Briefing for the Incoming Minister of Revenue - 2008
Introduction
As Minister of Revenue you are accountable for the overall working of New Zealand's tax system and for the Inland Revenue Department. Tax policy decisions are made jointly by yourself and the Minister of Finance.
For the year ended 30 June 2007, Inland Revenue collected 75.4 percent of total government revenue and 83.1 percent of total tax revenue.1 Total staff at 30 June 2008 numbered 5,976 (measured in full-time staff equivalents).
Constitutionally, tax can only be levied in accordance with laws enacted by Parliament. Inland Revenue has an obligation to levy tax in accordance with the law to the best of our ability. We also have an important obligation to maintain confidentiality of people's tax affairs. The Commissioner has statutory independence from Ministers to ensure we are able to levy tax and carry out our duties independently. We also administer KiwiSaver and a range of social policy initiatives which are not part of the tax system but are generally administered using the infrastructure put in place to collect tax. The Policy Advice Division of Inland Revenue, jointly with the Treasury, provides advice to Ministers on tax policy and assists with the management of tax legislation through Parliament.
Inland Revenue has an obligation to ensure that the tax system as a whole is well-functioning. This is important to the government, the economy and society.
We have identified six key factors that contribute to a good tax system.
First, there should be clear and well-understood tax policy and legislation. Complying with tax liabilities should not be like walking through a minefield where an inadvertent error produces dire consequences. Taxpayers should be able to get on with their affairs while spending as little time and as few resources as possible consulting the Income Tax Act, Goods and Services Tax Act (GST Act) or seeking tax advice. This is helped by having a clear and simple policy framework and clear legislation, which helps not only taxpayers and their advisors but also the courts in coming to clear and consistent decisions.
Second, even with the clearest of policy and legislation, taxpayers will need to contact Inland Revenue on occasion. There are clearly administrative costs that the department incurs when people make contact. However, taxpayers should receive high levels of service and timely responses from good, technically competent and receptive people.
Third, finding information and receiving assistance should not be a struggle for taxpayers. For this to be provided cost-effectively, it is desirable for as much as possible to be provided electronically in easy-to-access ways. Providing information electronically also provides scope for information to be tailored to taxpayer needs as efficiently as possible.
Fourth, Inland Revenue should be able to anticipate and respond quickly to policy and administrative challenges. This is helped by having good, technically competent and receptive staff. It is also important, however, that agility of response does not lead to a culture of lobbying for favoured tax treatment or create uncertainty. To this end, the policy framework and legislation must be articulated as clearly as possible so that policy problems are evident.
Fifth, high tax rates and narrow tax bases are likely to increase the economic costs of taxation. High rates and narrow tax bases make it easy for taxpayers to alter their affairs in ways which reduce their tax burden. Where possible, it is attractive to ensure that tax is levied at low rates over broad tax bases.
Finally, a good tax system is characterised by high levels of voluntary compliance, which is helped by the tax system being perceived as broadly fair. That is more likely when the policy framework is clear. But it is also necessary to have good tax administration which makes it as easy as possible for those who wish to do so to get it right and as hard as possible for those who wish to do so to get it wrong.
We see our job as doing whatever we can to ensure that the government has a good, cost-effective tax system.
The key functions that Inland Revenue performs are:
- collecting tax to finance government spending;
- redistributing income in line with the government's equity objectives;
- delivering specific programmes that are not necessarily part of tax collection - including Working for Families tax credits, the student loan scheme, child support, KiwiSaver, paid parental leave, research and development (R&D) tax credits, and audits for government grants to firms;
- helping make the New Zealand economy competitive - not only by minimising the costs of collecting tax but also by providing high levels of service; and
- building trust and confidence in the public sector.
None of these functions stands alone. If the tax system is performing well in each area, they will be mutually reinforcing. Weaknesses in one area can undermine the others.
Our key advice is that the system we administer needs to be considered as a whole. An individual tax policy proposal needs to be considered not only on its individual merits but also on how it dovetails with other aspects of tax policy. The company tax rate, for example, needs to be considered in terms of how it fits with personal tax rates. When considering whether Inland Revenue should deliver a non-tax programme, consideration needs to be given to how this might impact on the management of the tax system. Similarly, a policy proposal may have merit but may have adverse operational implications for the department's overall activities. When a problem with the revenue base arises, the best response may be administrative action, such as educational and support initiatives, audits, a legislative change or a combination of these.
