Editorial: Tax reform needs to tackle growing debt

Over the past week, we have published a number of items on an important economic task facing the Government this year. The first article, printed last Monday, was by Finance Minister Bill English. Remarking on how well he had managed the recession, he acknowledged the recovering economy would need some changes to lift its growth rate and increase its potential wealth. One of these changes he called "strengthening the tax system".

He looked forward to the report due within a few weeks from the Victoria University-led Tax Working Group, though he added that the Government would "look through" this and other recent advisory reports to "pick out the best and most practical ideas".

The Tax Working Group has been the subject of a series of articles in our business pages from an Auckland University professor of tax law, Craig Elliffe. He reminded us that a weakness in our taxation was a matter of concern long before the recession blew a hole in the Government's Budget and left the country facing a decade of deficits and mounting debt.

The weakness is that we rely more heavily than most countries on revenue from personal incomes and company profits, which are "mobile" in the sense that people and firms can fairly readily emigrate. We also rely heavily on a few high-income earners. Professor Elliffe pointed out that the top 3 per cent of earners provide 26 per cent of income tax.

He also pointed out that not all forms of income are equally taxed. A person can avoid the top rate of 38 per cent by operating a family trust at 33 per cent or a company at 30 per cent. But the "most stunning example" of this inequity, he said, was in capital profit. "Someone who earns a salary of $100,000 and pays tax of $27,550 can be compared with someone who sells their holiday home with a profit of $100,000 and pays no tax."

He noted that investment in residential rental property in this country is about five times the amount invested on the stock exchange, and that property investment not only returns no tax, it costs taxpayers $150 million to $200 million a year in refunded income tax because rental deficits are deductible from other income.

The Tax Working Group is going to suggest ways that the country can reduce taxation on incomes and profits by introducing or improving taxes on property and purchases of goods and services. Mr English, in his article, was very enthusiastic about reducing taxes but he had nothing to say about the other side of the equation.

"The crisis of the past year," he said, "has hit most countries worse than New Zealand. Many will be saddled with permanently higher debt and will be forced to raise taxes. New Zealand has a unique opportunity to emerge from the recession in a stronger position than these countries. Sound finances and low taxes could be a key point of difference in attracting business investment and skilled people here."

The reference to "sound finances" as well as low taxes should mean the Government will not cut personal and corporate taxes without maintaining its revenue with other taxes, probably on property and a higher rate of GST. But Mr English sounds in no hurry to fix "a hole in the Government's books that will take several years to rectify".

When this Government comes to "look through" the Tax Working Group's report for "the best and most practical ideas", it will be tempted to pick only the popular ones, tax cuts. It is a convenient theory that merely lowering taxes can generate enough economic growth to correct deficits and reduce public debt. It is a theory we should not test.

Countries prosper when their public finances are under control.