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?

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Matt Nolan

Globally contracting money stocks

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In a chart on the Rates Blog today they point out that the money stock (note not really the money supply, depending on how you define it) in the Euro Zone is declining.  The indication then is that “Europe looks bad”.

However, the money stock is also dropping in Australia and New Zealand.  If there were figures for the US, I suspect we would see some contraction there as well.

Does this mean economic activity is taking a sharp turn downwards?  Not necessarily – we may be seeing a sharp uptick in the velocity of money or a movement in reserves as global interest rates tick up.  Furthermore, remember that growth in the money stock in many countries ACCELERATED in the middle of the great financial crisis – so to be honest, it is hard to tell exactly what is going on with these figures.

Overall, falling money stock (in conjunction with an easing in borrowing statistics) suggests we should be cautious – it looks like deleveraging is happening.  However, it is not a clear indicator of where the economy is directly going – if relative prices in the economy are adjusting then activity could still be rolling along nicely.

Matt Nolan

Maths and economics

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There has been a lot of negative talk about the maths in economics – like a huge amount.  Just look at these links, some of them are poor and reactionary, but some of them are excellent and the last two are my favourite (*, *, *,*,*,*).

Now although I believe much of this attack is excessive, and I believe the role of maths in economics is very very important, like all protestations there is a grain of truth to be found.

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Matt Nolan

Catching Australia: Really?

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Dr Bollard is spot on in saying that it isn’t likely that we will catch up to Australia in incomes (ht Kiwiblog and Rates Blog).

Simply put, I think the majority of economists believe that the ability of government to influence per capita incomes (especially given the relative size and scope of governance in Aussie and NZ) is relatively negligible.  Australians are 30% more wealthy then we are, and the belief is that a lot of this comes down to locational, scale, and endowment type advantages – not “magic policy”.

Furthermore, Australia is running down its natural capital stock here – any production numbers should take the temporary nature of some of this income into account.

And finally, just because production is 30% higher in Australia, what is the actual gap in happiness?

I’ve never liked the aim of catching Australia, it seems pointless (see here).  We should instead “aim” to have a society where citizens are as free from coercion as possible, so that they have the ability to find satisfaction.  I am glad that the RBNZ governor agrees.