Brian Fallow: Budget raises burden on business

Budget projections leave a $5.3 billion gap to be filled. Photo / Greg Bowker

The Budget has been widely seen as pro-growth and business-friendly, but the tax changes at the heart of it increase the net tax burden on business and deliver a large transfer from business taxpayers to personal ones.

The income tax cuts were more generous than expected.

The upshot is a $5.3 billion gap over the next four years between the revenue foregone through personal income tax cuts and the extra revenue raised by increasing GST.

Where does the Government expect to find that $5.3 billion?

About $1.4 billion will come from business taxpayers.

The company tax rate is cut from 30 to 28 per cent, saving them $1.1 billion over the forecast period, but that is dwarfed by $2.5 billion in "base broadening" moves.

Business bears the brunt of the changes to depreciation, as well as the lower thin capitalisation threshold.

Landlords are in the gun for a similar amount.

Losing the depreciation deduction and the changes to loss-attributing qualifying companies (LAQCs) will cost them $1.4 billion over the next four years.

But that still leaves the Government $2.5 billion short.

Smokers will stump up nearly $200 million a year in extra excise on tobacco, or $715 million over the four years of the forecasts.

IRD's auditors, on past performance, are expected to deliver $5 in extra tax for every extra dollar they cost, so extra spending on compliance is expected to yield another $745 million over the four years.

But that still leaves the Government more than $1 billion short.

Some of it will be borrowed. The tax package is supposed to be "broadly fiscally neutral" but in the first year it is not, pushing out the deficit by nearly half a billion dollars.

By year four it is revenue positive, but over the four years as a whole it involves a net borrowing requirement of $415 million. At least.

There is also an allowance for the dynamic effects of the tax package on the economy and therefore on the fiscal position.

That is estimated at $670 million over the four years.

It is hard to escape the suspicion that that number is there to close an arithmetical gap rather than representing an effect that can be quantified with great confidence and precision.

If the estimate proves optimistic, more will need to be borrowed.

The Treasury reckons the tax package will boost the level of GDP by a cumulative 0.9 per cent over the next six years.

That effect comes mainly by increasing hours worked and by lifting the proportion of working-age people who are in the workforce.

Cutting marginal tax rates may indeed encourage people to work more overtime (assuming that is something they get to decide, which is debatable).

But that is not our problem. We already work long hours by international standards.

For years economic growth has been driven more by an increase in the labour input than by labour productivity, or output per hour.

That reflects above all capital shallowness - low levels of capital employed per worker compared with, say, Australia.

So will the tax changes mean firms invest more in capital equipment?

It ought at least to lift our dismal household savings rate.

The uncertainty is where those additional savings will go.

The Reserve Bank, as regulator of the banking system, has embarked on a process of requiring banks to get more of their funding from more stable sources such as retail deposits.

So even if the switch from taxing incomes less and consumption more shifts the balance between spending and saving in a more provident direction, the extra savings may end up in the bank, substituting for funds imported from the commercial paper market in New York.

That is desirable, given how vulnerable we are because of our reliance on imported credit, but it does not of itself do anything to increase investment or jobs.

Other elements of the tax package would tend, if anything, to reduce investment spending. Accelerated depreciation of plant and machinery, particularly useful to smaller enterprises, is to be scrapped.

And the lower thin-cap threshold will raise the cost of capital for multinationals operating here.

Chief financial officers are no doubt busy trying to calculate the net effect of that and the lower company tax rate on their companies' bottom lines.

It could go either way, but at the margin there is likely to be some negative effect on foreign investment into this country.

And overall the tax burden on business is increased, as the Budget document acknowledges: "On average firms will pay more tax, as the reduction in the company tax rate does not fully offset the impact of higher taxable income owing to the changed depreciation and thin capitalisation rules."

The policy aim of boosting investment also runs up against the problem of a dearth of options.

With so much of the economy either foreign-owned, state-owned or farmer-owned, the stock market intercepts only a small part of the commercial life of the country.

The Budget foreshadows no measures to address that issue.

There is also a real question about whether it has done enough to head off the risk of another economically and socially destructive property boom like the one we experienced between 2002 and 2007.

Despite months of angst, in the end residential property investors escaped relatively lightly compared with what might have befallen them (like ring-fencing losses for tax purposes, taxing a deemed return on their equity, a land tax or a capital gains tax).

They lose their ability to deduct depreciation on buildings, which is estimated to bring $1.2 billion into the Government's coffers over the next four years, while changes to the LAQC rules yield another $200 million.

The depreciation change is only a timing issue, however, as those deductions are usually clawed back upon sale.

Scrapping the top 38 per cent rate of personal income tax will reduce the incentive to shelter income in loss-making property investments.

Some market economists believe the changes will be enough to pre-empt another housing boom and its spillover effects on interest rates, the dollar and investment choices.

Let's hope so. With average house prices already six times average disposable income and household debt at 1.5 times income, the implications of another investor-led bout of house price inflation are grim.

So how does the Budget stack up against its own billing?

There is an incentive to work more hours, but that's not really what we need.

It might increase savings, but that might only substitute for imported credit.

It could increase business investment, but the net tax burden on business has been increased.

And it might avert a relapse into virulent house price inflation.

But don't bet on it.

On the other hand reining in Government spending, not so much in the year ahead but further out, should take some upward pressure off interest rates and means the peak in net debt will be lower and earlier than projected last year.