Gemmell's foil

Norm Gemmell takes my piece over at the Spinoff on the Tax Working Group's recommendations as foil in his Public Finance Chair update at Vic Uni.

It's a bit weird. I agree with what Norm says, and don't think it disagrees with what I'd said at the Spinoff, but it's presented as though there are differences of opinion.

I suppose I'll start at the start, where there's potentially the biggest disagreement. 

Norm writes:

The Spinoff brought together a number of interested parties, including the economics blogger at the New Zealand Initiative, Eric Crampton.

Interestingly, Eric reports that his US experience backs up claims that a CGT which exempts the family home, encourages families to ‘divorce’ for tax purposes (so more than one ‘home’ becomes CGT-free). Here is Eric’s comment: “If you’re laughing, note that family friends back in the United States would divorce and remarry semi-regularly for tax purposes. They’d have a small party each time they did. Good luck to IRD in policing that.” Of course, the US allows married couples to choose between separate or joint taxation, which New Zealand does not. Do we really believe that this will be a substantive tax avoidance trick used with a New Zealand CGT? Unlikely I suspect, but perhaps the Family Court should be getting prepared!

I noted the American anecdote mostly to allay the scepticism of marriage-fundamentalists who can't imagine that anyone would respond to incentives in that regard. I've had others tell me, since my piece at the Spinoff, about their own stories of marrying or divorcing for tax reasons.

Norm seems sceptical here because Americans can already choose to file separately rather than jointly.

I never understood the ins and outs of the couple in the anecdote: they were the parents of friends of my wife's; the divorcing and remarrying was rather some time ago now.

But I know that the 2018 tax changes in the US worked to close a loophole where alimony payments were deductible in ways generating a substantial tax break for divorcing couples in particular circumstances.

Under the current system, people paying alimony can deduct those payments — no matter how big the amount — from their income before calculating what they owe in taxes. That deduction provides a significant benefit to the wealthiest Americans, whose top tax rate is 37 percent and who would otherwise owe taxes on all of their income, including what they paid out in alimony. Right now, the rich disproportionately deduct alimony — about 20 percent of taxpayers who currently claim the deduction are in the top 5 percent of household income earners.

If you file separately, the high earning spouse's income is taxed at the top rate. If you divorce, you can punt a pile of the high earner's income into a much lower bracket. Or at least you could in 2018.

Here's Forbes offering 4 reasons to finalize your divorce in 2018 to save money. 

Here's CBS noting couples rushing to divorce to save on taxes. And another. And another.

Bottom line: if the tax system provides strong incentives to do something, you might expect at least some of that thing to happen. With the CGT as proposed by TWG, there will be some couples who will choose to present as not-partnered because being in a civil union or marriage would mean that their second property would become subject to CGT; there will be some who divorce, on paper, to achieve the same end.*

I've no clue how many people will do that. We have only one house so no incentive to. But there is a whole enforcement apparatus around the benefit system checking into whether someone on benefit actually is enjoying support from their child's other parent; it would be odd to think that there won't be enforcement requirements at the top end of the distribution too if the state creates tax incentives for paper divorces.

On to environmental taxes, where I don't think we're disagreeing at all. Norm doesn't like the burden shouldered by 'if they're done well'.

Another TWG’s key recommendation is to shift towards environmental taxation.  Eric Crampton’s Spinoff piece reflects a commonly held economic view: “In principle, this has a lot of merit. Taxes that correct underlying distortions provide a double dividend. Not only do they raise revenue, but they also improve overall economic efficiency if they’re done well.” Of course, it can be hard to avoid the tautology here that ‘if they are done well’ they will be efficient; and ‘if they are efficient this must indicate they are done well’!

But, as with a CGT proposal that ignores the income tax and transfer system, a new ‘environmental approach’ to taxation that ignores the rationales for the current system risks the same incoherence. On climate change, for example, we already have an Emissions Trading Scheme designed to take greater account of the social costs of atmospheric emissions. So, whether and how a separate tax on carbon emissions, or a broader set of environmental taxes (such as on energy generation) should be pursued, needs much more careful thought than the TWG could possibly give it.

I completely agree with Norm's argument against imposing a carbon tax on top of the ETS, or other taxes on things already covered via the ETS.

Here's what I wrote.

The group recommended strengthening the Emissions Trading Scheme and having it shift, in effect, to being more like a tax by having the government sell more of the permits over the longer term. That recommendation should be supported if implemented well.

That isn't layering other carbon charges on top of the ETS. It's instead anticipating that eventually the government will be selling credits into the system rather than gifting them to incumbents during this initial phase. When that happens, the revenues from credit sales we can view as comparable to an environmental tax in the overall Crown revenue mix.

There's still heavy lifting in the "if implemented well." But this is hardly the same thing as layering a carbon tax on top of the ETS. And I would absolutely oppose layering other carbon charges on energy and the like - a well-functioning ETS means you don't need any of that sector-specific nonsense in energy or elsewhere.

I thought I'd made that pretty clear in the very next paragraphs, where I remind that stuff like tax breaks for buildings constructed to higher environmental standards are a poor idea:

So too should its recommendation to use congestion charging to help fund the roads – it makes a lot more sense, and is far more equitable, than measures like the Auckland petrol levy that fall very heavily on poorer families with less fuel-efficient cars.

The group also recommended using taxes to improve water quality if the government isn’t able to find better ways of dealing with the problem soon. It suggested water taxes and taxes on fertiliser as potential measures.

Making sure that water users face the cost of that use is important, but tax is a blunt instrument. A tonne of nitrogen fertiliser has very different effects depending on where it’s used. And water taxes have a hard time recognising regional differences in water scarcity. Water should surely be more expensive in Canterbury than on the West Coast, but the government would have a hard time finding the right prices. A cap-and-trade system like the Emissions Trading Scheme is more appropriate.

Other suggestions, like hunting for reasons to justify increasing existing waste levies, or giving tax preference to buildings constructed to tighter environmental standards, might give the appearance of doing good for the environment but seem destined to be a boondoggle if pursued.

I don't particularly disagree with anything in Norm's article, and I have a hard time reading it as disagreeing with what I actually wrote either. But the vibe of the whole piece feels like it's trying to disagree with what Norm thinks I'd written. I must have worded things particularly badly in that Spinoff piece.

* UPDATE: To be very clear: this is just an example of a recent tax change encouraging the timing of divorce. I'd need to dig into the tax code of the early '90s to know what was going on in the anecdotal account I provided. But there are plenty of other potential ones. I've even heard some folks get married to get in-state tuition.