Friday, 25 August 2017

GST and wealth

I thought it was common knowledge that implementing or increasing a consumption tax is a de facto wealth tax.

Suppose you saved $100,000 and expected to be able to fund $100,000 worth of consumption from that saving. If a 10% consumption tax comes in, you can fund 10% less consumption from that saving. The real value of that saving is then 10% lower than it was the day before the consumption tax came in. If that consumption tax then increases to 15%, the real value of the savings drops further.

It gets a bit more complicated if you bundle changes in consumption taxes with changes in other taxes. The 2010 tax shift did a few things simultaneously:
  1. It provided an across-the-board income tax cut AND increase in benefits that was matched by an increase in GST. This part was neutral across incomes: you pay less in income tax on next year's earnings (or receive more in benefits), but pay more in GST when you spend from next year's income. The two wash out for those earning and spending in New Zealand.

    Those who spend in New Zealand and do not earn in New Zealand - tourists - wind up funding more of the government's budget. The GST switch was, in this respect, a tourist tax. Unfortunately, it's a tourist tax where the revenues accrued to central government while the costs of accommodating tourists through upgraded infrastructure largely fall on local government. Keep in mind that the overall incidence will be a bit more complicated, but GST loads some of the burden of providing government services onto tourists. The more the overall tax system relies on GST instead of income tax, the bigger this effect (well, within reasonable bounds). 

  2. It also provided a real tax cut at the top. People on the left who prefer higher levels of government spending should restrict their anger to this part. Part (1) above was neutral, except for the increased tax on tourists. If you think that the overall shift made the tax system less progressive than you'd prefer, focus on adjusting things on this margin rather than messing around with GST. 

  3. The increase in consumption tax reduced the real purchasing power of accrued savings. If I planned on withdrawing $10,000 from a savings account next year to fund consumption, I would be able to buy fewer things with that withdrawal. Same goes for using a reverse mortgage to eat my house in my retirement. Before the tax change, I would have paid 12.5% GST on things I purchased, so would have been left with $8,750 in after-tax expenditure; after the tax change, I would pay 15% GST on things I purchased, so I would be left with $8,500. The real purchasing power of my stock of wealth dropped by 2.5%. The GST increase was then, effectively, a wealth tax. This will matter especially for older cohorts running down their capital in retirement: the increase in NZ Super payments compensated for the GST on NZ Super payments, but not for the reduced value of any accrued wealth.

  4. If your wealth is held in assets that pay taxable interest or dividends, then the tax on the returns to that wealth dropped because of the reduction in income tax. The real value of your stock of wealth dropped, because of (3) above. But the real value of the flow of earnings from your accrued wealth will depend on your marginal tax rate. If you were previously paying less than the top marginal tax rate, then this effect is a wash, for reasons stated in (1). If you were previously paying the top marginal tax rate, then you get a real tax cut on the flow of your dividend or interest earnings. The net effect between (3) and (4) will then depend on the extent to which you're living off the earnings from your savings, or eating the capital. 

  5. There were other base-broadening changes that disproportionately affected richer folks. They're complicated, and harder to turn into soundbites than the leftie "But poor people spend all their money and don't take foreign holidays where they don't pay GST on their expenditures (and I'll conveniently ignore the increase in tax paid by rich foreign tourists)", but they're still real. 
So what to make of the whole she-bang? John Creedy and Penny Mok ran some microsimulations to look at what the changes would be expected to do to labour supply and income distributions. They found increases in hours worked because of the cuts in income taxes, and basically zero change to income distributions. Like, folks can shout "the tax change was regressive, the tax change was regressive" all they like, but here's what Creedy and Mok found:

Caveat: it's ex ante microsimulations rather than ex post work. But it's the best guess I've seen about the overall effect. Since there was basically no change in the Gini coefficient in after-tax incomes between the two systems, it didn't really affect the overall progressivity of the tax system. 

So, some bottom lines:
  • It is stupid to hate GST for being regressive. In the first place, it's better to think of GST as being neutral over consumption over the life-cycle. That's what the Tax Working Group said too - maybe a bit regressive over current income, but neutral over life cycle in consumption. But that's the minor point. The major point is that GST is part of a tax system. Combining GST with a progressive income tax allows you to achieve any level of progressivity that you damn well want - with the added advantage that tourists pay GST but don't pay income tax. This isn't some right-wing-economist thing, it's a maths thing. At least at current margins. You could imagine pushing it far enough that the lowest income tax rate would have to go negative to compensate, but we're not anywhere near there. 
  • It is stupid to hate the 2010 GST/Income tax shift as being regressive. See Creedy & Mok, above. The overall effect looks pretty flat. 
  • It is not stupid to object to the part of the cut in the top marginal income tax rate that went beyond maintaining neutrality and did provide a real tax cut at the top. That's a point of fair debate around how progressive the overall tax system should be. You could have run the 2010 changes but with a smaller cut at the top and still have a better tax system than we had in 2009. I like the overall package they put through in 2010, but whether the top marginal tax rate should be 33% or 35% - that's more of a value judgment about what tradeoffs are worthwhile. If you think the tax system should be more progressive overall, do it by increasing income taxes at the top end rather than messing up GST.
Update: Mike Reddell, in comments, reminds me that the depreciation changes more than offset the drop in the company tax that also came in 2010. I didn't really hit on the company tax changes here since the imputation regime means that that just flows through into changes in the accompanying tax credits and then folks getting dividends wind up paying at their marginal rate anyway. But it would affect foreign beneficiaries of distributions who aren't able to use the tax credits. But, it's more than offset anyway by the depreciation changes. 

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