Briefing for the Incoming Minister of Revenue - 2005 - Part 2
Tax Policy
New Zealand's tax system, which relies for most of its revenue on a broadly based income tax and consumption tax, is fundamentally sound and well regarded internationally.
Nevertheless, a number of pressures are emerging. There is mounting evidence that our personal tax structure is fragile and that income splitting and tax sheltering are on the increase. There is also reason to believe that our company tax base is at some risk, company taxation being an important source of revenue. Of particular concern are Australia's lower company tax rate and full imputation system, which provide incentives for profits to be streamed abroad and can erode New Zealand's corporate tax base. How New Zealand should best respond to these emerging pressures is a difficult problem to which there are no simple solutions.
The tax policy section of this briefing explains New Zealand's tax policy process, compares New Zealand's taxes with those in other countries, discusses key challenges in tax policy and outlines what we believe should be key themes in future work. In examining key challenges, our focus is on income tax issues. This is not because our other main tax, GST, is unimportant - rather, it is because we believe there are fewer problems with New Zealand's GST. It is our income tax base where most pressures are emerging, although GST fraud and avoidance schemes also pose a significant fiscal risk. These issues are raised in the administration section of this briefing paper.
Throughout this briefing paper we work within the tax policy settings that existed at the time the general election was called.
The tax policy process
Policy Advice Division
Inland Revenue's Policy Advice Division, together with the Treasury, advises the government on all aspects of tax policy and on social policy measures that interact with the tax system. Its other roles include:
- forecasting tax revenues
- drafting tax legislation
- negotiating and maintaining New Zealand's network of double tax agreements with other countries
- providing ministerial services.
The Policy Advice Division has a relatively small staff. It includes about 50 policy analysts, forecasters and legislative drafters who are directly responsible for the management and delivery of the tax policy work programme.
As part of its role, the Policy Advice Division manages the Generic Tax Policy Process, which covers a range of activities from initial identification of policy issues through to drafting the ensuing legislation and post-implementation review of the legislation. Our tax policy website www.taxpolicy.ird.govt.nz plays a vital part in the process.
Another important role of the Policy Advice Division is to service the Minister's office. Over the previous government's term Inland Revenue provided two full-time staff members to the Minister of Revenue's Office and a part-time staff member to the Associate Minister of Revenue's Office. We will discuss the servicing of your office with you shortly.
Policy project management
The stages of our project management are:
- Identifying issues in tax and tax-related social policy through our links and communication with Ministers; the private sector; other parts of Inland Revenue, especially operational areas and adjudication and rulings; other government departments, such as the Treasury, Ministry of Economic Development, and Ministry of Social Development; and other tax authorities and international bodies such as the OECD.
- Developing those issues into policy proposals, taking into account how they will be managed through to implementation and review. This involves early identification of potential problems and options and how these might be handled.
- Managing the consultation process on major reforms. Consultation may range from the preparation of government discussion documents setting out proposed policy to less formal discussions with business sectors likely to be affected by policy proposals.
- Managing proposed changes through the ministerial and Cabinet stages and the ensuing legislative stage, from drafting of taxation bills through to supporting their passage through Parliament.
- Post-implementation review of major reforms when potential problems are identified, to ensure that new legislation is working as intended.
No policy project is a success until it has been successfully implemented. And successful implementation of new measures depends not only on making the necessary information available to taxpayers and Inland Revenue staff alike, but also on integrating the changes into operational systems - for example, by way of form redesign and necessary changes to the computer system. That can take a great deal of time and resources for implementing major reforms such as Working for Families. See page 40 for a discussion of current operational restraints on introducing new measures.
The policy development process
Since 1994, tax policy has been developed in accordance with the Generic Tax Policy Process. The process was introduced to ensure better, more effective tax policy development through early consideration of key policy elements and trade-offs of proposals, such as their revenue impact, compliance and administrative costs, and economic and social objectives. Another key feature of the process is that it builds external consultation and feedback into the policy development process, providing opportunities for public comment at several stages.
