The folly of excluding GST when discussing tax

Over on Kiwiblog I saw the title “tax system has got more, not less, progressive“.  I thought that sounded interesting, but after looking at the post, and Bill English’s initial release, I realised that this was actually false.  Danyl from Dim Post was right when he notes:

As although the change in income tax rates and thresholds may have made the income tax system more progressive, we had a countervailing increase in GST at the same point in time (along with changes to depreciation rules for housing and corporate tax rates).  The tax system includes ALL taxes, not just income taxes.

Now Eric Crampton has a go at defending the part of the principle involved – and it is true that the income tax system is shown to be more progressive.  And given that GST is an approximately flat tax, this implies that the change in progressivity is ambiguous.  I agree completely.

However, when the press release is based on data that excludes the GST change, and says:

Lower income households are paying a smaller proportion of net income tax than they did in 2008, indicating that the tax system has become more progressive since the Government’s tax changes in 2010, Finance Minister Bill English says.

As it does in the release, is just not true.  In fact:

 

12 replies
  1. Chris Miller
    Chris Miller says:

    Right-wingers were making this claim back in May, too, or at least a similar one – that people earning $55k or under didn’t pay tax. I wrote a post about it at the time (http://www.thelittlepakeha.net/2013/05/28/let-them-have-tax/) where I talked about a Pantograph Punch article and played with the WFF calculator and came to the conclusion that low income households without children pay the highest proportion of tax – a two parent middle-class household with at least two children seems to pay the least, followed by high income households. (Though looking at it now I notice that I said “least amount of tax” twice. Oops. I’ll have to figure out which one I meant and fix that sometime.)

    • Matt Nolan
      Matt Nolan says:

      Hi Chris,

      The link doesn’t seem to be working.

      Treasury has done a bunch of analysis showing that, including a broad set of taxes, as income rises the proportion of tax paid does indeed rise. With programmes like WFF society has explicitly stated that it wants the people with families to pay less tax.

      However, this is also the second time I have seen the figures taken out of context – the first time I had a bit to say as well:

      http://www.tvhe.co.nz/2013/07/25/dont-forget-that-prices-change/

      • Luc Hansen
        Luc Hansen says:

        Hi Matt

        I’m in recovery mode from Int Micro exam today, but I’m taking time out from swot for my other paper to engage you on the topic of whether GST is regressive or flat.

        So in the link you provided above in reply to Chris, I see that you replied to a comment of mine and informed me that GST is not a regressive tax. Rather its a flat tax (I have always understood flat taxes to be regressive, but never mind).

        Then I followed another link to Eric’s blog that explained why he (and, excuse my presumption, but you, too) think this is so: all earnings are spent within a life cycle.

        One problem: many people do not spend all their earnings within their life cycle. Actually, the richer you are, the more you leave to your descendants. Even my truck mechanic Dad left an inheritance!

        So the Hansen reverse-equivalence theory is that a flat tax is intergenerational theft – by the future generation from the current.

        I’m sure you have a good reply, and I look forward to it.

        🙂

        • Matt Nolan
          Matt Nolan says:

          My reply is that, if people leave funds to the next generation it is because they value the consumption of the next generation (or it is an accident, in which case they didn’t actually maximise their utility ex-post!). A consumption tax will tax that future consumption – implying that tax is paid on that income 😉

          Remember, a flat tax merely states that people who earn different amounts of income will pay the same proportion of that income in tax. A consumption tax merely changes the timing from when the income is earned to when it is used for its final purpose – which is when it has value in the first place 😉

          • Luc Hansen
            Luc Hansen says:

            “Remember, a flat tax merely states that people who earn different amounts of income will pay the same proportion of that income in tax.”

            Yes.

            And progressive taxation entails some paying a higher proportion of their income, so my thinking is, if not progressive, then regressive. This ignores the neutral, neither progressive nor regressive option, but I would – tentatively – suggest (while admitting I need to do more work on this!) that neutral is regressive.

            Another aspect where English is being a little simplistic – but he is being a politician rather than an economist here – is that the tax paid needs to be viewed throughout the lens of proportion of income earned, too. I dare say there are some bright buggers out there working on this as we speak!

