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Opinion: An independent body to set tax rates could boost stimulus
March 19th, 2009
By Infometrics economist Matt Nolan
New Zealand faces a number of fiscal policy challenges over the near term. Tax revenue is falling, government spending may well need to rise, and the country’s credit rating is under threat.
There is one way that the government can ensure that it provides an appropriate stimulus and maintains New Zealand’s sovereign debt rating – give an independent body (akin to the RBNZ) the ability to set tax rates.
A good fiscal stimulus is said to have three elements. It must be timely, temporary, and targeted.
How would an independent body setting tax rates provide these elements?
Essentially, the government would sign a policy targets agreement with an independent body. The agreement would state that this organisation has the over-riding goal of ensuring that the government’s budget is balanced in the medium term – but there would also be scope for the organisation to allow deficits or surpluses in the short-term depending on where we are in the economic cycle.
This type of policy would ensure that any fiscal stimulus is temporary. Without the potential for the government to dig itself into a hole of debt, credit rating agencies would be more comfortable in keeping a high rating for New Zealand sovereign debt in the face of rising short-term debt.
Furthermore, with this central body setting tax rates, the fiscal response to a recession would be immediate – with the central body able to immediately lower taxes if the environment requires it. This ensures that the fiscal stimulus would be timely.
However, it is not immediately clear that such a policy would fit into the category of a “targeted stimulus”. In order to see how this policy would at least be no worse than current policy in terms of targeting we have to think about how it interacts with government spending.
Given that the government still controls spending, it determines where any stimulus will be targeted in the end. As a result, the final stimulus to the domestic economy will be just as targeted as in the case when taxes are not set by an independent authority.
As well as satisfying the temporary, timely, and (to some degree) targeted criteria for any short-term stimulus, the independent determination of tax rates would also have medium term benefits:
- Greater transparency surrounding the cost of government policy,
- A greater level of intergenerational equity – as current generations are forced to take on the cost of their own spending,
- Increased certainty surrounding the medium term level of taxes.
However, there are issues with such a scheme. Beyond the potential operational concerns (which may be substantial), there are three primary issues which would need to be thought through:
- The doctrine of no taxation without representation,
- The issue of “which” tax rates could be centrally determined,
- The question of the appropriate “timing” when raising this tax revenue over the medium term.
Although I strongly believe in the concept of no taxation without representation, I do not think that the independent determination of taxes betrays this principle.
Over the medium term, tax rates will be set solely in response to government spending. As government spending is determined by elected officials, the tax burden is still implicitly set by a representative body.
The issue of what type of tax rates the central body would control is more difficult to deal with.
Although having an independent body setting distortionary taxes (income taxes, consumption taxes) may make sense, it doesn’t necessarily follow that other taxes should be set centrally (eg petrol or cigarette taxes), or that the structure of the tax system should be set independently.
The solution to this issue would be to have all tax rates tied to a single “choice rate” of the central authority, according to a policy targets agreement between the authority and the government.
Such an agreement would ensure that the underlying equity and externality argument for the structure of tax system is still controlled by government – leaving the central authority with only one rate to choose when trying to balance the budget.
The final question of timing is also essential. In an environment where taxes are determined outside of government, the independent body would want to time tax increases differently when extra spending is investment than when it is consumption.
This implies that in order to implement this policy, we need a clearer distinction between government consumption and government investment – a distinction that would provide the added bonus of increased transparency in government spending.
Although there are important issues to be ironed out, the concept of centrally set tax rates has a lot of merit – both in terms of our short term and longer term requirements of society.
_______________
* This piece first appeared in the Dominion Post on February 28, 2009. Infometrics is an economic information and forecasting company based in Wellington. To find out more, see its website here.
Tags: Economic Stimulus, Infometrics, Matt Nolan, Taxation
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March 19th, 2009 at 9:28 pm
Agree we should allow RBNZ to have ability to vary income tax & GST..
albeit only a small portion eg
- GST from 7 to 15%
- Income Tax, first $12k they can vary tax rate from 0-15%
they talk about OCR being a blunt too as it only effects householders with mortgages..
This would give RBNZ, a full arsenal to fight & control inflation..
while they could leave OCR in a more targeted range..
Issue, is being able to change these on a monthly/quarterly basis, is not easy. imagine telling retailers GSt from today is 10%. and take home pays from today have a lower tax rate for first 12k/pa.
