Countdown To The Budget - Tax
act-new-zealand
Wed May 20 2009 12:00:00 GMT+1200 (New Zealand Standard Time)
Countdown To The Budget - Tax
Wednesday, 20 May 2009, 5:24 pm
Press Release: ACT New Zealand
Countdown To The Budget - Tax
Article by Hon Sir Roger Douglas, ACT New Zealand
Wednesday, May 20 2009
Background:
Tax is all about expenditure. If the Government spends $70 billion per year, then they have to raise $70 billion per year through taxation, or other fees and duties. If it were to spend only $40 billion, then obviously we would be taxed less.
Any tax put in place to raise revenue is distortionary, but some taxes are more distortionary than others. When looking at tax systems, we must bear in mind two things: incentive effects and income neutrality. Incentive effects refer to the capacity for income taxes to affect how many people choose to enter the workforce, how many hours to work, and whether to spend or save. Income neutrality (otherwise known as horizontal equity) is the idea that those who receive the same amount of income and are in the same circumstances should pay the same amount of tax.
The incentive aspect means that tax policy has a major effect on our economic growth - provided that Government spending is reasonable. Tax influences work place participation and productivity. When after-tax incomes are low, some choose not to work, lowering workplace participation and overall production in the economy. Moreover, steeply progressive tax rates discourage the most productive employees from working hard.
High tax rates discourage hard work, lower capital accumulation, and lower our savings rate. Because incentives matter at the margin, it is more economically effective to lower tax rates rather than move thresholds, as National has focussed on. Lower rates incentivise all those currently paying that tax rate. Threshold changes, while important, only affect those who find themselves at the cusp of the threshold. Over time, if thresholds remain unchanged, then the effect of inflation is to force people into higher tax brackets - as occurred under Labour.
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The neutrality aspect was a significant driver of tax reform in the past. In 1984 we had a tax system which was steeply progressive - the top rate was 66 percent. However, because cash income was taxed while payments in kind - i.e., being given a company car, or a low-rate mortgage to buy a home - were not, there was widespread avoidance. By focussing on neutrality, our tax base was broadened by the introduction of a Fringe Benefit Tax, and a Goods and Services Tax.
Unfortunately, Labour failed to learn the lesson that neutrality was important - that all income should be taxed at the same marginal rate regardless of how your affairs were structured. By having a top personal tax rate of 39 percent, a trustee tax rate of 33 percent, and a company tax rate of 30 percent, people have been incentivised to structure their affairs in different ways to achieve tax advantage, without actually producing any economic gain. If you don't believe that tax rates are creating an incentive for people to tax plan, then the graph below plainly shows the spike of income just before the 39 percent tax rate kicks in - a spike that was nowhere to be found in 1999, when there was no 39 percent tax rate:
Visit: http://www.act.org.nz/blog/roger-douglas for graph
In addition, tax rebate schemes have ensured that people face a roller-coaster set of effective marginal tax rates. The effective marginal tax rate calculates the cost of earning an extra dollar. When you earn an extra dollar, the Government taxes that dollar and also takes away some of the benefits you receive, such as Working for Families. This results in effective marginal tax rates in excess of 100 percent for some. While that is the extreme scenario, thousands of families now have effective marginal tax rates in excess of 50 percent. In other words, for every extra dollar they earn, they lose more than 50 percent of it. The graph below sets out the effective marginal tax rates:
Visit: http://www.act.org.nz/blog/roger-douglas for graph
Programs like WFF could be delivered by reducing tax rates, creating positive incentives rather than perverse incentives.
The current debate going on is whether tax cuts are affordable. Something is missing from the debate. What is missing is the fact that every budget has two sides - a column for revenue (tax), and a column for expenditure. In other words, tax cuts can be made affordable by dealing to Government waste, and that also means restructuring Government spending to deliver value for money in health and education, as previously outlined.
So What Choice Do We Have?
