Taxing Spending: Should We Think About Introducing a Progressive Expenditure Tax

Listener: 7 May, 2005.

Keywords: Regulation & Taxation;

I have long been intrigued by Nicholas Kaldor’s proposal for an Expenditure Tax. Instead of taxing income: what one puts into the economy, why not tax expenditure: what one takes out? Should not those on the same income who can live more frugally pay less tax than the profligate? (Can I hear you saying, “Easton, you are a puritan”? I plead guilty, but am also attracted for environmental reasons.) As Kaldor points out, advocates for such a tax have included Thomas Hobbes, John Stuart Mill, Alfred Marshall and Irving Fisher, which shows that supporting it is not a matter of being politically left or right.

I confess that, more contentiously, I also support a wealth tax (with a large exemption), as did Kaldor, because wealth gives political and social power. I favour lots of private wealth, but the power more evenly distributed. Wealth taxes are not on the current policy agenda (and involve some nasty technical problems). I’d go for an expenditure tax, even without a wealth tax.

GST is a sort of expenditure tax, but it is proportional to spending rather than progressive where one pays proportionally more tax as expenditure rises. It suffers from various loopholes, including the fact that GST is not charged if one spends directly overseas as a tourist or is a modest personal importer.

During the big tax reforms of the 1980s, when GST was introduced, I looked at a progressive expenditure tax as a replacement for income tax. But transitional arrangements make it extremely difficult to introduce overnight. There are just too many opportunities for tax evasion and fiscal instability, while transitional compliance costs would be high.

An expenditure tax is essentially an income tax with savings deducted from income so they are exempted from being taxed. We could move towards an expenditure tax, by subtracting some savings when income is calculated for tax purposes. This is particularly attractive these days when New Zealand is desperately short of domestic savings. As shown by the rising current account deficit – how much we borrow overseas – we need to save more. It is not just that the nation may be increasingly owned by foreigners, but we are also increasingly vulnerable if there is an international financial crisis.

Will subsidies raise the private savings rate by more than they reduce the public savings? The empirical evidence as to how people save is murky. The evidence suggests that people don’t behave according to that mainstay of economic theory, rational economic man. Significant savings are most likely to occur when people lock themselves into long-term savings plans. This suggests that, given the national savings deficit, we might use the government subsidies to get people to commit themselves. That is a major attraction of the September 2004 Harris Committee’s proposal to encourage workplace based schemes, a voluntary version of the 1975 New Zealand Superannuation Scheme, in which worker’s commit themselves to investing directly some of their wages and salaries into pension accounts. The government is expected to announce its response (and also fostering home ownership) in the Budget.

The proposal will not rule out other measures to promote private savings. We could exempt from taxation income deposited in certain sorts of long-term savings accounts. When someone does their tax return they would deduct those deposits from the their income liable for tax. However, when they withdrew savings in the account, the withdrawals would be taxed as if they were income.

Would this be an incentive to save? The scheme defers tax, rather than avoiding it altogether. (Experts call it an “EET” scheme, since deposits and interest are “exempt” but withdrawals are “taxed”. Our current approach is “TTE”.)

Deferral has its attractions. First, the savings are likely to be withdrawn when one is retired with less income, so the tax rate would be lower. Second, since nobody fully trusts the government, better to avoid paying tax now than expect any promise to avoid paying in the future, the current arrangement.

Any deferral means the government receives less tax revenue, so it saves less even if we save more. I can think of ways of maintaining fiscal discipline. Introducing a partial expenditure tax will involve a lot of thinking. We should think about it.