March 20th, 2009 at 9:38 am
Either adjust GST (expensive to implement), or ban fixed term mortgage rates – i.e. variable rates only – that will sharpen the OCR instrument.
March 20th, 2009 at 10:28 am
Reduce income and corporation tax – by introducing an umambiguous capital gains tax. (Family homes/homes exempt.)
This would help incentivise investment toward productive capacity.
This would also help improve savings volume.
“New Zealanders need to save more and rebalance the economy from being one based on foreign borrowing and consumption to one based on saving more and investing more in productive capacity to reduce our debts.”
From:
http://www.interest.co.nz/ratesblog/index.php/2009/03/19/have-your-say-should-we-save-the-tax-cuts-or-donate-them-to-charity/
March 20th, 2009 at 10:32 am
Josh – I agree with your thinking. See:
http://www.interest.co.nz/ratesblog/index.php/2009/03/06/new-zealand-could-go-bankrupt-within-next-5-years-markets-believe/#comment-17877
March 20th, 2009 at 10:52 am
“they talk about OCR being a blunt too as it only effects householders with mortgages..”
“Either adjust GST (expensive to implement), or ban fixed term mortgage rates – i.e. variable rates only – that will sharpen the OCR instrument.”
That view is a bit of an urban myth – according to the RBNZ even when a large proportion of rates were fixed the OCR was still effective. It doesn’t just work through mortgage rates it also:
1) Influences the exchange rate,
2) Changes the return to saving,
3) Has a strong impact on the cost of business lending.
As a result, there are other channel with which the OCR influences economic activity and thereby inflation – recent policy ineffectiveness had more to do with low international interest rates and messed up beliefs surrounding asset prices then anything else.
“Issue, is being able to change these on a monthly/quarterly basis, is not easy. imagine telling retailers GSt from today is 10%. and take home pays from today have a lower tax rate for first 12k/pa.”
Fiscal policy wouldn’t be used as a stabiliser in the above article unless we faced extreme circumstances where monetary policy fails. As a result, it isn’t a question of fiddling with the rate every month/quarter – only when things go crazy, such as in the current environment.
The main role of having centrally determined taxes is that it makes fiscal policy neutral and more transparent – so we don’t have circumstances where we face a “lolly-scramble” without facing up to the true costs of it.
“Reduce income and corporation tax – by introducing an umambiguous capital gains tax”
The composition of taxes is no doubt important – but that is a separate issue to the issue of whether they should be set independently …
March 20th, 2009 at 12:28 pm
What if the RBNZ got taken over by ideologues of the left or right? The amount of power they would wield would be immense; and with no threat of being voted out- the very definition of antidemocratic. If instead they were appointed by the government each term then it would politicize the role greatly.
Also how about first revising the concept of inflation? The asset bubble was totally missed by the central banks of the world, who recorded artificially low inflation while property prices were hyperinflating and kept interest rates low; and now still record positive inflation during the fastest deflationary crash since the 1930s.
If you aren’t even measuring the right thing then how the heck can you devise sensible policy to change the outcome?
March 20th, 2009 at 12:38 pm
“What if the RBNZ got taken over by ideologues of the left or right? The amount of power they would wield would be immense; and with no threat of being voted out- the very definition of antidemocratic”
I 100% agree with this point – hence why we have a PTA for any such body. Generally, you would want an independent body that keeps an eye on these things as well – but then again we could always ask who keeps an eye on them
“Also how about first revising the concept of inflation? The asset bubble was totally missed by the central banks of the world, who recorded low inflation while house prices were hyperinflating and kept interest rates low; and now still record positive inflation during the fastest deflationary crash since the 1930s.”
Because the concept of inflation does capture what it is supposed to. The CPI is not inflation, house prices are not inflation. Inflation is a lift in the level of prices over time – and this is something that is nearly impossible to measure.
The issue with the increase in house prices was a bubble – people’s expectations of future house prices were not realistic. Ultimately, we have to ask question about what causes this problem – is it poor education, bad information, unavoidable cycles. Criticising the measurement of inflation is a red herring.
March 20th, 2009 at 1:14 pm
Matt – first of all, and I should have said before, good topic for discussion.
