Tax question looms over country’s economic recovery

As we look further ahead, post the recovery phase . . . we will need to look again at our tax system’s overall design.

On March 25 Parliament sat for the last time before adjourning for the Covid-19 level 4 lockdown. On that Wednesday, under urgency, it passed an extraordinary three-page act that granted the Government the power to spend up to $52 billion before June 30, 2020, with no further appropriation or approval required.

This little act gave the Minister of Finance the fiscal authority he needed to respond to the virus crisis.

Around $20b of that has now been committed covering the wage subsidy scheme, tax changes to support business, increased funding from the health sector and an increase in benefit payments.

The next wave of spending to support the economy is expected to be unveiled in the Budget on May 14.

$52b is an incredible amount. To put it in perspective, it’s 17 per cent of our GDP, or about 60 per cent of last year’s core government spending.

Like Governments around the world, our Government has spent heavily to cushion the impacts of the lockdown on people and businesses and to preserve as much of the capacity of the economy as possible.

The next wave of spending will be focused on aiding economic recovery and is likely to spread over several years as the Government runs expansionary fiscal policy that supports investment in public infrastructure and in rebalancing and retraining parts of our economy.

This spending will be funded by government debt. As a result of economic growth and careful fiscal management by the previous and current Governments, our net debt of roughly $60b fell to just under 20 per cent of GDP by the end of 2019. This left us in a strong position in this crisis.

But with the magnitude of the spending on Covid-19 already and the need to fund further years of deficits into the future, our net debt may rise by as much as $80b more and reach 40 per cent of GDP by 2024. Budget 2020 will forecast this out for us.

The growth in the debt will need to be stopped at some point, and a sensible programme of repayment begun. Not all of it needs to be repaid. If net debt at 20 per cent of GDP is considered a prudent target for New Zealand, the combination of some repayment and economic growth can get us back there over time.

But inevitably, tax revenues will be needed to service the debt and, eventually, to make some repayments. And yet the impact of the economic recession caused by Covid-19 will be to reduce tax revenues for the next few years.

So what does this mean for the tax system? Will we see major new taxes or higher tax rates announced in Budget 2020 to fund this spending?

I think that’s unlikely for a couple of reasons. In the first instance, it’s political. Labour made a clear commitment not to introduce new taxes such as a capital gains tax or to raise tax rates in its first term of government. With an election still planned for this September, it’s unlikely to break that commitment, even in the face of Covid-19.

The Prime Minister recently reconfirmed the Government would not introduce a capital gains tax, even considering the need to fund all this additional Government expenditure.

The second reason is in many respects more important. Higher taxes can impede economic growth.

In a recent report on the use of tax measures in responding to the Covid19 crisis the OECD recommended that the best way to boost tax revenues over time was to support solid economic growth with strong and sustained fiscal stimulus.

Where in time Governments need to increase tax revenues, they should look to broadening the tax base in ways least detrimental to growth. The OECD did not recommend just increasing tax rates across the board.

For evidence of this growth-led approach to increasing revenue, we can look at what happened after the global financial crisis (GFC) in 2009.

Tax revenue fell sharply in 2010.

But once economic growth got restarted, tax revenues recovered strongly without the need for higher tax rates overall or new taxes.

Between 2012 and 2016 after the GFC, New Zealand’s gross domestic product grew at between 2 per cent and 3 per cent each year while tax revenues grew consistently at more than 5 per cent a year. To hit the economy with new taxes or higher rates of tax in the short term as it tries to recover could be damaging.

The Government has already released a series of tax changes as part of the initial response to Covid19. There are short-term changes to allow Inland Revenue more discretion to manage the effects of late payments and filings.

But there are also long-term changes included restoring depreciation on industrial and commercial buildings, increasing the low value asset write-off threshold, easing the rules on carrying forward tax losses, and a new tax loss carryback option that will allow businesses to carry back Covid-19 tax losses in to 2019 or 2020 and gain refunds of previously paid tax. These measures are sensible changes to our system.

But as we look further ahead, post the recovery phase of responding to Covid-19, we will need to look again at our tax system’s overall design.

The OECD report notes that efforts to restore public finances should not come too early, but that sound tax policy has a key role to play at the right time to do that.

Last year the Tax Working Group found the tax system had many strengths and was sound. This is a great asset in a crisis like this one and is a result of careful stewardship by government, officials and the community over several decades.

But the group also found the tax system relies on a relatively narrow range of taxes, individual/corporate income tax and GST and it is not particularly progressive.

The two obvious gaps compared with other countries are the lack of a capital gains tax and relatively little use of environmental taxes. Like any tax, both areas are politically charged, and a capital gains tax is off the table.

But as the economy reshapes around a new world reality, and a recovery gets well established, we may need to rethink the role of the tax system from an economic, equity and environmental perspective.

Budget 2020 may give us some early insights into the Government’s view on the future tax system but I suspect a better picture may emerge as the political parties develop and release their tax policies ahead of the election.