T is for Tax

July 12th, 2014 at 4:00 pm by David Farrar

One of the big ones. Tax.

Taxes are one of the most tangible links between the government and civil society. We all pay taxes in some form, and in exchange we expect the government to provide certain goods and services: roads, infrastructure, the courts, law enforcement, education, and support for society’s most vulnerable.
 
From this perspective, the oft-quoted declaration ‘taxes are the price we pay for a civilised society’, widely attributed to Oliver Wendell Holmes, rings true.
 
However, it is a common misconception that a dollar taxed is a dollar that can be spent by government on goods and services. In reality, a dollar taxed is a dollar that must be spent on collecting , ensuring compliance, public administration of policy and, of course, the actual public policy.
 
Besides, increases in tax rates do not automatically lead to an increase in tax revenue, as illustrated by the Laffer curve. Named after Arthur Laffer, this curve popularised the notion that higher tax rates may actually cause the tax base to shrink so much that tax revenues will decline. Conversely, a cut in tax rates may increase the tax base so much that tax revenues increase.
 
How so?
 
Taxes distort behaviour by influencing the personal decisions people make about their work and consumption. For instance, people who would prefer to work longer hours or at a higher pay may work less or refuse a pay rise to avoid being taxed at a higher rate. Higher personal income taxes encourage workers to substitute their preference for work to economic activities that they would otherwise not prefer.
 
This is known as the deadweight loss of taxation, where the tax system causes individuals to pursue actions they would otherwise not prefer. To gain maximum tax revenue, there must be a careful balance between low rates with a greater tax base, and high rates with a smaller tax base.
 
There is also the issue of tax incidence, which describes who bears the cost of the tax. For example, increasing the tax on high income earners may not necessarily mean that they bear the cost of the tax. If workers are receiving less money in their pocket, for an equal or greater amount of work, employers may feel compelled to raise their wages to ensure employees receive the same take-home pay. Thus it is employers who bear the burden of a higher rate of income tax.
 
Taxes are not the price we pay for a civilised society. At best they are the price we pay for a civilised government. But they are also the price of overly bureaucratic procedures, unpredictable outcomes, and the loss of freedom to make our own decisions.

 

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24 Responses to “T is for Tax”

  1. nickb (3,696 comments) says:

    They also distort investment decisions – for example why would you invest in the NZ sharemarket when you can gear up from the banks to the hilt, get tax refunds for 10 years from a loss-making investment, then pay nothing back on the way out when you sell that rental property for a large tax-free gain.

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  2. igm (1,413 comments) says:

    More waffle of left-wing envy. Get a life loser!

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  3. nickb (3,696 comments) says:

    Lol, you must be new here igm….

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  4. DisgruntledOne (20 comments) says:

    ” If workers are receiving less money in their pocket, for an equal or greater amount of work, employers may feel compelled to raise their wages to ensure employees receive the same take-home pay. Thus it is employers who bear the burden of a higher rate of income tax.”

    Could someone please explain this? I don’t understand how increasing the employees’ need for a higher wage changes the likelihood of them receiving one. Surely this has not actually altered the balance of power in negotiations, and surely the employees would have wanted a pay rise even before the tax rate went up?

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  5. mikenmild (12,316 comments) says:

    You are expecting too much from a column from the grandiosely named New Zealand Initiative. The series reads like it has been penned by a secondary school economics student.

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  6. peterwn (3,332 comments) says:

    DisgruntledOne – Such employees will consider employment in various countries, are highly employable and have a good chance of landing any relevant job they apply for. Employers whether the State Services Commission, company or school boards or proprietors of family and other businesses may be willing to match or exceed ‘outside’ offers for such people. If the person is capable of making a profit for the company, saving money or achieving more ‘delivery’ from an existing budget, the organisation comes out on top even though it may have to pay the person a premium. For example an Inland Revenue commissioner who can squeeze blood out of a stone with minimal political backlash, it is worth while to ensure the commissioner is properly remunerated. Otherwise ATO, HMRC or IRS could well successfully poach that person.

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  7. Fentex (1,130 comments) says:

    Taxes distort behaviour by influencing the personal decisions people make about their work and consumption.

    But not, in it’s own special case, how much sugar you consume as apparently. Odd how a tax disliked by otherwise defenders against distortion by tax is singularly ineffective at changing behaviour. Amazing how the rarity of ineffective tax and their personal dislikes align.

    I don’t understand how increasing the employees’ need for a higher wage changes the likelihood of them receiving one. Surely this has not actually altered the balance of power in negotiations, and surely the employees would have wanted a pay rise even before the tax rate went up?

