Matt Nolan

Shift to GST and “imbalances”

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Further to our discussion of New Zealand doing a compensated shift of taxes from income to GST (see here, here, here, here, here, here, here) we come to the issue of economic imbalances in NZ.

Ok, so the imbalance has something to do with tradable sector activity flatlining while non-tradable sector activity increased – meaning that we have more non-tradable activity as a % of total activity.  There is a feeling this isn’t sustainable.  In part this might be true, but to be honest we have also had a massive increase in our terms of trade – which implies we can sustain more non-tradable activity for each unit of traded activity.

However, I digress.  If we accept that there is an imbalance, if only for the sake of argument, we can say that the higher exchange rate is a symptom of this imbalance.  Given this, what will GST do?

Now, changing from income tax to GST is likely to bump up the domestic price level immediately.  The increase in the domestic price level will then translate into a lower dollar – however, since this is because of a lift in domestic prices, is will not help competitiveness in any way.  Namely the real exchange rate remains unchanged

However, correct me if I’m wrong, but there is one way that shifting to GST promotes exports and discourages importing.  I believe that GST does not tax the “value-added” from exporting.  This is effectively subsidising exports.

Furthermore, I think that firms do get GST rebates on imports – but if they don’t that implies that the change in the price level, which goes through the exchange rate, does act like a tax on imports.  If this is the case it would discourage importing.

If anyone has any more details on the tax treatment of exports and imports I would like to hear about it – as this is the way that the tax shift could change structure, not through an adjustment in the exchange rate per see.

Matt Nolan

Tax shift and immigration

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There is talk that a lower income tax might, at the margin, reduce immigration.  Now when the income tax cut is measured with an increase in consumption taxes, this argument becomes a lot weaker.

By taxing consumption instead of income we increase the price of everything, and thereby lower incomes.  If people HAD to consume in the same place where they worked then this would have no impact on immigration incentives at all!!

If people could decide to save (which we could) then shifting from income tax to consumption tax gives people, at the margin, the incentive to work in New Zealand – but to move away and use this income somewhere else.

When the shift is introduced we are increasing the cost of consumption domestically – so people who have saved will want to move away (at the margin) and people who have borrowed will be more likely to stay in the country.

The net impact on migration is going to be ambiguous, but on the margin we can tell that there will be more incentive to work here and less incentive to spend here.

Of course this ignores one major thing, the dollar will fall to compensate for the change in the price level – implying that an “unexpected” increase in GST could have no impact at all at the margin for those with savings or borrowing (as the lower dollar reduces the value of domestic income overseas and makes consumption here cheaper for those with foreign income – thereby increasing the incentive for people who have saved to move here, and reducing the incentive for those who have borrowed to move here)

Matt Nolan

More winners and losers from GST

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So, us New Zealander’s are switching some income tax to consumption tax.  Good for us.  In order to think about whether this is a good thing we need to discuss costs and benefits.

It turns out this switch is also a “transfer” of resources between two groups, relatively speaking.  These groups are people that HAVE borrowed and people that HAVE saved.

When we increase GST and lower income tax we are saying “we will tax future consumption more and future income less”.

If people have borrowed this implies that they purchased consumption when it was relatively “cheaper”, and are now going to be taxed at a lower rate on the income they are making to pay it back – as a result, borrowers win.

If people have saved, this implies that they have deferred consumption when it was cheap – and will buy things when they are more expensive.  As a result, savers lose out from the change in relative taxes.

Since it is “true” that people on low incomes borrow relatively more of their income, then in a static sense this switch could be seen as more “progressive” right?  I don’t really like static definitions, but if people are complaining about the poor and saying that the poor borrow more then it is important to keep this initial transfer in mind …

Personally, I think borrowing and saving  is based more strongly on lifetime income, impatience (which I think is income neutral) and the lumpiness of consumption – as a result, I’m don’t see to much progressivity here.  However, this does tell us that people with a stock of liabilities will benefit and people with a stock of assets will lose.

Matt Nolan

Quote: From Keynes to Key

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A famous quote from Keynes:

When the facts change, I change my mind. What do you do, sir?

This is what John Key really needs to say about the “revelation” that he wouldn’t increase GST in 2008.

John Key now knows that increasing GST and reducing income tax is seen as a way to improve economic efficiency – so he is willing to do it.  When he said they wouldn’t do it, it was because the facts he was labouring under were different.

Criticising him on the basis of a speech in 2008, before the impact of the great financial crisis was clear, is petty – shame on the politicians, and other members of society, indulging themselves in this.

Matt Nolan

Why the income to GST shift isn’t pointless

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There is a feeling out there that the increase in GST would be pointless if completely compensated.  I’m not sure I agree.

Even with a fully compensated scheme, and even given some welfare costs, there are reasons why we may want to shift the burden from income to consumption:

  1. Consumption tax is easier to enforce (self-reinforcing) – therefore it will be cheaper to implement and have less avoidence,
  2. On a similar note, with a consumption tax it is easier to ensure that the tax falls equally on all income,
  3. Given income tax also hits interest income, a consumption tax treats current and future income equally while an income tax promotes current consumption, (note that this does imply that the baseline rate must be slightly higher

Now, having it set up in the fully compensated way does imply that effective marginal tax rates are unchanged – and therefore so are labour supply incentives.  When thinking about “productivity” and the such the changes to the top tax rate, and to taxes on property, will be more important – but we won’t know about that until May 😉

Matt Nolan

An unseen cost of shifting from income tax to GST

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Following recent events it is obvious that New Zealand will do a “compensated shift” of the tax system away from income tax and towards consumption tax – removing a “flat component” of income tax and replacing it with a flat income tax.

Lovely.

However, when we think about the happiness and general welfare of society there are issues that appear given such a change.  One issue I want to focus on is timing, specifically the role of credit constraints in making GST a more “welfare damaging” tax then a tax on income.

When credit markets are imperfect (say because of information asymmetries) individuals can become “credit constrained”.  Namely, someone who expects to have a high lifetime income, but has low current income, cannot borrow to “smooth consumption” over their lifetime.  This is costly as agents who could lend to each other profitably in the perfect information case don’t, it is a market failure.

Now, if we tax consumption instead of income we are taxing the credit constrained individuals more NOW and less in the future.  As a result, their disposable income is lower now than it would have been.  As they are unable to borrow on their higher future income they are less able to smooth consumption.

The best example of people in this situation are tertiary students – in reality they should be the main people complaining about this change to the tax system.