Cullen warns of big deficits without reform

Michael Cullen's Tax Working Group has warned of unsustainable deficits without tax reform. He says an ageing population and the gig economy will blow out pension and health costs and cut tax revenues. Thomas Coughlan reports.

Yesterday's Future of Tax background paper was packed with alarming statistics about the future of revenue and a looming blowout in expenditure that will create sizeable deficits unless the Government addresses it now.

The report detailed the effect that New Zealand’s ageing population will have on all aspects of taxation and revenue. As the population ages, expenditure will increase to accommodate rising healthcare and superannuation costs, while revenue will decrease as more and more income earners retire and are not replaced. 

In 2015, the Government’s primary expenses were 28.4 percent of GDP and primary revenue was 28.9 percent, leaving a small surplus of 0.5 percent. In 2030, primary expenses will be 31.1 percent of GDP, while in 2045, they will rise even further to 33.8 percent. Projected primary revenue will remain steady at 29.8 percent in 2030 and 2045, opening up a deficit of 4 percent of GDP by 2045. 

The Group notes that while it had been asked to construct a system that provided revenue to sustain expenditure at the historical norm of around 30 percent of GDP, this will not be enough to sustain healthcare and superannuation at current levels beyond 2030. Something has to give. Either revenue must increase or the Government will need to cut spending.

The severity of the problem is underlined by the rule-bending that was required to get the projection into the report. The Group’s mandate is to consider sustaining revenue of 30 percent GDP over the next five to ten years. That is the period ending 2031 if you interpret that period as commencing once the Group’s recommendations are implemented in the 2021 tax year, as the Government has indicated.

A figure from the Tax Working Group's paper showing the need for increased revenue or decreased expenditure in future. 

Michael Cullen, the Group’s chairman, told Newsroom that keeping spending at current levels would be difficult in the future, given changes to the population.

“If we look out into the longer term, it will be hard keeping Government spending around current levels. That will place pressure on the system in some way or another,” Cullen said.

“It does point to the discussion around alternative sources of taxation and how they can be fairly and equitably introduced,” he said. 

Cullen also raised the issue of the burden of an ageing population being increasingly born by the young.

“Under the current system, the future demands for tax from health and super will have to be met entirely out of labour income and that might be unfair and have its own perverse outcomes,” he said.

'A raft of new taxes'

The issue of the level of maintaining a level of Government expenditure provoked an attack from the Opposition, which accused Labour of using the Group as a front to introduce a raft of new taxes.

“This isn’t a time when we need to be taxing New Zealanders more,” said Opposition Finance Spokeswoman Amy Adams.

She implied that taxes could even be lowered, given GDP and the consequent tax revenue were increasing at levels greater than what was needed to fund Government services.

“I would argue that just because the economy is growing doesn’t mean the tax take should automatically grow,” she told media after the release of the document.

“Our position would be that the Government should take as much tax as it needs to run services well,” she said. 

On the issue the demographic burden she said that extra taxes could disincentivise saving, which was necessary to ease the strain on the system. She also reiterated National’s policy of slowly raising the retirement age to 67 as way of easing the burden on public finances. 

Vast inequality in savings

There is vast inequality in the marginal effective tax rates on different types of saving, strongly favouring property.

The marginal effective rate on money in a bank account, PIE, superannuation fund, company, or foreign shares sits between 47.2 percent and 55.7 percent. By contrast the effective marginal tax rate on equity in property is 11.3 percent on owner-occupied property and 29.4 percent on a rental property. 

“That really shows everything,” said Terry Baucher, director of Baucher Consulting.

The low rates are largely a symptom of the lack of capital gains tax, which is likely to be only partly remedied by the Group, which is prohibited from imposing a CGT on owner-occupied property (the family home). This does not mean the inequality could not be redressed in other ways. Andrew Coleman, who teaches public finance at the University of Otago, said that there could be an opportunity to lower the tax on savings in other areas. 

Low effective rates on savings in property have a distortionary effect. They encouraged investment in areas of the economy that were not necessarily the most productive, simply because they were taxed less.

“There is a trillion dollars of household property,” said Baucher. “That is a massive amount of idle capital”.

Baucher added companies that earned considerable amounts of revenue from capital gains were being given a gentle ride by the tax system.

“Phone or electricity companies pay effective tax rates of about 28 percent, but retirement village operators who book capital gains as revenue don’t pay tax on that — their tax is down around 11-12 percent,” he said.

Burden of tax could shift

Individual income earners carry most of the tax burden, but that will need to change in future as demographic change and technology shifts the burden to capital.

The report also looked at the split between revenue earned from individual income taxes and other forms of tax. This is of pressing concern for the Government as the gig economy shifts more people into self-employment and is likely to reduce the tax take. 

A bad taxation gig

Income from individual taxpayers currently makes up 40.2 percent of total taxation revenue, so any decline in revenue from this area will be keenly felt by Government finances. 

“We have a system which has basically been created on the assumption that we are all either employers or we’re business owners or we’re employees and our basic tax system works on that assumption,” said Cullen.

The burden of income from individual income tax also raises pressing questions about the need for a wealth tax or some tax on capital to equalise the tax burden, which rests disproportionately on income earners.

Cullen said that this raised an important question about the sustainability and fairness of the system.

“If you’ve got a situation, which is very likely over the future, that more people’s income will come from capital income than labour income mainly because of the changing demography, does that mean we will have to look at using more capital income sources rather than labour income sources?”

He insisted the Group was keeping an open mind ahead of submissions, but most expect the Government answer next February to be 'Yes'.

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