How to stop ‘the normal principles of taxation’ destroying our economy and begin changes to create a citizen economy (Part A)
EDITOR’S NOTE: Taxation is the mechanism for redistribution of wealth to combat inequality and for redirecting resources to build a society. But our current tax principles though largely hidden or not understood by ordinary people, lie at the root of all our current inequality and struggling economy. Struggling at least for ordinary people. This article shows our current tax principles are central to our economic problems. Understand and fix tax and we are on a path to greater economic security and wealth for all, a ‘citizens economy’.
Special Analysis by Stephen Minto.
In my article ‘Housing – We can’t build our way out of this housing affordability crisis.’ on 23 August 2021 I looked at the economic structure driving housing affordability and how to solve it. I identified ‘the normal principles of taxation’ as a major factor driving excessive investor demand.
Those normal principles are helping create three of the main problems we are facing in our society:
- tax avoidance,
- inequality, generating poverty (including the housing affordability crisis),
- environmental damage, and the resulting multiple related crisis’s. (e.g climate).
These three problems show the current ‘normal principles of taxation’ are sending the wrong economic signals to the economy and distorting it away from its primary purpose, the supply of goods and services to meet our society’s wants and needs. But there is a simple reset of the principles that removes the structural drivers currently creating these problems. And a reset is essential to fix these problems as new taxes or laws will just be lipstick on a pig if we don’t fix the underlying structural drivers.
This relatively easy reset does not require any international agreement or loss of autonomy for New Zealand.
NOTE: For your convenience, we have structured this long-form report into five sections. Part A continues below. But you can download the full analysis via this PDF, without cost, which contains Part A, Part B, C, D, and E.
To summarise the five parts:
- In Part A we look at six ways the existing normal principles of taxation are damaging the long term economy and subsequently our society. They show the basic principles of economics are being undermined by the normal principles of taxation. I then identify the two main actions of a reset that will fix this damage.
- Part B in this series details the full range of required tax reset ideas (e.g. get rid of damaging GST) and goes through the impacts from the full reset and how many of those challenges actually put the economy on a more sustainable and stronger growth base, with more competition.
- Part C in this series covers aspects of the Pandora Papers and how it is the ownership structures of companies and trusts that are creating moral and economic problems just like the normal principles of taxation do. I raise some basic questions about how we should/could change the powers of, or scope, in which these entities are formed and operated. It is only in the structural permission about how they work that we can stop the economic problems we currently have.
- Part D in this series examines beneficial impacts and reasons why the capital revenue distinction must go. Including how it will operate and impact business.
- Part E in this series details impacts on various sectors of the New Zealand economy.
What are ‘the normal principles of taxation’?
At a very high level, income is identified by having three features:
- It comes in
- It is periodic (not one-offs)
- It has the character of income in the hand of the person who receives it.
From these base features principles arose. They have been adapted and interpreted through case law of a capital/revenue distinction. That can be defined as:
- Capital is not taxed but revenue is, so some businesses try to label items as capital to reduce their tax bill. A lot of the Pandora Papers covers this type of ‘legal’ activity.
- A sale of a farm, as a one off, is generally capital and not subject to tax. You would expect that to be reinvested somewhere rather than used to live off. But the sale of produce from the farm (periodic – used to live off) is taxable.
- Expenditure incurred to gain that ‘income’ should be deducted before tax is paid. Money spent to gain income is not really income that can be taxed.
- So you get gross income and net income.
- Expenditure incurred can’t be questioned.
- Costs to run a business can’t be questioned for taxation because it is up to the owners how to run the business regardless of the consequences or how sensible they are.
These are enough principles for my purposes; but inherent and inseparable in these principles are some values:
- tax is a cost, and
- it is legitimate and necessary for efficiency to minimise that cost. Like you would with any other cost.
But there is the catch in this, tax is not a normal cost.
Why are these ‘normal principles of taxation’ a problem?
Here are six points that explain why the principles send the wrong economic signals to the whole economy and undermine economic growth.
1. They undermine comparative advantage and encourage monopoly
(Small businesses with lower costs should have an advantage in price over big firms. But larger firms use costs to reduce their tax to give them an advantage.)
