I wrote a book! (I know, I am as surprised as you...) Casey Plunket from Chapman Tripp says parts of it suck. I say otherwise.

Late last year, the Institute of Policy Studies published my book about tax in New Zealand. In The New New Zealand Tax System, I document how much tax different groups of people in New Zealand pay overall, taking into account income-based and consumption-based taxes, and how that tax bill compares to what similar people pay overseas.

The Herald did an article on the book last week, which upset Caset Plunket of Chapman Tripp. In short, Plunket thinks a capital gains tax is not necessary in New Zealand because our company tax is bigger than the OECD average.

Now, in the latest gripping turn in this saga, here is my press release responding to Plunket.

13 February 2012 – For Immediate Release
 
Plunket claims about corporate tax simplistic and misleading
 
Casey Plunket’s claims (Chapman Tripp press release 10 Feb 2012) about the role that corporate tax plays in New Zealand are misleading, says Rob Salmond, author of The New New Zealand Tax System.
 
Plunket says that New Zealand does not need a capital gains tax because of its robust corporate income tax regime. Plunket’s argument overlooks two important points.
 
First, while New Zealand’s corporate income tax is indeed larger than most in the OECD, New Zealand is also more forthcoming than the rest of the OECD in allowing shareholders to fully write-off corporate income taxes against their already-low personal income taxes.
 
“Using corporate taxes as a reason to not have a capital gains tax, Mr Plunket ignores the relatively generous compensation that shareholders now receive elsewhere in the tax system.”
 
This issue is addressed on pages 100-104 of The New New Zealand Tax System.
 
Second, Plunket says Salmond ‘confuses legal liability with economic liability.’ In fact, it is Plunket who is confused about how economic liability for corporate tax works.
 
Shareholders do not ultimately shoulder all the burden of corporate taxes, as Plunket claims. Firms can raise the funds to pay corporate taxes in at least three ways:
·      they can fund the tax from their customers through higher prices;
·      they can fund the tax from their workers through lower wages;
·      they can fund the tax from their shareholders through lower profits.
Firms can also engage in all of these activities at once in order to pay the tax.
 
Individual firms decide among these strategies based on the risk of financial repercussions from the affected party. When shareholders can easily move their investment elsewhere, for example, firms will be less likely to ask shareholders to fund the tax.
 
“There are sharply divergent views among leading economists about how much of the corporate tax burden is ultimately borne by consumers, workers, or shareholders. Little of this research supports Mr Plunket’s view that ‘the corporate income tax is a tax on shareholders.’  Making policy proposals based on this assumption is simplistic and misguided.”
 
This issue is discussed on pages 48-52 of The New New Zealand Tax System.

 

 

 

Comments (9)

by Matthew Percival on February 13, 2012
Matthew Percival

For your first point Rob are you referring to the Imputation Credit system and how we don't have double taxation in New Zealand versus a classical tax system where income is taxed at both the company and shareholder level?

I don't entirely comprehend your second point. You say firms can raise funds through higher prices. That isn't always going to produce more income and if it does the additional profit will also be taxed. Same deal with lowering wages, any savings add to the profit and will be subject to tax and the firm may no operate in the same manner with a lower wage bill.

Without reading Plunkett's viewpoint I think he is coming from the following perspective. The shareholders are entitled to the profits of a company (although some of the profits will need to be re-invested). However prior to accessing those profits the company has to pay company tax, therefore the company tax is ultimately a cost to the shareholder in accessing the profits of the company.

by Rob Salmond on February 13, 2012
Rob Salmond

@Matthew

On your first point: Yes.

On your second point: I will answer by way of an example. Consider a firm that makes $1m in gross profit. In year 1 there is no tax, so net profit is also $1m. Everything is in equilibrium. In year 2 the government shows up and demands 20%, breaking the equilibrium, but nothing else about the business environment changes. Does it follow that the net profit will automatically drop to exactly $800k, meaning the shareholders pay the whole $200k int tax bill? No. Here are some things that migth happen instead:

1. The business reacts to the tax by increasing prices. If sales stay the same, this might take gross profit to $1.25m, which would give net profit of $1m leaving shareholders with no tax burden and customers with 100% of it. But (as you note) some customers might refuse to buy at the higher price, maybe taking gross profit down to $1.125m (or any other number, I am just using this for illustration). In that situation, the new net profit would be $900k, with shareholders funding just under 50% of the tax and customers paying just over 50%. Firms with inelastic demand curves are in an especially good position to pass on tax costs to consumers. Illustrative example: Apple.

2. The firm reacts by cutting wages (or not providing wage increases). Let's say they cut $250k in wage bill. That would take gross profit to $1.25m, net profit to $1m, shareholders fund none of it, labour funds all of it. But, as you might fear, lower wages can sometimes lead to lower productivity. That might, for example, lead to lowered profits, say back down to $1.125m, giving net of $900k, with the tax funded just over half by labour and just under half by shareholders, compared to the equilibrium levels the year before. Firms can use this strategy especially well when there is surplus labour supply. Example: major employers in small towns, employers in an environment of persistent, high, or rising unemployment.