This briefing is our stocktake of how the tax system is functioning. Overall, we see the tax system as operating well. By international standards we have robust tax bases which generally collect taxes efficiently over broad bases at moderate rates. We believe that the tax system is seen as reasonably fair. Compliance costs are relatively low and the administration cost per $100 raised is modest. However, in all of our key functions there are pressures and risks that the government will need to manage over the next few years.
The current worldwide financial turmoil and New Zealand recession will affect revenue collections and debt levels. They also may, on occasion, create the need for rapid policy or administrative responses. We need to be well prepared and ready to provide considered responses as circumstances change.
The increasing integration of global commerce poses challenges to tax policy and administration. New government programmes and an increase in the public's expectation of the level of service that needs to be provided are stretching Inland Revenue's administrative capacity. The overall tax system is becoming less coherent as the same income is being taxed at increasingly different tax rates, depending upon the form in which it is earned. The delivery of social policy programmes on a platform designed to collect tax has created costs, complications and business pressures which will have to be addressed. Some core infrastructure will also need to be renewed.
The current tax system can be summarised as strong but not stable. While there are many good features of the tax system, certain aspects will need to change over the next few years, in some cases significantly, to meet the challenges we face. The government will need to make decisions in terms of both tax policy and how the tax system is delivered. Given the strains on the existing system, this needs to be a managed change process. Overall, we consider that the process would be one of evolutionary change rather than a radical departure from the current architecture.
Collecting tax to finance government expenditure
New Zealand's revenue is mainly derived from income tax (71.6 percent of total tax revenue for the year to 30 June 2008), GST (19.7 percent) and excises (2.8 percent). Other taxes (5.9 percent) are customs duty, road user charges, gaming duty, motor vehicle fees, energy resources levies, the approved issuer levy and gift and cheque duties.2
The primary purpose of taxation is to raise revenue to finance government spending. Our education and health systems, police and defence forces, for example, require a robust and sustainable tax system that raises sufficient revenue to make them affordable, in conjunction with a sound government fiscal position. A sound fiscal position provides the platform for the government's economic policies and can provide the government with the fiscal flexibility to pursue its overall policy objectives.
The current tax system has performed well in this regard in recent years. Given the size of current government expenditure, tax needs to be a substantial fraction of the economy. According to OECD figures, tax now amounts to 36.0 percent of GDP in New Zealand. Figure 1 shows tax as a percentage of GDP in New Zealand and a number of other countries.
Figure 1:
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Revenue growth has been very strong but there are signs of weaknesses in parts of the tax base. The main elements of the New Zealand tax system are described in Taxes, distortions and the New Zealand tax system.
The main challenges we see are maintaining the very strong past performance of the corporate tax base in the light of international developments and, to a lesser extent, individual income tax given the reduced coherence of the tax system that is becoming evident. These issues are considered in Policy challenges.
Redistributing income in line with the government's equity objectives
While the primary purpose of tax is to raise revenue, it is also universally used by societies to redistribute income towards lower income earners. A progressive income tax system such as ours that imposes higher average and marginal rates on higher incomes is often used to achieve this.
Even a proportional tax system (where marginal rates are constant) such as our GST has a redistributive function since more tax is still paid by those earning and spending the most over their life-times. Government spending on health, schools and social programmes will also have distributional effects. The Tax Review 2001, chaired by Robert McLeod, (the McLeod Review) argued that most redistribution occurs through government spending and that, if an increase in progressivity is desired, this would best be achieved through an increase in targeted spending, not an increase in tax rates.3 While a key decision for the government is how redistributive to make the tax system, it is important to bear in mind that it is not only taxation but also government spending that will determine the overall progressivity of the government's fiscal programme.
We believe that our total tax system is mostly seen as fair. Our tax bases are more comprehensive than most countries', leaving fewer loopholes that can undermine redistribution objectives and perceptions of fairness. From a tax administration point of view, this is especially important since these elements impact heavily on voluntary compliance. A tax system that is seen as fair will raise revenue at lower cost and help build trust and confidence in the public sector.
However, a reduction in the coherence of the tax system appears to be undermining this critically important element of our system. To a growing extent, different types of income are being taxed at different rates, and rates are becoming increasingly dependent on the form in which income is earned. Unless this is happening in accordance with explicit policy that is understood, this can undermine the integrity of the tax system. Taxpayers are increasingly entering into arrangements which exploit these inconsistencies in order to minimise tax. Over time this can undermine the revenue base. The challenges in this area are discussed in Policy challenges.
