Q & A – The top five questions on tax reform
Deloitte managing tax partner Thomas Pippos answers your top five questions on tomorrow's tax reforms.
1. What are the economic benefits of the reforms?
The tax switch sets the foundations for future growth but it’s not a panacea to all of New Zealand’s economic concerns.
The reductions in personal income tax from October 1 will increase after-tax incomes and, along with an increase in GST, should result in a tilt in consumer behaviour away from consumption towards savings and investment.
However, the critical driver to economic prosperity is growth in real wages. This package of reforms is a step in the right direction but to achieve material real wage growth an increase in productivity is necessary – which is not solvable by tax measures alone.
2. Will the tax cuts improve workforce participation?
Yes – but the question is, by how much.
Reductions in income tax rates will put more money in the pocket of all employees and this should have a positive effect on workforce participation as the same amount of effort results in more money in the hand.
The critical issue of high effective marginal tax rates for those receiving Working for Families (WFF), however, remains. WFF can result in material marginal tax rates that actively discourage workers from looking to improve their income. As a generalisation they can add another 20% to one’s existing marginal tax rate.
3. How will the increase in GST affect retail prices?
Different retailers will undoubtedly have different reactions to the GST increase, for different products.
New Zealand businesses and consumers live in a GST-inclusive world. Businesses must advertise products targeted at end consumers as “GST inclusive” and retail shoppers react by paying (or not paying) that price. GST is just one of the ingredients that make up that price.
In some situations the price consumers are currently paying may be the top pricing point – and they will not be willing to pay more, regardless of whether GST has increased. As an example, more people may be frequenting the office coffee machine if the price of a latte breaks $5.
Retailers are likely to focus on maintaining and increasing demand for their product rather than looking to immediately recover an additional 2% increase in their input costs.
4. How do these changes fit with the rest of the Budget package?
The tax changes coming into effect on October 1 are part of a wider range of tax reforms announced in the budget, some of which, like the increase in GST, will offset the benefit of personal tax cuts.
For example, the removal of depreciation deductions on most buildings (from the 2012 income year) will have the greatest impact on higher income earners as they are likely to have a greater investment in property.
The extent to which taxpayers will be personally better off in the medium term is effectively dependent on three main factors:
• their annual taxable income (which affects the benefit they derive from the personal income tax cuts);
• the amount of their income spent on items subject to GST (which results in more GST being paid by them); and
• the amount of depreciation deductions they previously claimed on rental and commercial properties that they will no longer be able to claim.
While it’s hard for taxpayers to get past their own circumstances, it’s important to remember that the point of the tax changes is to change the incentives of the tax system to build the economy overall to everyone’s betterment.
5. What about the government’s goal of tax rate alignment?
The tax rate alignment nirvana where the top personal, trust and corporate tax rates are all aligned is best left to people’s dreams – the global downward gravitational pull on the corporate tax rate is such that it will almost always be below the other rates.
Mitigating this gravitational pull in the near term is the insatiable demand for current revenue by foreign treasuries, brought on by the global financial crisis.