Monday, April 18, 2011

Roger Kerr: Tax Changes Wide Of The Mark

In the Herald on Sunday Bernard Hickey wrote that the tax changes announced in the May 2010 budget had failed. “The company tax cut was supposed to encourage companies to invest here and employ more people.” Together with changes to personal tax, GST and depreciation, this “would bring down the budget deficit and transform the economy from a consuming and borrowing junkie into an investing and exporting powerhouse.”

“Transform the economy”?  No one made that claim.  A Treasury paper released with the budget indicated that GDP might be a modest 0.9% higher in seven years’ time as a result of the tax package.

My own commentary described the budget as “Sound Steps But No Step Change.”  No other reactions summarised on the National Business Review’s website suggested the package was transformational.

I noted that it basically restored a measure of integrity to the tax system which was lost under Labour.  The top personal rate was returned to 33% from 38% (not 39% as stated in the article) and the alignment with the trust rate reduced incentives for tax avoidance.

However, the changes to work incentives were not large.  Taking account of last year’s income, ACC and GST tax changes, and assuming income is spent as it is earned, the after-tax income from an extra dollar of earnings by someone on the top rate would have gone up by about 5%.  The comparable changes for most other taxpayers were probably smaller.

What’s more, the tax switch only took effect last October and the company tax reduction only this month (for companies with a March balance date).

The claim that the tax package blew out the budget deficit is unsupportable.  The budget put the fiscal costs at $415 million over four years, or around $100 million a year on average.  Hence the budget’s assessment that the package was “broadly fiscally neutral.”

As far as distributional effects are concerned, the budget noted, “All household groups will receive on average around a 0.5% to 1% increase in their real disposable income.”

Perhaps most importantly, the tax package was not a ‘real’ tax cut.  Government spending represents the true tax burden: it must generally be financed from current taxation or borrowing (which is deferred taxation).  Budget documents indicate government spending is rising this year as a share of the economy.  Indeed core Crown expenses for each year to 2015 are forecast to be higher as a percentage of GDP than in any of the Cullen years (2000-2008).

None of this is a recipe for economic take-off.  The 2025 Taskforce did not even include an income tax/GST switch in its recommendations (though it argued for a lower, flatter tax scale funded by reductions in the government spending share of the economy).

The bottom line is that the economic effects of the tax package were always likely to be modest and take time to be realised.
In a report last month, the IMF welcomed the package but its view is that New Zealand’s potential growth rate has halved during the past decade under the weight of government spending and regulation.

The latest report of the 2025 Taskforce stated: "Our reading of the economic literature and the historical evidence suggests that closing an income gap of the size New Zealandfaces, and reversing our decades of relative decline, cannot be done with government spending at more than 40 percent of GDP.”  (The IMF recently put total (central plus local) government outlays in New Zealandat 44% of GDP.)

Bernard Hickey is right to suggest that New Zealandis on a precarious economic path (the main concerns being our internal imbalances – and consequent external debt – and the slump in productivity growth).  A wide-ranging programme is needed to solve these problems, such as the one recommended by the Taskforce and widely endorsed by business organisations.

We must hope next month’s budget is a serious instalment in such a programme.

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