Friday, April 21, 2023

Ruth Richardson: The taxation problem I should have fixed 33 years ago

How have we got to the point where our lowest-waged workers are now paying tax rates that were set up to sock it to those on higher incomes?

If you’re a minimum wage earner who works more than 40 hours a week, you’re now in the middle $48,000 tax bracket, paying 30% on any additional earnings.

Inflation has dragged you into a higher tax bracket.

To make things worse, the higher bracket at such a modest income level is a tax on ambition that risks killing the incentive to upskill, gun for promotion or take on a side gig.

The idea that drives progressive taxation is that as people become better off, they should pay higher taxes. We need to rethink this logic. The trouble is that our so-called progressive rates have become regressive, hitting minimum-wage workers.

Far from abiding by the old adage that there should be no taxation without representation, meaning only Parliament should set the tax brackets and rates, inflation moves earners into higher brackets by stealth.

Over time, the effect of inflation on fixed income tax brackets is that of steady but stealthy hikes to both your marginal and average tax rate. Economists call this process bracket creep or fiscal drag.

When four of our five tax brackets were set back in 2010, $48,000 was a decent salary, and so the 30% tax bracket would only affect the relatively well-off.

Now, the median earner nets close to $62,000, meaning a big chunk of their wages are taxed at this high-income rate and will soon fall into the even higher income bracket of 33%.

This could have been avoided. Had Bill English insisted back in 2010 on legislating annual tax bracket updates in line with inflation, the median earner would now be paying $2019.50 less in tax than they do now.

Of course, such a sensible measure would have left English then and Robertson now with a little less money to play around with at budget time.

The place to start is not with tax levels, but with spending demands. Tax and borrowing levels are designed to cover spending demands and as we have now (re)discovered to our cost, undisciplined spending drives unsustainable inflation.

My 1994 Fiscal Responsibility Act set out five principles of responsible fiscal management: reducing public debt to prudent levels, requiring an operating balance to be maintained on average over a reasonable time, maintaining a buffer level of public net worth, managing fiscal risks, and maintaining predictable and stable rates of taxation.

The breach of these principles on the spending side has imperilled not just the quest for stable rates of tax but price stability itself, a monetary policy imperative.

So, to tax levels.

Any government is free to hike taxes if they dare, but this should be done transparently and with scrutiny. That means collecting advice from the Treasury on how the tax hike will affect New Zealanders and overall productivity.

It means presenting any proposal to Parliament and fielding questions from MPs. It means setting out a clear rationale for your tax hike and the cost/benefit analysis so voters can cast judgement come election day.

Without this due process, Jane Average’s extra $2000 tax bill is a dishonest, undemocratic money grab. Taxpayers could be justified in invoicing Grant Robertson for their money back.

Any promise of tax relief that does not involve ongoing indexation should be protested as a sleight-of-hand: A partial refund of stolen wages attached to a promise to keep on stealing.

Of course, this problem is inextricably linked to inflation. For most of the English–Robertson era, inflation ran low and politicians found bracket creep easy to ignore. But now the issue is urgent, with inflation at a 30-year high.

These obvious tax injustices demand remedies.

The first port of call is to tackle tax rates. A government could decide to adopt a flat tax, which would avoid both the disincentive to progress and the scourge of fiscal drag. Or the steep five-step bracket regime could be collapsed into two, with the top bracket kicking in at, say, twice the minimum wage.

Second, the stealth tax needs to be slayed forever by legislating for an automatic annual inflation adjustment to the chosen tax brackets. After all, that has become standard practice on the other side of the ledger as benefits and minimum wages are now inflation adjusted.

We expect our finance ministers to rein in inflation by limiting the splurge of taxed and borrowed money into an overheated economy. But here’s where perverse incentives kick in: How can finance ministers be trusted to fight inflation when, thanks to bracket creep, they profit from it?.....The full article is published HERE

Hon Ruth Richardson served as finance minister in the fourth National Government and is a board member of the New Zealand Taxpayers’ Union.


colin said...

Why tax brackets at all. Why not a linear tax rise from, say 10% at $10k to 40% at $400k, then flat or another tax gradient after that. Seems much more fair. Crossing a tax bracket is quite painful. This way an extra $ earned incurs only a marginal amount more tax. ?? Maybe I am missing something, but I've never heard of this being discussed and rejected.

Barend Vlaardingerbroek said...

'Progressive' tax rates discriminate against couples only one of whom works. One income of 80K comes with a tax burden more than do two 40K incomes. But the unit of prosperity is the household, not the individual.

TJS said...

Well they're very good at spending money but not very good at making it. When they do, if ever, they either stuff it up or sell it off. 30% is too high for low income, with the cost of living most things are out of reach. It's far worse now than it was 7 years ago. That's the "Elephant in the room". To coin a phrase.

Anonymous said...

perhaps it's time to try out friedman's 'negative tax' idea. the threshold could be set at 'minimum' of 'living' wage. this would also reduce the incentive to stay on benefit, at least for the able.

Anonymous said...

Why pay tax at all to corrupt governments (crime syndicates) who push through un-mandated undemocratic policy in secret that has the smell of Marxist/Communist agenda all over it!!

TJS said...

I said the last 7 years, it seems like a decade but in reality it's it's been 5.5 years hasn't it?