TVHE

David Farrar states that this is how Labour has framed the idea of tax cuts – a $150,000 pay increase for Jack Paul Reynolds, and only a few dollars for the rest of us. David states that we must look at the macroeconomic impact, and that we can’t focus on who gets what, specifically he says:

If the debate becomes one of simply who gets how much, they will have problems

However, I think the debate about who gets what is important.  However, I do not think that it actually falls in Labour’s favour.

Jack Paul has specific skills, he is hard to replace, and is seen to add a lot of value.  The “elasticity of demand” for his service is very very high low.  Furthermore, he has a lot of high paying outside options – he has a good reputation as a CEO.  This means that his “elasticity of supply” is very high (note that I am using quite a discrete margin in this case).

What does this mean?  Well, when he labour income is taxed, the FIRM will pick up the tab – as a result his gross wage is representative of this.  Now this also indicates that, when taxes are lower, the tax payment by the firm will be lower.  As a result, over time his gross wage will adjust DOWN to represent this lower tax rate.

As a result, the direct impact on Jack’s Paul’s pay packet is likely to be very low proportional to both income and what other people receive.  It is Telecom that faces most of the “incidence of tax” in this case – not him.

As a result, a tax cut isn’t a $150,000 pay increase for Jack Paul.  Nowhere near in fact.  National should be using basic economics to debunk these sorts of myths, so that Labour can’t try to pitch it as a class war.

So, us New Zealander’s are switching some income tax to consumption tax.  Good for us.  In order to think about whether this is a good thing we need to discuss costs and benefits.

It turns out this switch is also a “transfer” of resources between two groups, relatively speaking.  These groups are people that HAVE borrowed and people that HAVE saved.

When we increase GST and lower income tax we are saying “we will tax future consumption more and future income less”.

If people have borrowed this implies that they purchased consumption when it was relatively “cheaper”, and are now going to be taxed at a lower rate on the income they are making to pay it back – as a result, borrowers win.

If people have saved, this implies that they have deferred consumption when it was cheap – and will buy things when they are more expensive.  As a result, savers lose out from the change in relative taxes.

Since it is “true” that people on low incomes borrow relatively more of their income, then in a static sense this switch could be seen as more “progressive” right?  I don’t really like static definitions, but if people are complaining about the poor and saying that the poor borrow more then it is important to keep this initial transfer in mind …

Personally, I think borrowing and saving  is based more strongly on lifetime income, impatience (which I think is income neutral) and the lumpiness of consumption – as a result, I’m don’t see to much progressivity here.  However, this does tell us that people with a stock of liabilities will benefit and people with a stock of assets will lose.

There is a feeling out there that the increase in GST would be pointless if completely compensated.  I’m not sure I agree.

Even with a fully compensated scheme, and even given some welfare costs, there are reasons why we may want to shift the burden from income to consumption:

1. Consumption tax is easier to enforce (self-reinforcing) – therefore it will be cheaper to implement and have less avoidence,
2. On a similar note, with a consumption tax it is easier to ensure that the tax falls equally on all income,
3. Given income tax also hits interest income, a consumption tax treats current and future income equally while an income tax promotes current consumption, (note that this does imply that the baseline rate must be slightly higher

Now, having it set up in the fully compensated way does imply that effective marginal tax rates are unchanged – and therefore so are labour supply incentives.  When thinking about “productivity” and the such the changes to the top tax rate, and to taxes on property, will be more important – but we won’t know about that until May

When discussing the upcoming changes to the New Zealand tax system the National party has made it clear that they want any change in GST to be “compensated”, so that those on low income aren’t “worse off”.

Now this is actually a wildly complicated question.  Any change will create winners and losers, that is undeniable.  If we think of compensation in welfare terms there is no way to perfectly compensate everyone without making any change viciously complicated – or not making any changes at all.

My presumption is that the goal isn’t “welfare compensation” per see.  My guess is that any compensation will be such that people (outside the property sector and those in the top income bracket – where a rejig “might” take place) will pay the same proportion of their lifetime income in tax (although any progressivity from any change in incomes will also be accepted).

Why do I think this?

