Saturday, 16 July 2011

Comments on Labour's tax policy

As far Labour's recently announced tax framework goes the key policies are
  • zero income tax on the first $5,000 of income;
  • an increase in the top marginal tax rate to 39% for incomes over $150,000;
  • exempting fresh fruit and vegetables from the GST (technically, zero rating them);
  • a 15% capital gains tax.
About the best comments I have read on these announcements comes, not surprisingly, from Seamus Hogan at Offsetting Behaviour.

On the $5,000 tax exemption Hogan writes,
In principle, I don't mind the $5,000 tax-free policy. There are fixed costs to working compared to not working, which are not recognised when one has to pay tax from the first dollar earned. I could see a tax-free bracket having a non-trivial effect on decisions on whether to enter the workforce part time or not at all, particularly if the tax-free threshold could be lifted over time. A tax-free bracket is also a much more moral way of ensuring that workers receive a living wage than would be an increase in the minimum wage. I find it difficult to believe, however, that the other policies in the package could make up for the cost of exempting the first $5,000 of income from tax for every taxpayer. This is the unpleasant arithmetic of tax policy: Tax cuts at a particular income level only have an efficiency-relevant impact on the behaviour of those taxpayers whose marginal income is at that level, but they give a tax reduction to anyone whose income is at that level of higher; cuts in tax rates at the lower end, therefore come at a large fiscal cost for a only a small change in reduced disincentives.
On the marginal tax increase Hogan says,
The proposed increase in the top rate is silly. There is such a small proportion of the country’s income earned at those levels that the policy can hardly be expected to bring in a significant amount of revenue, but will surely lead to the usual tax avoidance games. It is hard to escape the conclusion that this is a purely symbolic policy designed to make people with incomes less than $150,000 feel good that those with more income are being taxed more. If so, it is appealing to a rather ugly side of human nature.
As to the fruit and veg tax cut Hogan says,
The zero-rating of fresh fruit and veg might just about be the most appallingly cynical election bribe the country has ever seen. I am not saying that it would be the most costly election-bribe policy enacted; that mantle would have to go to either National Superannuation or interest-free student loans. Rather, I suspect that this policy would have the highest cost relative to benefits, with benefits defined according to a policy’s proponents’ underlying preferences. Consider first the costs of the exemption: of relatively small importance is the lost revenue that will need to be made up elsewhere. More important, is the additional transactions costs in compliance, enforcement, and definitions that the policy would introduce. Much worse, is the erasing of the line in the sand that currently stands between a clean GST and one with messy exceptions; once we start on this slippery slope, there will be no clear line left to defend against creeping exemptions and tweaking of the GST system likely to be proposed in the future. Against this, are two putative benefits. First is the idea that the exemption will make the GST more progressive. I haven’t seen any data on this, but I would extremely surprised if taxing fresh fruit and were not a progressive tax; if one wanted to use the tax system to redistribute from poor to rich, I suspect the proposed exemption would rank second only to high cigarette taxes as a method for achieving that objective. The second supposed benefit is the health benefits from eating more fresh fruit and veg. The trouble is that nutritionists tell us there is no nutritional advantage to fresh over frozen or canned, so unless someone can show some convincing data giving a significant elasticity of demand for fresh fruit and veg that does not result from a substitution away from preserved fruit and veg, we would need to dismiss this benefit as well.
As to comments on the CGT Hogan puts that off for another post. This is sensible given that there are good economic arguments on both the pro and anti sides of the debate. On issues like this the devil is in the details.

Former ACT Leader Rodney Hide comes out against a CGT, He argues at that a CGT is effectively a double tax on business:
A business generates $100 a year. The going discount rate is 10 percent. The value of the business is $1,000. That’s if there’s no tax.

Introduce a tax of, say, 30 percent, and the business now yields only $70 a year. The business is worth only $700. The tax liability is capitalised into the value of the business.

Now let’s say I buy the business and fix it up. I double its income to $200. In the absence of any tax the business is now worth $2,000 and I can sell the business and pocket a $1,000 capital gain. However, if there’s an income tax of 30 percent the increase in the business’s value is from $700 to $1,400. My capital gain is now only $700.

My gain is not tax free even though I appear to pay no tax on my gain.

That’s because the capital value reflects the extra tax the extra income the business generates.

A capital gains tax of 30 percent reduces my gain from $700 to $490. I am doubly taxed.

Capital gains aren’t tax free and a capital gains tax doubly tax savings and investment.

1 comment:

MacDoctor said...

A capital gains tax of 30 percent reduces my gain from $700 to $490. I am doubly taxed.

This is only half the story. A significant portion of capital gain comes from capital expenditure on plant and/or improvements. This has been paid for by after tax income, so a tax on this is a double, double tax. In addition, inflation will raise the amount of capital gain that attracts tax, while added nothing to real profit, further eroding an investment.

Labour address neither of these issues, which is unsurprising given that they ignored fiscal drag for the nine years they were last in government.