Regarding your point about RBNZ’s view of mon.pol/OCR effectiveness, in terms of meeting their aims under the, present, PTA, it’s not difficult to see why they draw that conclusion. Also from a structural point of view does indeed OCR:
1) Influences the exchange rate,
2) Changes the return to saving,
3) Has a strong impact on the cost of business lending.
to drive down inflation. However, I think one reason for the ‘blunt’ critisism comes from the fact that a larger proportion of inflation is associated with the domestic sector than the productive sector. In particular because of the linkage with ex.rate we have seen a situation akin punishment of the innocent while the guilty have gone ’scott-free’. Add in the impact on business lending and our productive sector has indeed been punished of late. Which seems ever more like economic cannabilism to me as we need that sector to function ever more effectively.
To help with this problem a fiscal focused instrument could help, see the Public Comment section of the New Zealand Manufacturers and Exporters Association website; titles are fairly self-explanatory. (Linked from my name here, by the way, I’m an ‘Invited Member’ with them, hence my interest in articles on this website.) Also I’d be interested in your critique on a semi-related idea I worked up recently detailed here:
http://www.interest.co.nz/ratesblog/index.php/2009/03/06/new-zealand-could-go-bankrupt-within-next-5-years-markets-believe/#comment-17877
Regarding composition of taxes, in working through the practical implementation aspects of your idea, I think that if you intend good fiscal stimulus as at least one healthy outcome, then we would need to ensure the structure of taxation is a neutral as possible to avoid unintended distortions, or be very aware of how said structure might influnence the outcome of stimulus focused spending. So doing a thought experiment, suppose we gave a general tax reduction before before we entered our recessionary period, where would that money have gone? I doubt it would have been saved or invested in development of productive capacity.
March 20th, 2009 at 2:09 pm
Hi Les,
Thanks for the comments.
My impression was that the OCR is quite a good tool to use for influencing inflation – as it directly influences the monetary aggregates that cause inflation. By changing the short-term interest rate the RBNZ can influence short-term spending and saving decisions. As long-term interest rates should (in theory) not be influenced by the short-term level of the OCR this should impact on productive investment at all.
I realise that the OCR seems like a very blunt instrument – and when the issues seem to be sectoral (eg housing) then the OCR is not the way to deal with them. However, when we look at simply controlling inflation – the OCR provides a very appropriate instrument.
“I think that if you intend good fiscal stimulus as at least one healthy outcome, then we would need to ensure the structure of taxation is a neutral as possible to avoid unintended distortions”
I’m definitely a fan of reducing distortions – however, we have to recognise that society may be willing to give up some efficiency to gain some “fairness” or equity. The structure of the tax system is supposed to represent this – and as a result the initial make-up of the PTA should also represent this.
In the article the suggestion is to give a central authority control of some central tax rate – not relative tax rates.
March 20th, 2009 at 2:34 pm
This is a dreadful idea. I want to be able to look the politician in the eye who dares take more and more tax, thus my efforts, from me, and don’t want to give them yet another out. I’m sick to death of IRD staff and auditors telling me they have no discretion and politicians hiding behind that, when they made the (usually incompetently drafted) laws in the first place: why on earth would you want to give them the same excuse to launch 90% bonus taxes here. ‘Oh it wasn’t me, the ‘higher tax commission’ decided this, I can’t do anything about it’. Yeah right!
Next thing you’ll be saying contracting out MP salaries to a supposed bunch of woolly headed bureaucrats with no concept of value is a good idea … oh, hold on …
Economics be damned. Morality first.
(Gareth, I love ya mate, in a completely platonic sort of way, but would have expected better than this from someone in your firm.)
March 20th, 2009 at 2:42 pm
“I want to be able to look the politician in the eye who dares take more and more tax”
You can – as the tax rate will be set to match politicians spending. If the politicians don’t spend anything, there won’t be any tax.
March 20th, 2009 at 3:25 pm
Matt:
You can – as the tax rate will be set to match politicians spending.
Well then what really is the point, other than adding yet another department of bureaucrat salaries onto the already too long list of deadwood – at best – salaries I’m paying.
I do see your point, and I guess you’d even advocating lower taxes in absence of spending: but politicians are going to become even more removed from the cost of their spending.
If the politicians don’t spend anything, there won’t be any tax.
No, as stated, at a minimum we’ve got to now cover the cost of the new transaction cost you’ve just harpooned into an already way, way, way over-bureaucratised, over-regulated country.
