Financial transaction taxes and New Zealand

Given my uncertainty about who to vote for the the next New Zealand general election I’ve been exploring registered political parties wikipedia pages. While looking I noticed that a number of smaller parties tended to favour a financial transactions tax (Progressives, Alliance, Democrats, and Direct Democracy). Looking at the parties websites, the only party I could find that mentioned the Financial Transaction tax was the Democrats.

The reasons they gave for the tax were:

  1. It will reduce businesses compliance costs,
  2. Reducing collection costs by having the tax administered through banks,
  3. It will increase everyones spending power as the tax rate will be lower than the GST rate but raise the same amount of revenue.

However, I’m not sure I entirely agree, here is why:

Lets focus on the third point (the other points sort of fall out of it) – that it will lead to the same level of government revenue but at a lower rate of tax increasing peoples disposable income with no trade-off.  When I put it this way it seems ridiculous, and that is because it is ridiculous – you can’t reduce the amount of tax you take from the economy and increase the amount of tax you make at the same time. As an economist I don’t like to say that some statements are entirely wrong, but in this case it is.  More then that it is blatantly misleading!

In order to see this more robustly, lets talk about how the financial transactions tax works. The financial transaction tax is a tax levied on every dollar withdrawn from a financial intermediary. Now lets take an example from the New Zealand 2001 tax review.

Say that the tax is set at 5%. Firm A takes out $100 to make a good – thereby paying $5 in tax. Firm A then sells this good for $200. Customers withdraw $200 to pay for the good, paying $100 in tax. As the market transaction created $200 of value and $15 of tax the true tax rate is 15/200=7.5%  As a result, the 5% tax rate is a guise – depending on how many “layers” there are in the economy the true tax rate may be substantially higher than that.

As a result, the tax rate would have to be “effectively” the same in order to raise the same revenue as GST which it is supposed to replace.

There are further problems with the tax.  This tax penalises industries which are more vertically dis-integrated, as a 5% tax rate is charged the whole way down the value chain.  For example, if we add one more firm into the production process in the above example the effective tax rate in the industry rises to 11.25%.  This will lead to a number of negative consequences:

  1. Increases the cost of making complicated products that require a large value chain relative to simpler products,
  2. It changes the relative price of products based on their complexity – this is something that does not involve the fundamental value of the product, implying that it will cause inefficiencies in the allocation of resources,
  3. It convinces firms to vertically integrate when they otherwise would not have – thereby leading to competition issues further down the value chain of the industry.

One final issue I wish to raise is this taxes impact on saving.  As savings is deferred consumption for an individual or household, this is effectively a tax on savings – as when you withdraw it you will have x% less than in the absense of the tax.  At the margin this would lead to a reduction in savings behaviour (as people decide to hold funds instead of placing them in the bank) which would eventually lead to a lower quantity (and higher price) for investment activity.

No tax system is perfect, however I find the financial transaction tax perverse as a means of raising revenue.  As a tax it has the largest impact on some of the goods that provide the most economic value, it is more economically inefficient then GST and it is not transparent – given that the true tax rate on a certain good with this tax depends on the length of the value chain.

As a result, I still don’t know who to vote for.  I can’t vote for Labour or National given my historical feelings, these parties are ruled out because of their support for a subversive and inefficient tax mechanism, ACT and Libetarianz are overly obsessed with vouchers and seems to lack an understanding of some forms of social value, NZ first are racists, United support income splitting and are overly conservative, the Family/Kiwi/Pacific parties are all religious, Legalise, Maori, and Republic parties seem to focus on specific issues rather than governance, and the Green Party understand externalities but not government failure.

Where is the party for the middle of the road economist in New Zealand?

  • goonix

    I haven’t heard much about vouchers from ACT in a while.

  • “I haven’t heard much about vouchers from ACT in a while.”

    They always have vouchers on the mind – I can smell the voucher press from here 😉

  • CPW

    So… what’s wrong with vouchers again?

  • “So… what’s wrong with vouchers again?”

    Vouchers constrain choice. If we give people vouchers instead of money they will have a lower level of utility.

    If we try to justify vouchers on externality grounds I would say that prices aren’t set appropriately – its a relative price issue not an income issue.

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  • Do vouchers constrain choice like the Community Services card, or Winston’s SuperGold card? What if the voucher was a cheque with your child’s name on it? What if you called it a scholarship?

    You could always get drunk and vote DAFT.

  • CPW

    As per are discussion Matt I was talking about school vouchers, you were talking about food stamps. I agree that not constraining choice is good: school vouchers would be a step in that direction, food stamps a step away from it.

