Business Wants Lower, Flatter Tax Structure

5 April 2006

Business organisations representing a broad cross-section of New Zealand businesses have told the government they want a lower, flatter tax structure to come out of the business tax review.

Federated Farmers, the New Zealand Business Roundtable and the New Zealand Chambers of Commerce advocate lowering the top and middle personal tax rates to 28 percent and the company rate to 25 percent in two steps by 2009/10. The Institute of Chartered Accountants of New Zealand supports the proposals, but has a preference to have the corporate and individual rates aligned.

In a letter to the prime minister accompanying the proposed package (copies attached), the organisations state: “We see it as consistent with the government’s commitment to a ‘bold’ review. However, if the government is not prepared to go that far, we recommend reducing the top personal tax rate to 33 percent and the company rate to 28 percent as an immediate step.”

Charles Finny, chief executive of the New Zealand Chambers of Commerce, said that the review was a business tax review, not a review of company tax alone. “Around 40 percent of New Zealand businesses are unincorporated – for example as sole traders or partnerships – and would not benefit directly from reductions in company tax.

“However, the Chambers are also concerned that New Zealand’s company tax rate compares favourably with Australia’s, which, at 30 percent, is already below ours and may fall further in the period ahead.”

Federated Farmers president Charlie Pedersen said the personal tax rate mattered most for most farming businesses. Farmers favoured across-the-board tax reductions, not special tax concessions for favoured industries or activities.

Business Roundtable executive director Roger Kerr said that the group’s approach was consistent with the advice the government received in 2001 from the McLeod Tax Review. It favoured a lower, flatter tax structure with an alignment of company and other entity tax rates, and the proposal was a major step in that direction.

The tax director of the Institute of Chartered Accountants, Craig Macalister, said that the Institute’s emphasis on alignment of company, trustee and personal tax rates recognised the need to reduce taxation compliance costs and ensure more certainty in the use of one business structure over another.

The group said that the package would benefit investment, employment, productivity and economic growth in New Zealand; improve the international attractiveness of New Zealand’s tax structure; and be fiscally responsible. Broad parameters of a strategy for funding the package had been considered, including the revenue benefits to the economy of the impetus to growth from a lower tax structure.

The introduction of a payroll tax to fund a reduction in the company tax rate was not seen as either necessary or as good tax policy.

Speaking for the group, Charles Finny stated: “The government has said it does not rule anything in or out in its review of business taxation.

“We believe the government would wish to hear what business wants from the review at an early stage. Our proposals would also benefit directly many other New Zealanders, and indirectly the economy as a whole.”

5 April 2006

Roger Kerr
New Zealand Business Roundtable

Charles Finny
New Zealand Chambers of Commerce (Inc)

31 March 2006

Rt. Hon Helen Clark Copy: Hon Dr Michael Cullen,

Prime Minister Minister of Finance

Parliament Buildings Hon Peter Dunne,

WELLINGTON Minister of Revenue

Dear Prime Minister

The business community at large has welcomed the government’s review of business taxation. There is strong business support for the government’s commitment to raising the rate of economic growth and to a “bold” review, and the two issues are obviously closely connected.

The business organisations associated with this letter accordingly felt it might be helpful to the government if we were to formulate a collective view of the main elements of what we would like to see come out of the review. You will note that we represent directly or indirectly a very broad cross-section of New Zealand business.

Our main criteria in developing a proposal were to reform business taxation in a way that would benefit investment, employment, productivity, competitiveness and economic growth in New Zealand; make New Zealand’s tax structure internationally attractive, particularly in relation to Australia; and be fiscally responsible.

We think it is important to recognise that the rates of tax on companies and other entities cannot be considered in isolation from personal tax rates, since individuals are the ultimate owners of business entities. Personal and company tax are interrelated through the imputation system. Many businesses, such as sole traders and partnerships, including many farming operations, would not benefit from a business tax review that focused on company taxation alone.

We have based our approach on the conclusions of the government’s 2001 Tax Review which advocated moves towards a lower, flatter income tax structure. This was a comprehensive and competent exercise. Like the review group, we do not see a need in present circumstances to extend the tax base or to introduce new taxes, and we do not favour selective business tax concessions. We want to see changes that would simplify the tax system and reduce business compliance costs.