The problem with the argument you state and ascribe to Plunket is that it assumes the level of gross profit is unaffected by the rate of profit tax. That assumption is false.

There is also an accessible, fair-minded discussion of this issue here:

http://www.econlib.org/library/Enc/CorporateTaxation.html

 

 

 

 

by Matthew Percival on February 13, 2012
Matthew Percival

Thanks for the explanation.

If the company can either cut costs or raise income in year 2 the first thing I would be asking as a shareholder as why wasn't the company doing those things in year 1!

In your example it is highly unlikely the company is being run as efficiently as it could be in year 1. Why did it take the implementation of tax for the company to start performing at a more optimal level?

In your example the shareholders have lost out in year one. The company made $1mil in net profit but could have made $1.25m if management had the foresight to price their product/service in accordance with how the market values their product/service. Thus the shareholders have lost out on $250,000. It is not fair to use year 1 as a base point for year 2 and try to ascertain who is funding what because the business is not running at the same efficiency across both years.

A business should be meeting the market at the value at which the market values the product/services of the business. A business that values it's products/services on a cost + x% basis is not being run at it's optimal efficiency and it is the shareholders who miss out.

by Andrew R on February 13, 2012
Andrew R

Is this the same Casey Plunket that the economicillteracy blog had this to say about:

Hard-pressed Chapman Tripp lawyer Casey Plunket has laid the smack-down on Labour’s plans for a capital gains tax by announcing that “high earners” – presumably Chapman Tripp lawyers – will desert the country in droves as they seek lower tax rates elsewhere: Lawyer Casey Plunket, whose personal tax rate would increase from 33 to 39 cents in the dollar under Labour as someone who earns more than $150,000 a year, says it would lead to more high earners heading overseas. It’s difficult to know where to begin with a statement this stupid. He presumably lives in New Zealand because of family connections, because he can get a job he enjoys working with people he likes, because it’s a great place to bring up his kids, because it has some of the best quality of life in the world …. but no, apparently he lives here because we have lower marginal tax rates than Australia.... 

by Ross on February 15, 2012
Ross

Matthew,

I am not sure I follow your logic, or understand your point.

Companies do increase prices, cut wages, and or cut their profits. The Ports of Auckland are currently trying to slash their wage bill. Does that mean their wage bill has been too high?

by Ross on February 15, 2012
Ross

Matthew,

I am not sure I follow your logic, or understand your point.

Companies do increase prices, cut wages, and or cut their profits. The Ports of Auckland are currently trying to slash their wage bill. Does that mean their wage bill has been too high?

by Matthew Percival on February 16, 2012
Matthew Percival

I'm not sure how I can put it much differently.

It shouldn't take an economic downturn for a business to look at it's effiicencies. A business should be periodically reviewing it's costs and making efficient decisions.

My understanding of the Ports of Auckland situation is limited so I'd rather not go there except to say that if this is a good idea why didn't they try and do it 10 years ago?

 

by Ben on February 17, 2012
Ben

i think Matthew's point is that tax is not going to determine whether managers squeeze their customers or their workers more... Fiduciary obligations to shareholders mean managers must do these things as much as possible anyway.

All profits must go to shareholders in the long-term, subject to short-term allowances (call them a form of  "retained earnings") for paying projected tax liabilities.

Any change in corporate tax therefore comes out of the shareholders' end, no-one else's.

by Chris Taylor on February 21, 2012
Chris Taylor

In his article, Casey Plunket compares the NZ corporate tax take to other OECD countries: "...corporate income tax accounted for a higher proportion of tax revenue here than in most other OECD countries".  Casey Plunket then states that this "the" reason why the Tax Working Group did not advocate a capital gains tax. 

My reading of this is that the tax working group did not reccomend a capital gains tax in New Zealand because it would result in New Zealand shareholders having to wear a disproportionally (compared to in other OECD countries) higher proportion of the total tax take (directly though capital gains tax and indirectly through corporate tax) and that that would not be a good thing.  Putting aside the issue of whether or not that would be a good thing, what is not clear to me (not having read the tax working group's report!) is whether the tax working group took into account the difference between the taxation treatment of distributions from corporates through the OECD countries.  Rob, you seem to imply in your article above (in the first of the points that you make in response to Casey Plunket) that the tax working group did not take that into account - are you able to please confirm this (and thereby let me escape from the need to read the TWG report!).  If the tax working group didn't take that into account, that would seem to me to be quite an ommission where the basis for the justification that they gave for not having a capital gains tax (based on my understanding) centres around the tax burden on the shareholder.

 

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