Below is a paper CTU secretary Peter Conway presented to the NZ Fabian Society. It is asking the question about whether next Thursday we will see a ‘tax switch’ or a ‘tax swindle’.
In particular Mr Conway focuses on the impact of possible changes in the tax scales.
He argues that the tax switch is built on poorly developed arguments around tax and economic growth and the connection between tax and labour mobility. He does however agree with the arguments around the need for greater tax on property. However it is unfair if the benefit of these changes is overwhelmingly captured by those already on high incomes.
Peter Conway
12 May 2010
Introduction
Next week the 2010 Budget will set out what is being described as a tax switch. As you know, the National Party went into the 2008 election promising massive tax cuts. Whereas Labour abandoned some planned policy announcements due to the deepening global financial crisis and the need to focus on jobs, National cynically refused to withdraw their tax plans pre-election. On 9th December 2008, one month after being elected, the Government announced a revised tax package.
This package essentially abandoned the second and third tranches of the pre-election promise of tax cuts. However, they did maintain an $800 million tax cut for April 2009 aimed mainly at those on higher incomes. These tax cuts were funded by the savings from changes to KiwiSaver, discontinuing the research and development tax credit, and replacing the next steps in the previous government’s tax cuts.
The Tax Working Group (TWG) reported earlier this year and the Government has given some indications of the likely response. It involves increases to GST, cuts in personal tax and some changes around property. In Australia, their Government released on 2nd May an initial reaction to a fundamental tax review. They decided to keep GST at 10%, introduce a super profit tax on mining companies, cut company tax in two bites for larger companies and one bite for smaller companies from 30% to 28% from 2012, and increase compulsory employer contributions for workplace superannuation from 9% to 12% from 2013 to 2020.
In this paper, I discuss possible changes, examine the underlying assumptions used for these tax changes and then look at some specific issues such as GST and personal income tax rates.
There are many aspects of this subject that I simply do not discuss. For instance, I do not dwell on the question of whether a tax ‘switch’ as compared with increased taxes should be a policy preference in our current fiscal circumstances as a result of the impact of the global financial crisis. This would also raise the issue of the impact on the social wage of continued cuts in public spending and greater use of ‘user pays’ options.
Possible Changes
I have no specific knowledge of what is likely to be in this month’s Budget. At this stage the assumption is that:
- GST will rise to 15 cents in the dollar compensated by tax cuts “across the board” and an increase in super payments; increases in benefits and WfF payments.
- Benefit rates and thresholds will adjust on the basis of a 2.02% inflation adjustment (a 2.5% additional GST figure is a 2.22% increase but GST does not apply to all items in the CPI[2] so the actual inflation increase is assumed to be 2.02%).
- Tax rates will reduce with the top marginal tax rate going from 38% to 33% to align with the trustee tax rate.
- Tax deductibility for depreciation on property could end.
- ‘Ring fence’ losses from rental property investments to prevent such losses being used as an offset on other income.
- A ‘bright line’ test for property sales where property sold within (say) two years is subject to tax.
- There could be a tightening of “thin capitalisation” rules which target foreign owned companies financed by high levels of debt rather than equity (shares). Interest paid on debt is tax-deductible whereas dividends on shares are not. The change would reduce the level of debt at which special rules kick in.
- There could be some changes to eligibility for WfF for those on relatively high incomes compared with others supported via WfF.
- Changing the way that WfF measures income to prevent high net worth individuals using trust and company structures to qualify.
- Corporate tax rates could reduce – however there will have been some timing issues in relation to assumptions, at the time the Budget was finalised, about what Australia would do.
- Rather than use of tax credits for research and development (they axed the previous scheme), the Government announced this week some additional and some redirected spending on science and innovation.
Most expect the tax changes announced in the Budget to apply from October 2010, but April 2011 is a possibility or there could be some changes in October and others in April. I am not suggesting however that any ‘compensation’ for GST would be delayed, just that there could be some elements of the tax package that take longer to apply, or are subject to further detailed work prior to implementation.
Revenue neutrality could be achieved over two or three years rather than one.
There are various scenarios that could eventuate. The Tax Working Group (TWG) looked at several options in great detail as to the revenue or costs, the impact on growth, equity, compliance issues and so on.
