Brian Fallow: Repackaging the tax burden

Whatever else it is, National's tax policy represents a large step towards a flatter income tax scale.

National estimates that raising the income threshold for the 33c rate from $38,000 to $50,000 would benefit about 300,000 taxpayers, and that raising the threshold for the top 39c rate from $60,000 to $100,000 about another 200,000.

The Treasury's estimate that by next June there will be about 471,000 taxpayers with incomes of more than $50,000. On the present tax scale they would pay $12.1 billion of the $21.1 billion of income tax the Treasury forecasts for this fiscal year.

They represent only about one in every six income taxpayers. But they contribute the lion's share, 57 per cent, of the income tax take and 25 per cent of the total tax take. They are, in fact, the taxman's best customers.

The converse is that, under National's tax policy, five out of six taxpayers will have a marginal tax rate of 19c in the dollar or less.

The 3 per cent of taxpayers with incomes above $100,000, about 85,000 people, are expected to pay $5.3 billion this year, or 25 per cent of the income tax take. They would get 10 per cent of the benefit of National's tax cuts by year three, roughly $390 million.

National would cut the proportion of taxpayers in the top two tax brackets from 27 to 16 per cent, but it would still have four tax brackets.

It would retain a 15c rate at the bottom but would push the threshold up from $9500 to $12,500.

The McLeod tax review in 2001 advocated having just two tax brackets: 18c in the dollar up to $29,500 and 33c above that.

The McLeod committee said the low-earner rebate, which produces the effective 15c band at the bottom of the scale, increased complexity, particularly for beneficiaries trying to work, while raising the marginal tax rate for most taxpayers.

It said the $9500 threshold was a poor indicator of need: low-income families had incomes well above that threshold and received other assistance.

Many people with low incomes were not needy, including second-income earners in middle- and high-income households, some self-employed people and people earning income for only part of the year, such as immigrants and emigrants.

It concluded: "Given that income is a poor indicator of need, proposals for a tax-free zone poorly target those in need and have large fiscal costs. These fiscal costs would raise marginal tax rates for most taxpayers."

Australia has a high top tax rate of 47c in the dollar, because at the other end of the scale the first $6000 of income is tax-free. That dilutes the average tax rate (the total income tax paid divided by income) so significantly that even with Australia's more progressive tax scale, people have to be earning nearly $100,000 before they pay a higher proportion of income in income tax there than they do here.

Accepting the need for redistribution, the McLeod committee said the main and most effective method of addressing the bad effects of income inequality was through Government spending rather than the progression of the tax scale.

Lower-income households not only pay less tax, but get a higher share of Government spending on healthcare, education and welfare than higher-income households do.

The scope for achieving additional redistribution by way of a more progressive tax scale was limited, the committee argued, because there were too few in the high-income brackets and too many in the low ones.

It said it would be necessary to take $5 from every taxpayer earning more than $50,000 to give $1 to every taxpayer earning less than that.

Using targeted income support instead, as Labour prefers, raises the vexed issue of effective marginal tax rates.

The effective marginal tax rate a person pays is based on how much of every additional dollar earned is lost as a result of tax and the abatement or whittling down of entitlement to income-tested benefits.

The arithmetic is the same whether the benefit is delivered through the welfare system or as tax credits.

It is an inevitable consequence of targeting assistance that there is some zone of income at which entitlements abate and people lose a significant part - often more than half - of every extra dollar they earn.

Labour's Working for Families package, as designed in last year's Budget, pushed that zone further up the income scale than the previous Family Support system.

Labour's latest proposed top-up would push it further up still, leading to the accusation that what was originally a measure to make work pay has become middle-class welfare.

National says it will keep most of the Working for Families scheme until it can come up with something better that leaves no one worse off - a daunting policy design challenge.

But in the meantime, the effective marginal tax rates would be lower under National than Labour, reflecting the lower income tax component.

The McLeod review also wanted the top 39c rate scrapped because it sent a negative signal to the most skilled and internationally mobile taxpayers (whether they are in that income bracket or aspire to be).

Also, having a gap between the top personal rate and the company rate creates incentives for people to use companies and trusts to shelter income, which in turn leads to more complexity in the tax rules as the Government tries to close off the opportunities to do that.

On the other hand, as McLeod noted, many countries have deliberately reduced their company tax rates to significantly below the top personal tax rate, with a view to attracting and retaining capital.

National says it will cut the company tax rate from 33 to 30 per cent, but not until 2008, unless fiscal conditions allow an earlier move.

Unveiling the tax policy on Monday, National's leader, Don Brash, hinted that dropping the 39c rate or pushing the threshold further out was still on the agenda.

"That top 39c rate is still too high and still cuts in at too low a threshold, but further changes will have to wait," he said. "Our priority in the first term of Government is to reduce tax rates on low- and middle-income New Zealanders, to give people better incentives and ability to get ahead in life."

This is a far cry from the stance Brash was taking a few years ago, when the emphasis was on cutting the company rate and the top personal tax rate on the grounds that this would deliver most economic bang for the revenue buck.

Finance Minister Michael Cullen said National had always said the corporate rate was the one that had to go down in order to stimulate growth, but now that was being put off for three years.

"Why? Because the politics aren't as good about corporate tax cuts as they are about personal tax cuts."