- Business is supposed to be efficient and reduce costs, to be competitive. The theory goes, by driving down costs you drive down price which is better for satisfying consumers wants and needs. This is more efficient and only business can do this as government is wasteful and costly.
- But this same efficiency driver on a micro business level sees tax as a cost that a business gets nothing for on a balance sheet. So to avoid tax, a dead cost, the ‘normal principles of taxation’ allow them to grow other costs to not only prevent having to pay tax, but also to do things that drive up the price of their goods and services so they gain more profit.
- We all know and experience the marketing techniques that large business use to keep their profits high, or how they run anti-competitive practises to undermine competitors. e.g. run an airline along the routes of a competitor so they don’t grow and move into their high cost routes. And these techniques cost a lot. They rely on big data from loyalty cards, slick advertising, changing superficial designs with new releases, glamorous shops, etc. And they rely on access to debit financing. These are just ‘normal’ large business practises based on behavioural/marketing psychology and finance.
- So large businesses don’t mind incurring these costs because they will reduce the ‘dead cost’ taxation they have to pay. And it is a big saving, 28% on every dollar spent. So consumers/taxpayers in having a reduced tax are actually helping large companies pay for techniques to make us pay more money for their goods or services. So we pay twice for their supplied good or service – once on the high/‘discounted’ price and second through the tax subsidy.
- Small businesses simply can’t afford to run the same techniques or access debt finance in the way a large firm can. Their whole pricing structure is done differently; they reduce their costs and run a tight ship. These economic rules simply don’t apply to large business because the normal principles of taxation turn costs into an asset for them – a tool to drive out smaller competitors while driving up price. Small firms can’t compete against these large firms no matter how good the quality or price they charge for their good or service.
- Another perverse result is large businesses become less concerned about quality and service in part because like any large bureaucracy they have to wear a few problems. But also in part because large businesses not only compete on price and quality, but compete through ‘cost accrual competition’. The ability to accumulate costs that work to their advantage over smaller competitors. And it is profitable and relatively easy and ‘legal’, but it shifts a large business’ focus away from innovation and building quality or low price, and into a focus on gimmicks and primal manipulations to trick us to buy. And it reduces competition as smaller firms can only compete by reducing costs and there is a limit to that.
- We can see this most easily in fast food and retail where there has been a slide into franchise. The Chemist Warehouse is one of the most recent. Costs on the floor are tight but the marketing, site location rental, management fees, executive salaries, advertising, debt financing are all high cost. In a generation the smaller owner run businesses taking pride in their business are largely gone from New Zealand. So many small businesses struggle and fail because it’s hard to find niches to escape the larger firms relying on costs and turnover to drive their pricing. Cost efficiency is no longer a key economic driver for a large business; ‘cost accrual competition’ through saving tax is the easiest way to wealth.
- In addition larger businesses are more likely to spend on vanity expenses because it still reduces their tax bill so it gives them an advantages over smaller competitors. e.g. take a lease on property in prestigious locations, purchase on finance or lease luxury cars, still get a 50% deduction for business ‘entertainment’ expenses – meals and lunches, tickets and who knows what else.
- ‘The normal principles of taxation’ remove the natural competitive advantage of a low cost business supplying the same goods and services. These smaller business are normally New Zealand owned and operated. And to catch that advantage all businesses have to follow that high cost model, and treat tax as a cost to be minimised, leading to larger and larger businesses leading to monopoly capitalism. Cost accrual competition is a powerful economic tool and we the taxpayer are subsiding it to only some people’s advantage.
2. They undermine redistribution of wealth (tax) and the resulting economic stimulus
- Almost all businesses do not create wealth, they simply accumulate wealth. And to accumulate they rely on the education and health systems to support access to employees and customers. They also rely on infrastructure, courts, police etc in which to do business. Tax minimisation, avoidance and evasion, undercuts the process of redistribution of wealth which pays for the supply of these services and therefore it undercuts the provision of the services the business needs to function with.
- Redistribution by taxation also supports demand across the economy which in turn supports business accumulation of wealth. The ‘tax is a cost to be minimised’ attitude comes from the normal principles of taxation, but tax helps promote the multiplier effect which benefits the entire economy. The principles need to change so that no business has an incentive, and mechanism provided by the principles, to minimise tax, as it works against the long term supply of goods and services, within the economy.