Delivering non-tax programmes
Since the mid-1980s, Inland Revenue has taken on new tasks, including student loans, Working for Families tax credits, child support, paid parental leave and KiwiSaver. This year we have also taken on the new R&D tax incentive.
We must ensure that these programmes run smoothly and efficiently. Nevertheless, if Inland Revenue is to fulfil its core mandate of providing a good tax system that raises sufficient revenue to finance government spending, an important question is how broad the set of tasks assigned to it should be.
As we take on a greater set of tasks, departmental resources and management time are drawn away from core tax matters. Where the tax system is used to deliver social policy or other objectives, it is important to consider whether systems that have been designed with one objective in mind are serving us adequately when used for another purpose. Using the tax system to provide incentives for certain activities may sometimes be a cost-effective way of delivering assistance but there are important effects on the coherence and clarity of the tax system that need to be taken into account.
Delivery mechanism for social policy or other objectives
In our view, Inland Revenue has done a good job of expanding its set of activities. Indeed, a key reason why Inland Revenue has continued to be the delivery agency for new initiatives is that it has been successful in delivering in the past when it has taken on new functions.
However, there are undoubtedly some growing tensions. The continued addition of functions puts operational pressures on the department. A particular concern is that systems that operate successfully for dealing with tax issues have been extended to deal with non-tax matters. This has meant that systems designed to deal with tax have evolved to take on these different tasks. If one were designing a social policy delivery system from scratch it would be fundamentally different from a system based on tax collection.
One example is Working for Families tax credits. Despite being only 6.3 percent of tax registrations in the year to December 2007, Working for Families generates approximately 17.5 percent of phone calls to Inland Revenue at peak times. There are often much larger end-of-year adjustments that need to be made for Working for Families than for income tax. Many of the phone contacts are aimed at ensuring that these end-of-year adjustments are correct. This means that systems which work quite well in an income tax context may work less well in other areas.
A second example is KiwiSaver, which works off employer monthly schedules. There appear to be many minor errors that employers make when filing these schedules. It would not be sensible to require that all minor errors are corrected if tax were the only use of the schedules. However, because Inland Revenue is effectively providing a banking service for those saving in KiwiSaver accounts, it has a duty to ensure that exact amounts of money are recorded in each saver's account. Practical compromises that can be sensible in an income tax context may not be sensible when new functions are added to Inland Revenue's set of tasks.
Using the tax system as the delivery platform for other policies also affects the way those policies are designed. The student loan collection system, for instance, is complex and would most likely have been designed very differently if it had not been linked to the tax administration. The design is markedly different from how a bank would typically manage the risks associated with a debt-book based on unsecured loans to a highly transient population.
We continually review whether we have the best methods in place for administering our expanded set of tasks. This includes consideration of possible policy changes which would make it less costly for both Inland Revenue and taxpayers. Where substantial new functions are being contemplated for Inland Revenue, it is sensible to make these major changes carefully and to give full consideration to how best to adapt systems for these new functions.
Irrespective of views on whether it would be good, in principle, for Inland Revenue to be the delivery agency for further social policy or other objectives, we currently face an important practical short-term constraint. The range of tasks that Inland Revenue has taken on in recent years has seriously strained our systems.
Inland Revenue is addressing those strains and ensuring it is equipped to meet future expectations of government and taxpayers by developing a multi-year proposal to renew our infrastructure and capability. Essentially, through the overlay of new functions, our business has changed and we need to change the way we do business accordingly. We are planning initiatives which will equip our infrastructure and our people to deliver better value for money, make it easier and less costly for individuals and businesses to comply, and allow Inland Revenue to respond quickly and efficiently to changing government expectations.
Further information can be found in Administrative issues.
Tax incentives
A second issue is the use of the tax system to provide incentives to achieve non-tax policy goals.
A government may, at times, wish to use the tax system to provide incentives for certain activities. However, there are also costs to be considered.
The more often the tax system is used for providing incentives, the more murky will become its guiding principles. This will create more need for taxpayers to seek tax advice when making normal commercial decisions. It will make it more difficult for Inland Revenue to apply anti-avoidance provisions in a consistent and predictable way. It will also make it more difficult to identify and correct any policy defects. This is because it will become more difficult to spot whether measures which appear to penalise some firms relative to other firms reflect flaws in policy or deliberate policy intentions.