Accordingly the essence of the proposal in the attached paper is to lower the company rate of tax to 25 percent and the present top and upper middle personal tax rates to 28 percent in two steps at the start of the 2007/08 and 2009/10 tax years. We see this as a substantial step towards the widely agreed goal of aligning the rates of tax on company, trustee and other income with the top personal tax rate. We also see it as consistent with the government’s commitment to a ‘bold’ review. However, if the government is not prepared to go that far, we recommend reducing the top personal tax rate to 33 percent and the company rate to 28 percent as an immediate step.

We believe that a move to a lower and flatter tax structure could be readily funded by a combination of existing provisions for additional spending or revenue reductions; reductions in base spending; a lower operating surplus; and the revenue benefits of the impetus to the economy of a lower tax structure. As the McLeod Review noted, the capacity for redistribution of public expenditure programmes and a less progressive tax scale would not put at risk the government’s equity goals.

It is also our view that, given the government’s major tax review in 2001, there is no need for the tax review to be protracted. Indeed decisions on the lines suggested could be announced in the 2006 Budget.

The New Zealand Institute of Chartered Accountants supports the thrust of our proposal but would prefer an alignment of lo
wer company, trustee and top personal tax rates.

We are aware that other business organisations generally support the suggested package and we are confident that it would be widely endorsed and welcomed by the business community at large.

We hope you find this initiative constructive and we would appreciate the opportunity to discuss it with you and responsible ministers.

Yours sincerely

Charlie Pedersen

Federated Farmers of New Zealand (Inc)

Review Of Business Tax: Recommended Strategy

1 Introduction

This memorandum outlines the main elements of a business tax package that is consistent with Labour's coalition agreements with New Zealand First and United Future, and recognises the broad constraints within which the business tax review is being conducted.

The package focuses on a lower and flatter tax structure funded from the existing provision for additional growth in operating spending or revenue reductions; modest savings in base spending; a lower operating balance; and the revenue benefits of the impetus to the economy of a lower tax structure.
2 Tax rates

We think that the central outcome of the review should be a reduction in the rate of company tax (and related rates of tax) and a narrower gap between the top personal and company tax rates.

We propose a company tax rate of 25 percent. The present top and upper middle personal tax rates would be reduced to 28 percent.

The changes could be introduced in two steps at the start of the 2007/08 and 2009/10 tax years (see the appendix for details).

The following factors have been taken into account in proposing the above rate structure:

- The government's commitment to raising the rate of economic growth and to a 'bold' review.

- We think the medium-term objective should be to lower the company rate of tax and the top personal rate to 25 percent, or below, in parallel with a reduction in the ratio of government spending to GDP. This would enhance efficiency and stimulate economic growth. Progress should be made toward this objective in the present parliamentary term.

- The 2001 McLeod Tax Review was a recent comprehensive and competent examination of the tax system. We see no need for a further protracted review. The McLeod Review supported a lower, flatter income tax structure and saw no need for additional taxes.

It recommended a two-step personal tax scale of 18 percent and 33 percent, and a company tax rate of 33 percent. The Tax Review observed in its final report, "At these tax rates … New Zealand would be likely to remain an unattractive destination for internationally mobile capital and people" (page vii). Given changes in the fiscal position, there is more latitude for tax reductions today than in 2001.

- The coalition agreements envisage a tax system that provides better incentives for productivity gains and improved competitiveness with Australia. The reporting in Australia of 'income' generated in New Zealand points to a company tax rate that is no higher, and preferably lower, than Australia's rate of company tax. Australia's present rate is 30 percent. Australia is expected to reduce personal income tax, and could well lower its company rate over the next few years.

- Personal rates of tax – not the company rate of tax – are generally the relevant tax rates for new domestic equity-financed investment through companies and for investment by sole traders and partnerships, such as self-employed farmers, trades people and members of certain professions. A reduction in the company tax rate alone would not generally be relevant to sole traders and partnerships.

- Reductions in high effective marginal tax rates, such as the top personal rate of tax, and in taxes on capital income, are the most important from a growth perspective. Lower personal rates of tax would also help to address the high effective marginal tax rates associated with the phase-out of family and other income-related assistance.

- The principle of a lower and flatter tax structure, which acknowledges the inter-relationship between entity and personal tax rates, has substantial merit. The suggested package would constitute a significant step in that direction. The desirable goal of alignment of entity and personal tax rates, including taxation of trustee income and fringe benefit taxation, would greatly reduce administration and compliance costs and reduce tax planning.

