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April 2005 Taxation in New Zealand: Myth
and Reality Some common arguments about taxation are based on incorrect assumptions - persistent beliefs with little basis in reality. One myth is that New Zealand is a low-taxing country. Another is the claim that the income tax burden falls disproportionately on middle-income earners and the poor. In a recent study produced for the Business Roundtable, Personal Income Tax in New Zealand: Who Pays and Is Progressive Taxation Justified?,* Sinclair Davidson, associate professor in the School of Economics and Finance at RMIT University in Melbourne, addressed three questions:
In answering the first question, Dr Davidson commented that tax comparisons among OECD member countries can be misleading. The OECD consists of 30 economies. Some are large with low tax rates, but many are small with high tax rates. Using unweighted averages means the average tax-to-GDP (gross domestic product) ratio is biased upwards. The unweighted OECD ratio of tax to GDP was 36.3 percent in 2002. Compared to New Zealand's ratio of 34.9 percent, it might be concluded that New Zealand is a relatively low-taxing country. However, when the average OECD ratio is weighted for population and GDP, a more accurate picture emerges. The average OECD tax take is 31.2 percent when weighted for GDP, while on a population-based weighting the average OECD tax take is 30.9 percent. New Zealand's 34.9 percent appears in a new light. The difference in tax burdens is even bigger if the comparison is restricted to English-speaking nations. On an unweighted basis the average tax take of these countries is 31.8 percent. Based on a GDP weighting the average falls to 28.3 percent; on a population basis the average is 28.7 percent. These comparisons make it clear that New Zealand is not a low-tax economy compared with non-European economies. High tax burdens are one reason why many European economies are struggling to grow. In addition to the overall burden being high, New Zealand's top marginal tax rate cuts in very quickly at an income level of 1.2 times average per GDP. This compares unfavourably with the United States at 8.5 times per capita GDP and Singapore at 9.5 times per capita GDP. Dr Davidson next examined whether the facts support a perception that the so-called 'rich' do not pay their fair share. Treasury data show the tax burden is actually concentrated in households in the top half of the income distribution. In 2004-05 the top 2.58 percent of taxpayers paid 24.07 percent of personal income tax. These taxpayers pay 9.33 times more in tax than their population share. The top 10 percent of households pay almost as much in tax as the next decile earns in income. In comparison, between 40 and 60 percent of households receive more in government benefits than they pay in tax. People earning less than $40,000, who make up 79 percent of the taxpaying population, only pay 33 percent of all income tax. Many have come to believe that progressive taxation (a graduated tax scale) means 'fair' taxation. Finance minister Dr Michael Cullen, for example, has framed the argument against flatter taxes by saying that "it really is a matter of fairness". However, the 2001 Tax Review chaired by Rob McLeod noted that philosophical arguments can be made for and against both progressive and proportional tax systems, and that each can be described as 'fair'. Dr Davidson finds arguments for progressive taxation to be unsatisfactory. In the end, any sense of fairness in a progressive system can only be arbitrary and will therefore always be controversial. If 'fairness' is defined as proportional taxation, Dr Davidson's paper shows that New Zealand's system is not fair: higher income earners are paying far more than the proportion they earn. A pure flat or proportional tax would mean that a taxpayer who earned 5 times as much as another would pay 5 times as much tax - neither more nor less. Higher income earners would gain with a flatter tax structure, although experience suggests they could end up paying much the same amount of tax as before because less effort would go into tax minimisation. Moreover, they would not be the only ones to gain. People would have a greater incentive to work to increase their income as they would not move into higher tax brackets, and the elimination of high marginal rates would boost economic growth, to the benefit of the community at large. The 2001 Tax Review weighed up competing arguments and came down in favour of moves towards a lower, flatter tax structure. The Economist magazine reports this week that the idea of a flat tax has been adopted in several ex-Soviet Union countries and is being debated elsewhere. As its leader says, "The flat-tax idea is big enough and simple enough to be worth taking seriously."
Roger Kerr is the executive director of the New Zealand Business Roundtable For more information, contact: Roger Kerr Web: www.nzbr.org.nz |