New Zealand Needs Tax Reform

New Zealand Centre for Political Research

The New Zealand Centre for Political Research is a web-based think tank that takes a research-based approach to public policy matters and encourages the free and open debate of political issues.

“Never let the truth get in the way of a good story.” The quote is attributed to Mark Twain but he could have been talking about New Zealand where misinformation campaigns continue apace. What’s worse is that these days they get reported as news.

In particular, there is a continuing stream of stories in the media, not only about the how the rich are getting richer and the poor, poorer, but also about how more and more children are living in poverty. Yet when the Government finally released some new facts and figures that shed light on the issues and countered the propaganda, it was hardly reported.

Last week Treasury released its 2016 tax estimates, showing just how wrong claims that the so-called rich don’t pay their fair share of tax, really are. The truth is that a small number of higher income earners pay the lion’s share of the county’s tax burden. The report also showed that the proportion of tax that they are paying is increasing.

As the Acting Minister of Finance, Steven Joyce, told Parliament, more than half of all income tax (55 percent) is paid by the top 20 percent of households.

The top 10 percent of households pay 37 percent of all income tax – up from 35 percent in 2008.

At the other end of the scale, families in lower income households are paying less tax – the 20 percent of households with the lowest incomes will pay just 2 percent of income tax this year, down from 3 percent in 2008.

When Government transfers – benefits, superannuation, and Working for Families – are also included in the equation, the ‘net’ tax story becomes even more noteworthy – while the 30 percent of households with the lowest incomes pay $1.7 billion in income tax, they receive a total of $10.6 billion in income support.

Minister Joyce explained that New Zealand is on track to becoming a country where almost half of all households will pay no net tax at all: “Treasury estimates that 42 percent of households will pay no net income tax—that is, they will pay less in tax than they receive in welfare benefits, Working for Families, New Zealand superannuation, or accommodation subsidies. This compares with 39 percent in 2007-08, when this Government took office.”

The Minister also referred to the Ministry of Social Development’s new report on the material well-being of New Zealand households, which found that across a large range of measures, “household incomes have been growing solidly since 2011 in real terms – that is, after inflation – with slightly higher gains for lower-income households. The report also finds there is no evidence of increasing hardship or child poverty; in fact, there is evidence pointing to falling hardship and child poverty rates.”

Since the report covers the year to 30 June 2015, it does not take into account the recent benefit and Working for Families increases, but nor does it cover the more recent pressures created by the current housing shortage.

The report shows that in spite of record low inflation, wages have increased by 25 percent since 2008. The fact that household incomes have increased at a faster rate than wages, is explained in part by an increase in the total hours in paid employment per household. This is largely attributed to the rising participation of women in the workforce.

The Minister explained that higher household incomes are reducing poverty: “The report concludes there is no evidence of any rise from 2008 in income poverty, either before or after deducting housing costs.

“It also says there is no evidence of any increasing depth of relative income poverty over the last two decades, and there is no evidence of any sustained rise or fall in household income inequality before housing costs in the last 10 to 15 years using a 90:10 incomes ratio, or in the last 20 years using a Gini measure, or in the last 25 years using the top 1 percent share of incomes.”

The Minister for Social Development, Anne Tolley, was also questioned in Parliament about the report, explaining that the in-depth information was being collected by the Ministry to enable the Government to better gauge the effect of social policy initiatives on low income families.

With regard to income poverty, the Minister said, “there is no evidence of any rise in recent years. In fact, depending on whether you look at measures before or after housing costs are deducted, recent trends are all either flat or falling. There is also no evidence of a rise in poverty and material hardship trends for children, and it is important to note that this data was collected before the Government’s $790 million child material hardship package came into effect in April this year.”

She also explained that the report refuted the claim that inequality is rising – “In terms of inequality, the report finds that there is also no evidence of any sustained rise or fall in household income equality before housing costs, and there is also no evidence that the income share of the top one percent has risen in recent years.”

In effect, these two reports show that in spite of the National Party’s track record of advocating for lower taxes, under John Key’s Government, New Zealand’s tax system has become much more progressive.

Finance Minister Bill English tried to counter this when he highlighted in Parliament the benefits of the 2010 tax cuts: “The Government’s reduction in taxes on income and savings in 2010 have helped to lift take-home pay. Since the Government was elected, real take-home pay – that is, income after taxes and excluding inflation – has increased by around 2.2 percent per annum. In the 10 years up to 2008, the increase was around 0.5 percent per annum, so take-home pay is increasing at around four times the rate in this 10 years than it did in the previous decade.”

The reality is however, that in this age of increasing globalisation, there needs to be constant downwards pressure on taxes if economies are to remain internationally competitive and living standards are to continue to rise.

