Wednesday, February 21, 2024

Tighter tax take points to trouble ahead

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We’re entering a stage in the economic cycle that could be a major wake-up call for society, Cameron Bagrie says.
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You can only push so far against the laws of economics before there are consequences.

Inflation siphons money out of people’s pockets and adds to costs.

Higher costs, if not matched by revenue, mean lower profits.

Less profit means less tax.

And so, one of the key indicators to turn of late has been government tax revenue.

Throughout 2021 and 2022, tax revenue beat expectations, courtesy of a stronger economy and low unemployment, which boosted income tax. Farmers paid a lot of tax.

That worm has now turned. Tax revenue is still rising in aggregate but coming in below expectations and some tax components are showing major declines.

Tax revenue undershot the Half-Year-Economic and Fiscal Update projections in the fiscal year to January, February and March, with March showing a $2.3 billion gap to forecast after being broadly flat in the six months ended December.

The culprits included lower terminal tax, provisional tax and goods and services tax, which are all barometers of the profit cycle. When firms and farmers make less money, they pay less tax.

Figures for the 10-months to April (which are now comparable with the updated Budget 2023 projections) showed core Crown tax revenue $1.4bn below expectation and total revenue $1.5bn lower. The Treasury lowered its core Crown revenue projections in the 2023 Budget from $130.2bn to $126.7bn and tax revenue from $118.1bn to $115.3bn for the year, and the out-turns still came in a lot weaker.

Here are some key tax divergences.

Corporate tax revenue for the month of April 2023 came in at $1bn compared to a forecast of $2.7bn (a variance of minus 64%) and this compares to $1.6bn in April 2022.

Corporate tax revenue for the 10 months ended April was 6% ($940 million) below the same period for the prior year (though 2022 was a good year).

Other person’s tax (individual tax outside PAYE) for the 10 months ended April was 6.2% ($535m) below the same period for the prior year, reflecting lower provisional tax estimation.

Other person’s tax was 28.6% lower in the month of April 2023 compared to April 2022.

Less terminal and provisional tax has been a big driver. Businesses or farmers are not doing as well as the Treasury thought they were.

Overall, the tax take is still up in the 10 months ended April 2023 compared with the same period of the prior year, supported by PAYE, reflecting a strong labour market.

However, the turn in some tax components is significant and signifies the brutality of rising costs.

Inflation comments tend to focus on households. The consumer price index peaked at 7.2%.

Producer price inflation for non-labour inputs (the business equivalent of household’s consumer price index) peaked at 9.7%. Farm cost inflation rose to 15% and is currently running at 12%, though that includes interest costs, which are not included in the consumer price index. The cost-of-living index measure, which includes interest costs, peaked at 8.2%.

The rural sector is particularly exposed to rising costs because they are a price-taker on the revenue side. The lower New Zealand dollar has helped but commodity prices are under pressure as global economic conditions deteriorate. 

A lot of cost increases have been beyond businesses’ control, including covid, supply chain challenges, Ukraine and energy prices. Some of these have eased and, globally, what we call goods inflation is receding.

The economy still has ample demand with constrained ability to meet it, which has been a recipe for price rises. Firms are still struggling to fill job vacancies, though border reopening has helped. 

But inflation can also be put down to a gap between ideology and reality. Pick your example. 

Take the consistent ramping up of the minimum wage, which adds to costs. I’m for higher wages and some catchup was needed to put some respectability and fairness into incomes, but the speed has been phenomenal and productivity gains are not matching. Firms have not been able to adjust to the speed. 

Or how about the slow re-opening of borders and regulatory impediments to getting much-needed employees into the country?

The extent of the turn in the tax cycle is one reality reset. Costs hit profits, which hits tax.

Some pull-back in profits was to be expected. Profits tend to do well at the top of the cycle and are more sensitive to movements in the cycle so suffer more in tougher economic times.

As profits come under pressure, so too does the inevitably of the next stage of the economic cycle.

Part of restoring economic balance will be a stronger focus on costs and efficiency. Analysing labour inputs/costs will be a major part of it. This is the stage of the economic cycle we are now entering, and it could be a major wake-up call for society. Taming inflation is not friendly for asset prices, spending, profits, or jobs. We have yet to see the impact on jobs. 

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