Read more…

Good summaries here and here.  Speech is found here.

There was nothing in the speech (when it comes to tax – which is the sole focus of this post).  An increase in GST was already very likely – but the government wouldn’t even commit to it.  Given that it isn’t going to be finalised in size or scope until the May budget, and given that the they want to compensate by changing tax rates it is likely they won’t introduce this until March/April 2011.

Note:  I’ve heard rumours they would change GST in October.  Increasing GST just before Christmas, with no compensation, and coming out of a recession with elevated unemployment is what I would term moronic.  As a result, it can’t be ruled out

No land tax, no capital gains tax, probably some fiddling around depreciation rules (although that wasn’t even pointed at in the speech), all implies that the government isn’t really that serious about ensuring property is treated the same as other capital investment.

I heard today that we were going to hear about “significant changes to the tax system”, something about a “step change”.  Other than the possibility of a slight shift from income to consumption taxes there was nothing in this speech.  To be honest, it makes me laugh a little

Update:  The more I think about it, the more this speech implied a STEP BACK from the MINOR adjustments that everyone already expected.

No mention of LAQC’s, no mention of changes to the treatment of depreciation on property, no commitment to a GST rate change, no aims to flatten the income tax scale per see (as the higher GST would be fully compensated).

A lot of (waffly) talk about investment and minor fiddles with benefits – which aren’t the purpose of this post, but which indicates how tax reform DOESN’T HAVE A PRIORITY in terms of the governments thinking.

In reality this speech has shown that this government is less willing to change issues that have been illustrated with the tax system then we believed before the speech.  That was a surprise, given how little was expected in the first place

Update 2:  So it wasn’t a “major economic reform” in the tax sense.  But yesterday he did say:

Mr Key said the details of any changes would not be revealed before the Budget in May, but his speech would spell out the Government’s overall economic programme for the year.

That isn’t as bad.  The speech didn’t have any details, that is true.  However, it didn’t really spell out much in terms of tax changes either.

When it is put in this context it feels like there wasn’t supposed to be much too it – so I don’t feel as bad about it as I did.  However, there are two major negatives still:

1. it means we will have to wait until May until we have any sort of “certainty” around tax policy – that is not a good thing for the economy.
2. The things I said above still hold – expectations of tax change are now lower than they were, and the things that weren’t mentioned will be analysed as much as the things that were!  As a result, this increases uncertainty MORE, as well as indicating that any changes may be smaller than the policy changes suggested by specialists.

Update 3:  For those who are interested in the wider social policy discussions, opinions, and other tax stuff look:

Offsetting Behaviour, Brad Taylor, Public Address (1 and 2), The Standard, Homepaddock, Education Directions, Colin Espiner, Dim Post (and 2), Not PC, Gonzo.

Also everyone else is grading it so I better.  C+ for catching an increase in GST and not putting in a tax free threshold.  However, it loses marks for creating uncertainty and not balancing expectations – both serious issues with such a speech (and really polices in general).

Agnitio sent me a couple of links to an interview I did on unemployment last night (here and here).

It is consistent with what I wrote yesterday, even if it doesn’t seem that way.  Furthermore, I don’t believe the government was too “inactive” in this case – we aren’t a centrally planned economy, blaming the government appears pretty arbitrary.

Relative to my expectations (which albeit were low) the government actually performed quite well in terms of the recession – by not really doing anything excessive, but still trying to make sure that any painful transitions are smoothed over (by not removing, and augmenting, automatic stabilisers).

I don’t like the idea of a “zero tax” threshold at the bottom of the tax system.  I see it was suggested today by Mark Keating, so I thought I should explain why I feel this way (ht Kiwiblog).  I’ll put down three reasons, in reality the third reason is by far the most important:

1. I don’t believe the cost of “churn” is very substantial – implying that any benefit from setting a zero tax will be negligible compared to taking the tax and sending it back.
2. The effort required to set a zero tax and enforce payment of tax when moving out of the bracket requires effort as well – as a result I don’t think it is self-evident that setting a new bracket would reduce administration costs (it might even increase them).
3. If we set a zero tax bracket this also acts as a tax cut for EVERYONE earning more than that amount.  This has to be paid for by INCREASING other tax rates (substantially as well, since the loss of the bottom bracket will cost more than an equivalent cut anywhere else).  As a result, effective marginal tax rates will be higher than if we taxed and paid benefits (for the same average tax rate in other words).  This reduces labour supply incentives for higher income earners.  As these earners tend to be more responsive to tax there would be a SIGNIFICANT efficiency cost.