    The claim that increasing taxes on employees hurts employers because they feel compelled to raise employee pay is another odd case of logic stopping at someone’s personal dislikes. If carried on that logic leads to employers raising their prices and transferring the cost of the tax on their employees to their customers.

    It is a claim that increased taxation increases inflation if carried through.

    But for some reason here the logic is not followed and the presenter argues the expense is not passed from employee to employer to customer but stops at the employer and thus reduces their profit and presumably disincentives them from creating more employment or some such risk because for some odd reason it is claimed people working for profit and overcoming obstacles to doing so will be frustrated totally by this one more imposition that they cannot mitigate by passing on to their customers for some obscure unrepresented reason.

    So no, one cannot explain the reasoning that chooses to stop short.

    It amazes me that people who often claim to be hard headed rational observers of behaviour and scientists examining nature and people make complex arguments about risks and rewards that are effectively game theory analysis of taxation ignore the results of game theory so brazenly – the suggestion that as taxation may cause marginal gains to reduce for the higher returns from working harder and longer are an absolute barrier to those who seek profit is nonsense.

    Especially when presented by people who in other avenues argue it is capital and knowledge that matters and not mindless labour. If they were to be believed then it is capital gains that must be taxed and not labour. Imagine the howls.

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  8. Nostradamus (2,427 comments) says:

    Hmmm…

    Taxes distort behaviour by influencing the personal decisions people make about their work and consumption. For instance, people who would prefer to work longer hours or at a higher pay may work less or refuse a pay rise to avoid being taxed at a higher rate.

    This logic is far too simplistic. Our tax system is a progressive tax system based on marginal tax rates. So, if someone offers me a pay rise, I might pay a higher rate of tax (but only to the extent that the pay rise took me into the next tax bracket, and even then, only on the part of my higher pay that falls into the next tax bracket).

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  9. jcuknz (689 comments) says:

    On the other hand the responsible worker earning above average doesn’t worry that they are moving into a higher tax bracket for those extra dollars as Nostradamus points out because they know as an above average paid worker it is their responsibility to look after the less fortunate in their society…. but of course this is a rubbish statement for the selfish right wingers thinking of how they can grasp every cent in their foolish struggle for wealth and position in society. This was my position during my later working life and I regarded those who complained or refused overtime as foolish idiots while the efforts of my wife and I put us in the top 5% of the workforce.

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  10. holysheet (466 comments) says:

    Why do we have income tax at all?
    What I would like to see is a consumption tax, Gst at 26%. and no income tax. This way if you want to save your money then you don’t pay as much tax as one who will spend their money. This will do away with the black economy as they can only spend the cash they get. There is no advantage in doing cash jobs, as a way of avoiding paying tax as there would be no incentive.
    Most people spend their money, the more they earn the more they spend.
    If i want to spend up large on a boat, holiday home or whatever, then I would be paying more in GST than I would in income tax.

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  11. PaulL (5,446 comments) says:

    Tax incidence is a real theory, but this is a very summarised version of it. In most cases the employee would in fact get an after tax pay cut. But assume they’re internationally demanded, and after the tax rise they are now (after tax) paid less than they can get in Australia. In a world with no friction, they’d up and go to Australia without a pay rise. In the real world, they probably don’t move. But arguably, next time you need to hire someone from Australia, they’re not willing to come, so you pay a higher salary to top it up. OK, so now the tax incidence is on the employer, but since all employers in their industry have the same problem, they have a reasonable chance of passing it one to their customers, and therefore it becomes inflation. There were a lot of ifs in that logic chain.

    The Laffer curve is a real thing, but all the Laffer curve notes is that taxation revenue is a curve with tax rate. At 0% tax the revenue is zero, at 100% tax the revenue is zero (because nobody would work for free). It has little to say about the shape of the curve other than those two points. So whilst it’s possible that we have reached the point on the Laffer curve where an increased tax rate will decrease revenue, there’s no evidence that proves that. In my opinion it’s unlikely we’re at that point, so probably the most we can say is that an increase in tax rate is unlikely to give a 1:1 increase in tax revenue – some of it will leak off, but overall tax revenue would probably still increase.

    I think it’s a useful piece in that it identifies some of the considerations that need to go along with taxation changes, but it doesn’t provide any particular insight into how those considerations apply in NZ’s situation.

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  12. PaulL (5,446 comments) says:

    @holysheet: it’s hard to have a progressive tax system based purely on consumption taxes. If you aren’t concerned with a progressive tax system that imposes more taxes on those with more wealth, then that’s fine. But if you are, then we need some proxy for a wealth tax – and income tax is the closest proxy we currently have.

