One of the early moves of the present Government was to cut the top tax rate and increase GST which has the biggest effect on low-income earners as a portion of their incomes.
The arguments for reducing tax rates on high incomes are based on a concept called the Laffer curve, drawn on a napkin in a Washington restaurant by Arthur Laffer in the mid 1970s. Laffer's simple graph purported to show that there was such a thing as an ideal tax rate on incomes that would ensure maximum tax revenue for a government.
This idea was seized upon by the Reagan administration in the 1980s to justify tax cuts for the wealthy. It was argued that if the rich paid less tax, everyone would benefit through a trickle-down effect.
If richer people pay less tax, it gives them more money to save and invest in new businesses, technologies, plant and equipment, the theory goes. Those further down the ladder gain through more jobs and higher incomes.
If top income earners are taxed too much, it is also a disincentive for them to work harder. Dentists play golf on Wednesday afternoons rather than drill teeth. There is some truth in this. But there is no concrete evidence about there being a "best" top tax rate.
It is also argued that higher tax rates for top earners could lead to a brain drain and an inability to attract and retain top executives and other talent to New Zealand. We would become a bastion of corporate mediocrity.
These are the arguments used to support the flatter income tax system that we have moved towards in recent years.
But there are counter-arguments that are seldom acknowledged.
The economic theory behind a progressive tax system can be illustrated by a simple thought experiment. Who would experience the most discomfort from a $50-a-week pay cut? Someone earning $500 a week or someone earning $3000 a week? A flatter tax system suggests the discomfort would be about the same.
Moves towards flatter tax systems in New Zealand and abroad have coincided with rising income and wealth inequalities, though many other factors are also involved.
The rise in inequalities in many Western nations has also coincided with speculative asset bubbles and crashes.
While this is largely the result of financial deregulation over the past 30 years, growing inequalities have also played a part.
Those with money to invest seek the best returns and often pile into speculative assets such as shares or emerging markets or investment properties, creating distortions in these markets. Meanwhile those further down the income ladder struggle to make ends meet.
Even more insidious is when house prices are bid up by investors seeking speculative returns. In this globalised age, these investors may be domestic or international.
Higher top tax rates will make it harder to attract and retain top corporate talent? This suggests that there is a fixed pool of omnipotent corporate heroes, rather than fresh talent coming through all the time.
It could be argued that if their desire to live in New Zealand is prompted by slightly lower marginal tax rates they are hardly ideal long-term citizens. But it should be acknowledged that if top earners are expected to pay a higher average tax rate they should expect their taxes to be put to good use.
Maybe the extra tax revenue should be ring-fenced as the Government did with the proceeds from asset sales. This could ensure greater accountability in how the funds are used.
An economy is like a dynamo. It needs balance to function effectively. When inequalities become too great it fails to function effectively. Demand gets distorted. The wealthier may seek higher returns in speculative assets. But the majority can't provide the broader demand to stimulate new businesses, output and employment.
The trickle-down effect was an anecdotal concept to justify tax cuts for the rich. It has contributed to the economic imbalances that many economies are currently experiencing.
Peter Lyons teaches economics at St Peter's College in Epsom and has written several economics texts.
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