollar coins! Crazy, right? Yes, but that’s what we’ve been doing with taxes and benefits.
Whilst they did not undertaken an integrated analysis, the fundamental point that the two things – taxes and benefits – are basically the same was recognised as long ago as the 1967 Ross Report. Ross advised the government of the time that “cash benefits received are, in effect, negative taxes and these must enter into the assessment of the criteria of equity and ability to pay”. A similar point was made by the McCaw Report.
An important dimension of the real life integration of the current tax and benefit system is the process through which welfare benefits are reduced as people’s incomes rise and additional government income deductions start kicking in, meaning that the effective marginal tax rate faced by low and middle income people is often far higher than the notional income tax they pay on the last dollar they earn. Professor Susan St John at Auckland University has vigorously pursued this issue over many years.
However, the additional government deductions include not only the Working for Families Tax credits and the Accommodation Supplement, which are often focussed on, but also other social taxes which also kick in as people’s income rises, including repayments on a variety of loans and debts, including student loans, and payments of child support by non-custodial parents.
Back-slapping amongst some tax experts that the New Zealand system is a simple, broad base, low tax rate jurisdiction is frequent. But it is jollity derived by arbitrarily defining things that effectively are taxes as non-taxes, simply because they aren’t called so. The old adage “barks like a dog” seems relevant here. In fact, for many low and middle income families, effective tax rates, as opposed to income tax rates, are very high, on a narrow base.
The 2010 Tax Working Group indeed correctly identified one main problems of the tax system as the high effective marginal tax rates – but only those introduced by Working for Families tax credits. However the Tax Working Group did conclude that “There should be a comprehensive review of welfare policy and how it interacts with the tax system, with an objective being to reduce high effective marginal tax rates.” The best way to do such a review, in my view is to integrate it with a tax review. Others, including Terry Baucher , have already vigorously made this point.
An integrated review will throw up serious challenges. The tax system, narrowly defined, is based on assessing an individual person’s income. Redistribution in the welfare system – or if one prefers, the negative tax system – relies on assessments of family, not individual income. The two different tax units – the individual and the family - exist in uneasy relationship to one another. However, it is best to address these issues head-on, rather than pretend they do not exist.
There is a further challenge an integrated review will need to address. The purpose of a means tested welfare system is supporting people in need. A core criteria for successful performance is that government proactively ensures that people are getting their full entitlements. Yet the philosophical basis of the traditional tax system is that Inland Revenue have no interest in ensuring people are getting their full income entitlements.
The second issue of importance after ensuring a broad terms of reference is another issue of breadth – this time of representation. Again, history can provide some negative guidance. Over the seven reviews undertaken over the last century, 62 people have been appointed to sit on the various tax committees. Of these 62, a mere three percent have been women, one in 2001 and a second in 2010, a point well-made by blogger Andrea Black. Surely we can do better in 2018. World Values Survey data for New Zealand shows that women have on average a different perspective to income inequality than men and have significantly stronger views on tax evasion, so a more representative body could well-lead to more representative decision making regarding the tax-benefit system.