The great debate: Family help - or cutting tax for growth

Opinion

The Government's latest Budget deposits an average of $100 a week extra into the pockets of low and middle income families. But will it hinder economic growth?

Here, Business Roundtable chief executive Roger Kerr, and Victoria University associate professor of public policy Bob Stephens argue the toss. 

Bob,

In the 2002 speech from the throne, the Governor-General said: "My Government sees its most important task as building the conditions for increasing New Zealand's long-term sustainable rate of economic growth."

The 2004 Budget, however, contained no such policies. The Government says that the Working for Families package, the centrepiece of the 2004 Budget, will encourage beneficiaries to take up employment. However, this effect is likely to be small, as research commissioned by the Treasury suggested.

The Budget was a missed opportunity to boost economic growth because:

* Working for Families does little to improve incentives. It mainly rewards activities that would take place without it.

* The average effective marginal tax rate across all taxpayers will be higher with the package which will discourage employment, other things being equal. While lower effective marginal tax rates for some beneficiaries may encourage them to work, taxpayers on average are likely to be discouraged from engaging in productive activities.

* The $1.1 billion annual cost of the package could have been used to enhance growth, for instance by lowering and flattening the income tax scale, as recommended by the McLeod Tax Review of 2001.

Working for Families will largely redistribute income to families with dependent children, many of whom are on middle or upper incomes. It would be better to cut their taxes. We should not kid ourselves that the package is a contribution to increasing the rate of growth.

- Roger

* * *

Roger,

You are still living with the outmoded economic theories of the 1980s. The present view within the OECD and New Zealand is that investment in social policy and improving job opportunities for those out of work is sound economic policy.

The Working for Families package will help overcome labour shortages, sustaining the high rate of economic growth. It will also achieve social goals such as the alleviation of poverty for families with dependent children.

International research shows that in-work payments such as Working for Families are an excellent way of attracting those not working, or working part-time, into the full-time labour force.

Not just the unemployed, but sole parents and many women and men who are inactive enter work.

The large increase in take-home pay for those earners on low-to-middle incomes with dependent children is far more of an incentive to enter work than the effect of a small tax cut for those already employed.

The main gainers of a tax cut are upper-income earners, already working excessive hours, who may use the extra money for leisure. But earners on low and middle incomes have the incentive to keep working, spend the extra money, increasing business activity and profits, and thus encourage economic growth.

And the economic growth can occur as new workers have been encouraged into jobs. A virtuous circle has been created and one that is essential if we are to offset labour shortages from the impact of population ageing.

- Bob

* * *

Bob,

Economics is not a matter of passing fashions. There is an even stronger professional consensus for economic liberalisation today than there was in the 1980s.

Today's "current high rate of economic growth" is largely the result of New Zealand's free-market reforms as the OECD recently reported.

Wealth redistribution and wealth creation (growth) can't both be given priority at the same time. Working for Families will redistribute income and may alleviate poverty but that is not the issue we are debating.

The Government could spend about $1 billion on the package or make equivalent tax reductions.

From a growth perspective, the choice is clear. As the Treasury has stated: "Moving to a flat tax rate for personal and company tax rates is likely to have the greatest impact on economic growth."

The in-work payment does little for growth. It accounts for just a third of the cost of the package and will largely be paid to households already in work. It does not encourage a second member of a household to enter the workforce.

The Treasury estimated that only 2 per cent of sole parents (about 2160 beneficiaries) would move into work. Each additional job would cost about $84,600. How can that be good for growth?

The deadweight costs of raising an additional $1 billion of tax revenue are also a large drag on growth - perhaps as much as 50 cents for every package dollar.

As a package to increase growth - the Government's stated top priority - it doesn't stack up.

- Roger

* * *

Roger,

Rogernomics and Reagonomics, the economics of Maggie Thatcher and Ruth Richardson, were all based on supply-side economics - with the correct incentives, people will work longer and business will invest.

The package is firmly in that tradition: with significantly greater payment to families with dependent children from working than staying on the benefit, there is a strong inducement to enter work and stay in work. The Treasury has underestimated labour supply impacts as they could not model the childcare changes.

Childcare costs have been the largest barrier to work for sole parents and secondary earners.

For the cost of the package, one could lower the bottom personal tax rate from 19.5 per cent to 17.5 per cent. That is hardly an inducement to enter work, with a gain of $15 a week, and virtually no reduction in child poverty.

Our true company tax rate is already low. Our low productivity growth is because companies send profits overseas rather than reinvesting them.

The Child Poverty Action Group argues that the package is too growth-oriented, with too much emphasis on work and not enough on immediate poverty relief for families with dependent children.

Working for Families has the right balance - poverty alleviation for beneficiary and low-income working families, incentives to enter work as a long-term solution to poverty and the greater work effort raising future economic growth.

- Bob

* * *

Bob,

The Government has stated that its most important goal is to lift the rate of economic growth.

The package focuses on the redistribution of income rather than growth. The Government cannot give priority to income redistribution and growth at the same time.

Lower and flatter rates of tax, as recommended by the McLeod Tax Review 2001, would do far more for growth.

A growth-oriented policy would lower the rates of tax that do the most harm. It would cut high effective marginal rates of tax rather than the bottom statutory rate (19.5 per cent).

Childcare subsidies are a minor element of the package. They account for about 3 per cent of its cost. Like much of the package, childcare subsidies are not well directed at moving people into work.

The bottom line of this debate is whether the economy is projected to grow faster. It isn't. The Government's projections in the recent December economic and fiscal update show growth falling away to under 3 per cent a year on average in the next four years compared with 3.7 per cent in the past five years and also 3.7 per cent for the whole period since 1993.

Neither Working for Families nor other Government policies are lifting the country's growth rate. If the Government is serious about growth being its top priority, it should abandon its failed policies and put in place a more credible strategy.

- Roger

* * *

Roger,

Yes, the package is designed to reduce poverty among families with dependent children.

The increase in family support will alleviate poverty for beneficiary families.

The new in-work payment will overcome poverty for families in work and, by encouraging entry into work, will remove much of the cause of poverty.

The package will also encourage economic growth.

Not just immediately by allowing people to utilise their skills in the labour market, raising output, productivity and tax revenue, but also in the future, through its investment in children.

The skills and abilities of today's children provide the prerequisites for tomorrow's society and its economic and social outcomes.

Their work effort will pay for yours and my pensions and health care, but also the level of their skills is the main driver of future high-tech industrial development.

The package is about social investment in our children.

Too many children have a poor start in life because of poverty.

The result of hunger and lack of basic amenities, overcrowded and substandard housing is poor education and health, and a greater prevalence of crime and domestic violence.

Working for Families removes the source of these afflictions.

This social investment will let people achieve their potential, raising the skill level and productivity of our workforce. Social growth is the real driver of economic growth.

- Bob