The Big Kahuna: Turning Tax and Welfare in New Zealand on its head.

By Gareth Morgan and Susan Guthrie

One day, when he was contributing to the Tax and Welfare Working Group, economist Gareth Morgan made an off-the-cuff remark that the solution to all of New Zealand's tax and welfare woes lay in abolishing the present welfare system and radically overhauling the tax system. He called this idea the big kahuna.

• Language: English
• Publisher: BookBaby
• Release date: Aug 1, 2011
• ISBN: 9781483526706

Gareth Morgan

Gareth Morgan is a writer, broadcaster and lecturer on the philosophy of science.

Book preview

978-0-9864574-9-4

INTRODUCTION

Anyone who has had the privilege of travelling widely in some of the less developed regions of the world will have come away with a sense of how far Western society has come in a comparatively short time. If you’ve ever had the chance to come into contact with people living anything like a subsistence existence – waking, working, eating, sleeping, waking again, working… – then you’ll have returned to civilisation with an impression, part gratitude, part vertigo, of how high the fortunate portion of humanity has lifted itself.

In three short centuries – the span of a dozen or so generations, beginning with the Industrial Revolution in Great Britain – the West has caught wave after wave of miraculous technological advance, leaving the Rest paddling ineffectually far behind. Our lives are so much better than our ancestors’, just as they’re so much better than those in the developing world.

But hang on. Given the massive rise in productivity that technology has made possible, are our lives really as different as they ought to be? Why is it still considered morally questionable for someone who hasn’t yet reached the age of retirement to try to extract a bit more from life than paid employment can deliver? Why does society actively prevent people from doing this, unless they’ve saved a big enough stack of cash to do it? Why, given that a significant proportion of what needs to get done in society gets done by people who aren’t paid to do it, are we so obsessed with working for cash? We’re like those people – you probably know them, even if only from the mirror – who have stuffed their houses with all the latest labour-saving devices purely so that they have more time to… work. It’s hard to avoid the conclusion we’ve all gone a little bit funny about money.

Money, as they say, can’t buy happiness. On the other hand, money makes the world go round. A balanced view of the stuff lies somewhere between those two proverbs: we can let money make the world go round, but we need more to make us happy than the spectacle of a spinning globe. This is the first message that this book seeks to convey: modern, developed societies produce far more than the mere means of subsistence, and given the whole point of civil society is to secure for its members the benefits of collective action, surely we can afford better lives than we currently allow ourselves.

And therein lies the second message. Society is a collective enterprise. It entitles us to certain benefits, but it also places upon us distinct responsibilities. We may have slightly lost track of the benefits – the sheer quality of life that the affluence of the West affords – but we’re in danger of completely losing sight of the obligations.

Nowhere is this clearer than when we look at how we redistribute within our society. Governments do this by taking tax from some people and giving cash to others (government cash payments are called transfers and include things like NZ Super, Working for Families and the Unemployment Benefit). But what happens when people don’t pay tax or line up for transfers not intended for them? Not a harmonious society, that’s for sure.

We’ve inherited a social order that arose, philosophically and historically speaking, from Victorian England. Most of our founding fathers arrived as refugees from a society that had lately seen miraculous change (the Industrial Revolution) and a simultaneous, steep descent into profound social malaise. Britain in the mid-1800s was drastically polarised between rich industrialists on one hand, and the abject poor on the other. Both classes were as much a product of industrialisation as anything else that emerged from the nation’s dark, satanic mills. Change was vital, and revolution was afoot. It’s been plausibly suggested that had colonisation not occurred to relieve the pressure, Britain would have gone the way that one of its most astute critics, Karl Marx, said it would: bloody revolution. Our forefathers, then, arrived determined that whatever kind of society they built here, it wouldn’t make the same mistakes as the Old Country. They brought with them the ideas of the social reformers of nineteenth century Britain – Adam Smith, Jeremy Bentham, John Stuart Mill – and when they designed our political system, some of these ideas provided the framework. They didn’t question the equal worth of individuals, nor that this translated in practice into the need for the state to redistribute wealth to ensure a dignified existence for all. That, in essence, is a key purpose of transfer policies – or at least, it was, until everyone seemed to forget.