Current personal income tax rates are set out below.
| Annual income | Tax rates |
| $0 – $14,000 | 12.5% |
| $14,001 – $48,000 | 21% |
| $48,001 – $70,000 | 33% |
| $70,001 and over | 38% |
In addition, tax rates on other income are:
Portfolio Investment Entity (PIE) is at 0%, 12.5%, 21% or 30%.
Company 30%, then marginal personal income tax rate of shareholder (0-38%) on payment of a dividend.
Trust Trustee income – 33%.
Qualifying company/Loss attributing qualifying companies pay 30% with a possible claw-back on payment of dividend to high marginal tax rate recipient.
Partnerships pay the marginal tax rate of each individual partner.
Superannuation funds 33% or 30% if widely held.
You can see from the tables below that if (say), the top tax rate was reduced to 33%, and company tax to 27%, then the cost is $1.1 billion. If company tax is unchanged at 30% then the $1.1 billion cost reduces.
| “Aligned” and “non-aligned” examples (Fiscal Cost in 2009/10 tax year -$ billions) | |||
| 30-30-30 | 27-27-27 | 30-30-25 | 33-33-27 |
| $1.6 | $3.1 | $2.3 | $1.1 |
Add in another $2.0 billion for tax cuts in the 21% rate (to 19%) and the 12.5% rate (to 10.5%) and the overall cost is $3.1 billion. If there were some tax threshold changes as well this gets more complicated.
| Base-broadening and revenue-raising Options (Fiscal revenue in $ billions) | ||||||
| GST(increased to15% with automatic adjustments to benefit and superannuation levels) | CGT(fully implemented, accrual based estimate; assumes 2% property inflation, excl owner occupied housing) | Land Tax(0.5% tax rate) | RFRM(on residential rental property) | Remove depreciation on buildings (assumes no loss offset if sold at loss) | Remove depreciation loading on new assets (excl buildings) | Thin capitalisation rules changed(from 75% to 60%) |
| $1.9 | $4.5 | $2.3 | $0.7(+ $0.15 from saved losses) | $1.3 | $0.3 | $0.2 |
GST going to 15% (a 20% increase in the rate) raises $2.2 billion but reduces to $1.9 billion with benefit rate adjustments, and reduces to around $0.2 billion with offsetting tax cuts.
So part of the pre-Budget guessing game is that even if we assume (perhaps incorrectly) that the cost of tax cuts is around $3.1 billion as above, there are various combinations to make up that amount to achieve revenue neutrality. Some options have been ruled out, such as a land tax and risk-free return method[3] (RFRM). If we assume the GST rise is certain then that reduces the gap from $3.1 billion to $1.2 billion. So some combination of thin capitalisation, depreciation changes and other property tax changes such as higher levels of enforcement or a stricter “intentions test” on investment property could be the source for this amount of revenue.
Before I look at the impact of these changes – especially the GST increase and the personal tax rate cuts, I want to go back to some of the underlying arguments being used to advance the merit of this anticipated package.
Does our Tax System need fundamental change?
The TWG looked at tax reform in this particular iteration through a lens based on:
- Efficiency and growth
- Equity and fairness
- Revenue integrity
- Revenue neutrality
- Compliance and administrative costs
- Coherence
Susan St John was among those who criticised this narrow focus in effect. She said in essence that it was an artificial exercise to only look at changing the tax mix. Worse than this, the outcome was couched in terms of changing the mix for the high income people to take more from them in the form of capital taxes and less in the form of income tax. The exercise could equally have been couched in terms of making high income people pay a fairer i.e. larger share and using the revenue to reduce effective marginal tax rates (EMTRs) and improve equity, for example by universalising the in work tax credit (which does help child poverty) and/or cutting taxes on low incomes (to be more like Australia) or it could have included an analysis of revenue requirements to cope with realistic spending needs around health, education and so on.
There was almost no consideration of financial transaction taxes or environmental taxes.
Even with this narrow approach, the TWG failed to get a consensus on a broader based CGT without family home. At times this looked possible. Labour and the Greens were positioned to support it. This was the best opportunity for decades to get a consensus but the TWG could not help in the end.
The fundamental conclusions of the TWG were that our tax system:
- Relies heavily on taxes that are the most damaging to growth
- Lacks integrity, fairness and coherence
- Relies on a tax base which is not sustainable.