I would rather Infometrics do something really positive by selling the advantages of ditching altogether the market distorting OCR, and the RBNZ, and tying currency back to some type of commodity basis to take away the governance of money supply from the politicians. Then we’d be talking progress.
March 20th, 2009 at 3:46 pm
Trying to gather my thoughts better. I understand the argument whereby such independence supposedly builds in responsibility to the tax making process: I just don’t believe it. By the time responsibility can be battered around between the Minister and this independent group, as another political football – look at the health sector – it can thus effectively be taken out of the game, and the politician has another fence to hide behind from being responsible for his/her decisions. Wherever there is a new layer of bureaucracy, there is simply a new layer of bedded in cost, with nothing else gained, and more of my freedom lost. At least that’s what history has taught me.
I think that states it a bit better
March 20th, 2009 at 5:42 pm
Hi Mark,
Thanks for your comments,
I definitely understand your concerns – we don’t want to increase the layers of bureaucracy further. However, this isn’t quite the way I envisage it.
Currently, there are departments forming tax advice and building models to explain what the government should do to pay for their spending. I’m simply trying to say that it might be a good idea to let them implement their policies – in order to force parliament to be more disciplined with their spending. As a result, I see the concept as a way of using current staff, and current staff roles, rather than building further layers of government.
“I would rather Infometrics do something really positive by selling the advantages of ditching altogether the market distorting OCR, and the RBNZ, and tying currency back to some type of commodity basis to take away the governance of money supply from the politicians”
We have views on these issues – but they might be different to the views you have. Personally, I still believe in the OCR – given how “sticky prices”. These are important issues to discuss – and I will try to keep it in mind for future articles.
March 20th, 2009 at 8:51 pm
“There is one way that the government can ensure that it provides an appropriate stimulus and maintains New Zealand’s sovereign debt rating – give an independent body (akin to the RBNZ) the ability to set tax rates.”
“Ensure”? Do you mean such a move would guarantee our sovereign debt rating would not be downgraded? And if so, by what mechanism is such a guarantee provided?
March 20th, 2009 at 10:48 pm
Are yes tax well acording to the Dictionary tax means=compulsory payments by wage earners companies etc imposed by goverments to raise revenue. It also has another meaning = A heavy demand on something=toll=burdon=drain=load etc I belive the later terms descibe best the state of this countrys systems no amount of talk new ideas will solve this problem unless the end result is less taxes on the producing sector with a view that big goverment is wrong’ BAZ
March 21st, 2009 at 10:41 am
Mark Hubbard – I am interested in:
“the advantages of ditching altogether the market distorting OCR, and the RBNZ, and tying currency back to some type of commodity basis to take away the governance of money supply from the politicians.”
What do you have in mind? Can you give some more detail on your thinking here please.
March 22nd, 2009 at 4:29 pm
Matt – thanks for your responses to my previous comments, I’ll respond to those as we go, however, I’ve now gelled an opinion on the key idea you have raised here. I like the idea of the three benefits you have highlighted, particularly greater transparency, although I don’t think we need to wait until this kind of idea is implemented to improve on that. I am guessing the answer to the question – where else are they doing this in the world, so we can have a look at their experience – is probably nowhere of significance, if at all. Whether I’m right or wrong on that (would be grateful for you pointing to some supporting research), I’d still be wary of NZ being at the forefront of this kind of approach and my reticence comes from agreement with Mark Hubbard’s concerns and that I also believe our more pressing priority regarding taxes should be around tax structure and levels.
Plus if I believed implementation of monetary policy via our independently operated OCR mechanism was more effective in sustaining the health of our economy, not just how well (or not) it deals with inflation, I might feel more encouraged with your idea. Before proceeding I will just say, somewhat tongue in cheek, but meaning no offence to you or your idea, that if there is little other international experience to substantiate the benefits of your idea, rather than New Zealand as whole being a test case I’d like to volunteer Christchurch – then perhaps us ratepayers here might get better transparency on the reasons and returns for some of the investments our city council has made.