- Tax is like no other cost as it is not fixed. The principles calculate it as a relative cost based on what income is left over after costs. So on a micro economic level a business see’s an advantage to run up costs to minimise payment of tax. But on a macro economic level that minimisation is damaging the economy in which it functions. Tax minimisation is actually an act of self harm by a business in the long term. The normal principles of taxation are creating the problem.
3. They subsidise risk taking and provide no choice for taxpayers on doing that.
- By allowing business to deduct expenses to reduce their income that is liable for tax; it makes the New Zealand taxpayer subsidise the provision of that good or service through sacrificing tax collected. And as said before the saving is not always passed on, prices are held high and profit maximised so consumers are not getting the benefit of the subsidy. The normal principles of taxation allow no choice for society on making this subsidy. e.g. huge amounts of investment resources can be used to subsidise the business of taking rich people on tourism flights to space. Would people vote for that choice, over lifting more children out of poverty? But there is no vote, we have no choice, and it is tax revenue we could have.
- The entrepreneur who has the knowledge to make these choices about what costs to incur should take the risk for those choices. Choices and risks should not be subsidised by taxpayers or government as that is not their role.
- If the people or the elected representatives decide to subsidise an activity that is okay. And that is very different from a blanket subsidy as happens currently under ‘the normal principles of taxation’.
4. They punish innovation or the efficient use of resources
If two businesses supply the same good or service but one does it at a higher cost than the other, why should the lower cost company pay more tax? This is not good economic policy.
- The Lazy Inefficient company B has more expenses ($100) so only pays $14 in tax but the efficient/innovative company A ($50 in expenses) pays $14 more tax at $28.
- The normal principles of taxation are sheltering poorly performing companies, and punishing well performing companies. And the taxpayers through having less tax collected are subsidising the inefficient poorly performing company.
- And the principles allow more investment income to be made available to this poorly performing company. i.e. wasting scare investment capital. (If B did not get the tax subsidy and had to also pay $28 in tax like efficient company A, then Lazy inefficient B would only get $8 to reinvest).
- To those who say the high cost of B could be due to the quality service they provide. Yes, and that will mark them out from their competitors, and that quality should sell them. But there is no way for the blunt instrument of taxation to tell the difference of quality to wasteful spending; so it shouldn’t. If customers don’t want that business’s ‘quality’ then that is a market signal. There is no reason for the taxpayers to subsidise a business’s choices on quality as the entrepreneur might be right or wrong and there is no way to tell, except by the customer.
- More can be said on this example but it does not change the fundamental point that the wrong economic signals are being sent. e.g. Company A could have less customers and be price matching to Company B to maximise their profit rather than passing on the savings from innovation to their customers. Company B becomes a tool to make customers pay more as its existence takes up some demand, which slows the introduction of potential new competitors. This is another reason to have B out. This shows tax is only part of fixing the economy but a very very important part.
5. They subsidise environmental damage or resource waste by creating an externality
- Of course not all companies have high cost structures because they run anti-competitive practise, or have vanity expenses, or they are just seeking tax minimisation. Some businesses, are just very costly to undertake and there is nothing inefficient about that, e.g. mining.
- But should the costs to run those enterprises be subsidised by the taxpayers taking a reduced tax collection? The high costs of those business choices should be borne by the risk taking entrepreneur with the knowledge to take those risks.
- For example, if you do the Hump Ridge track you see some great wooden viaducts used to bring out the timber from a milling operation. The devastation of the local forest was complete but the business as reported never made a profit as its costs were so high and the sales income never fully came in. New Zealand got nothing of substance out of this destructive exploitation. Yes workers got wages and scrimped a life of remote hardship. The directors would have got income along the way. Yes there is now some tourism value but it’s probably not much more than if it was left. Overall, the value of the forest asset was wasted without profit. The ecological and cultural value lost can’t be quantified.