  • “I agree that not constraining choice is good”

    Fair point – I was far too vague in what I said 😛

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  • dracotb

    ” 1. Increases the cost of making complicated products that require a large value chain relative to simpler products,

    No it doesn’t as the tax needs to be paid anyway. Taxes are the costs of externalities that cannot be adequately attributed to any particular business or activity. Ergo – that cost will still be there and needs to be met.

    2. It changes the relative price of products based on their complexity – this is something that does not involve the fundamental value of the product, implying that it will cause inefficiencies in the allocation of resources,

    This is illusory. If the people making the product (and its sub-products) are adequately rewarded and people are buying the product then it is obvious that resources are being efficiently allocated. If they weren’t then the product would cease to exist.

    3. It convinces firms to vertically integrate when they otherwise would not have – thereby leading to competition issues further down the value chain of the industry.

    How many mergers were there last year? How many of the small businesses that added value to a large multi-national corporation got bought out by that corporation?
    These things happen already and I doubt if changing the collection of taxes to a transaction tax would have a significant change on how often they happen.

    One final issue I wish to raise is this taxes impact on saving. As savings is deferred consumption for an individual or household, this is effectively a tax on savings – as when you withdraw it you will have x% less than in the absense of the tax. At the margin this would lead to a reduction in savings behaviour (as people decide to hold funds instead of placing them in the bank) which would eventually lead to a lower quantity (and higher price) for investment activity.

    Or it could persuade people to keep their savings in the bank. With a transaction tax if people want to avoid paying taxes all they have to do is leave the money in the bank.
    You assume that everything that somebody saves will be spent and this is a false assumption. You also assume that people don’t pay tax when they withdraw money from the bank which is, again, false as they pay 12.5% when they spend it. There are a few exceptions to this of course but part of the logic for a transaction tax is that these exemptions themselves cause a market distortion. Have everything under the same rules and that distortion goes away.

    I see a couple of possible advantages with a transaction tax.

    1.) Demand for NZ$ will be reduced decreasing the value of our $ on the international money markets
    2.) As foreign investment will now have to cover the tax they will tend to be longer investments

    These will stabilize the NZ$ at a lower value making our exports more competitive.

    Like you say, no tax system is perfect so we have to pick a system or combination of systems that delivers what we want to achieve (the state being able to afford what’s needed for the good of the country) while being cost effective.

  • “Taxes are the costs of externalities that cannot be adequately attributed to any particular business or activity”

    Firstly, we are looking at a revenue gathering device – not an externality tax, so the efficiency argument does not hold.

    Secondly, the tax is different than in the case of GST, as GST is on the “value-added” component of the production process, when a financial transaction tax is applied to the whole price at each level of the value chain. As a result, a process that creates value at the beginning of a long value chain will get taxed at a rate many times higher than the financial transactions tax.

    “If they weren’t then the product would cease to exist”

    Relative prices are to do with the allocation of resources and therefore allocative efficiency. Taxes causes inefficiency (in a technical sense) by screwing up the allocation of resources. People will still make the goods – but the price signal which is supposed to be used to trade them no longer works as well.

    In the case of a financial transaction tax, the tax will be higher on goods with a short value chain than goods with a long value chain, implying that they become more expensive then they were without the tax. In the case without a tax people are trading goods based on their true valuation of the good and so the allocation of resources is such that welfare is maximised. When the tax comes in it artificially changes the price of one good relative to another, changing the allocation of societies limited resources. As we know the previous allocation was optimal (so in the absense of externalities – given that they have hopefully been solved by coase bargaining or externality taxes), this new allocation is not as good.

    “These things happen already and I doubt if changing the collection of taxes to a transaction tax would have a significant change on how often they happen”

    Saying that they happen already does not change the argument that they would become more prevalent.

    “You assume that everything that somebody saves will be spent and this is a false assumption”

    No it is a tautology – the point of savings is deferred consumption, that is what it is. As a result it is not false. (I see bequests as consumption – ergo this view).

    “You also assume that people don’t pay tax when they withdraw money from the bank which is, again, false as they pay 12.5% when they spend it”

    No I didn’t actually say that – you are right that they pay 12.5%, as we care about real buying power, not nominal values.

    However, the financial transactions tax will lift the price of goods in the same way a GST rate will. If the “effective” tax rate is set to be the same, then a financial transaction tax will charge us 5% to withdraw our money and then 12.5% on buying the good!

    Also think about the sort of goods we save money for. They tend to be large durable goods. If they are goods that we add value on in NZ (stemming from the buy NZ goods campaign), then they will be facing an “effective” tax rate greater than the GST rate now (as goods with a longer value chain will get taxed at a higher rate). This is actually another reason why the tax will discourage savings.

