Financial transaction taxes and New Zealand
Posted April 29, 2008on:
Given my uncertainty about who to vote for the the next New Zealand general election I’ve been exploring registered political parties wikipedia pages. While looking I noticed that a number of smaller parties tended to favour a financial transactions tax (Progressives, Alliance, Democrats, and Direct Democracy). Looking at the parties websites, the only party I could find that mentioned the Financial Transaction tax was the Democrats.
The reasons they gave for the tax were:
- It will reduce businesses compliance costs,
- Reducing collection costs by having the tax administered through banks,
- It will increase everyones spending power as the tax rate will be lower than the GST rate but raise the same amount of revenue.
However, I’m not sure I entirely agree, here is why:
Lets focus on the third point (the other points sort of fall out of it) – that it will lead to the same level of government revenue but at a lower rate of tax increasing peoples disposable income with no trade-off. When I put it this way it seems ridiculous, and that is because it is ridiculous – you can’t reduce the amount of tax you take from the economy and increase the amount of tax you make at the same time. As an economist I don’t like to say that some statements are entirely wrong, but in this case it is. More then that it is blatantly misleading!
In order to see this more robustly, lets talk about how the financial transactions tax works. The financial transaction tax is a tax levied on every dollar withdrawn from a financial intermediary. Now lets take an example from the New Zealand 2001 tax review.
Say that the tax is set at 5%. Firm A takes out $100 to make a good – thereby paying $5 in tax. Firm A then sells this good for $200. Customers withdraw $200 to pay for the good, paying $100 in tax. As the market transaction created $200 of value and $15 of tax the true tax rate is 15/200=7.5% As a result, the 5% tax rate is a guise – depending on how many “layers” there are in the economy the true tax rate may be substantially higher than that.
As a result, the tax rate would have to be “effectively” the same in order to raise the same revenue as GST which it is supposed to replace.
There are further problems with the tax. This tax penalises industries which are more vertically dis-integrated, as a 5% tax rate is charged the whole way down the value chain. For example, if we add one more firm into the production process in the above example the effective tax rate in the industry rises to 11.25%. This will lead to a number of negative consequences:
- Increases the cost of making complicated products that require a large value chain relative to simpler products,
- It changes the relative price of products based on their complexity – this is something that does not involve the fundamental value of the product, implying that it will cause inefficiencies in the allocation of resources,
- It convinces firms to vertically integrate when they otherwise would not have – thereby leading to competition issues further down the value chain of the industry.
One final issue I wish to raise is this taxes impact on saving. As savings is deferred consumption for an individual or household, this is effectively a tax on savings – as when you withdraw it you will have x% less than in the absense of the tax. At the margin this would lead to a reduction in savings behaviour (as people decide to hold funds instead of placing them in the bank) which would eventually lead to a lower quantity (and higher price) for investment activity.
No tax system is perfect, however I find the financial transaction tax perverse as a means of raising revenue. As a tax it has the largest impact on some of the goods that provide the most economic value, it is more economically inefficient then GST and it is not transparent – given that the true tax rate on a certain good with this tax depends on the length of the value chain.
As a result, I still don’t know who to vote for. I can’t vote for Labour or National given my historical feelings, these parties are ruled out because of their support for a subversive and inefficient tax mechanism, ACT and Libetarianz are overly obsessed with vouchers and seems to lack an understanding of some forms of social value, NZ first are racists, United support income splitting and are overly conservative, the Family/Kiwi/Pacific parties are all religious, Legalise, Maori, and Republic parties seem to focus on specific issues rather than governance, and the Green Party understand externalities but not government failure.
Where is the party for the middle of the road economist in New Zealand?