It is not as if there have been no changes to the tax system. Until the 1980’s we had relatively high top tax rates at 66% personal tax on high incomes and 48% on companies. The Lange/Douglas government reduced both to 33%, introduced imputation of dividends, and introduced GST at 10% (1986) which was raised to 12.5% (1989). This was of course a much less progressive system at a time of accelerating inequality. A new top rate in 2000 – 39% (now 38%), company tax 30% since 2008, and Working for Families has become a major feature of the tax system. These are just a few of the more significant changes.
So the TWG argument is that despite these changes – or because of some of them – the tax system fails on those three factors described above.
Personal income and company taxes damage growth?
There is an extensive literature investigating the relationship between fiscal policy
and economic growth. NZ Treasury[4] has commented that studies for an OECD panel for the period 1970 to 1990 did show that ‘distorting’ taxes had a negative economic growth effect. However they also acknowledged that public investment spending had a positive impact on economic growth. It is possible therefore that even if a tax did have a negative effect on growth, the public investment from that tax revenue could have a positive effect which outweighed any reduction. But this does not contradict the argument that, all things being equal, if a tax did have a strongly negative effect on growth, then that is a problem.
Treasury suggested therefore, that a more useful way to evaluate the growth effects of fiscal policy is to think about the distinction between ‘distortionary’ and ‘non-distortionary’ taxes and between ‘productive’ and ‘nonproductive’ public expenditure. A sound fiscal position may also enable an economy to cope with shocks, helping to reduce volatility.
The OECD has noted however that in recent decades, one of the most marked changes in taxation has been the large cut in the top rate of personal income tax of most OECD countries, which has been driven in part by concerns over the impact of high rates on entrepreneurship, as well as by tax evasion of highly-paid employees and self-employed professionals. The OECD analysis suggests that a reduction in the top marginal tax rate raises productivity in industries with potentially high rates of enterprise creation so may enhance productivity in countries which have a relatively large share of such industries.
But – and this is interesting in the New Zealand case – they note that it is likely that other policies and institutional settings, such as those that affect the cost of business start-ups and the competitive environment, have a more direct impact on entrepreneurship. For example, the analysis shows that the positive impact of lowering top marginal tax rates on productivity is stronger in countries whose product market policies discourage business start-ups, entry of new firms and strong competition. But the World Bank has ranked NZ in the top three countries for ease of starting a business. As we would expect, any tax changes need to be analysed in a broader context.
Slemrod and Bakija[5] examine the relationship between the marginal income tax rate and productivity in the USA. They found that from 1950 to 2002, periods of strong productivity growth actually occurred when the top tax rates were the highest and, on average, high-tax countries were the most affluent countries.
Also in the USA, in a study looking at the effect of tax cuts in 2001, the Center on Budget and Policy Priorities noted that in 1993 the US increased the top marginal tax rate from 31% to 39.6%. But this did not damage growth. In fact the economy experienced its longest economic expansion in history during the 1990s. Real GDP grew by an average of 4% a year from 1993 though to 2000, almost 50% faster than the average from 1973 to 1993.
Despite major tax cuts in 2001, 2002, 2003, 2004, and 2006, the economy’s performance between 2001 and 2007 was far from stellar. Growth rates of GDP, investment, and other key economic indicators during the 2001-2007 expansion were below the average for other post-World War II economic expansions.
In New Zealand, the average annual growth rate in the five years before the 2000 increase in the top tax rate was 1.9% whereas in the five years after the increase in tax it was 3.52%.
Economic growth in the period after the major 1986 reductions in personal and company taxes was not impressive. Essentially it flat-lined.
In the 1984-92 period our average annual growth rate in real per capita GDP was 0.4% compared with 3.02% in Australia and even when the growth rate recovered from 1992 to 1998, the average annual rate was 3.3% compared with 4.24% in Australia.
The graph below essentially tells the story before and after the 1986 changes. It is as depicted by Paul Dalziel[6] using quarterly seasonally adjusted real Gross Domestic Product for Australia and New Zealand between 1977 and 1998, scaled so that the average value for the calendar year of 1984 equals 100.
