Alasdair Thompson: Why Labour will cut business tax rates

Alasdair Thompson

This year's Budget will announce wide-ranging cuts to business tax. That may seem a big call but Finance Minister Michael Cullen can afford to make the cuts, and he wants to.

Although he said (January 7) that the Government was not considering lowering company tax in the Budget, he will want to announce the timing this election year, along with faster depreciation write-off schedules for many items of plant and machinery, and clearer rules for R&D spending.

Though it would be sensible to abolish the high compliance cost fringe benefit tax as well, by transferring the value of annual benefits such as company cars into the PAYE system, the Government has not yet shown it has much initiative in dealing with business compliance costs, even when it's easy to do.

There are several reasons for expecting the tax cuts. The Prime Minister indicated this is to be a year focusing on business, or growing the national cake rather than deciding how to re-distribute it as in previous years.

Second, it is election year, and with economic growth forecast to slow in the coming months from the sustained run of the past five years, Cullen will be keen to head off criticisms that at this rate we'll never make it back into the top half of the OECD, let alone catch up with the Aussies. Cuts to business taxes at the margin will help to underpin local business confidence.

Third, cuts to business taxes will undoubtedly lift investment spending. Treasury papers say this has a downside as companies could be encouraged to hold on to profits and not pay dividends. Business says this would be positive for the economy as it would encourage business to re-invest faster than otherwise, in people-skills as well as in more productive equipment.

ANZ bank economist Joseph Healy showed in 1992 that New Zealand dividend payouts to shareholders are the highest in the developed world. The funds generated are not retained in business for their expansion, and this extraordinary lack of re-investment by companies is a major contributor to our dismal growth record.

But we agree with the Treasury that a lower business tax rate would bring us back on the radar of overseas investors.

Likewise, faster depreciation and better R&D rules will re-inforce the store the Government places on innovation as New Zealand's economic driver.

Fourth, the cost is very affordable at $525 million for a 3 per cent cut in the business tax rate to 30 per cent, since company tax is a withholding down-payment only. The Treasury papers made public by Act leader Rodney Hide on January 8 gave this figure and said the lower amount paid by companies would be clawed back when dividends were paid to resident shareholders, who would then pay tax at their marginal tax rates.

Fifth, the Government will recoup its modest outlay several times over within a few years as the economy expands in response to the cut. If, as shown in a separate Treasury paper, a $5 billion tax cut would conservatively add 1 per cent to economic growth in the medium term, a $500 million cut to the company tax rate would add 0.1 per cent to GDP over time, or roughly $1.5 billion each year and compounding every year thereafter.

With an investment like that on offer, Government would be silly to refuse.

Sixth, the Government can obviously afford company tax cuts of this order - and much more besides if it wants to build a constituency for even faster growth.

It can have its cake and eat it. But it will want to be seen to be fiscally cautious, partly for the sound reason that the labour market is approaching supply saturation.

Last year, Cullen acknowledged that four years of reasonable (4 per cent) growth indicated that more (consumption) spending among the lower-waged should be afforded. This year, the structural development of the economy since 1999 has shown with even more clarity that there is ample room for tax cuts.

The Government is on track to report an annual surplus of $6.5 billion a year. For about 10 per cent of this, New Zealand's growth would be underpinned and held at 4 per cent or more well into Labour's ambitions for a third term, and beyond.

* Alasdair Thompson is chief executive of the Employers and Manufacturers Association (Northern).