New Zealand - Raising GST might not lift savings  

It is likely tomorrow that in the 2010 Budget, Finance Minister Bill English will cut income tax rates while raising the rate of GST from 12.5 per cent to 15 per cent, effective probably from October 1, writes Tony Alexander this week.

One reason given for the shift in where tax comes from is to discourage consumption and encourage saving.

The theory is that if people have to pay more for goods and services, they will buy less. But there are two problems for those hoping the moves will improve household savings.

First, because the amount given back in income tax may roughly match the extra taken by GST, the net impact on purchasing ability of a typical household will be minimal. Second, the rise in GST itself is a signal not to save.

This is not just because one will have an incentive to spend more and finance it at a low interest rate before October 1, but because of what will happen to savers.

If, in the past, you have saved money instead of spending it, your wealth will decline in real terms by around 2.2 per cent on October 1.

You will be punished for your saving while those who spent the money will have had both the enjoyment and a 2.2 per cent price advantage.

The government is likely to highlight that fiscal restraint will be needed for many years and that there are some major issues down the track as the population ages.

In other words they will be highlighting a future environment in which extra tax may be needed. The easiest way to gather it is a GST increase, as European governments are doing at the moment in their time of fiscal crisis.

GST was introduced in 1986, raised in 1989, and again will be raised in 2010.

Does one have an incentive to spend in order to beat the next increase another 20 years from now? In theory, yes, but that is so distant, hardly anyone would take such a tax hike prospect into account when deciding whether to save more now.

The bigger impact on savings willingness over and above the likely tax changes is the shock recently associated with the global debt/credit crisis.

People have been reminded that running high levels of debt is dangerous. That lesson has probably reduced the willingness of Kiwis to borrow.

But if we cite the past two to four years as reason for a change in behaviour, one has to take into account other things going on – such as the huge quantity of savings lost by those who were putting aside funds in earlier years.

Some will have done a lot of their dough by selling shares when the market was low over a year ago and missing the recovery, or will simply still be waiting for the NZX 50 for example to get back to the peak reached late in 2007. It is still 26 per cent below. Then there are those conscientious savers who lost their money in finance companies.

Frankly, the only group one can identify as having an experience highly likely to lead to reduced borrowing and more saving in financial instruments is those who geared themselves into dodgy apartment schemes.

At least KiwiSaver should in theory lead to a better household savings rate, which will tend to keep interest rates slightly lower than would otherwise be the case – but not if we decide to offset savings by running a higher mortgage and paying it back when we retire.

Source: The Southland Times, New Zealand, dated 19/05/2010