Roundtable chief urges income tax rate of 20pc

By Brian Fallow

WELLINGTON - Both National and Labour are pursuing wrong-headed tax policies, according to Business Roundtable executive director Roger Kerr.

Both major parties had failed to show leadership towards what should be the two main goals of tax policy: reducing the overall tax burden on the economy, and flattening the tax scale, Mr Kerr argued in a speech to the Franchise Association in Rotorua on Saturday.

Government spending, the best measure of the tax burden, had been stuck at around 35 per cent of gross domestic product for the past five years, despite the long-run objective under the Fiscal Responsibility Act of reducing it to 30 per cent.

Mr Kerr was critical of Treasurer Bill English's "dollar for dollar" pledge, that for every dollar of tax reductions, spending will be increased by a dollar. Such a pledge undermined the credibility of National's commitment to further cuts. For its part, Labour's credibility is undermined, in Mr Kerr's view, by a raft of spending promises far in excess of the extra $300-odd million to be raised by introducing a new top rate of 39c in the dollar above $60,000.

Public policy should focus on reducing the tax payable on the next dollar of income (marginal income) as that was what affected such decisions as whether to work, train or take a promotion, Mr Kerr said.

The 1996 and 1998 tax cuts widened the gap between the middle effective marginal tax rate and the top rate from 5c to 12c. The further cut promised by Mr English for next year would widen it by a further 1c.

Whatever the political rationale for targeting the cuts at middle income earners, by cutting the lower rate while leaving the top rate unchanged, the moves had amplified the inevitable distortions in a progressive tax scale.

For example, it increased the disincentive for people on lower and middle incomes to save through life insurance and superannuation schemes (since their savings would be taxed at a substantially higher rate than their other income).

It also increased the incentives to income-split, by shuffling investment income among family members. "Before July 1996, the maximum annual saving per recipient from transferring income from a top rate taxpayer to a non-earner (say a child) was about $2780. Under the proposed scale it would be $5675."

Labour's proposals, meanwhile, would only make matters worse. Raising the top rate to 39c would increase the deadweight (opportunity) costs of taxation and the distortions of a steeply progressive tax scale.

Being motivated by a desire to increase Government spending, it would increase the overall tax burden as well, Mr Kerr said.

"If New Zealand were really serious about retaining or attracting the skills of outstanding innovators, entrepreneurs, artists and sportspeople, it ought to be setting a goal of applying a flat income tax of no more than, say, 20 per cent," he said.

"By going in the opposite direction, Labour will be sending a strong signal to productive people with international skills to migrate to countries with higher average incomes and/or lower overall tax burdens."

While compassion for those in hardship justified a tax-funded safety net, it did not justify a progressive tax scale. Issues related to income distribution should largely be addressed through welfare, rather than tax, policies, Mr Kerr said.

"When all is said and done, envy turns out to be the only real motivation for a progressive tax scale."

* Meanwhile, Labour's finance spokesman, Dr Michael Cullen, yesterday poured scorn on the view that tax rates, and the total tax take, must continue to fall "or some kind of economic nuclear winter will descend upon us."

Reasearch commissioned by the Inland Revenue's now-disbanded taxation economics team concluded the growth-maximising tax take was about 20 per cent of GDP.

But in the end, all it showed was that since the 1930s New Zealand's growth rate was highest at times when that was the tax take, Dr Cullen said.

"For that fact there are obvious explanations which are completely unrelated to taxation: the recovery from the Depression, the Second World War, and the Korean War wool boom," he said.

"If we compare OECD countries today we can find no clear relationship at all. The only two in which the tax take is less than 25 per cent of GDP are Mexico and Turkey. Amongst the rest it is very hard to draw any conclusions except that where taxation contributes to very high non-wage labour costs this does seem to be associated with high levels of structural unemployment.

"Even in these cases, such costs are also usually to be found in countries where there are rigid labour markets, which may be the more important factor."