From Kiwiblog we hear the following statements from Bill English:
Low-income earners would have to be compensated if GST was increased as a result of the current tax review, Finance Minister Bill English says. …
“We don’t want to go down the route of raising taxes,” he said. “The Government has a strong preference not to increase taxes to close the deficit. We prefer more efficient taxes over higher taxes.”
Cool. The government believes that it is fair to charge those on low incomes proportionally less (equity) and it would like the tax system to be efficient. The only issue here is that there is a trade-off between these two elements of the tax system.
In terms of proportionality we can think of GST like a flat income tax – in both cases an individual will pay the same proportion of their lifetime income in tax eventually. Offering rebates to people on low incomes is then the same in either case – it implies that people on a lower income pay proportionally less of their income.
How does this impact on efficiency? Well, to raise the income to pay rebates the government has to increase tax rates on people with higher incomes, providing a disincentive to work. Furthermore, there will be some range of income over which the rebate will be abated. Depending on how the tax system is designed this implies that there will be very high “effective marginal tax rates” for some groups. We see this with Working for Families where some households would get taxed at over 90% on any additional income they earn – providing a strong disincentive for these people to work additional hours, or do anything to earn additional income. Finally, higher and more progressive tax rates give people with the ability to try and avoid tax the incentive to – another factor that hurts the efficiency of the tax system.
As a result, I agree with what the finance minister said, we need to look at efficiency and equity when making decisions. It will be interesting to see exactly what trade-off the government, and society as a whole, is willing to agree upon.