Who’s paying all their tax?

Nobody likes paying tax, but for a large number of people it’s now an inconvenience they don’t have to bother with.

Tax avoidance is disturbingly high in New Zealand, especially of the top personal rate of 39%. The government was warned back in 2000 that this new rate would be a nightmare to administer, and the reality is worse than expected.

What’s the evidence for this? First, there has been a massive peak in salaries around $38,000 and $60,000, which just happen to be the thresholds for paying a higher rate of tax. Either this is a bizarre coincidence, or more likely, people are shuffling their income around to avoid the tax.

Another amazing fact from the IRD is that the number of millionaires in New Zealand has actually fallen since 1999 – well, reported millionaires that is. In a period of strong economic growth, it’s hard to believe this is the case.

The problem is that New Zealand has a variety of different tax rates for income (four different levels, from 15% to 39%) and different rates for corporations and trusts. This creates an irresistible opportunity for people to minimise their tax by classifying their income in different ways.

What it means is a boom time for accountants and tax lawyers. Their clients are able to use trusts, split their income with a partner, create a corporate body, and/or sacrifice salary for benefits such as superannuation to avoid tax. In a country like New Zealand with a high proportion of small businesses, the self-employed and farmers, the opportunities to shuffle income are obvious.

This is only human nature. If there is a legal way to pay less tax, you can’t expect people not to take it. As Kerry Packer once said in Australia, “ If anybody in this country doesn’t minimise their tax they want their head read.”

In contrast, most ordinary workers on a set wage or salary have no such luxury. Raising tax from this group is like shooting fish in a barrel for the government – there is nowhere to run and nowhere to hide. The level of avoidance means that the rest of us are carrying a heavier load than would otherwise be necessary.

Unfairness like this undermines the moral foundation of the entire system. This is deadly serious, because to a large degree tax depends upon people accepting the system as fair and reasonable.

So why doesn’t the IRD just crack down on all these loopholes? The problem is that it doesn’t work. They have been trying for the last six years with a range of new laws and audits which have only made the system more complicated. It’s been a losing battle for the government because people are always one step ahead and able to find a new loophole.

On top of this, it’s almost impossible to tell who is using vehicles like trusts and companies legitimately. Using a sledgehammer approach is likely to penalise some people unfairly.

The fundamental problem is the system itself, with its confusing variety of rates. We need lower and flatter taxes instead which are matched to the corporate rate. By aligning the rates there would be no point in shuffling income around; people would just have to pay up.

This would still mean that high income earners pay the vast majority of tax, but it would be much harder to avoid. In fact, given the level of avoidance, a tax cut might cost less than expected. This is exactly what happened in the 1980s when the top rate was cut from 66% to 33%. The amount of money received by the government actually increased, because it removed loopholes and encouraged more taxpayers to come out of the closet.

As a start, the top rate of 39% should be scrapped. In terms of money raised, it has been completely unnecessary. The government has hit the jackpot in recent years with massive government surpluses – $9 billion for this year alone. In fact, taxes could have been cut and revenue would still have been far higher than expected.

No-one doubts that tax is a necessity for a modern, civilized society. But the cost of raising tax in New Zealand is far higher than it ought to be.

Our tax system has become like an overloaded and unbalanced boat. Plugging leaks is not the answer because as soon as one hole is fixed, another one crops up. The answer is to release some of the excess weight and get everybody above deck and rowing, rather than chasing leaks.

Phil Rennie is a Policy Analyst for The Centre for Independent Studies. His paper “How to fix a leaky tax system” is published this Thursday and is available at www.cis.org.nz