I have added a vertical line showing the timing of the huge cuts from 66 and 48 cents to 33 cents for both the top personal and company tax rate.
These statistical juxtapositions do not show anything particularly useful and five years is not a long period in terms of a lagged effect on economic growth. I would not argue these figures prove that lower tax harms economic growth. But they at least show that tax cannot be a major factor compared with other significant influences on economic growth. Surely if after a massive cut in both income and company taxes in 1986 we see no evidence of an impact on economic growth, that particular line of argument should be abandoned by its proponents. And if we see a growth rate in the five years after an increase in the top tax rate in 2000 that is almost double that of the average rate for the five years before the cut, again it is hard to see a growth dividend. But we all know that lots of other things are affecting those numbers. That’s the point.
We have just seen announcements in Australia including changes to company tax. The rate will reduce to 28% by 2015. At the same time, they announced that compulsory superannuation contributions will rise to 12% by 2019, and they have introduced a super-profits tax.
There are a number of points to make in any company tax comparisons. A recent study by PricewaterhouseCoopers and the World Bank[7] compared this “total tax rate” around the world. Their calculations put Australia’s current “total tax rate” at 48%. New Zealand’s is 32.8%. I presume that takes account of factors such as state payroll taxes which can be around 6%. We have the 7th lowest rate in the OECD.
Company tax is not a final tax as we have an imputations system. So a cut in company tax would, all things being equal, benefit offshore shareholders (at least in terms of direct benefits).
We have had a company tax difference with Australia in the recent past (33 vs 30%) with no discernable impact on economic growth.
Finally, more and more people are questioning the obsession with economic growth compared with broader considerations that encompass such issues as the survival of the planet as well as social outcomes, wellbeing, inclusiveness, social stability and so forth. Even if a tax does harm growth, it could improve welfare in other ways. I only mention this (rather large) topic as my main focus has been on the lack of high quality evidence that lower taxes assist economic growth.
Tax system lacks integrity, fairness and coherence?
This was one of the major areas for discussion, particularly in relation to the absence of a capital gains tax of a broad nature. Of specific interest was the fact that it was estimated that the owners of $220 billion (this could be an overestimate according to some critics) of investment property received tax credits of around $150 million based on $500 million of tax losses.
An obvious target is to ring fence losses from rental property so that they cannot be offset against other income. It has been argued that it would take only relatively small adjustments to the package of costs able to be claimed as tax-deductible expenses and offset against other income, to yield a substantial increase in tax revenue, which could help to pay for reductions in income tax.
There are also concerns about high effective marginal tax rates (EMTRs). This focuses on those who are on benefits that abate sharply as they earn extra income. At the extreme end of this debate there are two obvious options. One is to make the payment universal or not abate at all, and the other is to have no benefit or a form of universal basic income.
Peter Harris wryly observed in his recent Fabian paper that if most of those on low incomes pay no tax, then not many hit high EMTRs. I would add to that a suggestion that, for most of the time, those who theoretically face a very high EMTR only rarely actually face the full effect of that high EMTR. That is because they spend a lot of time being infra-marginal before they hit the next threshold for abatement.
But, it is true that middle income earners can face high EMTRs over quite a long range.
Susan St John has noted that there is no incentive for the single parent to work more than 20 hours a week until they can work around 38 hours, because the minimum family tax credit (MFTC) abates at 100 cents for each additional dollar of net income, resulting in no increase in income for the additional 17 or 18 hours worked. But those subject to this high abatement rate for MFTC averaged 2,500 people in 2007 and 2008. Around 300,000 families benefit from WfF. A much larger group than 2,500 do however face EMTRs of around 60%.
Other distortions are around loss attributing qualifying companies (LAQCs). The number of LAQCs has doubled in the last 5 years. Total losses claimed were $2.3 billion in 2008. As Peter Harris pointed out, this is twice as big an issue as the $830 million claimed as losses on rental properties. The number of LAQCs filing returns more than doubled between 2003 and 2008, from 63,400 to 129,900, and the total tax losses relating to residential property investments owned by LAQCs increased nearly 800% over the same period, rising from $105m to $812m.
Trust income took off from $2 billion in 2000 to $6 billion in 2006. So this is about tax avoidance and the integrity of the tax system.
