Luxon's tax proposals

National Party leader Chris Luxon announced a few tax policies on Sunday:

• Index tax thresholds back to 2017
• Abolish the 39% tax rate
• Abolish the Auckland Regional Fuel Tax
• Reverse the 10-year bright-line test extension and restore interest deductibility for investment property
• And if either the Light Rail Tax or the Unemployment Insurance Scheme go ahead, he'd reverse those.

I agree with most of this, with a couple quibbles, and a bigger overarching concern about long term fiscal sustainability. 

First the stuff in Luxon's pitch. 

Failing to index tax thresholds in a high inflation environment is a tax increase with distributional consequences that probably aren't what Parliament would choose if it were trying to increase tax revenue. I'd prefer that he formally index the thresholds so that they ratchet upward every 1 April when enough fiscal drag has accumulated. 

Whether you use $1000 or $500 increments would depend on how expensive it is to update systems to do this stuff - the accountants would have a better handle on it than I do. But it isn't hard in principle. Say you ratchet whenever the cumulative increase rounds to $1000 thresholds. Once inflation means that the $14,000 threshold needs to go up to $14,501, increase it to $15,000 at 1 April. But don't reset the inflation anchor to the new threshold, just keep it running from the old one. Then you have overs-and-unders where for a little while the thresholds are too low relative to where they should be, then too high, then too low again, but they never get far out of whack. And it only shifts by $1000 increments. 

Abolishing the 39% rate also makes sense. Remember what Norm Gemmell said about it last year. 

The new top tax rate In November 2020, Inland Revenue conducted a regulatory impact assessment of the government’s proposed new top personal income tax rate of 39% on incomes above $180,000 (Inland Revenue, 2020). This clarifies that the objectives of the policy were to: (a) raise more revenue to fund the government’s intended future spending; and (b) do so in a way that improves equity.

Evaluation of the policy ex ante can therefore be decomposed into four important aspects: (1) How much equity improvement will be achieved? (2) How much extra revenue will be raised? (3) What sacrifice in efficiency will be made in pursuing these objectives? (4) Could the objectives be achieved at a lower efficiency sacrifice? 

On (1), empirical analysis from Inland Revenue (2020) shows that the effect of the top tax rate increase on the Gini coefficient – the most commonly quoted inequality index – is likely to be very small. It is forecast to fall by 0.2%, from 0.493 to 0.491. In fact, despite ‘raise the top marginal income tax rate’ being a popular mantra of the political left, changes to income tax rates at the top of the income distribution typically have little overall distributional impact. This is partly because the Gini coefficient weights each individual by the inverse of their rank in the income distribution.

...

Inland Revenue (2020) estimates that, averaged over the first three full years of its operation, the new tax policy will raise, on average, $510 million per year, 2021/22–2023/24.3 This represents just under (over) 0.4% of total Crown expenses (revenue) in 2020 (see Treasury, 2020). It is clear therefore that the new tax policy has a very limited capacity to increase Crown spending, or increase equality via the targeting of that spending at lower-income groups.

If tax revenues have to be maintained, it would be better – in terms of equality improvements delivered at lower efficiency losses – to raise GST rates (for all) and lower income tax rates only at the bottom of the income distribution. Alternatively, income transfers to lower earners (such as via family tax credits) could be paid out of higher GST revenues and almost certainly reduce inequality indices. Similar scenarios have been examined rigorously by Thomas (2015, 2020) and shown to be more effective for redistribution in many OECD countries, including New Zealand.

It is hard to avoid the conclusion that the new higher top tax rate is a policy designed to deliver the appearance of redistribution by focusing attention and revenue-raising raising on top earners. However, especially given the way the new policy has been structured, the actual effects are likely to be minimal on equality and small on revenue, but will impose significant costs in terms of the efficiency and integrity of tax revenue raising in New Zealand.

Emphasis added. Norm is Chair in Public Finance at Vic. 

Abolishing the Auckland Regional Fuel Tax, which is meant to be funding transport improvements in Auckland, would mean some other way of funding transport improvements would be needed - or a rethink of how transport is funded more generally. That could be worthwhile.

Reversing the tax moves in property also makes sense. Go back and read Norm's piece - the housing tax changes had introduced incoherence into the tax system.

The UI scheme isn't in place yet and is a bad idea anyway. Promising to reverse it provides some certainty so people don't go and cancel existing employment insurance policies in expectation that the new scheme would be durable. 

But there remains a big overall hole. Treasury's long-term fiscal outlook is grim unless we have some combination of fixing NZ Super to deal with increasing healthy life expectancies, restraint in growth of expenditures on government services (primarily healthcare), or tax increases. And it will only get worse in high interest rate environments.

Luxon's tax moves get rid of a pile of measures that cost a lot relative to the amount of money they might bring in. It's good to be rid of them. But if we think that defence expenditures are going to be higher over the next decade, and that health expenditures will too, then we need some clearer signals about where restraint might be applied to cover the cost - or where taxes might increase to plug the hole. 

Gemmell's piece suggested that a combination of GST increases and reductions in income tax rates in the lower tax bands would be more efficient than the combination of policies Labour had put up. It also wouldn't be a bad start if looking for ways of raising overall revenue. Make the GST increase neutral for those on lower tax rates by adjusting their tax rates down, and the GST increase winds up being progressive in effect. And remember that GST hits spending out of capital income as well. 

I'd prefer starting with spending restraint and doing away with useless or harmful bits of spend where we can find it: make-work construction projects during a construction labour shortage; Envirojobs; and, Medsafe for starters. The last one only somewhat tongue-in-cheek. 

And definitely start indexing NZ Super to healthy life expectancy: have a one-off upward ratchet in the age of eligibility scheduled for a decade from now, then have it upward-indexed whenever healthy life expectancy increases. Complement it with an enhanced disability benefit for those ineligible for Super but no longer medically capable of working - and remember there will be some who are in that hole even with an eligibility age of 65. 

I'd chatted this morning with Newstalk's Mike Hosking and with RNZ on all of this.