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Damned if you do, damned it you don't; tax specialist Terry Baucher recounts the twisted tax tale of Morton's fork and how it applies in NZ. Your view?

Personal Finance
Damned if you do, damned it you don't; tax specialist Terry Baucher recounts the twisted tax tale of Morton's fork and how it applies in NZ. Your view?

By Terry Baucher*

When Henry VII, Henry VIII’s father, became king at the end of the War of the Roses, the Crown was very nearly bankrupt.  Ordered to replenish the Treasury, Henry VII’s Lord Chancellor, John Morton, devised what is now known as Morton’s Fork when he declared: "If the subject is seen to live frugally, tell him because he is clearly a money saver of great ability, he can afford to give generously to the King. If, however, the subject lives a life of great extravagance, tell him he, too, can afford to give largely, the proof of his opulence being evident in his expenditure."  It was a perfect “Heads I win, tails you lose” argument sweeping up the miserly and the extravagant alike. 

Morton’s policy was ruthlessly carried out and was so successful that by the time Henry VIII became King in 1509, he inherited a fortune estimated to be at least £1.3 million, a colossal sum at the time and making him one of the richest kings in Europe.   However, his father’s tax policy had been highly unpopular, so one of Henry VIII’s first acts was to order the execution of two of his father’s principal tax collectors Edmund Dudley and Richard Empson, allegedly for their over-zealous use of Morton’s Fork.  A case, perhaps, of taking tax cuts a bit too literally. 

In the 21st Century we like to think tax policy is much more sophisticated and fair.  However, tax authorities, including the IRD still use Morton’s principle to assist the collection of taxes.  I recall one instance where a taxpayer pleading poverty was then asked by investigators to explain why he had been seen a week earlier driving a Rolls Royce.  A large tax bill soon arrived. 

You can't win

More commonly Morton’s Fork is applied during an IRD investigation to present taxpayers with two equally invidious positions: either accept the IRD’s position and therefore be liable for taxes, interest and penalties; or incur substantial legal and accounting costs by continuing to debate the issues (still, of course, with the attendant risk that the defence is unsuccessful).  

Given the IRD’s vastly greater resources, it is no surprise that many taxpayers concede rather than fight on even when their advisors consider they have a strong position.  Those taxpayers whose pension transfers from the U.K. were selected by the IRD for a “risk review” were facing this dilemma, so the decision to review the treatment of overseas pensions was a welcome one.

But one of the groups who are regularly confronted with the modern equivalent of Morton’s Fork would be in most people’s view the least likely to face the issue: low paid workers.   It is unquestionably good policy to get people off benefits and into employment but sometimes the interaction of tax and social welfare rules present intractable problems for the ambitious.  As a person’s earnings rise so benefits decline but not always at the same rate. 

In 2009 the Victoria University of Wellington Tax Working Group was shocked to discover that for some workers the effect of taxes and abatements of benefits/ Working for Families Tax Credits,  resulted in effective marginal tax rates of over 50% and in some instances as high as 100%.  Working more hours or even accepting a pay increase can therefore be counter-productive because of the effect on these other benefits.    

The graph below from 2007 illustrates the distortionary effects of this conundrum: instead of a relatively smooth Bell Curve note the large number of spikes at the left hand side where clearly some income manipulation is going on to avoid the effects of taxes and benefit abatements.

The final report of the Victoria University of Wellington Tax Working Group recommended a major review of the social welfare system to deal with the issue of high effective marginal tax rates. That didn’t happen but if the proposals to get beneficiaries into work are to have a long term impact then the issue of the interaction between benefits and taxation needs to be addressed.  Otherwise the low paid will continue to find themselves trapped by the 21st century equivalent of Morton’s Fork.

*Terry Baucher is an Auckland-based tax specialist with 20 years experience.

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6 Comments

The least likely to understand the tax system, and the most powerless to effect any change, are the ones that are getting skewered.  Can you imagine this problem hitting the opposite end of the wage spectrum?  A 0.0001% not sure if they should earn more because they will end up losing money through taxes?  Says a lot about the rule of law, and demokracy, I'm not going to kid myself that this is some kind of innocent mistake.

George Carlin explains the economic system

Why we have poor people

not for anyone with sensitive ears.

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The thumbs up is more for G.C. videos. He is right on the button. And who worked for them evil overlords and was renowned for his "Smiling Assassin" ways? Why Jokey Smurf of course the current leader of our great country.

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I doubt the spikes at $15k have anything to do with the tax rate/level of income/benefit abatement of beneficiaries & low low paid workers.  $15k is about the income level of a solo parent beneficiary (one child), unemployed beneficiary before additional supplements (which won't be incl as income).  There are so many who won't earn any more because they don't want to work if they can get paid for nothing.  There will also be a link to the spike at $60k as well - those that can split their income to a spouse/partner would as tax rebates at the $15k level can still be received and they didn't have to pay the 39% tax rate.

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Yes , I have seen this tax vs benefit conundrum at work in real terms . My wife needed to employ in-store supermarket demonstrators for a food company .

She had a problem finding staff in that if someone did 10 hours a week  then they got a reduced benefit , and after paying tax on their income and the cost of travel to do the work, it was better to sit at home on the benefit.

Basically you have this incongruous situation where employers arre forced to compete with the benefit system .

Crazy 

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And people still don't understand the benifits of Morgans tax plan to everybody

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The govt is giving those on "benefits" (ie dole & DPB) a hard time.  Fair enough.

 

But those on other benefits (which the govt doesn't count as "benefits") cost the country far more.  eg getting superannuation at 65 is one.

 

WFF is another egregious example of middle class welfare gone mad

 

My daughter-in-law has got three children all at school, they have been for years.  But she has no plans to go out an work, because of the amount of WFF she would lose. 

 

There is absolutely no benefit to anyone in this system.  It contributes to blowing out the govt's expenditure, when she should be out there earning & paying tax to improve its fiscal position.  In dollar terms her family is worse off than it would be if she worked.  Also, when she is forced into the workforce after her WFF finally expires many years in the future, she will be totally work-unready.

 

Key has said he would resign rather than change WFF.  A question:  Is WFF inflation-adjusted?  If so, this colossal boondoggle is fated to hang around our neck like a rank albatross until the end of days. 

 

Crazy system!  Cheers

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