Yes, the zero tax rate at the bottom will increase labour supply incentives for those on very low incomes.  But this will only lead to efficiency gains if we believe it will get the more elastic secondary earners into the labour market.  If we are doing it to promote equity it doesn’t make sense – as those that are actually poor are likely to provide very inelastic labour supply.  Overall, it is likely that the negative impact of higher EMTR’s on middle and high income earners will outweigh any positive impact through a increase in, our already enormous, part time labour force.

The purpose of the zero tax bracket is to make sure that people get a minimum living standard.  The better way to do this is to ensure that society pays everyone a living wage at whatever level it believes is fair.  Leave redistribution to the welfare system (where our social value judgments are transparent), tax needs to be applied on the basis of efficiency in order to be effective.

There is some suggestion that the size and scope of governments around the world has become excessive.  Two recent examples of this are:

• From the Economist,
• From Reform, in the UK.

The Standard has suggested that similar comparison in NZ could be a little out of whack, and in the most part I agree with them.  After all, Labour was elected to a third term on the promise of larger government, National was re-elected to keep it at that level, as a result I think society is suggesting that they want government to continue spending a quarter of our income.

However, I do disagree with them with regards to the idea that government spending didn’t markedly rise as a proportion of GDP in Labour’s third term – to me the GDP Statistics seem to suggest this was the big mover (with the recent increase solely the result of a recession, and “automatic stabilisers”):

Over at Kiwiblog there is discussion of the Democrat loss in Massachusetts.  Reading through the piece David Farrar stated:

Priorities. Obama’s fiscal stimulus did little bar increase the deficit massively, and turn the country into deficit hawks. Unemployment went well beyond his worst forecasts

Now I found this statement unusal in that David’s writing is usually very balanced, and yet I do not find this statement balanced at all.  Why?

1. We have no idea if Obama’s fiscal stimulus did anything until the data is all finalised.  In a couple of years researchers will be able to look over the data and discuss the design, implementation, and need of the scheme and reach an educated conclusion.  At the moment people can only present an opinion on the basis of ideology.
2. Personally (going onto my ideology ), I think the fact that unemployment rose even further than expected was the result of the shock being larger than expected (and areas of the US economy being more fragile).  During the crisis the US government was able to borrow cheaply and use this borrowing to undertake investment when the cost of building this investment was cheap (thanks to the spare capacity in the economy) This sounds like a good thing to me …
3. Unemployment as high as  10% indicates to me that there was a hole in demand – I do not believe that “structural” economic issues could be sufficient enough to warrant 1/10 people who want a job not being able to get a job.  With the Fed unwilling to soften its monetary stance further the government is in a position to be “consumer of last resort”.  Although I don’t really like the idea of this, in the face of sticky prices and a massive shock to the economy I have to concede that such a role exists in extreme circumstances.

As a result, if I had to guess I would say that the immediate crisis would have been worse if the stimulus hadn’t happened. This appears to be a moderate position among economists, between the “stimulus did nothing” and the “we needed more stimulus” extremes.

Now, we may find that the long run impact of this borrowing will be bad, and we may look back on the evidence and find that the scheme is flawed.  However, the point that “Obama’s fiscal stimulus did little bar increase the deficit massively” is an extreme view (that could potentially turn out to be true) – not an objective fact.

The Tax Working Group has released their report, as you all already know.  The recommendations are as expected, so its not particularly exciting in that sense.

However, there are some issues I would like to discuss – lets start with the idea that we “urgently need to cut the corporate tax rate” if Australia does.

Currently there is talk that, if Aussie cuts the corporate tax rate to 30% we need to do the same immediately.  We are told this as if it is a self-evident truth, and told that if we don’t all investment will head to Australia.  This is a touch over the top.

Read more…