Consultation throughout the process contributes to greater transparency of policy-making, allowing the government to set out the policy objectives of proposals and the trade-offs it has made in developing them. Therefore it helps the public to understand the rationale behind government policy proposals.
Major tax initiatives are now subject to much greater public scrutiny at key stages in their development - from broad proposal through to post-implementation review. As a result, we now have more opportunity to develop workable options for reform by drawing upon information provided to us by the private sector early in the process.
The increased opportunity for consulting on tax policy has resulted in growing numbers of individuals and organisations making submissions on proposals, whether set out in a discussion document or introduced in a taxation bill. Submissions are becoming increasingly technical and detailed, which in turn makes the process lengthier and requires greater policy and parliamentary resources.
Developing a new tax policy work programme
One of the first steps for the new government in relation to the Generic Tax Policy Process is to develop a three-year revenue strategy that is effectively linked with the government's economic strategy. The next stage is the development of a rolling tax policy work programme that gives effect to the revenue strategy. At present, the work programme covers an 18-month period.
Developing the work programme involves scoping broad policy proposals and prioritising and sequencing the development of initiatives. We also look at budgeted resource requirements, the time needed to develop, legislate for and implement initiatives, and modes of consultation and communication to be employed throughout the process.
This stage of the Generic Tax Policy Process culminates in a joint report by the Policy Advice Division and the Treasury to the Treasury Ministers and Minister of Revenue that suggests a policy work programme. Once approved, the work programme becomes a detailed tax policy agreement between the government and the two departments.
When it is made public, as it usually is, the work programme is received with much interest by the tax and business communities, to whom it provides greater certainty and an understanding of the government's direction in tax policy.
As time passes and the work programme is updated and new policy initiatives are added to it, there is a risk that there will be more items on the programme than can be progressed during the 18-month period. That can place a major strain on finite tax policy resources and parliamentary resources, and result in slower progress for other priorities. It is therefore important that when items are added to the work programme, existing priorities are reviewed to ensure that the government's expectations across the work programme are met.
The management of the work programme will be a key issue for both Ministers and officials in ensuring that priorities are delivered as agreed. There is a large set of issues on the current work programme, and these will need to be either reviewed or advanced. We will be reporting to you shortly on the work programme.
The 2002-2005 tax policy work programme
Major features of the 2002-05 tax policy work programme included tax-related measures to support growth and innovation. The work programme also included measures to simplify the tax system (especially for small businesses), reduce compliance costs, protect the revenue base and promote social cohesion. Recent highlights include:
- Increasing New Zealand's access to worldwide labour, skills and capital. Policy reforms included removing impediments to international recruitment through temporary relief of much of the offshore income of new migrants and returning New Zealanders, and changes to the tax treatment of trans-Tasman superannuation, stock lending, venture capital and foreign hybrids. Also contributing to this objective was an expansion in our network of double tax agreements with other countries.
- The coherent taxation of savings and the entities through which people invest and save. A June discussion document on the taxation of investment income proposed reforms aimed at removing anomalies between the treatment of savings held through collective investment vehicles and savings held directly by individuals. We have also made a significant contribution in the design of the government's work-based savings package announced in Budget 2005.
- Improving the efficiency of capital allocation. Measures included changing the basis of depreciation deductions and giving companies that bring in new equity investors better access to Research and Development tax deductions.
- Tax simplification and reduction of tax compliance costs. Examples of recent changes include some of the fringe benefit tax reforms and measures designed to make tax easier for small businesses - including the introduction of tax pooling, the alignment of provisional tax and GST payment dates, and raising the depreciation low-value asset threshold. A key part of our simplification work is the progressive rewrite of the Income Tax Act, begun in the 1990s, to make the Act easier to use and understand.
- Social cohesion. Improving incentives for beneficiaries to enter paid employment and relieving child poverty were the objectives behind the Working for Families reform enacted last year. A bill before Parliament proposes further improvements to the way that child support is administered by giving liable parents who have defaulted on their payments an incentive to re-enter the system.
