Confirmation that taxes impose significant economic costs, and that tax revenue should be regarded as an expensive resource in considering government spending activities, is contained in a new report released today by the New Zealand Business Roundtable.

Authored by Dr Alex Robson of the Australian National University, the study No Free Lunch: The Costs of Taxation explains the ways in which taxation affects the incentives faced by workers and investors to engage in productive activity, and consequently affects economic growth.

Robson explains that the costs of raising a dollar in taxation are higher than a dollar because “all forms of taxation alter economic choices and drive economic activity from higher to lower valued uses.”

For example, if the rate of income tax is increased, some people might decide to work fewer hours, they might conclude that it is not worthwhile training for an additional qualification or seeking promotion, or they might elect to stay on welfare rather than take a job. A homeowner might also decide that it is better to paint the house and forgo after-tax income rather than pay a tradesperson to undertake the work simply because of the higher tax wedge between gross and after-tax wages.

These are examples of deadweight costs. They cause total national income to be lower than it would otherwise be.

These deadweight costs are generally the most important costs of taxation but they are not the only ones. Additional costs include enforcement, avoidance, and compliance and administration costs, and non-productive rent-seeking activities when some section of the population tries to persuade the government to divert resources from another.

The pure deadweight costs of taxation are difficult to measure with any precision. An earlier Business Roundtable study by Erwin Diewert and Denis Lawrence put the costs of raising an additional dollar of tax on labour income at $0.18 (18 cents) in 1990-91. The Treasury uses a figure of 20 cents on top of each dollar of tax collected in cost benefit analysis of tax-financed spending proposals. On this basis a school which costs, say, $10 million annually to run if paid for by parents through fees would cost $12 million if paid for by taxes.

Robson's survey of other studies suggests these estimates may be conservative. If research findings from the United States apply to New Zealand, total deadweight losses from all taxes may have amounted to between $10 billion and $13 billion in 2005-06.

In its 2005 report on the New Zealand economy, the OECD stated unequivocally that “higher taxes have a negative impact on economic growth”. High effective marginal tax rates do the most harm. Looking at 98 different countries, Robson finds that “on average, countries which significantly cut taxes on upper incomes between 1980 and 2000 enjoyed average per capita growth rates of nearly three times those that did not”. These and similar findings contradict frequent claims by the minister of finance, Dr Michael Cullen, that taxes do not adversely affect growth.

Commenting on the report, Business Roundtable executive director, Roger Kerr, said that it was a timely update on an important economic issue.

“Taxes create deadweight losses regardless of whether they are spent wisely or wasted by governments. For tax-funded expenditure to be a net social gain, it has to be very effectively spent. With New Zealand's total tax and non-tax receipts now a massive 43 percent of GDP, close to the level of Germany, this burden is clearly a factor in the country's flagging productivity and per capita income growth rates.

“There should be far greater awareness that private spending is less costly to the economy than government spending; that governments should only spend money for essential public purposes; and that lower and flatter taxes, as recommended by the 2001 McLeod Tax Review, would minimise the economic costs of raising tax revenue”, Mr Kerr concluded.

Purchase No Free Lunch: The Costs of Taxation by Alex Robson ($22.50 plus postage and handling $2.00).

Download as a PDF for free. (Requires Adobe Acrobat.)

www.nzbr.org.nz

For more information, contact:

Roger Kerr
Executive Director
Ph: 04 499 0790
Email: rkerr@nzbr.org.nz
Web: www.nzbr.org.nz

Alex Robson
Ph: +61 2 612 54909
Email: alex.robson@anu.edu.au

Greg Dwyer
Ph: +64 9 358 2796
Email: g.dwyer@clear.net.nz