Option A - ACT New Zealand's Policy:
Sizeable tax cuts require a commitment to cutting waste - such as the Families and Charities Commission, and the corporate welfare carried out by the Ministry of Economic Development - as well as restructuring health and education to increase choice and reduce costs.
ACT is dedicated to delivering tax cuts to the New Zealand public, but only to those who want lower taxes in exchange for personal responsibility. If you like the current system of high tax rates and Government monopoly, you can stay with it. Otherwise, you can opt out.
We would make the first $30,000 of income tax free, with an additional tax free allowance for non-working dependents (be that a non-working partner or children). This tax-free threshold will be indexed to inflation to ensure that inflation does not push low-income individuals into the higher tax bracket, as Labour allowed. Beyond $30,000, everyone will pay a flat rate, declining over the next 15 years to 15 percent. This 15 percent tax rate will be the personal income, corporate, and the trustee tax rate. There will be little incentive to tax plan.
These sharp reductions in tax rates and substantial tax-free threshold will be achieved by putting the onus back on individuals to provide for their health, superannuation and risk insurance. People will be encouraged to take out catastrophic health insurance. For superannuation, individuals would be expected to save for their retirement. Risk-insurance to protect against job loss and accidents would be available through the market.
Option B - The Rest:
The other parties will continue to promise tax cuts, only to dash your hopes before they arrive. That's what Michael Cullen did, taking away the stingy $10 a week he offered. That's what Bill English is setting you up for.
We'll be told that tax cuts are unaffordable. Tax cuts are never unaffordable - only Government spending is unaffordable. When you are told tax cuts are unaffordable, what politicians really mean is that they would rather waste money on corporate handouts and handwringing reports put out by Commissions that should not exist.
Because health, education, and welfare programs will continue without major reform, Government spending will have to increase - and sooner or later, that means higher taxes.
Every other party believes that tax cuts are a zero-sum game - that the money is not raised because of tax cuts, or it is raised and spent on the latest pet project. But, as outlined above, tax cuts have incentive effects that improve productivity and make us all wealthier.
Your Decision:
What would you do if you were the Finance Minister? Which option would you choose?
If You Think Option A Is The Best Move Forward [ACT's Policy]:
By choosing ACT's plan, you allow individuals to opt out of the current failing model, and instead take control over their own lives. People opt out in droves, revelling in the lower rates of tax and re-asserting control over their own lives.
Because low taxes allow people to keep the fruits of their own labours, people have the incentive to work hard and save. Economic freedom creates a flexible economy that creates jobs, boosts incomes, and delivers real gains in the standard of living. As people are now purchasing their own healthcare coverage, the costs of healthcare decline rapidly, as hospitals compete for business. Moreover, income insurance to protect against job losses creates a competitive market that encourages people to find new work, rather than spend years on the benefit. Superannuation savings accounts ensure that people retire with more money in the bank Because tax rates are flat and treat income equally, there is little incentive for people to avoid paying tax or spend time re-structuring their affairs to achieve a tax advantage. Tax lawyers and accountants are redeployed into the productive economy.
If You Think Option B Is The Best Move Forward [All the others' policy]:
Tax rates remain high, although there are occasional changes around the edges. The poor incentives that taxes create - combined with the continued subsidisation of non-work - encourage more people out of the workforce. With the number of dependents set to increase, caused by the retiring babyboomers, tax rates will rise to cover the cost. Many leave New Zealand to avoid being punished for success.
High tax rates inhibit productivity growth, which sees New Zealand slip further down the OECD ladder. As New Zealanders lose their relative position in the world, more redistribution of income is called for to help those at the bottom. As tax rates rise to cover the increased costs of health, superannuation, and the new redistribution programmes, people see the level of taxation as unduly burdensome. This further encourages people to engage in unproductive tax planning, enriching tax lawyers and accountants.
As our corporate tax rates are higher than those found overseas, we struggle to attract investment. Lower capital investment reinforces the trend towards low productivity growth.
ENDS
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