            Finally, and gingerly 🙂 just because some people today value consumption tomorrow for their descendants doesn’t mean society needs to let them act on that if overall welfare is improved by putting those earnings to work in today’s economy. But taking that further is a little beyond me, for the moment 🙂

            • Matt Nolan
              Matt Nolan says:

              Progressive, flat, and regressive are not moral judgments – they are descriptions of proportions. Even if we think a “flat” tax is morally regressive, due to the idea that the marginal utility of income is declining, this doesn’t change our definition 😉

              “is that the tax paid needs to be viewed throughout the lens of proportion of income earned, too”

              That is what Treasury has already released a bunch of papers on in recent years – the proportion of tax paid does indeed rise with the income distribution.

              “Finally, and gingerly 🙂 just because some people today value consumption tomorrow for their descendants doesn’t mean society needs to let them act on that if overall welfare is improved by putting those earnings to work in today’s economy”

              We have to be a bit careful here. Firstly, having people consume or work isn’t a social good – we shouldn’t confuse the idea of a social planner with a social good. Society doesn’t “need” people to do anything unless we make a specific argument about why there is a social capital, externality, or co-ordination element involved in the individuals choice!

              Secondly, patterns of production and consumption should likely be based on the incentives faced by individuals. Given that value comes from consuming goods and services that are produced the timing of taxation “when” consumption takes place or “when” the income to purchase consumer goods is reasonably irrelevant – unless we have certain practical views about implementation and avoidance (which tend to favour GST).

              • Luc Hansen
                Luc Hansen says:

                Damn. I will obviously have to be more careful with my composition because I wasn’t intending to argue from a ‘moral’ pov.

                I was thinking, rather, that as we do have a progressive tax system, and there is pretty wide acceptance of that system – with arguments mainly at the margins, not on the principle – then a flat tax imposed within that system is regressive, empirically.

                Am I confused here?

                And I accept that when GST was imposed by Labour and then increased ( by both Labour and National governments) the immediate effects were ameliorated with tax reductions – a packet of fags per week for the lower echelons 🙂 – but fiscal drag soon makes a nonsense of that, which adds to my point above.

                And yes, I also accept that the proportion of tax paid does rise with income distribution, but that’s not what I’m curious about . My point here is that since the top rate of tax is capped, income garnered above that threshold must increase proportionately more for those lucky (just joking) folk than the tax they actually pay,
                empirically.

                I know, I should do my own research and not rely on your good self as a short cut! But you do tend to cut to the chase 🙂

                As for the second part of your reply, social goods, incentives etc., I’ll get back to you in a couple of years or so, if that’s OK. 🙂

                In closing, while I agree that consumption taxes are favoured as efficient taxes, their effect on overall welfare depends on redistribution policies and in this, GST is similar to free trade. The evidence that free trade adds to overall welfare is convincing, but it does come with a caveat that within a nation state, the winners share their gains with the losers, and if the winners aren’t willing to share their gains with the losers via redistribution then we have a problem, not with free trade but with the lack of willingness to share the gains.

                And that is not an economic problem. That’s Social Policy (my minor) 🙂 Exam for that tomorrow! – gotta swot but thanks for your time.

  2. Eric Crampton
    Eric Crampton says:

    English and Key took a lot of stick for cutting the top marginal rate independently of the GST hike. Not nuts and not unfair for them to respond, now, showing that top earners pay more. I don’t think they’ve fully made their case on those grounds as yet, and you’re right that English’s press release is plain wrong where it says “tax system” rather than “income tax system”. But partialling out income taxes isn’t nuts where the prior critiques had also partialled out income taxes.

  3. Matthew
    Matthew says:

    Surely Chris is right though that WFF affects progressivity, even though we have made a desicion we like children.

    • Matt Nolan
      Matt Nolan says:

      Indeedy, but both the idea of progressivity and inequality become fraught when we start looking into non-income characteristics. Given that, it is useful to look at the Treasury work pointing out that our tax system is still indeed very progressive if we are going to make claims about the level of progressivity!

      Furthermore, it points out that there are important issues beyond progressivitiy when it comes to the tax system – if we as a society place weight on the distribution of income over household characteristics. If we care about the “capability” of groups to achieve levels of wellbeing, then this is very much the case!

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