- The same destruction and waste occurred in the areas around the ‘Bridge to Nowhere’ in the inner Whanganui. All over New Zealand subsistence businesses were supported by ‘the normal principles of taxation’ for people to eke out an existence to the detriment of traditional Maori life and culture, the environment, and their own lives. The ‘normal principles of taxation’ were one of the systems within colonial exploitation that allowed profits to be stripped back overseas without as much redistributive effect from an effective taxation. The principles were a tool to strip value out of the new nation as the costs of exploitation were offset to the income. It is a tool in a class system that strips income away from the redistribution/taxation process.
Colonial legacy justification and creation of an externality
- Yes, you can argue that this sort of tax subsidy for business was necessary to enable economic activity in new lands. And that is the colonial argument. From where we stand today we can see the waste and destruction of that legacy and thinking. Our climate and environment is imperilled because of it. But it’s still happening, that structure is still in existence within the normal principles of taxation, and it is helping drive environmental damage and climate change. The rules were made through judge law to favour the wealthy to help drive their, or their class’s, wealth. This reset will at least make the full cost fall on the risk takers and they will at least be more careful in future because the cost will fall on them fully.
- If income from a business activity almost matches the cost of the activity, then very little tax is paid. So when the good is being sold the price does not reflect the cost of society’s human and physical infrastructure that was required to support that activity. Because tax was reduced this cost is not calculated into that sale price. i.e. a seller will work for the highest price but if the cost of production is subsidised, the threshold for the sale price is being subsidised and the true cost is not reflected in the price resulting in false economic signals being sent to producers. The normal principles of taxation are creating an externality of the cost of society.
- A business must fully contribute from its income back to society through paying tax or there is no point in society letting the business be in existence. Like the purchase of the viaducts, or the mill boilers, tax is just a cost that should be factored in and you can’t avoid it.
- Each business or activity needs to be viable in its own right so it has a cost that reflects if it is a high cost activity. Current loss offsetting hides a costly activity and dissuades companies funding research or looking for alternatives to get around high costs. Subsidising by tax undermines that drive for innovation.
- Environmentally damaging activities like mining are one such activity where if the cost of tax was not able to be avoided, a higher price would generate more focus on recycling, or innovation to find alternatives. See more comment under heading ‘Different sectors have different impacts’
- It is no longer appropriate for our business community to be molly coddled and subsidised by socialising their costs onto the New Zealand taxpayer, the government, and the environment.
6. The ‘normal principles of taxation’ are helping cause an international destabilisation problem.
- President Xi in China is crushing democracy in Hong Kong as he see’s it as a vehicle to undermine China. But he is fighting the wrong enemy. As a former colony of Great Britain Hong Kong follows the basic outline of ‘the normal principles of taxation’. And most of the tax principles were set through english case law by judges who arguably have acted in their own or their class’s economic interest when making decisions that set precedent. As a colony these tax principles facilitated economic value being stripped away from the colony and the lands near it to the benefit of the ‘mother country’. In the post colonial world we still see these tax principles being used to strip value out of countries with little tax paid, and then into tax havens for the use of the billionaire owners of Google, Amazon, Microsoft and others.
- China has become the factory of the world as large multinational companies moved manufacturing there for cheap resources and low regulation. President Xi wants the work and business to stay so it will give stability and economic strength to China. He was recently reported on CNN Aug 18, 2021 by Laura He as pushing on China’s rich to redistribute wealth. So he can see problems in his nation but he is asking business people bound by a tax system to act outside that system. His quest for security by taking on democracy and the Uyghur people means he is no longer walking with his people as a leader, using the wisdom of the crowd to guide his nation but is leaning into an inherently unstable autocratic leadership model. And he is adding fuel to the cold war that leaders in the US, UK and Australia, seem willing to hype up in a new alliance. He has chosen the wrong enemy; it is the colonial based tax structure that is undermining China’s security, e.g Transfer Pricing and Thin Capitalisation are able to undermine revenue and the ability to grow domestic based businesses in a way that spreads wealth. That has to be dealt with by simple consistent rules as suggested here that do not favour multinationals, as the current normal principles of taxation do. Democracy needs to be decoupled from exploitive capitalism and a tax reset will help do that.