- The environment. The key proposed reform is the introduction of a carbon tax aimed at ensuring that New Zealand plays its part in reducing emissions of greenhouse gases. Recently enacted legislation has also improved business access to deductions for repairing environmental damage.
- Protecting the revenue base. Important recent reforms include changes relating to the tax treatment of deferred deductions, Australian unit trusts, foreign-owned banks operating in New Zealand, and corporate migration.
Setting priorities
The work programme must balance the resource requirements of the Minister of Revenue's main tax policy initiatives against those required for initiatives introduced by other Ministers - for example, in the areas of social policy or sector assistance - which can have substantial tax implications. It must also allow room to meet private sector concerns when tax legislation is identified as causing unintended practical problems. Finally, there is an increasing demand for tax policy resources to be allocated to international tax areas such as OECD work and trans-Tasman tax matters, a reflection of the increasing extent to which New Zealand must take into account international tax trends in setting its domestic rules.
Given the many areas of government policy that have tax implications, the sheer complexity of tax issues and the limited resources available to deal with them, it is essential for Ministers to discuss and set out their tax policy priorities. Since many areas of government raise important tax policy issues, the allocation of tax policy resources is likely to affect the government's ability to pursue non-tax policy objectives, especially in economic development and social policy. It is therefore desirable for Ministers in those areas to be clear about the implications for the tax policy work programme of policy developments in their portfolios.
Budgetary fiscal rules
The tax policy work programme can also be affected in very important ways by any budgetary fiscal rules the government decides to adopt.
In setting fiscal rules, it is essential to ensure that fiscal discipline on expenditure applies in an equal way to initiatives that would reduce tax revenue - otherwise there is an incentive for expenditure initiatives to be packaged as tax initiatives.
That being said, there are a number of ways that budgetary fiscal rules might work. One possibility is to focus solely on the size of the government deficit. In this case, other things being equal, tax reductions may be seen as bad and tax increases may be seen as good. As well as making judgements about the size of the government deficit, governments need to make decisions about whether or not they want to see taxes and government spending rise or fall over time, and these decisions should be incorporated into the budgetary fiscal rules.
Questions also arise as to how flexible fiscal rules should be in trading off revenue gains against the costs of measures, legislative or administrative, which lead to these gains. For example, a government might consider that it is worth spending $1 million to gain $100 million of revenue but not worth spending $1 million to gain $1 million of revenue. The question arises of where the appropriate trade-offs are and whether budgetary fiscal rules should be flexible enough to accommodate trade-offs of this nature. Similarly, expenditure can be incurred either to raise additional tax revenue or to avoid the loss of tax revenue in the future - so should the government be thinking in the same way about trade-offs in both instances?
The tax policy implications of any fiscal rule proposals, therefore, must be considered before such rules are adopted.
Tax concessions
Those looking to reduce impediments to the growth of priority economic sectors often seek tax reductions or concessions for certain sectors. That can add to the strain on tax policy resources and, if implemented, could undermine the broad tax bases our tax system and moderate statutory rates rely upon. Inevitably, because tax collects a proportion of any business's profits, it is a restraint on the development of all sectors of our economy. That, however, is the inevitable cost of raising revenue to meet government expenditure commitments. Sector-specific concessions will increase the impediments faced by other sectors and, therefore, need a high level of justification. Moreover, sector-specific concessions raise boundary problems and can be open to abuse.
The legislative programme
Two tax-related bills await consideration when Parliament reconvenes: the Taxation (Depreciation, Payment Dates Alignment, FBT and Miscellaneous Provisions) Bill, which was before the Finance and Expenditure Committee when the House rose for the General Election, and the Child Support Amendment Bill, which was introduced in August and awaits its first reading. Both bills lapsed on 11 August, when the previous Parliament was dissolved, and Ministers will need to consider moving their reinstatement by Parliament.
The 2002-05 work programme also called for the introduction of a KiwiSaver bill in late November this year and a carbon tax bill in late February next year.
Continues in "Taxes, distoritions and New Zealand tax system"
Date published: 18 Nov 2005
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