Since the early days, our tax and transfer policies have run off the rails. Social emergencies such as the world wars, the great influenza epidemic and the great Depression, enjoined changes, but it meanwhile began to dawn upon politicians how much leverage tinkering with the works gave them. Between them, tax and transfers provided a rich vein of political rhetoric and symbolism: the rapacious taxman and the parasitic dole bludger were paraded before terrified voters like bogeymen. The tax and transfer system came to represent little more than the electoral equivalent of an automatic teller machine: push the right buttons, and it will reliably deliver votes. Any thought of the actual purpose of the thing has been lost in the scramble for political advantage. Little wonder it’s been apparent for quite some time that the system is sick.

This book proposes two major changes to policy in New Zealand – one is to the coverage of the tax régime, the other to the approach we take to transfers. Our work looks at the tax and transfer régime in a holistic sense, and recognises that the intervention of the state via tax and transfers is intended to redistribute resources from some in society to others. Do we know what the rationale is for current policy? And if so, do we achieve our objectives? These are questions that can only be answered by examining the tax and transfer régime as a whole, an approach that has been eschewed by successive governments in recent times. Instead, governments have chosen to establish taskforces to look at parts of the tax and transfer system only, confined by quite specific terms of reference that have precluded a whole of system assessment.

This piecemeal approach has undermined any serious attempt to review how we redistribute and as a result, we’ve all but lost sight of why we tax and transfer in order to redistribute, the extent of redistribution that we deem desirable and whether or not we achieve those objectives.

To rate our present system against its objectives, we first look at the intellectual crucible in which the modern notion of redistribution was formed. We present five principles that any tax and transfer system ought to live up to. And we look back at how our present system has evolved through time – how it has blundered away from the purity of its principles like Frankenstein’s monster.

For those who want to cut to the chase, we present our analysis of the present system’s shortcomings in chapters four and five, and move onto our own recommendations for the reform of tax and transfer policies from chapter six.

The first reform we recommend covers an issue that successive tax studies have recommended be addressed by New Zealand governments in order to lift economic efficiency.

It’s a comprehensive capital tax (CCT) that all owners of productive capital (land, buildings, structures, plant and equipment, intellectual property) are annually liable for, although it can be offset by those that produce a taxable income return in excess of the minimum required of New Zealand’s productive capital (which we set at 6% pa, a rate that reflects the return available risk free, being the average government bond rate over the past decade).

Hand-in-hand with the CCT proposal, we alter the income tax régime to a single flat rate on every dollar of income. All income, whether cash or in kind, is captured for taxation purposes. This is what the CCT achieves.

To the casual glance, it looks as though our taxation system functions according to the desirable principle we call vertical equity (whereby resources are taken from those who have relatively more in society and given to those who have relatively less): it’s a progressive scheme, after all, which sees you pay a higher rate of tax the more you earn. But this ignores the fact that the greatest source of means for the well off isn’t income (which can be manipulated to appear artificially low), it’s wealth, and the present system largely leaves that beyond the reach of the redistributive machinery. Narrowing the tax base in this way results in progressive tax rates that rise more steeply than they should, and creates all manner of incentives for taxpayers to avoid paying at such high rates.

Over the last few decades, the redistributive goals of our society have been reduced to assistance of last resort. Like an ambulance at the foot of the cliff, it kicks into action only when a person’s lot has fallen so far below what society deems adequate that our compassion is engaged. This hand up approach to redistribution isn’t what the architects of our system – and the originators of modern redistribution – had in mind at all. It’s underpinned by the weird notion that the highest ambition of humanity – the very definition of self-fulfilment – is to be in paid employment; anyone who can’t or won’t aspire to it, by implication, is somehow less than human. It’s cruelly and unnecessarily stigmatising and actually robs us all of a whole range of choices that the affluence of our society ought to be able to make available. The second reform is directed at making quite explicit the redistribution objective of the state, by paying every adult an unconditional basic income (UBI). Nobody misses out on this bottom line entitlement – it’s the right to a dignified existence, to full participation in society, that a modern productive economy can provide and that the state can fund from taxes. This is a quite different approach to the present one. The UBI provides for every adult to receive enough to eat, clothe and house themselves, unconditionally – this being the universal entitlement to an adequate basic income.

People then are free to choose to engage in paid or unpaid work secure in the knowledge that their basic living expenses are covered. They’re not compelled (as we presently are) to seek paid work only, out of fear that to fail to do so is to threaten their very existence. With a UBI, they avoid the stigma of being unemployed if they can’t find paid work, or the loss of respect society associates with that situation. A person may well choose to care for children rather than stand behind a store counter day after day, for example. Who is to say that society values the store job more? In a society that produces far more than required for the basic needs of food, clothing and shelter, why shouldn’t a basic income be guaranteed? If nothing else it’s a signal that the society is sufficiently developed for all to live in dignity.