- And the ‘west’ is also struggling with conflict and polarisation in society, driven through culture war issues like immigration, climate change, vaccines, and abortion rights. In the ‘west’ the culture wars are facilitated through a dysfunctional 4th estate and poor quality democratic processes. These culture wars have some urgency for ordinary people, ‘taking our jobs, taking our opportunities’, but theses are just the scapegoats for the very real economic struggle many are experiencing. It’s about the economy getting polarised. Ultimately the western nations have the same enemy as China in the poor functioning of the tax system. The tax system is helping build monopolies, facilitating tax avoidance, and undermining local businesses. We are all poorer.
- The normal principles of taxation are well overdue for a complete overhaul so they build each nation’s economy and redistribute wealth, and that is the purpose of taxation, not to concentrate wealth and build tax havens.
- Note: The need for international trade by New Zealand will not be impacted by these changes but it may, or may not, modify it. And with the supply chain disruption brought by the Covid-19 Pandemic, it makes it an excellent time to bring in changes that will ameliorate the disruption we are already experiencing. It will help our nations build back on to a more sustainable path.
How shall we reset ‘the normal principles of taxation’?
- In the media and policy world the strongest reset theme for taxation is greater transparency and sharing of information from other jurisdictions (especially tax havens) so tax can be claimed. This is all essential work that needs to be done but transparency and sharing information does not remove the structural problems created by the principles. And the current principles have created a complex set of rules that are an administrative burden.
- And the creation of new taxes like wealth taxes will not deal with the structural drivers of wealth concentration. As the Pandora papers show the normal principles of taxation are a major driver of wealth concentration and tax avoidance.
- I propose a structural reset that uses existing economic understandings which therefore won’t destabilise the economy, and it works alongside the existing market forces, sending appropriate signals to the economy.
The two main reset actions are:
- Remove deductibility for all expenses except for domestic salary and wage payments.
2. No capital revenue distinction for non-individuals.
This is supported by:
- A very broad legislative definition of ‘income’ to ensure everything that comes in is taxed regardless of traditional capital revenue distinctions. Even to include related party loans (with an exception for 3rd party loans – perhaps a strict list of who can be a 3rd party). The Pandora papers show this is essential regardless of even this reset. Because the current normal principles of taxation allow a company to make income but then through a series of entities turn it into a loan to be made back to the company or another related party and a ‘loan’ is not taxable. Part C, in this series, gives an example.
- No grouping of companies for tax purposes. Companies are separate legal entities and will be treated that way for tax.
- The original intention of grouping was to prevent tax avoidance but it has now been twisted to be a major tax minimisation technique. i.e. Company tax rates in the past had a progressive structure. To avoid paying the higher rates a company created lots of sub companies and spread the income out so each paid an amount just below the high tax rate. This was then stopped by the requirement to group the companies so they did pay the higher rates of tax. But then for anti-competitive purposes parent companies began to run subsidiary companies – not to make a profit but to make a loss (the exact opposite of what companies should be set up for in an economy). Using ‘cost accrual techniques’ and low income. e.g. run a small airline at a loss to compete with a budget airline to preserve their other profitable routes. Grouping then allowed their losses to be offset against the income of their profitable routes so less tax was paid. If a situation arose where the loss company was no longer needed the losses could be retained but limited liability remained as a protection for the parent company. A long time ago the progressive tax rates on companies were removed and company tax was made a flat tax rate but nobody got rid of this ability to group companies. The companies wanted it kept. It is overdue to get rid of grouping.
- Without a capital revenue distinction and strict application of entity status, shifting assets between separate legal entities will generate taxable income because their status as a separate legal entity now becomes important for tax purposes. With less advantage in having separate legal entities, companies will become bigger which will improve transparency and reduce the ability to avoid tax or scrutiny. This reset will work with international trends to improve transparency. With more potential exposure to risk, behaviour and focus will change.
- A company to trade in New Zealand must be required to have a company registered and based in New Zealand through which all its activities are subject to tax that are ‘sourced’ from New Zealand. And they must have a New Zealand bank account. An asset in New Zealand can’t be owned by a foreign based organisation in a tax haven as the risk of tax avoidance is too high. If there is not a base in New Zealand, e.g internet sales, then work must be done with banks on how sales can be caught for tax or punishments if not. This is already a tax issue and not created by this reset.