    “I see a couple of possible advantages with a transaction tax.”

    “These will stabilize the NZ$ at a lower value making our exports more competitive.”

    This is the same argument as the Tobin tax argument right. As a result, why don’t we just introduce a Tobin tax – that would give us these benefits (assuming they exist – this would make a good topic for another thread 🙂 ) without the costs associated with a financial transactions tax.

    Also an important thing to remember is that a lower New Zealand dollar implies that our imports are more expensive. We have to show that the increase in income associated with higher exports would compensate us for the high prices on imports (and also that the distribution of these gains would be appropriate) in order to associate a lower dollar with higher levels of welfare.

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  • The issue I have with FTT promoters is that they invariably overestimate its capacity to gather revenue. It’s always claimed that regular punters will have a much reduced tax bill becuase so much revenue will come from transactions by the finance industry but there’s never any acknowledgement that these extra costs would at least be partially passed on to the consumer nor any acknowledge that much of the transactions that would be taxed would disappear overnight).

    Perhaps the most inummerate attempt at describing the effect of an FTT was from Direct Democracy Party (also known as Kelvyn Alp) apparently a 1% FTT could replace all taxes and produce massive surpluses! (http://www.dekode.co.nz/ddp31/ – detail tucked away in the policy snapshots).

  • dracotb

    No it is a tautology – the point of savings is deferred consumption, that is what it is. As a result it is not false. (I see bequests as consumption – ergo this view).

    The point of savings isn’t always “deferred consumption” though. In fact it could be argued that to save for something isn’t saving at all. Savings generally tend to stay in the bank (investment portfolio) and generate an income.
    Bequests couldn’t be considered consumption unless the receiver spent the whole lot. This would be true of some of them but, IMO, it shouldn’t be considered the rule. Some facts and figures here would be nice. The question would be: What proportion of bequests gets spent and which remains in savings/investment?

    However, the financial transactions tax will lift the price of goods in the same way a GST rate will. If the “effective” tax rate is set to be the same, then a financial transaction tax will charge us 5% to withdraw our money and then 12.5% on buying the good!

    I must admit that I was thinking more along the lines of replacing GST with the FTT as they aren’t too dissimilar.

    I wasn’t really arguing for it (although a couple of years ago I would have) as logic tells me that it would be a PITA to actually administer (what about cash? Would you ban it outright or put on a punitive tax? and what then would you do with people who started bartering? (people always find a way to trade (scroll down to the bit about gold supply)) and that it wouldn’t collect the amount that proponents say it would. I was more pointing out that it did have a couple of possible benefits (Devil’s Advocate).

    However, I do think that the exemptions in GST do produce a market distortion. I’m not sure how to apply GST to those exemptions though.

  • “Savings generally tend to stay in the bank (investment portfolio) and generate an income”

    But there is no reason to generate income once you are dead – so over a long enough life-cycle (which can include your children if we wish to make intertemporal comparisons – or can be taxed as a bequest, then we only need to look at the individual) all income should be used.

    Note I am talking about “lifetime consumption” not just single period spending.

    “The question would be: What proportion of bequests gets spent and which remains in savings/investment?”

    That question looks at a multi-period flow of resources, but not the whole lifetime of the resource – it is in that sense that all savings will become consumption. I can’t really give evidence as I am suggesting a way of looking at savings and investment and consumption.

    “I must admit that I was thinking more along the lines of replacing GST with the FTT as they aren’t too dissimilar.”

    I was thinking the same thing when I answer the question (except for the dissimilar part). The FTT is on products as well as savings (though its impact on chain value) – which is why I was talking about it in that way.

    “I was more pointing out that it did have a couple of possible benefits (Devil’s Advocate).”

    And I appreciate you doing this – sometimes I try to do the same thing while posting (at least trying to take an extreme point of view).

  • Matt, if your complaint about school vouchers is that they constrain choice, then you’re hardly middle of the road (even for an economist).

    They may constrain choice compared to giving parents cash, but even I’d be worried about giving every parent the cash and letting them choose whether to spend it on educating their kids.

    Vouchers are better than what we have at the moment.

    Suck it up and vote ACT. Actually, if you want some changes, come and help us out campaigning!

  • “Matt, if your complaint about school vouchers is that they constrain choice, then you’re hardly middle of the road”

    My complaint was about giving people food vouchers as part of their benefit – as I said earlier in the comments I was a touch unclear and clarified it.

    I haven’t been convinced to vote for anyone by anyone – does no-one really want my vote 🙁

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