Treasury has previously noted that “cutting the top personal tax rate to 33% would reduce opportunities for tax avoidance by aligning the top personal and corporate tax rate”.
When it comes to discussing tax a rather curious logic emerges, which is that when someone avoids tax it is somehow an integrity problem of the tax system rather than an integrity issue for the taxpayer! This leads the debate into some strange places. When we have suggested putting up the top tax rate to 45 cents, say, for income above $150,000 or three times the average wage, one of the responses we have got is, “there would be an integrity problem”. In other words, the top income earners would avoid this tax. OK, but then what about increasing the trust rate also? But more importantly, the integrity issue is at least a moral one. Are we to believe that all those who structure their affairs to avoid any trickle down via the tax system will use their lower taxes to generate a trickle down by other means?
Those who consistently demonise taxes and attack government expenditure contribute to this atmosphere where it is ‘fair game’ to avoid taxes. We then see advocacy for a GST rise which is hard to avoid – but hits at those who were not manipulating their affairs to avoid tax in the first place!
Tax base relies too much on mobile labour and capital?
The Government is arguing that workers and investment capital are more mobile (i.e. – can go overseas) than property and consumption. This is meant to justify a “tax switch” from personal taxes to GST and a form of property tax. But for workers it is not tax rates that prompt a shift overseas but higher wage rates. We can’t catch up with Australia by cutting taxes. We already have the 3rd lowest personal tax rates in OECD.
So if labour mobility is the problem – then it is more likely that wage rates should be the policy target, not tax rates.
And don’t we now have a tax system that is propping up low pay? Making work pay should be a wages policy not a tax policy!
And we have the evidence of migration rates to Australia post reducing the top tax rate from 66 cents in the dollar and also post increasing the top tax rate to 39 cents in 2000.
So in the five years following the massive cut in the top tax rate from 66 to 33 cents net migration was -21,500, -13,700, -16,800, -24,400, -1,200, +11,700. This is a loss of 65,900 people.
In the 5 years following an increase in the top tax rate from 33 cents to 39 cents, net migration was -9,100, -11,400, +28,100, +42,000, +25,700 and +9,300. This is a gain of 84,600 people.
But hang on, shouldn’t it be the other way around?
I am not saying that people left or came here because the top tax rate was reduced or because the top tax rate went up.
I am just saying that the top tax rate doesn’t look like it is a driver of migration flows.
Even if TWG and Treasury are simply arguing that because labour is mobile we should tax people less on personal income (rather than lower taxes will influence labour mobility) it is still a weak argument given overall labour force participation rates in New Zealand.
There are many different figures about comparisons in personal income tax rates across the Tasman. One measure is to use tax wedges. NZ is at 21.2% compared with Australia at 26.9% (and latest figures out yesterday for 2009 show that NZ is at 18.4% and Australia at 26.7%). But to some extent this could just mirror the level of the average wage. We have a lower average wage, so with a progressive tax system our wedge cuts in at a lower rate than if we had an average wage equivalent to the Australian level. Other analyses show that Australian income tax rates are lower than in NZ until very high income levels are reached.
Heading into Budget 2010
I have discussed above some of the fundamental drivers of the tax ‘switch’ that will be announced on 20th May. We will have to wait until then before we can really debate whether or not it proves to be a tax ‘swindle’. But I have shown that at least some of the underlying assumptions for this switch are questionable. Now I turn to two of the changes in more detail.
GST
Much of the criticism so far has concentrated on the impact of a 20% rise in GST to 15%. My expectation is that most will be compensated for the initial impact of higher GST.
In the election campaign in 2008, John Key said that there would not be an increase in GST. The Australian Government after an extensive review of tax has kept GST at 10%. A GST increase here will widen the real wage gap with Australia.
Because people on low incomes tend to spend a higher proportion of their income in any one year, then GST hits their household budget really hard. A recent Television One survey showed two-thirds surveyed were opposed to a GST rise. It is likely to mean annual inflation spikes at 4.5% – 5% in January 2011.
The top decile pays 15% of total GST but it is 4% of their income.
The bottom decile pays 5.5% of total GST but it is 14% of their total income. (Yet they are likely to get only minimal compensation in the Budget).
And the 5th decile by way of comparison pays 6.5% of total GST and it is just under 8% of their total income.