- In ‘Part D (of this series) – Beneficial impacts for all with no capital/revenue distinction and less tax minimisation’ I go through more discussion of these points. In particular how taxing disposals of cash accumulations is not double tax but sends a beneficial push into quality and price for goods and services.
Economic policy and tax principles alignment
This reset does four main actions:
1. It removes the structural drivers for all the six economic problems listed above. Obviously other actions need to be taken in addition to tax for issues like international relations. This reset does not restrict actions but better supports them.
2. It stops almost all tax avoidance techniques based on currently ‘legal’ processes. Nobody is telling business how to run their business or control what they do. The choices are all still with the business, it is just the consequences and risks that will be fully carried by the chooser.
3. It removes any incentive to waste or damage the environment, or any assets, as all costs will be fully carried by the producer. Because things will cost more, the throw away culture will not be structurally supported by the tax system. Note – things are costing more now but with no quality improvement. Quality has the chance to come back.
4. It redirects investment capital to producing goods and services to meet the needs of society. With interest no longer deductible for tax there will less demand to debt finance. Finance will therefore be freed up for investment in actually producing goods and services. Yes some capital will be taken up to hold assets like land but that is a good investment at the moment. The purpose of debt financing is largely cost accrual competition. Part B of this series has more on the potential positive changes in how investment may occur.
But is this economically viable? We must look at the numbers.
Financial impact of reset
From the Statistics New Zealand website we have the ‘Annual enterprise survey: 2017 financial year (provisional)’.
It states for businesses/enterprises the:
- total income for New Zealand is $644.2b (billion) and total expenditure is $560.7b.
- Surplus potentially subject to tax = $83.5b (If the current tax of 28% was applied, this = $23.38b)
- 2017 Inland Revenue Annual report, says corporates actually paid $14.2b.
For contrast from the Inland Revenue website 2017 annual report –
- Total tax in 2017 was $69.2b and Individuals paid 48% ($33.2b) plus GST 26% ($17.9b) = 74% of total tax was paid by you and me.
Taxation under a reset calculation – A soft transition calculation
The existing tax rate of 28% could be used or a lower rate of 15%. But if we aim to increase taxation because it is sorely needed for social purposes, and to pay down debt, and we don’t want to cause too much business disruption, then the following is an option.
- Businesses claimed they had $83.5b income over expenses for the 2017 year.
- If we initially taxed all companies at 10% of total income, no deductions for costs (except domestic salary and wages). And indexed to go up in future years. This will give a massive boost to small business.
- $644.2b x 10% = $64.42b tax.
- As business had $83.5b over costs it means there is income available to pay the $64.42b tax. They would have to shift profit expectations and likely no dividends. Impacts will depend on the individual business. If we add in the Individuals tax, and ‘other’ ($37.1b) tax paid that year (I leave out GST as it must be dropped – as it damages the economy) we would have: a total tax for 2017 of $101.2b
- The amount of 10% should be indexed to go up 1% every one, or two or so years, until it reaches 15% or 20% or whatever the government of the time decides. The 10% rate is too low for the urgent needs of climate change and human need. (The cost is higher now because actions were not taken earlier, and business in aggregate has not supported taking action sooner, in fact they hindered action).
- This increase in tax collected is without any new wealth tax or capital gains tax, and with a reduction of the headline tax rate. But there may be other reasons to do new taxes. In times of war. Or environmental crisis. Or a housing crisis. Tax is so low at the moment and the social needs so pressing, plus the debt must be paid down, that the amount of tax to be paid must go up.
- Another reset benefit is it could be possible/investigated to require all money deposits to a non-individual to go through one bank account with an instant deduction for 10% tax. A credit can come back once a salary or wage payment is made in the Inland Revenue employer account. This means no provisional tax or due dates to worry about. A great compliance saver for small business. Obviously all bank accounts would have to be linked to an IR number to prevent avoidance but if all non-individuals bank accounts were automatically subject to tax, then that removes some temptation to avoid tax liability.
