When the electorate will not support capital gains, wealth, inheritance or land taxes, how can we enhance equity?
The top priority is to lift productivity to make everyone on average better off. How can this be done equably, within constrained policy space?
An ideal “first best” policy mix might be compulsory savings, a capital gains tax, and more optimal human capital policy settings impinging on NZS eligibility age as well as on education and immigration.
Compulsory saving can lift domestic savings rates to lift labour productivity, reduce the real exchange rate and improve export competitiveness. Deeper and more patient capital markets would foster the growth of knowledge-intensive firms owned and anchored in New Zealand.
Capital gains taxes can reallocate capital from inflating property prices into wealth-creating tradeable sector investment. Lifting the NZS entitlement age would free up money to invest more in educating those too young to vote.
Though such policies would be politically self-immolating, the outcomes sought could be achieved through “second best” policies, through focusing on multiple objectives with single policy instruments, through rethinking capital and labour dichotomies, and through enhancing active knowledge flows:
Lipsey and Lancaster’s 1956 paper The General Theory of the Second Best addresses the challenges faced when one market failure cannot be solved to achieve optimality. In such cases, it may not be wise to seek optimality in solving other market failures. The best policy might therefore be second-best interventions.
For example, ideally a binding global agreement should place a cost on greenhouse gases and allow markets to drive emissions reductions to achieve an optimal mitigation response. However, if this first-best policy is unachievable we must look to second-best policy such as forest planting, and interventions to encourage electric vehicles, distributed generation, bioenergy, biochar, and building in wood.
A capital gains tax might be first-best policy, however equity can be progressed through augmenting owner-occupied housing with new state, social and private rental housing models that can deliver affordable and secure housing.
To overcome capital misallocations, the state can invest in a targeted way in knowledge-intensive firms to ensure they are capitalized for long-term growth and anchored in New Zealand. Such a policy would be second-best in California or Texas, however it might be first best in capital-light New Zealand.
The 1972-75 government introduced a first-best, retirement-focused compulsory savings scheme. Were it not abandoned when the government changed in 1975 New Zealand would have avoided premature industrialization and be a much richer country today.
While the New Zealand Superannuation Fund and Kiwisaver are both “second best”, collectively they form a strong foundation to build from. They could be augmented by savings and investment interventions that are geared towards human capital development and to tradeable sector capital formation.
Multiple objectives with one policy instrument
The Tinbergen Rule argues that for each policy objective at least one policy instrument is needed. Many policy interventions can be used, however one will always be better than the others. This rule has been dogmatically interpreted to mean “one policy instrument for one policy objective” – Tinbergen had a finer mind.
Mixed objectives can dissipate effort, and make performance management more difficult. This thinking influenced the 1980s and beyond state sector reforms; often for the better. The Reserve Bank was given an inflation band target as its major objective, and the OCR mechanism as its main lever.
Government trading activities with economic, employment and regional development objectives were corporatized and given a single commercial objective. This led to significant productivity gains. However, it also led to ideological overreach as privatization and offshore asset sales meant New Zealand sold its banking and insurance sectors at a time when the service sector was growing and becoming more knowledge-intensive. We blundered down the deskilled low road when we could have chosen the knowledge-intensive high road.
Multi-functional land management was replaced with single-purpose conservation, forestry and farm land use models. This contrasts for example with multi-functional forestry in Germany and Scandinavia which has supported economic, environmental and amenity value services for centuries.
Some interventions can have a dominant objective, while allowing flexibility around individual circumstances, or allowing other objectives to be progressed. An example is the ability to draw down KiwiSaver for home ownership.
It is also possible to use one instrument to promote multiple objectives that deliver optimal societal benefits even where some objectives will be delivered sub-optimally. For example, Singapore-style individual development accounts can support education, life-long learning, health, home ownership and retirement savings, while also lifting overall domestic savings rates. Draw-down from these accounts depends on an individual’s needs and life-stage.
Rethinking capital and labour dichotomies
Thomas Piketty uses capital and labour shares as equity indicators – when the returns to capital exceed economic growth rates equity falls.
However, capital and labour overlap. Education creates human capital, and returns from it can exceed those from land, rental property and other capital investments. Wage and salary earners also receive income from capital investments they make through Kiwisaver or shares. The value of knowledge-intensive firms can largely be intangible capital (skilled workers and intellectual property) rather than physical capital (plant and equipment).
Given advances in digital technology, computing and artificial intelligence, on-line learning, and economically tractable big data the lines between human and physical capital are likely to blur even further.
Investment in human capital is the best way to lift productivity and enhance equity. Critical investments include literacy, numeracy and digital skills capabilities that provide the foundation for deeper learning and for multi-disciplinary connections. Effective learning will increasingly require distilling useful knowledge from otherwise overwhelming information overload, and ensuring that learning directions support individual life-narratives.
Enhancing productive knowledge flows
Economics is about individuals with their evolved human psychology and computational powers, self-interest, and the information flows and decision making that harmonize individual and social benefits.
That information is imperfect, distorted in transmission and asymmetrical is core to economics. This shapes our institutions, laws and regulations, consumer behaviour, student choices, market structures, and how we deliver services. Information failings have catastrophic consequences. The 2008 Global Financial Crisis came partly from the loss of publicly visible transaction records that linked derivatives to the real property underlying their value.
Enhancing information flows in ways translating into productive knowledge has massive wellbeing potential. It requires moving as close as possible to complete and symmetrical information that is construable and acted on in social value-creating ways.
Enhancing productive knowledge flows needs filtering devices and choice architecture to focus human construal and computational power on what creates value. For this to work for society as a whole it needs to create mutual benefits.
We face new challenges – and opportunities. The Internet has turned an information-constrained world into one overwhelmed by information that is difficult to navigate and draw meaning from. People who managed bounded rationality through rule of thumb heuristics and satisficing now face boundless distractions that obscure what matters.
Interventions to enhance productive knowledge flows need underpinning principles; religious or secular. When selling houses and used cars the Golden Rule tells the saint-like among us to show buyers the borer in the roof beams and the parts held together with duct tape.
The Islamic gharar principle constrains trade with high uncertainty, for example when the buyer does not know what she bought, or the seller what is sold. An Islamic scholar defined gharar as something that has “a pleasant appearance and a hated essence”.
For secular good citizens information flows must strive for mutual and equitable benefits, be based on respect for others, and integrity in every transaction. At a minimum it means “do no harm” whether in our free expression or through what we keep private.
Therefore, those who despair of improving New Zealand’s productivity and well-being through tax policy changes can take heart from other policy options still available to us. These options require new thinking, new ways of leveraging information’s non-rival properties, of creating human capital, and of harmonizing short and long term and private and social benefits.