Matt Nolan

Efficiency, equity, and tax

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From Kiwiblog we hear the following statements from Bill English:

Low-income earners would have to be compensated if GST was increased as a result of the current tax review, Finance Minister Bill English says. …

“We don’t want to go down the route of raising taxes,” he said. “The Government has a strong preference not to increase taxes to close the deficit. We prefer more efficient taxes over higher taxes.”

Cool.  The government believes that it is fair to charge those on low incomes proportionally less (equity) and it would like the tax system to be efficient.  The only issue here is that there is a trade-off between these two elements of the tax system. People can approach Tax Shark: tax preparation services in Roseville to help them.

In terms of proportionality we can think of GST like a flat income tax – in both cases an individual will pay the same proportion of their lifetime income in tax eventually.  Offering rebates to people on low incomes is then the same in either case – it implies that people on a lower income pay proportionally less of their income.

How does this impact on efficiency?  Well, to raise the income to pay rebates the government has to increase tax rates on people with higher incomes, providing a disincentive to work.   Furthermore, there will be some range of income over which the rebate will be abated.  Depending on how the tax system is designed this implies that there will be very high “effective marginal tax rates” for some groups.  We see this with Working for Families where some households would get taxed at over 90% on any additional income they earn – providing a strong disincentive for these people to work additional hours, or do anything to earn additional income.  Finally, higher and more progressive tax rates give people with the ability to try and avoid tax the incentive to – another factor that hurts the efficiency of the tax system.

As a result, I agree with what the finance minister said, we need to look at efficiency and equity when making decisions.  It will be interesting to see exactly what trade-off the government, and society as a whole, is willing to agree upon.

The Hand

Bank runs and TARP

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This is a Hand post, but it is actually just the normal authors of the blog.  We all had the same idea at the same time 😀

Over at Anti-Dismal, Paul Walker reaches the conclusion that

The moral of the story, markets can deal with asymmetric information

In the case of bad and good banks.  He states that banks are able to signal whether they are strong or not, and so government intervention is unnecessary.

However, this doesn’t seem to weigh up properly with the vast amount of literature that points out that bank runs are a concern resulting from asymmetric information (and multiple equilibrium – for economists this is because withdrawal decisions are strategic complements) and that a small amount of government intervention can help prevent said negative outcomes (here and here are seminal pieces).

Now there is a way that we can put both points of view together. Lets look at how the market is overcoming the asymmetric information problem:

At least one major US bank is advertising the fact that it refused TARP funds.

So the market was only able deal with asymmetric information in this case because the government created a mechanism that allowed banks to credibly signal (the TARP program).  It is ONLY because the government created this mechanism that the individual banks could signal their “strength” credibly, thereby preventing an inefficient bank run equilibrium.

So I would change the moral of the story slightly to

markets can deal with asymmetric information, when the institutions are in place that allow them to credibly signal quality – an issue government can sometimes help with

Matt Nolan

“Mobility of labour” is not a reason for favouring GST

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There has been a bunch of good stuff written out there about the trade-offs between using GST and a (flat) income tax to raise government revenue.  However, there is one point I think has been slightly exaggerated – the mobility argument for a lift in GST.  An example of this comes from an excellent article by Vernon Small.

Put simply, since people can leave or  go elsewhere – and so can investment  dollars – they should be taxed the least.

On the other hand, local consumption – which attracts GST – can by definition only happen here.

Now the first paragraph has a lot of truth in it.  But in reality the idea that “people can leave” in the face of tax and the idea that “consumption can leave” in the face of tax are equivalent.

Why?  People value their income only insofar as they can buy things with it.  As a result, if someone is forced to either stay at home or move overseas then a GST rate of 25% is equivalent to a tax of 20% on labour – as both taxes drive a wedge between what an employer is paying and what real goods and services a employee is receiving.  This point was also raised by the Tax working group.

So remember, it is not true that switching a “flat” component of income tax to a GST rate will necessarily lead to fewer New Zealanders going overseas.  If it does anything it will change the timing – leading to more New Zealanders staying around to save up income, and then moving overseas to spend it.

Matt Nolan

Quote of the day: On NZ property investment

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From David Chaplin’s blog on the Herald site:

If New Zealanders have a love affair with property investments, it’s one where government and regulators have acted as pimp.

That is awesome – and very true.

Matt Nolan

Supersize NZ

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I had forgotten about this, but a while back CIS released a booklet with a few essays on “how to supersize NZ” (as in make the economy bigger, not supersize in the McDonalds sense).  It was called Supersize New Zealand:  A collection of essays on how to improve New Zealand’s public policy.

Of course I’m linking to it because I got to write one of the essays (with the editing help of some other blog authors – thanks Agnitio, Goonix, Rauparaha and CPW).

I wrote on how we shouldn’t forget productivity when looking at social welfare policies – as at the time we had a Labour government in that was determined there was no trade-off between efficiency and equity and therefore determined that we should focus on equity.

However, by the time it was release we had a National government who believe there is no trade-off between equity and efficiency and so we should focus on efficiency.  They do this under the catch-cry of productivity, which lead me to write things like this.

There is no contridiction.  Ultimately, I just want politicians to face the trade-offs associated with policies and wrote articles that, at the time, illustrated the costs they were missing.

Matt Nolan

Tax and recovery: Two ways Bill English is correct

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Whale Oil is unhappy with Bill English mentioning a capital gains tax.  Specifically he says:

In times of recession it isn’t that the government should be looking for more taxes.

But there are two reasons why I think Bill English is correct at the moment.

  1. Bill English appears to be saying that he wants income to be taxed more broadly to remove the “incentive” to shift income into housing.  As a result, he is saying that he wants to broaden the tax base, which implies that they can improve incentives and REDUCE other taxes.
  2. During a recession we could “stimulate activity” by saying we will increase taxes IN THE FUTURE.  This isn’t what he is saying, and I’m not saying it is a good idea, but it is another potential way of viewing things.

Ultimately, there are incentive problems with the tax system and when Bill English says he is interested in a CGT it is because he realises that these problems exist and that they are causing structural imbalances.  Good on him for being brave and admiting he is willing to do look at these difficult issues.