It concerns me that you agree with some at RBNZ who believe inflation has been effectively controlled with the OCR mechanism. This might be the case, in theory, just in terms of looking at levels and adherence to the present PTA. I said before that domestic inflation has been a larger proportion than productive sector inflation. That because of the OCR’s (unnecessary – see the RCR idea, among others) linkage to the ex.rate we have seen a situation akin to punishment of the innocent while the guilty have gone ’scott-free’ – meaning exporters have been unnecessarily throttled in making their contribution to GDP and reducing our CAD, while the domestic sector has exacerbated the latter. If you go to the NZMEA website here http://www.mea.org.nz/media.aspx then the ‘Our Presenations’ section and look at the ‘Presentation on Monetary Policy Framework’ (9 May 2008) slide 15, it shows domestic inflation runs at 2.5 times that of tradeables. Until our inflation control mechanism and our tax structure (presently favours asset based passive investment over productive activity) this is unlikely to change, meaning ‘Ground-Hog Day’…..
Among other things, NZD hitting dizzing levels led to initiation of the Select Committee Review of Monetary Policy. This has now closed with the conclusion that we should maintain the status quo. See the recent NZMEA response to this here http://www.mea.org.nz/media/pressreleases.aspx ‘English defies the evidence on monetary policy’ (20 Feb 2009).
I hear what you say in response to the political influence of an independent tax setting body and associated PTA, however to reiterate, before we went that far I’d like to see the independent operation of monetary policy work better first and that might be assisted by:
1) A committee setting the rate, as per FOMC, BoJ, BoE et al, with RBNZ issuing minutes with voting declared sometime after the event, and refrain from warning of their intentions at MPS releases – which simply assists banks with their marketing. A committee would be less open to political interference and any ‘off-PTA’ directives and agreements. Actuation performance would probably match need better than when one individual is responsible for actuation, notwithstanding the fact that broad consultation on inflation drivers is made.
2) A PTA with a wider brief than just aggregate inflation control.
3) A supplementary instrument that reduces the linkage between OCR and ex.rate and is capable of dealing with specific inflation drivers (domestic) in a more precise manner – rather than knocking the guts out of exporters continually.
Back to tax rates being set independently – if we ended up with similar issues with this idea as we have with the way we implement monetary policy, because similar reasons of power, control and tacit disconnection of responsibility and accountability were in play, I think we might be worse off. I wonder sometimes if being so divorce from OCR actuation and not as deeply involved in the associated cause and effect relations leaves our politcians at a disadvantage when it comes debating moneary policy, it’s implementation and effects. Notwithstanding what you have said about the spend (cause) tax (effect) linkage being maintained with your idea, given my concerns around mon.pol I’d want to be sure this possible (probable?) disconnect effect is minimised.
However, that is not to say we should not continue to debate your idea as I think many would be glad of the benefits you state, especially the transparency one.
March 25th, 2009 at 1:03 pm
Hi Kate,
The guarantee would could from the fact that our tax policy is set to make sure that we can’t have a decade of deficits – the very problem that S&P pinned down as a reason for any devaluation.
Hi Lew,
Interesting set of comments. I will try to do a post about them at http://www/tvhe.co.nz at some point – once I have a little bit of time (maybe a weekend?). I will comment here when that is done.
March 25th, 2009 at 4:08 pm
Sorry I mean Les not Lew – w and s are right next to each other on the keyboard
March 25th, 2009 at 10:05 pm
Matt – yes, I thought you meant me.
Can you help me with something please.
In this discussion:
http://www.interest.co.nz/ratesblog/index.php/2009/03/24/opinion-5-reasons-why-house-prices-dont-represent-fair-value/#comment-18880
We were told:
“In 1999, Cullen introduced the 39 % tax bracket, an act of sheer stupidity on his part, and exacerbated this lunacy by fixing that rate to kick in at only $ 60 000. Estimates are that this added 17 % to the subsequent increase in house prices.”
When I asked where the 17% was from I was told it came from an Infometrics report and had been quoted in The Press. Would it be possible for you to ask around at Infometrics please and then let me have some more information on the associated analysis, and anything useful that may help with the following:
http://www.interest.co.nz/ratesblog/index.php/2009/03/24/opinion-5-reasons-why-house-prices-dont-represent-fair-value/#comment-18900
and:
http://www.interest.co.nz/ratesblog/index.php/2009/03/24/opinion-5-reasons-why-house-prices-dont-represent-fair-value/#comment-18967
where I was referring to:
https://www.dpmc.govt.nz/dpmc/publications/hpr-report/hpr-6.html
provided by ‘Waymad’.
Thanks, Les Rudd.