 |
|
13 March 2006 Is There a Case for a Payroll
Tax? Recent media reports suggest the
government may be considering a payroll tax as an option in its
review of business taxation. It might be used to raise some or all
of the revenue lost from a possible cut in the rate of company tax. In response to a request from the
minister of finance, the Treasury advised (on certain assumptions)
that a cut in the company rate from 33% to 20% could be paid for
by a payroll tax of 5.4%. What is a payroll tax? Unlike an
income tax which is a tax on labour income (wages, salaries, fringe
benefits etc) and capital income (such as interest, dividends, rents
and sometimes changes in the value of assets), a payroll tax is
a tax on wages alone. Although not intuitively obvious,
it is equivalent (at least in simple terms) to a tax on consumption
(such as GST). This is because most people spend most of what they
earn in wages (or from investments based on savings from wage income)
over their lifetimes. A payroll tax could be imposed
on either employers or employees, but generally speaking the ultimate
cost would be borne by employees. If employers pay in the first
instance, there will be an offsetting effect on wages or employment
over time. Only where labour is internationally
mobile might firms be forced to increase gross wages (and maintain
after-tax pay) to compensate for a payroll tax. In this case fewer
such people would be employed over time as firms would make adjustments
to maintain a normal return on investment. Exporting and import competing
businesses would be unable to reflect higher wage costs in their
prices. They would also respond by reducing their demand for labour. A payroll tax was introduced by
the Muldoon government in the 1970s but was controversial and quickly
abandoned. A number of Australian state governments have payroll
taxes but a reason for this is that they need a separate revenue
base (just like local government needs rates). The comprehensive McLeod review
of the New Zealand tax system in 2001 did not see merit in a payroll
tax. Its main recommendation was to adopt a lower and flatter income
tax structure. Why do tax experts not favour a
payroll tax at central government level? A key reason is the major
practical problems that arise from the self-employed (a growing
category) and investors in closely held companies being able to
characterise labour income as income from capital if it bears a
lower rate of tax. Also much the same economic outcomes could be
achieved in New Zealand's case, with far lower administration and
compliance costs, by increasing GST. Certainly there would be gains
from reducing the rate of company tax. Such a move would reduce
the cost of capital, encourage additional investment and stimulate
economic growth. However, the gains would be limited
unless there were parallel reductions in personal tax rates and,
preferably, an alignment of the top personal rate and the company
rate, as the McLeod review recommended. For a good number of businesses
(such as many small businesses and farmers), the personal rate is
the most relevant one for investment decisions. If the company tax
rate were set well below the higher personal tax rates the current
incentives to engage in tax planning and the costs and complexities
of the tax system would be greatly increased. However, a payroll tax is not needed
to fund meaningful reductions in company and personal tax rates.
These could be funded from the government's existing provision for
new spending or revenue reductions; savings in base spending; a
lower operating balance; and the revenue benefits of the impetus
to the economy of a lower tax structure. The idea that a cut in
wages is needed to fund a reduction in company tax would be hard
to defend. The argument that a payroll tax
would force firms to economise on labour in a tight labour market
and invest more in capital equipment, so raising labour productivity,
is unpersuasive. We do not need a payroll tax to make that happen,
and New Zealand still needs to create more jobs. Unemployment remains
relatively high among young people and Maori; significant numbers
of potential workers remain on benefits; and others, such as part-time
or older workers, have difficulty obtaining full-time jobs. A payroll tax/company tax reduction
package would do little for economic growth and would be no substitute
for a more credible growth strategy. There is no logic in the proposition
that a move in the direction of Australia's company tax rate necessitates
the adoption of other features of the Australian tax system. Most business organisations, analysts and tax experts would see a reduction in wasteful government spending (and thus a lower overall tax burden), combined with a lower and flatter tax structure, as being a better approach. Roger Kerr is the executive director of the New Zealand Business Roundtable. |