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6 May 2005 Some Taxing Issues Tax will loom large as an issue in the May 19 Budget and at the forthcoming general election. Last year, finance minister Michael Cullen was unable to think of a tax he had reduced. Labour is committed to a higher share of government spending in the economy and hence a higher level of taxation. National and other centre right parties have pledged tax reductions to help boost economic growth. Many of the government's
arguments against tax reductions are wrong or misleading. Disincentives to work are among the so-called 'deadweight' costs of taxation, which rise exponentially as marginal tax rates increase. A 1994 study for the Business Roundtable found that the deadweight costs of taxation of labour income in New Zealand were 18 cents for every dollar of revenue raised. Treasury analysis has suggested that reducing all income taxes to a flat rate of 19.5% would add at least 1% to economic growth over the medium term, or $1.5 billion each and every year to New Zealand's economic output. Dr Cullen has argued that tax cuts would be irresponsible because they would add to demand pressures and force the Reserve Bank to raise interest rates. However, on this analysis, government spending increases of the same magnitude as tax cuts actually add more to demand pressures because with tax cuts some of the money is saved, not spent. The government is increasing spending by a massive $2 billion a year. A sensible programme of tax reductions phased in over a few years would be readily manageable. Another argument of Dr Cullen's is that there is no fiscal headroom for tax cuts. Like a former minister of finance (Robert Muldoon) he is effectively arguing that 'I've spent the lot'. But there is no reason why wasteful and poorly designed spending, such as the Working for Families package, could not be scaled back to make room for tax cuts. Also the operating surplus should be reduced, more capital expenditure should be financed by the private sector, and holding growth in government spending below the growth rate of the economy would provide ample latitude for medium-term tax cuts. In response to calls to lower New Zealand's company tax rate from 33% to 30% to match Australia's, Dr Cullen has asked whether New Zealand businesses would also want features of Australia's tax regime such as payroll taxes and taxes on capital gains. This is a red herring. Adopting a good feature of Australia's regime does not mean we have to adopt bad ones. Australian business organisations have been pointing out that personal income tax rates are more important than the company tax regime in determining the amount of tax paid on business income. Businesses such as sole traders or partnerships pay the personal rate, and with the imputation system, resident investors in companies are taxed at their personal rate on dividends. However, Dr Cullen has raised New Zealand's personal rate from 33% to 39%, adding to the effective tax burden on business income. After wages, tax is the largest cost faced by most businesses. Internationally, it is a major factor in where firms decide to invest and do business. New Zealand is a high-tax country in our region; countries like the United States, Australia, Singapore and Hong Kong all have lighter tax regimes. The high-tax economies, predominantly in Europe, are struggling to achieve economic growth. It is also interesting to note that countries in our region are continuing to reduce high tax rates. The Bush administration has cut the top rate of federal income tax in the United States to 35%. Moreover, that rate applies at an income level of 8.5 times per capita GDP whereas the top rate in New Zealand cuts in at only 1.2 times per capita GDP. Singapore is heading towards top personal and company tax rates of 20% in an effort to maintain the real per capita GDP growth rate of 5% a year that it has achieved since 1960. In Australia, the Business Council of Australia (the equivalent of the Business Roundtable) and the Australian Chamber of Commerce and Industry are calling for Australia's top personal rate to be reduced to 30%, in line with the company rate. In the Budget, Dr
Cullen will announce some tax policy changes but they are likely
to be modest, in some cases dubious and in others merely tax deferrals.
So far Dr Cullen has ignored the recommendations of the 2001 McLeod
Tax Review to adopt a lower, flatter tax scale. If opposition parties
pick them up, tax policy could be a major point of difference in
the election campaign. Roger Kerr is the executive director of the New Zealand Business Roundtable For more information, contact: Roger Kerr Web: www.nzbr.org.nz |