A rise in GST increases the amount of tax paid by non-residents (e.g. tourists).
As I mentioned above, the anticipated impact on CPI inflation is 2.02%. But many fear that at least some retailers will round up even more than 2.22% or use this as an opportunity for additional price rises.
There is an argument that if we assume that all income is eventually spent, then GST is not regressive because those on high incomes will pay GST on all spending – in the end. I do not accept this. Obviously if someone has $100,000 saved then a GST increase does reduce the spending power of that $100,000. But to argue that GST is essentially not regressive because eventually the wealth of those on high incomes does get spent by them or their children is spurious. It is small consolation to a sole parent or a couple with a young family struggling through one of the most expensive periods of their lives at a relatively low income period in their lives, that their prospective lifetime income might be much higher. For many people it won’t be much higher, and few can be sure unless they have parents who can support them if they get into difficulties. Similarly for pensioners who have been unable to save significantly during their lifetimes.
Another argument we are likely to hear is that a higher tax on consumption alongside lower personal tax rates will boost savings. It may for some – whereas others may find it harder to save if they face a higher cost of living. But this is a weak policy lever to increase savings compared with boosting KiwiSaver and phasing in higher and compulsory employer contributions.
One aspect of the GST hike that has received little attention is the impact on wage bargaining. Workers have received minimal (or in some cases no) wage increases in 2009/10 so expectations are lifting going into the 2010/11 period. Skill shortages are starting to emerge again. Compared with 1986 when GST first came in, there is a much greater attachment to annual CPI as a base figure for wage increases.
If the perception of many workers in 2011 is that the overall outcome of the tax package was grossly unfair and they are now facing annual CPI (as at January 2011) of 4.5% to 5%, then they will want a decent wage rise even if they got some compensation for the GST rise.
Personal Income Tax Cuts
NZ has the third lowest top tax rate in the OECD.
Australia has a top rate of 45% and a tax free band up to $16,000.
A tax scale of 10.5/19/33 replacing 12.5/21/33/38 would give John Key an extra $312 a week. It would increase the take-home pay of the Telecom CEO by an extra $6,680 a week. And the last National tax package in April 2009 was worth $800 million a year to taxpayers, but a third of this went to the top three percent of taxpayers.
A reduction in the top tax rate will have many effects. For example, it will mean that any high income superannuitants will keep a greater proportion of their NZ Superannuation payments.
The Government claims that low income earners will be compensated for increases in GST and that the reduction in the top tax rate is fair because, according to Bill English[8], “investment housing and commercial property in New Zealand are largely in the ownership of higher-income people. “
This sounds like an argument that just as it is fair to compensate (low) income earners for higher GST it is also fair to compensate those on (higher) incomes for higher property taxes. But the combined impact of all their tax changes means those on higher incomes will be much better off. This aims to obscure the fundamental unfairness if it is high income people who get a huge benefit from these tax changes.
It is a good thing that there will be more rigorous property taxes and closing down of some rorts. But does that mean the cash raised from these measures should simply accrue to those on high incomes? And while it may be true that property investors tend to be those on high incomes, the reverse is not necessarily true.
So what are some of the other arguments we are likely to hear?
One is that if you cut tax rates of course high income people will get most of the benefit because they pay the most tax. Yes but that is because they get the most income.
It is estimated that 70% of salary and wage earners are on $40,000 or less. And there are 800,000 New Zealand families with a combined household income of $60,000 or less.
As for individuals:
The top 10% get 34% of the income and pay 44% of income tax.
The next 10% get 18% of the income and pay 18% of income tax.
The next 30% get 32% of the income and pay 27% of income tax.
The next 50% get 16% of income and pay 11% of income tax.
So what we are really seeing is the interaction of widening income inequalities and the tax system. As income inequality widens, tax rates should become more progressive if anything – not less.
This is an important issue. We are also likely to hear arguments that when transfers (such as WfF) are taken into account, those on top incomes are paying an even higher proportion of (net) taxes. But the fundamental point is this: if the bottom half of income earners share 16% of income and the top half of income earners share 84% of income, then we need to do more to lift incomes for those in the bottom half – rather than cut taxes primarily for those in the top half.