It’s argued that such an income is already guaranteed, at least to those who can’t find paid work, in the form of the unemployment benefit; to those who can’t work in the form of disability or illness benefits. But what of the person who chooses unpaid rather than paid work? The economy comprises a raft of unpaid occupations – parenting, care of the elderly, volunteer organisations such as sports clubs, artistic or creative pursuits, and so on. The amount of time that anyone can spend on these is largely limited by their access to independent means – their own income or wealth, or that of an earning spouse.

For a society that produces far more than is required to meet basic needs such a restriction on choice seems backward. The result of our UBI proposal may be that a greater proportion of the production of products and services comes from the noncommercial sector of society and less from the commercial one, but that’s not an outcome we should be afraid of. Where’s the logic in more and more commercially-based production, anyway?

An effect of the UBI is to deliver a more efficient and equitable approach to redistribution. In theory at least, it should make no difference if the state has in place the apparatus to select and monitor those that require a transfer, or whether the state simply pays everyone a transfer and claws back from those who don’t need it via taxation. Intuitively, you’d think the first method would be easiest – and that’s what we currently do. But as we’ll show in this book, this approach has problems. How do you decide who is deserving? How can you be sure that everyone who is eligible actually gets their dues? How many people do you employ to administer such a régime? The second method – the method we recommend – automatically guarantees that everybody gets the UBI. It then comes down to the relatively simple matter of ensuring the taxation régime is efficient and effective at clawing it back from those who don’t need it. The administrative overhead of monitoring our present unholy mélange of targeted welfare is no longer required.

This book is about a revolution in our tax and transfer system, not the next step in an incrementalist journey of patching up the current, structurally compromised régime. As such, its ideas will both tread on your toes and place new possibilities in front of you – often at the same time.

Chapter 1:

THE PHILOSOPHY

OF REDISTRIBUTION

Despite all the technological progress over thousands of years, some fundamental things about government don’t change. There are things that are best done collectively rather than by individuals (defence against aggressive neighbours, for one thing). But whatever your list of desirable state functions includes, it immediately introduces the question of who is going to pay for the collective activities the community enjoys? These two big issues – what do we do together (the role of the state versus the individual) and how are we going to fund it (who pays for the state) have been at the heart of every society, and have challenged the best minds, ever since humans came down from the trees.

Governments have always had to make decisions about how to fund their activity – what taxes would they deploy, for example – and, depending on what they decided, the laws about funding most often have had a redistributive effect, even if that wasn’t the specific intention. Imagine, for example, an ancient society facing the problem of funding an activity that benefited everyone (such as a festival to appease their gods). If it was paid for solely by those who were relatively well off – who had larger incomes or more wealth than everyone else – redistribution would occur, because some in the community would be enjoying benefits for which they themselves hadn’t paid. Others, the well off, had paid for them.

So even when there’s no directly redistributive intent, government activity (and the taxes used to fund it) most commonly achieves some sort of redistribution anyway. In this book, we’ll be concentrating on deliberately redistributive policies – government policies that commandeer the economic resources of some people and give them directly to others.

A government raises revenue from the community to cover core administration and government services such as running a parliamentary system, defence force and justice system. But it also raises enough to provide economic resources to those who for, one reason or another, it has decided to help. In present-day New Zealand, for example, depending on what definition you use, something close to 40 percent of the revenue raised as taxes is for the purpose of direct redistribution to people in the form of direct cash payments – something we call transfers (or more technically, direct transfers). ¹ We have a deliberate redistributive tax and transfer system, alright: what isn’t always so clear is whether we know why we distribute as we do and whether the result we’re getting is what we want.

Typically, anyone designing a redistributive system will have two main tools available to them – tax and transfer payments (a third, the compulsory purchase of land and resettlement, is another option, but it’s not typically feasible in modern, developed economies – although New Zealand was into it big-time for more than 100 years after the Treaty of Waitangi was signed). Tax is pretty self-explanatory: it’s money raised by government without any promise of exchange. Transfers can be regular payments or payments that compensate people for their out-of-pocket costs (New Zealand Super, Working for Families tax credits and the Unemployment Benefit are examples of regular income payments, and accommodation allowances paid by the government are an example of a compensation for costs).