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  13. Fisiani (1,051 comments) says:

    Labour and Greens want $5,000,000,000 extra TAX in CGT PLUS carbon tax PLUS rich prick tax plus any other tax they can invent.
    National will always look to lower tax to give taxpayers more money to spend.

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  14. ShawnLH (6,572 comments) says:

    Mikey says: “You are expecting too much from a column from the grandiosely named New Zealand Initiative. The series reads like it has been penned by a secondary school economics student.”

    Translation: “Being a union supporter and PSA member I find these articles scary and difficult to understand, and have no clue how to respond to them, having no clue about economics in general. So I better attack their name instead, just to say something, anything, negative.”

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  15. holysheet (466 comments) says:

    PaulL
    Why would it be unfair if everyone paid no income tax and only paid tax on what they spend?
    The wealthy would naturally spend more money and thus pay more tax in proportion to their income. The more you earn, the more you spend. It’s that simple.
    But, you have the choice when and if you spend your money.
    As long as the total tax take remains the same, I cannot see why this would not work

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  16. PaulL (5,446 comments) says:

    holysheet: it would work. But the general definition we have settled on (so far as I can tell) for a progressive tax system is that the rich pay a higher proportion of their income in tax than the poor. The generally accepted position is that the poor spend a higher proportion of their income than the rich – they don’t have the luxury of saving. So under your proposed system the rich would pay more tax than the poor, but they would pay a lower proportion of their income in tax than the poor. This would be a substantial change from our current system, and would in general result in higher taxes for the poor and lower taxes for the rich. In short, good luck with getting that through.

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  17. Fentex (1,130 comments) says:

    This way if you want to save your money then you don’t pay as much tax as one who will spend their money.

    A tax system that’s income is significantly reduced by people changing their behaviour is one of little use because it is unpredictable. And one that actively discourages economic activity particularly so.

    Besides which don’t be fooled into thinking anyone would be allowed to side step being taxed.

    People need to believe a system is fair-ish and falls across peoples shoulders evenly-ish or the political system under which it is levied will become untenable and fracture.

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  18. holysheet (466 comments) says:

    You are missing my point. Why do you presume that we need a “progressive tax system”
    If the lower paid workers get to keep all their income and only spend what they want (or need) to, then were is the concern?
    If everybody knows that the rich are paying more gst because they are spending more, then that has to be better than trying to hide their income in trusts etc. There would be no incentive to set up these trusts, as the income from these entities would be tax free.

    I am yet to meet anybody who, as their income has risen, hasn’t increased their spending. As I have already stated, the more you earn, the more you spend.

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  19. burt (7,424 comments) says:

    Taxes … It’s all very simple really.

    http://www.warroom.com/dinner_taxes.php

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  20. PaulL (5,446 comments) says:

    @holysheet: start with a base assumption that total tax take stays the same. If not, then the benefits of your suggested system are nothing to do with the system, and instead to do with reducing tax take. If the total tax take stays the same, and we agree that the rich would pay relatively less than they used to, then the poor must be paying more. In short, GST would have to go up a lot. And that’s why they’d care.

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  21. burt (7,424 comments) says:

    PaulL

    The regressive nature of GST is a problem for two parties, low earners and the opposition. If Labour genuinely cared about the regressive nature of GST it would have been unacceptable at 12.5% it’s because they, and their supporters, are in opposition that they highlight it.

    It is however a real problem. It would be easily offset by a reasonably broad tax free income threshold. All too simple though, can’t pick the winners and losers when it’s a broad and simple fiscal offset. Targeted benefits and *cough* tax credits buy more votes than simple fair solutions.

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  22. Fentex (1,130 comments) says:

    Why do you presume that we need a “progressive tax system”

    Taxation has to be progressive – it’s easy to demonstrate if one accepts these predicates;

    a) There will be taxation.
    b) There will always be people without economic surplus (the impoverished, the tragic, the handicapped etc).
    c) It is immoral and untenable to tax people who have no surplus.

    If you believe those things then you already believe that taxation must be progressive for there is already those you tax and those you do not, two steps of taxation.

    THe question becomes how you progress taxation, not if.

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  23. virtualmark (1,305 comments) says:

    mikenmild:

    You are expecting too much from a column from the grandiosely named New Zealand Initiative. The series reads like it has been penned for a secondary school economics student.

    There, fixed that for you.

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  24. masterman (19 comments) says:

    financial transaction tax would be fairer all round

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