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

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.

Matt Nolan

On compensating for a change to GST

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When discussing the upcoming changes to the New Zealand tax system the National party has made it clear that they want any change in GST to be “compensated”, so that those on low income aren’t “worse off”.

Now this is actually a wildly complicated question.  Any change will create winners and losers, that is undeniable.  If we think of compensation in welfare terms there is no way to perfectly compensate everyone without making any change viciously complicated – or not making any changes at all.

My presumption is that the goal isn’t “welfare compensation” per see.  My guess is that any compensation will be such that people (outside the property sector and those in the top income bracket – where a rejig “might” take place) will pay the same proportion of their lifetime income in tax (although any progressivity from any change in incomes will also be accepted).

Why do I think this?

Read more

Matt Nolan

Zero tax threshold: No thanks

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I don’t like the idea of a “zero tax” threshold at the bottom of the tax system.  I see it was suggested today by Mark Keating, so I thought I should explain why I feel this way (ht Kiwiblog).  I’ll put down three reasons, in reality the third reason is by far the most important:

  1. I don’t believe the cost of “churn” is very substantial – implying that any benefit from setting a zero tax will be negligible compared to taking the tax and sending it back.
  2. The effort required to set a zero tax and enforce payment of tax when moving out of the bracket requires effort as well – as a result I don’t think it is self-evident that setting a new bracket would reduce administration costs (it might even increase them).
  3. If we set a zero tax bracket this also acts as a tax cut for EVERYONE earning more than that amount.  This has to be paid for by INCREASING other tax rates (substantially as well, since the loss of the bottom bracket will cost more than an equivalent cut anywhere else).  As a result, effective marginal tax rates will be higher than if we taxed and paid benefits (for the same average tax rate in other words).  This reduces labour supply incentives for higher income earners.  As these earners tend to be more responsive to tax there would be a SIGNIFICANT efficiency cost.

Yes, the zero tax rate at the bottom will increase labour supply incentives for those on very low incomes.  But this will only lead to efficiency gains if we believe it will get the more elastic secondary earners into the labour market.  If we are doing it to promote equity it doesn’t make sense – as those that are actually poor are likely to provide very inelastic labour supply.  Overall, it is likely that the negative impact of higher EMTR’s on middle and high income earners will outweigh any positive impact through a increase in, our already enormous, part time labour force.

The purpose of the zero tax bracket is to make sure that people get a minimum living standard.  The better way to do this is to ensure that society pays everyone a living wage at whatever level it believes is fair.  Leave redistribution to the welfare system (where our social value judgments are transparent), tax needs to be applied on the basis of efficiency in order to be effective.

Matt Nolan

Filler: The Sweeney posts

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I am still feeling tired from Christmas, but my pre-set posts from before the break are now finished.

I did watch Sweeney Todd last night (the movie) and so will leave you with the two posts I did about the movie and welfare policies here and here.  Be warned, there are spoilers.