2008 Budget Personal Tax Package
Introduction
Economic growth is a priority objective of the government. Growth requires improvements in productivity and workforce
participation. Both would be assisted by lower taxes.
The reduction in the rate of company tax from 1 April 2008 is a welcome move. However, personal tax rates are more
important for many small and medium-sized businesses and professional organisations, and for new equity invested in
companies by resident taxpayers. A coherent, medium-term strategy for personal taxation is needed which is consistent
with the decisions on business taxation in the 2007 Budget. At present New Zealand’s tax policy is lacking in strategic
direction and vision.
The Tax Review 2001 (McLeod Review) remains a sound guide for such a strategy. A key recommendation was the adoption of
a lower, flatter income tax structure. This would reduce the deadweight costs, complexities and other inefficiencies of
the present system.
Proposed tax package
To have the maximum benefits for growth, reductions in the highest effective marginal tax rates are needed, ie those
that most influence the productive effort of taxpayers. The top two personal rates (39% and 33%) should be lowered and
aligned with the company tax rate and related rates. This would foster greater work effort, including investment in
education and training, and encourage unincorporated firms to use resources more efficiently. A reduction in the
effective rate of tax (business and personal) on new equity-financed investment could be expected to increase the
proportion of investment that is financed by residents.
From a growth perspective, reducing tax rates is preferable to adjusting thresholds because incentives to work, save and
invest at the margin are increased. Threshold changes only change marginal rates for a relatively small number of
taxpayers. (If the two top brackets were indexed for inflation since 2000, only around 15% of individual taxpayers and
about 12% of taxable income payable by individuals would be affected.) Also, as the Inland Revenue Department has
documented, tax thresholds induce many taxpayers to arrange their affairs in ways that enable them to avoid higher tax
rates, which does little for growth.
Nevertheless, fiscal drag (the increase in revenue collected as taxpayers move into higher tax brackets) is a problem
with the present scale. This is best dealt with by flattening the tax scale, as many countries around the world are
doing, but adjustments to thresholds, which could benefit lower income taxpayers and others, could form part of an
overall package.
This analysis suggests that aligning the top personal, company and trust rates at 30%, as the minister of revenue has
suggested, in one or two steps would have major benefits for the economy and New Zealanders.
The case for not reducing higher rates (the 33% and 39% rates) on equity grounds founders when looked at alongside
recent tax initiatives (eg the lower company tax rate, tax concessions and the Portfolio Investment Entity (PIE) rules)
which will reduce the tax rate on much taxable income to 30%. The Working for Families and KiwiSaver schemes also
provide significant tax relief for many taxpayers who earn incomes that are subject to the top personal rate of tax.
Reducing and aligning the personal, company and trust rates would significantly reduce the incentives and costs of
avoiding the top personal tax rate.
It would also restore equity between self-employed persons and those subject to PAYE who have less scope to avoid the
higher tax rates. The Working for Families scheme should also be adjusted by reductions in assistance to higher income
earners (many of whom would benefit from a tax cut), a reduction in the abatement rate and possibly by introducing a
universal element.
Fiscal headroom
There is scope, over time, to implement a much larger tax package than that implied in the 2008 Budget Policy Statement
(BPS). The BPS forecasts suggest that core Crown operating spending will increase by 0.9 percentage points of GDP by
2011/12. Slower growth in operating spending and a lower provision for new capital spending could help fund additional
tax reductions.
A somewhat higher proportion of capital spending could also be funded from debt without any significant change in
forecast debt ratios. The BPS forecasts take no account of the impact on growth over time of improved incentives that
arise from lower effective marginal tax rates. Over the medium term, perhaps up to 40 percent of tax revenue initially
forgone might be recouped from higher growth and less tax avoidance. We think that net tax reductions of up to $2.5
billion annually could be responsibly implemented in stages over the next few years.
Tax criteria
We consider the proposed package would meet the criteria laid down by the minister of finance:
- it need not involve increased borrowing for operating purposes;
- it would allow expenditure on public services to be maintained in real terms;
- it would not exacerbate inflation, which is a monetary phenomenon. Firm monetary policy is necessary and sufficient to
control inflation. Growth-oriented tax cuts would have a smaller impact on prices than redistributive measures because
they would increase output (reducing the problem of ‘too much money chasing too few goods’). At most, tax cuts could
have a one-off, not ongoing effect on the CPI; and
- it would be unlikely to have a measurable effect on income inequality since, as the McLeod Review demonstrated, the
difference between the impact on the distribution of income of a flatter tax scale compared with a more progressive one
is small. Moreover, as their incomes rise, lower income people benefit from facing a flatter tax scale, and it is
misleading to look at immediate (static) impacts alone. In addition, prices and wages adjust to changes in complicated
ways (for example, the increase in the top tax rate to 39% in 2000 appears to have pushed up house prices) so it is
difficult to say which groups might ultimately benefit from tax cuts. A general proposition is that the burden of taxes
(in the form of higher prices for goods or lower wages) falls on those who have the least ability to avoid these
effects, for example, by emigrating or raising their prices or wage rates. These are more likely to be the poor with
limited skills than the wealthy.
Other issues
We do not support the introduction of further tax concessions. Recent moves in this direction have added to the cost and
complexity of the tax system. Existing concessions should be removed or reduced.
A general tax ‘dividend’, possibly of a one-off nature, would have no incentive effects.
A tax-free income threshold should not be introduced because the revenue cost of such a move would be substantial and
other tax rates, including effective marginal rates for most taxpayers, would have to be set at higher levels than
otherwise. This is the Australian experience. The low income rebate is a better means of helping those in need. The case
against a tax-free threshold was well argued by the McLeod Review.
A ceiling of 30% on personal, company and trust rates should be lowered in future, having regard to countries in our
region such as Singapore and Hong Kong which have top rates of 20% or below.
ENDS