Tax Cuts Now On the Agenda

Business Forum article that originally appeared in the Dominion Post October 16 2006

Last week it was revealed that the 2005/06 budget surplus (following some accounting changes) was $11.5 billion. That equates to around $8,000 per household.

Such a level of over-taxing is indefensible. Tax reductions are now a virtual certainty.

The government’s recognition of this reality is welcome. The Treasury’s post-election briefing in 2005 emphasised the role of lower taxes, particularly lower marginal tax rates on personal and company income, in promoting economic growth.

It said “The potential growth benefits from an improved tax system suggest to us that the incoming government should seek to pursue this policy within the shortest possible timeframe.”

Finance minister Michael Cullen has made some valid points in the tax debate.

He has pointed out that the surpluses are historical, and can quickly fall in an economic downturn.

He has stressed the importance of maintaining a robust fiscal position to underpin New Zealand’s credit rating. Essentially this requires maintaining budget balance over the economic cycle.

Prime minister Helen Clark has noted that National’s tax thinking seems to waver according to forecast surpluses, and that leader Don Brash’s recent position that there may be less room for tax cuts could change again with the revised numbers.

Other views are less persuasive.

Some have argued that the surplus should all be applied to higher operating spending, for example on health and education.

But government spending has increased steeply in recent years to around 42 percent of GDP, including local government. This is squeezing the productive sector of the economy, putting pressure on monetary policy and the balance of payments, and harming economic growth.

In its fiscal planning, the government is allowing around $2 billion a year for new spending or tax reductions. There is ample scope for both.

The need for capital expenditure on infrastructure is not a show-stopper either.

Many infrastructure industries, such as telecommunications, ports, airports and gas, are wholly or partly in the private sector. New investment can be financed out of debt and equity as well as current revenues. The same goes for the electricity SOEs.

In the case of roading and water, Transit and councils have borrowing capacity and there is also scope for private sector involvement.

So less use of current revenue for capital spending would create additional scope for tax reductions, not to mention the winding up of the Cullen Fund.

Concerns about the inflationary impact of tax cuts are overstated. The United States and Australia are experiencing lower inflation than New Zealand, despite significant tax reductions.

From a short-term perspective, tax cuts put less pressure on monetary policy than expenditure increases of the same magnitude, as part of them is saved.

They also reduce wage and other cost pressures on firms. It is extraordinary to hear New Zealand unions opposing tax reductions for workers; Australian unions (and the Australian Labor Party) have supported tax reductions, including to top rates. Rhetoric about “tax cuts for the rich” has been largely absent in Australia.

More fundamentally, monetary policy, not fiscal policy, is what determines inflation over the medium term.

The debate should now focus on the form of tax reductions and the path of government spending needed for them to be sustainable.

The McLeod Tax Review’s advocacy of a lower, flatter and simpler tax scale, with an alignment between top personal, company and other rates, should be heeded.

It is widely supported by business organisations and tax professionals.

To their dismay, the government has instead reintroduced an ad hoc tax concession for savings and is talking about concessions for R & D and exports in the context of the business tax review.

Business at large does not want to go back to a tax scale riddled with special concessions. The government seems to be turning a deaf ear.

Given firm control of government spending, an income tax system with top rates of 25% or less within a few years would be within New Zealand’s reach.

This would put us nearer the league of Singapore and Hong Kong (where top rates are 20% or less) and greatly boost New Zealand’s attractiveness and economic performance.

Government spending, not the size of budget surpluses, should be the starting point for tax policy planning. National’s plans for tax cuts at the last election were largely based on surplus reductions.

There is a strong case for fiscal rules limiting annual spending increases to the rate of population growth plus inflation, unless taxpayers supported higher increases in referenda.

With tax reductions now on the agenda, we need a broader debate around spending limitations, the scope for greater private sector involvement in infrastructure and other services, and the case for lower and flatter taxes in the interests of competitiveness and growth.

ENDS

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