Debunking the myth of tax neutrality

By Brian Fallow

Between the lines


It is a fair bet that few people who voted for Labour did so because of its plan to undertake a comprehensive review for the tax system.

But however unglamorous, such a review, if done well, has the potential not only to put the Government's finances on a sounder footing for the next century but to help address some of the economy's structural weaknesses.

The case for a wide-ranging, first principles debate on the tax system is strong.

With each year that passes, the tax laws become more complex, unwieldy and arcane.

More importantly, technological change and the increasing international mobility of capital and labour pose growing threats to the existing tax base. We see this in the clamour for New Zealand to match Australia's planned cut to its company tax rate. Such pressure for an international auction on tax rates with the lowest offer winning can only intensify.

At the same time burgeoning e-commerce threatens to undermine indirect taxes like GST in a growing number of industries.

There is no shortage of helpful suggestions of new things that could be taxed, from carbon to capital gains, from imputed rentals to financial transactions.

Labour has said that any structural changes to the tax system which are proposed by the review and find favour with the Government will be incorporated in its policy for the next election.

No significant structural changes, such as estate duty or new forms of capital gains tax, will be legislated for in the coming term before the public has a chance to vote on them.

That does not mean no tax policy initiatives over the next three years. Labour's industry policy includes tax deductibility for research and development spending in the year the spending occurs, and a more liberal depreciation regime for capital expenditure.

It has also foreshadowed an alternative tax regime for new savings vehicles where the savings are locked in; the savings would not be taxed in the hands of a fund manager, but taxed when paid out.

Such measures should go some way towards lifting household savings rates and improving the quality of investment, which at the moment is far more likely to go into renovating villas than into R&D.

Lifting both the quantity and quality of investment is the key to raising labour productivity, which in turn is essential if household disposable incomes are to rise in a sustainable way.

What a Government taxes is as important as how much it taxes. One of the sillier myths of the past 15 years has been that of tax neutrality, that the tax system should not be used to encourage or discourage anything.

That is an eccentric Kiwi view and even here is honoured more in the breach than the observance. Hopefully, the review will take a more realistic approach.