There will always be pressure on black-letter borderlines in the law. Not all of the benefit of tax incentives will go to the firms undertaking the desired activities. Some is likely to be eaten up in accounting fees as accounting firms attempt to ensure that expenditure is described in ways which will meet the requirements of the incentive. Moreover, tax incentives and concessions narrow the tax base, requiring higher tax rates.
Another potential concern with using the tax system to provide incentives is that it may often be a poorly targeted way of delivering an incentive. This is because the benefit of tax concessions will often vary depending on the tax rate of the recipient and whether the recipient is in a profit or loss position.
Helping make the New Zealand economy competitive
Tax is a substantial cost on individuals (from whom resources are transferred to the government) and to the economy as a whole (since it creates disincentives to work, save and invest). Taxes create compliance costs for the public, and the cost of administering the system is expenditure that the government cannot devote to other priorities. Nevertheless, as Oliver Wendell Holmes said, "Tax is the price we pay for a civilised society".
It is therefore orthodox policy advice to seek to have the benefits of taxation with minimal costs. This means minimising compliance costs (keeping the tax system simple), administration costs (getting value for Inland Revenue funding) and the very substantial economic costs taxes impose (minimising distortions caused by taxes). As discussed in later chapters, the New Zealand tax system seems to rate highly in terms of its low economic costs (Taxes, distortions and the New Zealand tax system),and its simplicity and value for Inland Revenue funding (Administrative issues). We should nevertheless look at the tax system from a wider perspective, in terms of its impact on business and the economy. The tax system is one of the main interactions business has with government. If the government wants to create an environment in which business can grow and that attracts investment and entrepreneurship, the tax system must be responsive and easy to deal with. The certainty of the tax system and the speed with which that certainty can be obtained can be as important to business as the actual rate of tax being levied.
A good tax system is essential for a competitive economy. A good tax system is not just a matter of good tax policy. It also requires a good tax administration. Both need to be working well to help business grow and make New Zealand attractive to investors.
Good tax policy is not simply just what can be read in a textbook. Policies need to take into account administrative constraints and, if possible, policies should enhance administrative agility. Good tax policy needs to have good tax policy processes so that the concerns of the private sector are taken into account and so that legislative anomalies are corrected. These issues are discussed in The policy development process.
A good tax administration is not simply one that has the lowest cost. A professional, approachable, effective and efficient tax administration is an investment in a good environment in which to undertake business. What this means for Inland Revenue as it responds to the changing and increasing expectations of government and society is explored in Administrative issues.
New Zealand is increasingly likely to be competing with low-tax jurisdictions for investment. So long as New Zealand continues to provide a high level of government services, it is likely to be unable to compete by undercutting the rates of tax levied in these countries. What we can do is ensure our tax policy and administration are as competitive as possible.
Building trust and confidence in the public sector
Building trust and confidence in the public sector is important to any government. Inland Revenue is one of the most frequent ways that all parts of society deal with the core public sector. In the year to June 2008 Inland Revenue handled 16.34 million contacts with the public, including letters, phone calls and visits to Inland Revenue offices. It is vital for our reputation and the reputation of the public sector generally that those contacts are handled well. If the public loses trust and confidence in Inland Revenue, it is likely to impact on all parts of the public sector.
Inland Revenue deals with substantial amounts of public funds and protects the confidential data of individuals, families and businesses. People rightly expect that Inland Revenue staff maintain the highest possible standards of behaviour. Two important vehicles for reinforcing the commitment to integrity are the staff Code of Conduct and Inland Revenue's Charter, which makes broad commitments about the standards and approach people can expect when they deal with Inland Revenue. Inland Revenue has important responsibilities to protect the confidentiality of the data it has on people and businesses under the secrecy provisions of the Tax Administration Act.
Just as building trust and confidence in Inland Revenue is dependent on maintaining a good tax system, so maintaining that trust and confidence is necessary to make the tax system work well. If the public does not trust Inland Revenue, the integrity of the tax system and the voluntary compliance necessary for a good tax system will be undermined.
1 Source: The Treasury, Budget 2008.
2 Source: The Treasury, Financial Statements May 2008.
3 Issues paper and final report of the Tax Review 2001.
Date published: 30 Jan 2009
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