- A broad income tax base which, as far as possible, treats particular classes of businesses and all business activities on an even-handed basis, enhances economic efficiency. Concessional tax treatment for selected businesses, categories of spending or income are unlikely to achieve the government's growth objectives. Higher productivity in all industries should be encouraged, consistent with the coalition agreements. Preferential tax treatment for some activities or classes of taxpayers would not address the business community's call for lower rates of tax.

- We do not see a need to extend the tax base or to introduce new taxes. The introduction of a payroll tax, for example, would be opposed. The economic effect of a payroll tax would be similar to an increase in GST (which we do not favour) and involve much higher compliance and administration costs.

In the long run, the tax would largely be borne by labour through a reduction in post-tax wages and lower employment than otherwise. Feasible payroll taxes are problematic. Australian state payroll taxes reflect the need for an independent state tax base and do not provide a good model for central government. A move in the direction of Australia's company tax rate does not necessitate the adoption of other features of Australia's tax system. At the last election, no party advocated new taxes or higher taxes to fund a reduction in company tax.

- Lower income tax rates could be announced in the 2006 budget and implemented with the first step effective from the 2007/08 tax year (ie from 1 October 2006 for companies with 'early' balance dates). There is no need for lengthy investigations and extensive legislation. There was wide support at the last election for tax reductions.

- As suggested below, the package can be funded without introducing a new tax and without unduly increasing any inflationary pressures in the short term.
We see this proposal as consistent with the government’s commitment to a ‘bold’ review. However, if the government is not prepared to go that far, we recommend reducing the top personal tax rate to 33 percent and the company rate to 28 percent as an immediate step.

3 Funding

On a static basis, the above tax rate changes might cost about $4.4 billion a year (2.7 percent of GDP) when fully implemented. The first step would cost around $1.75 billion while the second step would cost an additional $2.65 billion. (These figures reflect 2006/07 income and tax data and provide a 'ballpark' estimate only.)

The total package could be financed as follows:

- allocating, say, $2 billion (about 35 percent) of the provision made in the 2006 Budget Policy Statement for additional operating spending or revenue reductions between 2007/08 and 2009/10 (inclusive);

- achieving savings of, say, $0.5 billion from lower spending or reduced tax concessions;

- reducing the forecast operating surplus by $1.9 billion, thereby funding more capital spending from debt. The ratio of the operating surplus to GDP would be around 1 percentage point lower than otherwise while the ratios of the deficit in cash available and gross debt to GDP would be about 1 percentage point higher.

It should also be noted that Treasury's ready reckoner, which was applied to estimate the static revenue cost of the package, does not take account of second-round macroeconomic effects and indirect effects on other taxes of tax cuts or increases.

We agree that tax reductions are not generally self-funding over the medium term. Moreover, all tax reductions are not equal. Whether they are growth-oriented or not has a major bearing on their economic impact. It is clear, however, that well-designed tax reductions can materially increase economic growth.

In those circumstances, a larger proportion of the initial revenue cost would be recovered over the medium term than is reflected in Treasury's ready reckoner. Treasury implicitly takes any such additional recovery into account when it updates its tax forecasts over time.

Some research undertaken in the United States suggests that a 10 percent reduction in income tax may increase taxable income by 4 percent. If this elasticity (net of the recovery of revenue through first-round effects which Treasury takes into account) is applied to the tax reductions proposed above, the cost of the package might be $3.3 billion or up to $1.1 billion (0.6 percent of GDP) lower than the static analysis suggests.

The level of company tax collections reflects the rate of company tax, the structure of company and other tax rates, the tax base and the performance of the economy. Company tax collections increased from 2.8 percent of GDP in 1984/85 to 5.4 percent in 2004/05. In nominal terms collections increased more than 6-fold. (In 1984/85 the company tax rate was 45 percent, it was increased to 48 percent in 1986/87, reduced to 28 percent in 1988/89 and was set at the present rate of 33 percent in 1989/90.) Australia cut its company tax rate from 36 percent in 1998 to 30 percent in 2001. Its company tax revenue is reported to have risen by over 100 percent between 1997/98 and 2004/05.

Finally, we submit that if the tax review extends beyond the lowering of tax rates, it should be examined in the context of the generic tax policy process.

ENDS

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