All Kiwis gain from putting paid to tax avoidance mysteries

It is no surprise to anyone to be told most people don't like paying more tax.

Recent media attention has focused especially on companies’ behaviour, with accusations of multinationals effectively choosing where to pay their taxes and how much to pay—or avoiding tax altogether. But the issue is just as relevant for ordinary New Zealanders.

For example, someone currently earning $75,000 a year pays $15,670—or about 21 percent—in income tax. But for every dollar they earn over $70,000 ($5,000 in this case), they pay 33 cents in tax, taking home just 67 cents.

Now imagine this top tax rate is almost doubled to 60c in the dollar. If they keep earning $75,000, they will pay an extra $1,350 in tax, raising their average tax rate by less than two cents to 23 percent. But for every dollar earned over $70,000, this taxpayer now only gets to take home 40 cents.

Would you work extra overtime if you got to keep just 40 cents out of every dollar earned instead of 67 cents or more? And, of course, if earning more also means losing payments like family tax credits, you could end up effectively with less than 40 cents per dollar.

High tax rates have another, more insidious, effect on people’s taxable earnings—some taxpayers go looking for ways to avoid the extra tax, either legally or illegally. Negatively gearing a rental property or earning less income while your lower-paid partner earns more are two of the legal ways. Or you might go and work in Hong Kong where tax rates are lower.

Discovering which people respond like this to higher taxes, how and how much, is the main motivation behind a new research project being run by Victoria University of Wellington over the next three years, supported by funding from the Ministry of Business, Innovation and Employment. Using the latest modelling techniques and data for New Zealand, the project will help to answer some of the questions around how people alter their behaviour when taxes change.

This is important for several reasons.

Clearly, illegal tax avoidance undermines the tax system’s fairness and credibility by forcing law-abiding taxpayers to pay more. And all tax-avoiding responses involve lost revenue that otherwise could fund better public services or welfare benefits. Such difficult-to-predict revenue losses make it harder for governments to forecast how much extra revenue they can expect from a new tax policy, and so how much more they can afford to spend.

These responses also undermine the efficient running of our economy. If entrepreneurs and the self-employed spend their time on ways to minimise their taxes, this is time that could be better spent doing what they are good at, generating new ideas and employment along the way.

If you think these responses to tax rates are not much of a big deal, consider an example from our neighbours across the Tasman.

For Australian employees who have a company-owned car, Fringe Benefit Tax (FBT) is levied on any kilometres driven for personal use. Until recently, the tax rate per kilometre was lower (on all the personal use kilometres) if you travelled more than 15,000kms, then lower still if you travelled more than 25,000kms and more than 40,000kms. So, clearly, driving more—or claiming to—would be good for your FBT bill.

How far did Australians claim they drove using their company cars for private use and did FBT make a difference? It is hard to know exactly how many kilometres our Aussie friends would have driven if there was no FBT regime. But data on how many cars travel various distances show an awful lot of Australians paying FBT reckoned they drove just over 15,000, 25,000 and 40,000 kilometres, with very few company cars apparently travelling other distances. Strangely, that aligned remarkably well with their fiscal interest.

Tax researchers in other countries have identified many other examples similar to this Aussie case. But not a lot is known about New Zealand taxpayers. So getting a better appreciation of how our fellow Kiwis respond to their taxes, through the Victoria University tax-modelling project, could potentially help improve understanding of our tax system and assist future tax policy setting.

Certainly, a first step towards a fairer and less distorting tax system has to be better knowledge of how distorting and equitable the current system is. This way, we might help Kiwi governments and voters make better choices over what kind of tax system we want.

This commentary, provided by Professor Norman Gemmell, Chair in Public Finance at Victoria University of Wellington, was originally published in the Dominion Post.