In a 2011 paper on our tax system, Treasury reported that New Zealand had the third highest proportion of tax on income, profits and capital gains within the OECD – behind Denmark and Australia. They warned that high personal income taxes distort behaviour by discouraging people not only from working harder, but also from gaining higher qualifications, since they would not gain much benefit from the higher salary that more education would bring. They concluded that such tax distortions could have a negative impact on productivity and economic growth.

They also pointed out how substantial the redistribution that is occurring through tax transfer payments – particularly Working for Families – really is, explaining that the differential in the tax paid by a single income household without children and one with children in New Zealand, is the biggest in the OECD.

This week’s NZCPR Guest Commentator, Darcy Allen, an Economic Research Fellow at the Institute of Public Affairs in Australia, outlines why income taxes are so detrimental:

“The real pain of income tax is not confined to the impact on our bank balances; the danger is in how income tax influences individual decisions. In short, income tax distorts the flexibility and responsiveness of our economy by decreasing our incentive to work, pushing us away from productive labour and towards leisure activities. The incentive to earn income is hampered by constant marginal decisions – ‘What am I going to take home?’ or ‘Is this tax deductible?’ – which are entirely the product of state interference.

“If these distortions exist, then why aren’t governments acting upon them? As with many policy issues, income tax debates are shackled by a lack of counterfactuals. While we can be confident high tax leads to misallocated labour and capital markets, we can never see what income could have been earned or which entrepreneurial endeavours undertaken because we can’t see a world where such taxes didn’t already exist. In part, this is why the economic distortion and efficiency arguments fall on deaf ears.”

In his article, Darcy suggests that tax reform would benefit from the simple rule – ‘don’t tax what you want more of’. It follows that lower taxes should encourage economic growth, by incentivising hard work and entrepreneurship.

That is certainly the case in Switzerland, where low tax has been identified as one of the fundamental drivers of the country’s success. In 1960, Switzerland’s Gross Domestic Product per capita was 23 percent lower than New Zealand’s. Today it is 93 percent above ours. That this country with few natural resources has transformed itself into a world class economy can be attributed to a large extent to tax competition. Each of the country’s 26 cantons (regions) has autonomy in tax matters, reflecting the different policy priorities set by local governments and residents. There is a strong belief that tax competition between cantons plays a positive role in keeping tax rates and public spending in check.

Swiss cantons also demonstrate the adverse relationship between taxes and prosperity: high-tax cantons tend to have lower income per capita than low-tax cantons, where more capital is available for productive uses.

In his article “Tax Competition: The Swiss Case”, Pierre Bessard, the President of the Swiss based Liberal Institute, explains, “Over time tax competition in Switzerland has led to many favorable developments and prevented costly policy mistakes. For taxpayers, decentralization on a small scale means greater choice and pressure on government authorities to spend tax money wisely as ‘voting with the feet’, ie, moving out of a jurisdiction, is an easily enforceable threat. Decentralization and tax competition also mean that tax authorities are easily accessible and generally taxpayer-friendly. Switzerland is probably one of the few countries in the world where rankings on the ‘customer-friendliness’ of tax authorities are regularly published in the press, whereby unfriendly cantons are named and shamed. There is absolutely no doubt that this is Switzerland’s greatest strength.”

While New Zealand’s taxes used to be relatively low by international standards, that is no longer the case. The disincentives created by higher taxes and extremely high transfer payments, particularly Working for Families, are undoubtedly contributing to the country’s declining productivity growth.

In 2011, the New Zealand Institute for Economic Research published a review of Working for Families, recommending that the scheme, which had been introduced by Labour in 2004, be scrapped. They concluded that there were better, more cost-effective ways of providing targeted assistance to low-income families that would not create such a huge disincentive to advancement through work.

They explained that the most damaging problem was the excessively high Effective Marginal Tax Rates, which can rise to 100 percent when someone is trying to get ahead, whereby for every extra $1 they earn, $1 is lost from their Working for Families benefit. As a result, many New Zealanders are now trapped in a system that discourages them from even trying to improve their financial position by working longer hours or looking for a promotion.

To remain internationally competitive New Zealand’s tax rates need to be lower than they are today. Lower taxes would reduce disincentives on productive behaviour, encouraging more work, saving, investment and entrepreneurship. By increasing productivity, lower taxes would enable all New Zealanders to enjoy higher living standards, reducing our reliance on ‘ambition-destroying’ income transfer payments.

During his time in office, Prime Minister John Key has shown himself to be a reformist politician, who has the ability to lead the country through controversial policy changes with a slow and steady hand. This period of stronger economic performance is providing him with a unique opportunity to use his skill to tackle fundamental tax reform and put New Zealand on a path to a future of sustainable growth and prosperity.


Are taxes in New Zealand too high, about right, too low?


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