Other government spending has redistributive effects, too: some important ones are known as indirect transfers, which are benefits individuals get when they receive a service or item but haven’t had to pay the full costs of supplying it (someone else has). Examples are universal health care and universal education for children. The term welfare state has come to mean societies that use tax and transfers to deliberately redistribute as well as provide indirect transfers through services such as education and health. While indirect transfers can and do have important redistributive effects, as noted, in this book we’ll be examining only tax and transfers that are direct cash payments to people paid by government (whenever you see transfer in this book, that is what we mean).

How tax and transfer policies interact determines the nature of the redistribution that occurs. This is why we’ve chosen to investigate both policies together, not separately as has become customary for taskforces established by the government in recent years. The silo approach to tax and transfers has led to nothing but trouble.

Why redistribute?

Governments can implement redistributive policies for any number of reasons. They might have policies that redistribute between different regions of the country, for example, or between different interest groups (paying subsidies to farmers is one common example). This book is about policies that directly distribute resources from those who have relatively plenty already (the ones who own assets and/or have high incomes in other words) to the rest of the community (who must, it follows, have relatively less). These types of redistributive policies are guided by a principle called vertical equity. We’ll have more to say about this shortly, but, as the Economist magazine says, it’s

…one way to keep taxation fair. Vertical equity is the principle that people with a greater ability to pay should hand over more tax to the government than those with a lesser ability to pay. ²

Policies that are guided by the vertical equity principle have a distinct effect on the distribution of income and wealth at any particular point in time. By acquiring resources from those who have relatively plenty, and giving them to the others, the gap between what different people own or have available to spend in any one year narrows beyond what it would otherwise have been. The world abounds with examples of where extreme widening of the gap between haves and have-nots has turned out to be disastrous for social and political stability and harmony.

Among the many ways in which redistribution according to the vertical equity principle might be achieved are progressive taxes and/or proportional (or flat) taxes combined with a tax-exempt threshold based on income or wealth. A proportional tax is one where the same rates of tax apply regardless of incomes, and a progressive tax is one where the average tax paid rises with income. The effect of progressive taxes is the redistribution of income from taxpayers facing higher-than-average rates to others in the community. Limiting transfer payments to people who have little income of their own is another popular option.

In practice, policies that are supposed to deliver on the vertical equity principle often fail – this is especially likely when many policies are used and they’re not well coordinated. Each on their own might have been useful, but together the effect is not what’s needed. For example, in New Zealand today, it’s not only those who have few resources of their own who receive direct transfers: some who have lots of wealth do, too. Nor is it the case that everyone who would seem to qualify to receive something (on the basis that they have low income and no assets) gets any transfer. What’s more, when it comes to redistribution, nothing much beyond annual income is considered eligible for tax. Yet income is a poor indicator of wealth. Quixotically targeting income means there are incentives to hide it from view – exacerbating even further the considerable amount of wealth tucked away well out of the reach of tax.

The idea that governments should actively apply the vertical equity principle is a relatively modern one. While tax is an ancient concept and earlier tax systems could have redistributive outcomes, it has really only been since the 18th century – coincident with the start of the Industrial Revolution and its huge impact on productivity, incomes, and wealth – that the principle became explicit. That such bounty could coincide with a deterioration in the well-being of so many, presaged an enlightenment in thinking that assigned to the state the responsibility of ensuring everyone is provided with the same opportunity to prosper.

Raising Tax

Societies have grappled with the moral and practical issues of how to raise tax for millennia. A popular early choice was to levy taxes from people who didn’t belong to your own community. Ancient societies such as imperial Rome relied on slaves to do much of the work, and to populate the army. This group, who had no rights within the community, were effectively taxed at 100% (what didn’t they give?). What’s more, the Romans, through their tributary arrangements, were impressively adept at collecting tax from the vast provinces they conquered, and these resources funded lavish lifestyles at home. ³

Fast-forward a thousand years or so, and the British were merrily imposing taxes on distant peoples, too. But it didn’t always go quite so well for the Brits. Imposing a stamp tax in 1765 sparked resistance that eventually culminated in the War of American Independence in 1776, ⁴ and less than two hundred years later, the salt tax imposed on India prompted Gandhi’s famous salt march, which led ultimately to India’s independence.⁵ The key point here is that in the past, communities have frequently chosen to fund their collective activities by using force to pass the burden outside their own community. The burden of payment was successfully offloaded elsewhere — until the provinces revolted, that is.

A modern-day version of the conquered people tax method, made possible by modern financial arrangements, is where communities offload the payments needed for their collective services onto people who haven’t even been born yet. That, in effect, is what borrowing is – burdening future generations with your debt. Like many other modern financial arrangements, this is pretty clever: these conquered people can’t even revolt!

