This article was published on 26 July 2008. Some information may be out of date.

Q&As

  • Would it be better to raise GST and lower income tax?
  • Possible raising of retirement age not a good reason to stay out of KiwiSaver.

QThere have been suggestions in the press recently that the government should help increase household incomes by reducing GST. Others have suggested reducing income taxes. I think GST should be increased and income tax decreased for the following reasons.

It seems that when you tax something more, people use less of it. Take for example a proposition to charge drivers over the Auckland Harbour Bridge 50 cents a ride. That cost would hardly affect the flow, except at the toll gates. At $5 you would see a huge drop off, and at $100 the bridge would be almost empty.

So there is a correlation between the activity and the cost. You could graph it with confidence.

It follows that if you increase taxes, people will work less. This is especially true when their increase in pay can disqualify them from receiving other government handouts such as Working for Families or rent supplements.

On the other hand, increasing GST would encourage good behaviour. If GST was increased to say 15 per cent and income taxes were reduced to “give back” an equivalent amount, what behaviour would that encourage?

The average person would get to keep more of his or her pay packet (or benefit) for the same amount of work/effort and that would encourage them (or at least remove the disincentive) to work harder.

The increase in GST, and therefore costs — except for residential rent and finance costs, which aren’t subject to GST — would encourage people to consume less. That’s good, because we would import less and produce more to export.

Domestic savings would go up, banks would have more to lend, so interest rates would drop. The exchange rate would drop too and that would help exporters.

Well off people would continue to consume their big ticket items, (they have always paid the most in GST anyway), and so more rich people would come here to live and invest, and isn’t that what we need?

Have I missed something or is this simply politically unpalatable?

AIt all sounds pretty good — although we should note that not everyone wants interest rates or the Kiwi dollar to fall, and I’m not sure those falls would happen anyway. You might have oversimplified the economics a little.

But the big concern is who gets hit hardest by higher GST. It’s true that the rich pay more dollars in GST because they spend more. But those on lower incomes — who can’t afford to save much — end up paying GST on a bigger proportion of their income.

With GST at 15 per cent, someone earning $500 a week and spending $480 of it would pay $72 in GST. Meanwhile, their friend earning $2000 a week and spending $1500 of it would pay $225 in GST. The friend’s income is four times as high but they are paying only about three times as much tax. That doesn’t sit well with many people.

Having said that, in another way the rich would be greatly affected by an increase in GST. You can’t avoid paying it by setting up trusts and other tax dodges.

That, and its simplicity, are big pluses for GST. And for the simplicity we have to thank Roger Douglas. As the finance minister who introduced GST, on October 1 1986, he made a point of applying it across the board at the same rate — then 10 per cent.

Ever since then, there have been suggestions every now and then to reduce or eliminate the tax on such items as basic foods.

But, having seen what happens in other countries with complex consumption taxes, I’m really glad we don’t do that. There are endless debates on what should qualify for the lower rates, and much more complicated accounting. It’s got to be more efficient for a government to assist the poor in other ways.

Perhaps that’s the solution. Raise GST and at the same time lower income tax particularly for those on lower incomes, and boost benefits. That’s how Douglas sold GST to New Zealand in the first place.

QThe main reason I have advised my adult children not to opt in to KiwiSaver is because the retirement age can be raised at any time.

Four per cent of my daughter’s annual income equates to $1700 a year. At age 33 she has 32 years until current retirement, so her total contributions would be about $55,000.

She is single and has a mortgage of $160,000 for another 20 years at currently 8 per cent. With a recession ahead, the interest rate will probably increase.

I consider the $55,000 that she would be investing in KiwiSaver (which isn’t guaranteed) would be spent more wisely on her mortgage reduction. Especially since if the retirement age was raised she could be waiting until she is 70 or older and may not be in a position to enjoy it anyway.

I consider the raising of the retirement age a real factor, but not many economists seem to think this a problem. Am I wrong?

AIf your daughter suffers from ill health, and is likely to die relatively young, the possible raising of the NZ Super age might be a big deal.

Otherwise, though, I don’t think it makes all that much difference. The current life expectancy for a woman at 70 is 17 years, and it is likely to be longer by the time your daughter is that age. Don’t you think it would be good for her to have some spare spending money then?

The fact is that she will almost certainly be far better off if she saves via KiwiSaver, making use of mortgage diversion after a year in the scheme, than if she concentrates on mortgage repayment alone.

For simplicity’s sake, let’s assume she stays on the same pay. The numbers work out like this:

  • In her first year in KiwiSaver she will get the $1,000 kick-start, the $1,043 tax credit and employer contributions of at least 1 per cent until next April, then 2 per cent. All of this will much more than double the $1700 she puts in.
  • After her first year, she can divert half her contributions, $850, towards mortgage reduction — which, as you imply, is a great idea. The other $850 stays in KiwiSaver, and she will get a tax credit matching that, plus an employer contribution that will start out also matching her money and then rise, so her contribution is more than tripled.
  • From April 2011, when her employer is contributing 4 per cent, or $1700, her contribution will be quadrupled.

As I’ve said before, four times as much money in is four times as much out in retirement. There’s no way simply repaying her mortgage can match that.

And while it’s true that there are no guarantees on KiwiSaver, your daughter could go into one of the ultra-safe funds that invest not only in bank term deposits but also something even safer — government and local body securities. If such a fund doesn’t grow steadily, we’ll all have more to worry about than KiwiSaver balances.

I would hope that as she learns about how share markets fluctuate but grow over the long term that she would venture into a riskier fund with a higher average return — given that she has decades to play with. But even if that doesn’t happen, she will still do really well.

You also worry about your daughter’s struggle if, for example, mortgage interest rates rise. But don’t forget that after a year she can always take a KiwiSaver contributions holiday and then put in any amount or nothing.

And if things get really tough at any stage, she can withdraw all her contributions, employer contributions and the investment returns on all her KiwiSaver money — everything but the government’s contributions. This would place her in a much stronger position than if she stays out of KiwiSaver and therefore misses out on the employer money and the returns on the employer and government money.

We should note that your daughter’s pay is highly likely to increase over the years. And once she receives more than $52,150 a year, her 4 per cent contribution will total more than $2086 a year. That means she will divert more than $1,043 and leave more than $1043 in KiwiSaver. And given that the maximum tax credit is $1043, her money will no longer be quadrupled. Still, it will continue to be more than tripled, whatever her pay level.

Another advantage of KiwiSaver with mortgage diversion is that the saving will always happen — unless she takes a contributions holiday. Out of KiwiSaver, she might not have the self discipline to save.

On the negative side, KiwiSaver does tie up her savings, so she can’t get hold of the money before retirement unless she suffers financial hardship or serious illness. That’s why I suggest she contributes no more than 4 per cent of her pay. But you’ve got to admit that the KiwiSaver incentives turbo-charge that 4 per cent.

And if a future government reduces the incentives, your daughter can simply stop contributing, content in the knowledge that she received all the good stuff while it was on offer.

Convinced? I would be interested to hear any further arguments against KiwiSaver for someone in your daughter’s position — from you or others.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.