Another argument is the old trickle down one about entrepreneurs. Let people retain more of what they earn and hope they don’t notice the limits on public services. If entrepreneurs are backed then jobs are created and so on. But last time we saw the trickle down become a trickle up – and then a flood out!
Peter Harris said recently the argument about economic benefits from cuts in the top tax rate is a “ruse: it masks a fundamental intention to reverse the redistributive agenda of the last nine years”.
This is not to say that tax rates and the threshold issue are not relevant. Hidden in the so-called chewing gum tax cuts of 2005 was an automatic adjustment to correct for fiscal drag. It got dumped, but it was a serious attempt to address the impact of inflation on tax thresholds.
This is not just a debate the union movement has with others – it is within our own ranks. Some have seen good pay rises over the years and now resent being in the top tax bracket. And they don’t think $70,000 is an especially high income.
There are some concerns about the impact of property tax changes on rents. It is hard to gauge this risk. If landlords have relied on untaxed capital gain and also offsets of rental property losses against personal income, then it is possible that they will shift post-Budget to relatively higher reliance on rental income. But if the value of investment property falls or rises more slowly, then this could have a downward impact on rents.
If rents go up, and the income from tax on property accrues to those on high incomes, we are going to end up with a highly inequitable outcome. But even if rents do not increase, the Government should not be allowed to foist on the media and the public that there is a virtue in giving those on high incomes a big increase in weekly income compared with those on low incomes.
And I don’t think the Government can legitimately rely on arguments about ‘dynamic’ economic growth effects and the impact of less labour mobility of lower personal income taxes to offset public dissatisfaction over the ‘static’ outcomes – in other words the view that when it all boils down everyone will simply look at who gets what from the tax changes.
I have not entirely discounted the possibility that the Government will target some form of rebate to those on low incomes to middle incomes – say the minimum wage of $26,500 to $50,000. Otherwise, those on incomes above $70,000 get the combined effect of cuts to the 12.5% rate, the 21% rate and the 38% rate. And if the biggest cut is in the top rate (38% down to 33%) then those on the highest incomes clearly have the most to gain.
So my main point in this part of the paper is this. If the Government cuts tax rates in such a way that those who get most are those on high incomes then that is unfair. There are other choices. It is ridiculous to say that those who pay the most tax should get the biggest tax cut – when the point is they already get the most income. And no amount of argument about savings, labour mobility, growth distorting taxes, and so on is going to obscure a simple analysis of who gains most from the tax changes.
Is this it?
So is this it? Is this the big lever? The Government would say that this is only one of six levers it has identified[9] but they have certainly put this one up in lights. In the end this is just a rerun of the old trickle down approach.
Tax cuts for those on high incomes and mining of protected areas in the conservation estate hardly makes the grade as a policy prescription for sustainable economic development. There is now added investment in science and innovation but that is really an acknowledgement that the Government got it wrong in wiping out the tax credit. And many are intrigued by the Government’s ‘economic growth agenda’ which is more of an evolving story than a stake in the ground. But that is the stuff of another paper.
Conclusion
Economists find it easier to argue over interpretations and analyses of what has already happened rather than debate the relative merits of what might happen. I am bound to be wrong in parts of this paper because I am having to guess about what might be in the Budget.
But I hope I have shown that the Government is relying on questionable assumptions for this tax switch and that there is a risk of highly inequitable outcomes when there were always better options available.
< ] I would like to thank Dr. Bill Rosenberg for comments on a draft of this paper.
[2] Housing rentals, mortgage payments and school donations – which together make up about a tenth of the consumers price index – are not subject to GST.
[3] This would assume a return of say 6% on investment property and tax that at say 33%.
[4]NZ Treasury, April 2004. New Zealand Economic Growth: An Analysis of Performance and Policy.
Joel Slemrod and Jon Bakija (2008). Taxing Ourselves: A Citizen’s Guide to the Debate over Taxes, 4th edition.
Dalziel, Paul. (2000) New Zealand’s Economic Reform Programme was a Failure, Department of Economics and Marketing Canterbury, New Zealand.
Paying Taxes 2010, http://www.pwc.com/gx/en/paying-taxes/index.jhtml
Response to a Parliamentary question.
Tax; better public services; support for science and innovation; better regulation; investment in infrastructure; improved education and skills.