The point at which tax gets tricky is when you’ve run out of people to dump the burden upon (and where the community has decided not to burden its descendents by borrowing, or has simply exhausted its lines of credit). Then the community is in the uncomfortable position of having to raise revenue from its own members. And this is where things can get nasty. Who pays? Who doesn’t? Who gets to choose?

The fundamental issues that face a community when it must pay for its own state activities has taxed (no pun intended) many of the greatest minds in history. Up for debate was not only whether you should tax income or property (or both), or spending (or some types of spending), but whether tax should be proportional to income (or wealth) or something more.

Like so many early Western ideas, you can find ancient precedents. The idea that some should pay more tax than others was clearly around as early as 360BC, when the ancient Greek philosopher Plato made the point that paying relatively more tax than others was a form of morally praiseworthy behaviour. To Plato a just man was the closest to an ideal man and…

When there is an income tax, the just man will pay more and the unjust less on the same amount of income. ⁶

By associating moral virtue with paying tax and, further, greater moral virtue with paying a higher rate of tax than others, Plato laid the grounds for vertical equity being a principle on which to base taxation. All men must pay tax but there are some who should on moral grounds pay more (those with greater means are in a position to, and should, pay proportionally more tax). This moral foundation of progressive taxation is well lost in the reductionism of modern economics that emphasises instead reducing hurdles to earning higher after-tax income. Progressive tax rates, in our contemporary literature, are seen as such hurdles, rather than being valued for their moral justification.

While progressive income taxes have the effect of redistributing resources from the relatively well-off to others, in the past they weren’t necessarily always introduced in order to achieve redistribution. Progressivity could solve practical problems such as taxpayer revolt (the well off might be less likely to object and more able to bear tax). So you can’t take the mere presence of a progressive tax régime in a society as evidence of what that society thought about what is fair (or good or just). It might simply indicate that the decision-makers had an eye on political expedience. This helps us to understand how ad hoc the progressivity in the income tax regime can be (and in our case, is) – how it can sit side by side with glaring omissions in the tax base that allow the well off to shirk their responsibilities.

It’s not clear whether it was moral considerations or views about who would make the least trouble that led to isolated examples of progressive taxes cropping up in Britain from the 14th to the 17th century. For example, by 1695 Gregory King in England was proposing a progressive income tax where the tax paid increased by a factor of three times each time income doubled. The rationale King gave was that it may be better spared.⁷ In 1799, when, prompted by the need to fund a war with France, the British Prime Minister William Pitt (the Younger) introduced income tax to Britain for the first time. He combined a low tax rate (a maximum of 10%) with exemptions that had the effect of making the tax progressive. ⁸ Again, it’s likely that any lofty moral considerations of what was fair were tempered with practical concerns: after all, only a few years earlier, the French lower classes had revolted and overthrown the monarchy in the French Revolution – a stark demonstration of the costs of getting it wrong!

Between 1799 and 1842, income tax was abandoned and reintroduced in Britain according to whether there was a war to fund. From 1842, income taxes became a permanent fixture and a progressive schedule of rates emerged in 1909. Top tax rates rose to extraordinary heights during World War II (close to 100%). ⁹ They remained around 80% until 1974, but from the late 1970s onwards, top tax rates were lowered, most drastically (and controversially) under Margaret Thatcher’s government. ¹⁰

Early examples of deliberately redistributive transfer policies

Up until (roughly) the time of the French revolution, helping those less well-off had been a moral duty. Since biblical times, people had given alms for religious reasons (improving your relationship with God was a popular one), and as late as the beginning of the 18th century, the collection and distribution of charitable aid was largely the preserve of religious groups. ¹¹

Some sort of formal state involvement in the collecting and distribution of charitable aid emerged in Britain in 1536, when the first of the so-called Poor Laws was passed. ¹³ This then was a tangible early example of using state transfer payments, rather than just differential tax rates, to effect redistribution. This required each parish to make weekly collections to assist the impotent poor (those who, for one reason or another, couldn’t work, or work enough, to escape destitution). For others, who seemed capable of work but who were without jobs (sturdy beggars, as they were known), there was no assistance. On the contrary, they were subjected to a range of more or less draconian punishments – bits were lopped off, or bored through, or they were branded or even put to death – to try to persuade them to work (presumably, the death penalty had the lowest rate of recidivism). The idea that those who received resources from others had to be deserving was enshrined in this policy. There were similar examples in Europe around the same time. ¹⁴ ¹⁵

While the great and good were giving alms to the deserving poor, it was pretty generally