The Chinese conducted an experiment at great cost to prove there is a limit to how much revenue taxation can raise. During the Great Leap Forward the Chinese government drastically increased taxes on farmers. The farmers stopped planting and 30 million people starved. The economy collapsed.
Somewhere between zero and 100 per cent is peak taxation, where a government collects the most revenue with the least damage to the economy.
The evidence indicates New Zealand has exceeded its peak taxation.
The Labour Government significantly increased taxation by keeping tax rates steady in a time of rapid inflation. Instead of revenue increasing, Finance Minister Nicola Willis says that the Treasury is predicting a significant reduction in tax revenue.
High interest rates are causing a recession. The economy is producing less tax, but high interest rates do not explain why productivity is negative.
Productivity, producing more with less, is what drives higher living standards. We are in dire straits as the economy now requires more effort to produce less.
Economists are debating the reasons for our negative productivity. There are many suggested including over-regulation, not enough capital, insufficient competition. They are all good candidates, but they all existed when productivity was positive.
What has changed is the huge growth in government under Labour that is squeezing the productive sector.
Given the importance of the sustainable limit of taxation you would think governments would be keen to know the limit. While the size of government is a huge philosophical debate, governments around the world have shown little interest in finding out what is the ideal size. Empirical research on the limits of taxation is scarce.
The New Zealand government has in its archive world-leading research on the limits of taxation. While the Treasury has never shown any interest, the Inland Revenue Department, which collects tax, in the 1990s commissioned Dr Patrick Caragata to find out. He contracted teams of eminent international economists, including professors Gerald Scully and Knox Lovell, to find out.
Using IRD data the economists built three models of the New Zealand economy. All three models came up with similar answers. Regardless of the type of tax, the sustainable level of taxation is reached when the government takes somewhere between 15 and 23 per cent of the economy.
The Treasury was horrified. The Treasury had assumed the figure was far higher. It had the finding peer-reviewed. That report said the sustainable tax limit was 15 per cent of the economy.
The Treasury did what the department does when it gets answers it does not like. It cut off funding to the IRD research unit. The unit was disbanded. The research was ignored.
We know about the research because no fewer than seven academic journals, after peer review, have published the results.
One model of the New Zealand economy predicted that while a future government could increase tax rates, it would result in no more revenue. This is what has happened.
Finance Minister Nicola Willis says that the Treasury is predicting a significant reduction in tax revenue. Photo / Mark Mitchell
There are countries in Europe where the state takes 50 per cent of the economy.
Other factors such as the quality of institutions and culture are important, but the size of European governments may explain Europe’s slow economic growth.
The size of our government is far bigger than the researchers found produced peak tax revenue and peak economic growth.
Under National the government was taking 28 per cent of the economy. Labour’s tax and spend took the government’s share of the economy to about 34 per cent.
New Zealand has had the world’s highest standard of living. Geoffrey Blainey, the eminent Australian historian, writes that by 1900 New Zealand was astonishingly successful, making us, along with Australians, the wealthiest people on earth. The government in 1900 took just 10 cents in the dollar.
Last year Dr Bryce Wilkinson produced “a historical perspective on the 2017-2023 government spending spree” where he outlined Labour’s spending. Spending grew rapidly before Covid-19 and then exploded. The increased spending did not improve government services.
Wilkinson says crises such as Covid-19 cause an increase in the size of government that never returns to pre-crisis levels.
The statistic to watch in Thursday’s Budget is the government’s projected share of the economy. No pre-Budget speech has indicated that the government will be returning to the pre-Covid size or to the size of government that would maximise economic growth.
We need protesters who realise that only a growing economy can fund health, education, and welfare to hold signs saying: “Less government”.