The economy context
- This reset is still only income that is being taxed; something that has ‘come in’. So money is there. Any realised capital gains would also be taxed because they would have ‘come in’. But as there are avoidance techniques for companies to delay gains coming in I am not expecting much to be collected under this category, initially. But a rising tax rate might persuade them to come forward earlier. But we could use the ‘risk free rate of return method’ to calculate this ‘income’. But that would be at least 15%. Other options to capture unrealised gains are being discussed in the wider media.
- If large businesses say they will go out of business, then that shows just how dependent they are on the tax subsidy. So are they truly viable? The slow introduction of a lower but more effective rate would give them time to adapt to moving away from debt financing, and high cost structures. But there are many more effective ways to achieve this change. I don’t expect them to move away from their marketing techniques but they would pay that cost without being subsidised by taxpayers. Issues with marketing and consumer protection can be dealt with separately but those actions will be undermined by the current tax system. Actions will be more effective with a tax reset.
- To stick to the concept of government spending being less than 30% of GDP reduces our ability to create wealth through the multiplier effect. A demand driven economy will bring better economic growth that actually satisfies people’s needs. The only risk to a demand driven economy is how to control pricing and inflation, (I propose an article on this at a later time). We tried supply side economics and we have poverty, housing shortages, housing inflation, a struggling health sector, and an education system beholden to overseas students.
- The recent talk about inflation and stagflation in part due to supply chain disruption make it the perfect time for the reset to happen as it will reduce business sector demand. All large businesses will be strongly focused on reducing their high cost business structure which will reduce demand and take pressure off inflation. Recall that a lot of business sector demand is micro business churn to drive price and demand up for their product or service. It is not growing the economy except in an incidental sense. Innovation, exports or savings are not being driven in the macro sense by that spending. By contrast small businesses with the lower tax rate will be opening up, increasing competition. I talk about inflation in Part B of this series but will require a further analysis.
Summary – we must reset ‘the normal principles of taxation’
- This reset is not about political sides or ideas. It is about making the economy work as it is supposed to, meeting people’s wants and needs.
- If we believe in markets with businesses competing on price and quality then this tax reset must be done because the current tax system undermines that, or
- If we see the economic system is failing and people are falling through the cracks then this tells us one of the main reasons why and how to fix it.
The current tax system is breaking the economy and society. We are a frog in a pot that’s been on the stove for a while.
- Further evidence the tax system is broken is seen in the US which has the same basic principles of our system and many of their largest companies aren’t paying much tax, e.g. Amazon, Honeywell, Halliburton, IBM, Fedex, Nike, US steel, Chevron, Delta. These companies are even managing through globalisation to avoid capital gain taxes. So we can’t just rely on new taxes to solve the existing problems. The foundation, ’Income tax’ must be fixed and this reset is how to do it so the big companies pay their fair share.
- Minimising tax is big business for every large firm. For the cost of a small team of accountants they can structure finances to avoid billions or hundreds of millions of dollars in tax. The purpose of tax is to redistribute wealth but ‘the normal principles of taxation’ are discouraging redistribution so economies and societies are struggling, with small businesses disadvantaged and people’s wants and needs not being met.
- The reset here retains largely the same tax system with all business treated the same. But the reset strips the rules down so there is nowhere to hide or shift the money. Because it is in the rules where the loopholes are found. And the rules/legislation are written with the normal principles of taxation firmly in mind, and with considerable input from those accountants who are deeply embedded in tax orthodoxy. The business sector has had a significant input into developing tax law and the business sector likes lots of red tape rules as it offers lots of loopholes.
- In this reset you can’t shift money between income (subject to tax) to capital (not subject to tax). A person can’t reduce their tax by claiming expenses real or imagined. There are no losses or capital losses. I suspect the reason why we don’t have a capital gains tax in New Zealand is the fear of capital losses undermining future government revenue along with complexity of the law – but this reset shuts down those fears.
- With this reset the tax system becomes much simpler and more transparent. This is why stripping the rules back, as is proposed in this reset, is actually the only way to get a truly broad based low rate income tax system.
EDITOR’S NOTE: For the full analysis, please download the PDF which includes: Part A, Part B, Part C, Part D, Part E of this long-form report.
About the author: Stephen Minto lives in Wellington with his two children. He worked for New Zealand Inland Revenue Department for approximately 33 years and is now enjoying no longer being bound by public service etiquette of being non-political.