Opposition leader Chris Hipkins has said that the Labour Party is looking at campaigning in 2026 on the need for heavier taxation. Capital gains taxes, wealth taxes and a land tax are “back on the table”.

There is indeed a longer-term fiscal issue. Treasury’s long-term projections show that the ageing population will cause unsustainable fiscal deficits if nothing is done to reduce spending or raise government revenues.

Labour’s own fiscal profligacy has brought this problem forward.

In Budget 2018, Treasury forecast that spending under the Labour-led government in the year ended June 2023 would be only 27.9% of projected GDP. Revenue was forecast to be 30.1% of GDP. There would be a fiscal surplus.

We know now that spending in 2023 was a staggering 32.3% of GDP. Meanwhile, outcomes in the big three spending areas of health, education, and social welfare had become increasingly unacceptable. Revenue was also up, but by far less – at 31.2% of GDP.

Treasury has declared that the resulting fiscal deficit is structural. Spending growth must be cut, or revenue increased.

Options for cutting spending growth

There is no shortage of options for cutting spending growth, the difficulties are political.

The quality of government spending is extraordinarily low. Spending programmes commonly lack a clear over-riding objective. That accountability problem is aggravated by resistance to proper measurement of results in relation to intentions.

This lack of transparency breeds waste and surely fosters corruption. The Auditor-General has repeatedly warned the public about these matters.

Much government spending is on activities that people could otherwise purchase directly from private providers rather than paying through the tax system. Most health and education spending is of this nature.

Paying through the tax system costs more. There are compliance and collection costs, as well as hidden costs. The hidden costs include the time and effort people put into reducing their tax burdens and the lost value from their changed activities. For example, an income tax is a tax on work that makes leisure more attractive.

If the government were to reduce progressively public provision where it is not needed, affordability issues could still be alleviated through the tax/income support system.

New Zealand Superannuation could be made more affordable by raising the retirement age and indexing it to the cost of living rather than wage rates.

It could also be means tested or asset tested. Why pay it to millionaires? The Residential Care Subsidy is an asset tested precedent.

Against this, we need government to excel in the provision of public goods. The inadequacies of the public health response to Covid-19, the debacles over immigration and the public infrastructure problems demonstrate the inadequate focus to date.

Few people probably realise how little taxation is needed to fund government spending on public goods. Statistics New Zealand’s annual assessments of how much spending is on ‘collective consumption’ are an indication of this. Its latest published figure is for the year ending March 2022. Spending on collective consumption was only 7% of GDP.

The big problem for politicians is public opposition to changes in the status quo.  But neither do people want themselves to be the ones paying higher taxes.

Taxation options

The major tax options are income and expenditure taxes, land taxes (e.g. rates) and wealth taxes. (Capital gains taxes are a subset of income taxes.)

Which combination is likely to be optimal? The economic literature on optimal taxation explores how to raise the required tax revenues at least cost to the community.

Heavy rates of taxation on capital income are a concern because capital is mobile internationally. The rest of the world does not have to invest in New Zealand and wealthy non-citizens do not have to migrate to New Zealand. Yet New Zealand needs more investment from overseas with the know-how, skills and market access that it provides.

An expanded scope for New Zealand’s existing capital gains taxes is attractive in terms of ‘perfect world’ economic theory. But, the problems of assessing capital gains, adjusting for inflation and accommodating cash flow needs are real. The difficulties are practical, not ideological.

The efficiency case is further weakened by likely exclusion of a capital gains tax on the family home.

An annual wealth tax looks even more problematic. Valuation problems make a broad-based one unimplementable. Tax lawyers and accountants will thrive by disputing IRD assessments.

As with a capital gains tax, unrealised wealth losses should be paid out, except they will not be. That failure is distortive. The inevitable failure to impose an annual wealth tax on the family home will be another distortion.

The overseas experience with wealth taxes accords with such concerns. The number of OECD member countries levying individual wealth taxes dropped from 12 in 1990 to only 3 in 2020.

But first things first. The prime need is for the government to stop spending so much money so poorly.

To read the article on the NZ Herald website, click here.