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Contents | Executive Summary | How to obtain this publication | Additional information
The following OECD assessment and recommendations summarise Chapter 4 of the Economic survey of New Zealand, published on 23 April 2007.
See also the excerpt "Two broad approaches for tax reforms" (in pdf).
Contents
A coherent, long-term direction for the tax system should be developed
Creating a more favourable environment for savings and investment will also require a well-designed tax system consistent with the objective of raising living standards. The NZ regime has long been regarded as one of the simplest and most efficient in the OECD. Looking forward, however, the system will face challenges. These include risks to the tax base arising from increasingly mobile capital and labour. It is thus important to have in place a clearer strategic direction for the tax system, but this will take time to identify and fully develop. Any changes in the interim should be designed so that they would not be inconsistent with the long-term strategy eventually adopted. Against the backdrop of a currently strong fiscal position, the government has already announced that the forthcoming budget will present a business tax package for implementation in 2008. Any wider reform should remain consistent with longer-term fiscal sustainability. Moreover, at this stage of the business cycle implementing substantial tax cuts beyond those already signalled could lead to additional monetary policy tightening.
There are two broad options for reform
In defining the direction for the tax system, there are at least two broad options that could be considered. One possibility would be to adapt the system within a comprehensive income tax approach. This could include lowering rates and flattening the structure so as to reduce efficiency losses, removing the existing small concessions and resisting calls for the introduction of new tax incentives. Another approach would be to move to a dual income system whereby capital income is taxed at a lower rate than labour income. By lowering the tax on savings and investment, this approach could help to increase the capital stock, which will be critical for future productivity growth in New Zealand. It also has the result that consumption in different periods is taxed more neutrally than in a comprehensive income taxation approach. However, this would require rules to avoid reclassification of employee compensation as returns to capital by owners of small businesses (including farms) especially if the tax rates on labour are considerably higher than those on capital. International experience with implementing changes such as a dual income tax system should be monitored, and developments appraised in light of New Zealand’s long-term strategy and objectives. Extending the dual income approach to the point of not taxing capital at all would approximate an expenditure tax. Any option to address the long-term challenges would need to be carefully evaluated against the criteria of efficiency, equity, simplicity and transition costs. Assessments need to be undertaken in an inter-temporal, general equilibrium framework to capture the full impact of each choice.
Weaknesses within current tax bases should be re-examined
No matter what strategy is selected, a number of distortions within the present tax bases should be reviewed. First, the government has increasingly used the tax system as a tool to deliver on other policy objectives. This has complicated the tax system and has had some adverse effects on individual economic behaviour. The Working for Families package provides assistance to families with children. The package has increased the incentives for some of those on welfare to move towards work and for some to increase their hours of work. But changes in the last Budget extended the income range over which assistance is withdrawn, which has raised the number of families for whom working additional hours becomes less attractive financially because of higher effective marginal tax rates. Alternative ways of supporting families without these negative effects on incentives to work could do more to raise living standards and should be investigated further. Shifting the balance of funding towards more generalised assistance with childcare costs for working parents would be one option. The negative effects could also be partially reduced by cutting the top personal marginal rate, which would also have the advantage of curbing income diversion towards income trusts, which are taxed at a lower rate. Second, by proposing tax credits for firms investing in R&D, exporting companies and employers providing skills training, the government has signalled its willingness to depart from a broad tax base. Any new or existing deviations from the broad base principle should be supported by strong evidence that the benefits exceed the cost. However, if the government wants to offer R&D tax credits, it should at least scale back the grants through which most R&D support is currently provided.
Raising GST would help to limit the cost of tax reform
Large-scale tax reforms are usually financially costly, mainly because losers need to be at least partially compensated. One way to make substantial tax changes without compromising fiscal sustainability would be to raise the rate of the Goods and Services Tax (GST), while keeping the considerable merits of a single rate. For instance, a 1 percentage point increase in the rate would generate almost NZD 1 billion (0.6% of GDP) of revenue. Because GST is a low, flat tax with few exemptions, rebalancing the tax mix toward GST would also reduce distortions to savings and thereby increase future consumption possibilities. The resulting effect on income distribution is likely to be limited, once evaluated in a life-cycle perspective, although if there were concerns about regressivity, they could be addressed, for example, through a modest refundable lump-sum income tax credit.
A number of other structural reforms need to be completed
To the extent that New Zealand is more exposed to macroeconomic volatility than most other OECD countries, the country should aim for regulations and institutions whose design and efficiency are at “best practice” levels. In many areas, reforms have guaranteed that markets are flexible and responsive, but some further efforts are needed, as mentioned in the OECD’s 2007 Going for Growth recommendations. First, the government’s policy to provide free early childhood education and care for 20 hours per week to all three and four year-olds is heading towards implementation, but there are increasing concerns about the likely availability of places. There is a particular risk that disadvantaged children will be unable to access these services, especially as parallel initiatives to upgrade staff qualification requirements will push up costs. Second, educational services require a sharper focus on outcomes, particularly reducing under-achievement of Maori and Pacific Island youth. It would also be desirable to reward the teachers who upgrade their skills and to develop the tools to link remuneration with success in improving educational outcomes. Third, proposed reforms to deliver efficient provision of road infrastructure need to be taken through to completion. Congestion pricing should be applied more broadly, together with other measures that enhance efficiency in the use of urban infrastructure and public transport. Fourth, further competition also needs to be injected into network industries, such as telecommunication and electricity. In the latter sector, the authorities’ top priority should be to remove policy-related uncertainties currently holding back investment, including those related to climate change.
Well-designed policies to address climate change efficiently need to be adopted
The government has recently renewed its efforts to address climate change. It has released discussion papers on energy and climate change policies, focusing on the years within and also beyond the first commitment period of the Kyoto protocol. A number of measures to reduce greenhouse gas emissions are envisaged, but the authorities have indicated their clear preference for using price-based mechanisms across a wide range of key sectors. However, these documents make clear that the government’s willingness to proceed towards implementation of climate change policies depends on the engagement of other countries. It is to be hoped that this requirement will indeed be satisfied.
Standard VAT rates
As at 1st January 2005
Source: OECD (2006), Consumption Tax Trends, 2006 Edition, OECD, Paris.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic survey of New Zealand 2007 is available from:
- SourceOECD for subscribing institutions and many libraries
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OLISnet, under "Publication Locator", for government officials with accounts ( subscribe)
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Additional information
For further information please contact the New Zealand Desk at the OECD Economics Department at eco.survey@oecd.org. The OECD Secretariat's report was prepared by Deborah Roseveare, Annabelle Mourougane and Shuji Kobayakawa under the supervision of Peter Jarrett.
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