What to do when you get what you wish for

John Key said all last year he wanted a “world class tax system”. Now Bill English’s working group has granted him his wish, with a stern injunction to get on with it. This is his big first-term test.

When English told the Treasury and Victoria University’s Centre for Accounting Governance and Taxation Research to form a group to research tax reform, officials thought they would be doing some repairs. By August Bob Buckle’s group had convinced officials the system was “broken”.

Buckle used that word on Wednesday launching the group’s report. He did not do so lightly. As a former Treasury official and now a Victoria professor, he is not given to hyperbole.

The group commissioned a great deal of theoretical and empirical analysis, all on its website, summarised in part in its report and amounting to a primer on what tax is, what it is for, how it works, how it affects economic performance and where it fits in a government’s economic management.

It is nevertheless incomplete. It only cursorily touches on what are loosely known as ”green” tax alternatives. The reason Buckle gave at the group’s one-day conference in December was that it focused on “revenue” taxes, not “behavioural” or “corrective” taxes.

This is an artificial distinction. Petrol tax raises revenue for roads. Tobacco tax raises revenue which helps meet the costs of fixing up smokers’ illnesses. Both affect behaviour.

If there were taxes on rubbish, that might encourage people to change behaviour and make less rubbish but it would also raise revenue and enable a cut in personal and company income tax. Greens call this taxing “bads” (undesirable activities) instead of “goods” (desirable activities).

The working group’s membership wasn’t exactly deep green. Nor is the government, which has shown scant interest in what some call the “green economy” — making money from the environment while also conserving and enhancing it. So the group’s dismissal is a relief to ministers.

But the group itself made plain the artificiality of its revenue/behaviour distinction by complaining that the system taxes too heavily activities that promote economic growth: income from work and profits earned from productive investment.

Its report’s main thrust is to lighten the tax load on these desirable activities — and thus change behaviour by strengthening the incentive to invest in productive enterprises and to work in those enterprises (and not decamp overseas).

More investment is critical to the government’s core policy agenda item: to lift productivity growth, which fell under Labour. Productivity growth is what lifts real wages over the longer term.

That is one criterion for a “world class” tax system: that it improves economic efficiency. Leaving a large “hole” in the system by not taxing capital gains, particularly on rental property, is economically inefficient.

Mark Weldon of the Stock Exchange, who needs more companies on his list and more investors in those companies’ shares, was hot on this at Wednesday’s launch. So was Rob Cameron’s capital markets development taskforce in its report in December.

Not taxing rental property capital gain income is not only economically inefficient, especially if rental losses can be offset as now against other income. It is also unfair and fairness is another critical tax-system criterion. People are less likely to resent paying if they think the system is fair.

The other criteria are systemic coherence, ensuring adequate revenue and limiting the costs to the government and taxpayers in gathering and paying the taxes. That points to a “broad-based, low-rate” system, the aim of the last major reform in the 1980s, since distorted by Labour’s 2000s changes. That in turn points to lower and aligned personal rates, a lower company tax, higher GST (with compensation for those on low incomes) and a targeted low-rate land tax.

The tax system and rates must also be politically sustainable. English emphasised this on Wednesday.

That is why tax is Key’s biggest test this term. He and English have until the Budget in May to make the decisions. While there is still some work to do on detail, Key could if he wants announce the reform programme in the Budget and start on some of the actual changes.

His problem is a cabinet which is hot on law and order but cool on risk and too many ministers who see major tax reform as risk. Also, the cabinet and Key himself closely study polls, which are often a recipe for paralysis. Polls are not signposts to a world-class tax system.

But Key also has opportunity. He has huge spare political capital. He is personable and highly acceptable. If he set out now to persuade the public major reform is needed and a good idea and would in time benefit nearly everybody through higher growth, he would very likely take the great majority with him.

Will he? The first major indicator will be his speech to Parliament on February 9. This is his big year, probably the biggest of his political life.