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Dr Muriel Newman

Tax freedom day

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Saturday was Tax Freedom Day. As far as the central government tax burden is concerned, Saturday was the notional day of the year when the average New Zealander stopped working for the government and started working for themselves.

This year we effectively spent 118 days working for central government. That’s a third of the year.

The calculation of 28 April uses the forecast of core government expenditure of 32.3 percent of gross domestic product (GDP) found in the Pre-election Economic and Fiscal Update. This may change of course, once the new forecasts are published in the upcoming Budget.

Government spending is regarded as the best measure of our overall tax burden, since almost all government spending is ultimately financed from present or deferred taxation (borrowing) in one form or another.  In addition, this measure is not distorted by whether the budget is in deficit or surplus.

This year’s Tax Freedom Day is 11 days earlier than in 2010 and 2011, when it fell on 9 May according to revised data. This earlier date reflects the progress that National is making in constraining the growth of core government spending.

In 2003 and 2004, Tax Freedom Day fell 12 days earlier on April 16. This was at a time when the Labour Government had kept core government spending to 29 percent of GDP. It was before the onset of their destructive third term spending spree.

You might recall that in 2010, the government’s 2025 Taskforce, an advisory body that was set up to propose ways of improving our economic performance, recommended that if core government spending was reduced back to this 2004 level of 29 percent of GDP, then the top rates of tax – personal, company and trust – could all be dropped to 20 percent, with all of the lower tax rates including GST (at 12.5 percent as it was back then) left exactly as they were. That would have meant that everyone earning more than $14,000 a year would have paid less income tax, and nobody would have paid more.

Just imagine the electrifying boost to our economy that a top tax rate of 20 percent would deliver. It would not only provide the jobs and growth the country so desperately needs, but it would also become a magnet for Kiwis living abroad to come back home. In addition it would draw to New Zealand those international businesses that are constantly on the look out for opportunities and competitive advantage.

Clearly, the earlier Tax Freedom Day falls, the lower the country’s tax burden and the more opportunities taxpayers have to build a better life for themselves and their families. While the present trend is finally moving in the right direction, government forecasts show there will be only modest improvements in Tax Freedom Day through to 2015 when it is projected to occur 6 days earlier on 22 April. This is largely due to the fact that National has opted to retain many of Labour’s popular big-spending programmes like interest free student loans and Working for Families. They argue that now is not the right time to cut such programmes as they are providing essential financial support to families during difficult economic times.

While it is bad enough that New Zealanders are forced to spend a third of the year working for the government to fund its core spending, sadly, this is not the whole story.

Core government spending is only a part of the whole cost of government, since it not only disregards some Crown outlays, such as the spending on State Owned Enterprises and hundreds of Crown Entities, but it also omits some areas of significant expenditure such as the cost of local government.  The OECD includes all of these in a broader measure of total general government spending. On that measure, New Zealand’s total general government spending is forecast to be 43.5 percent of GDP in 2012.  On this basis, Tax Freedom Day will fall on 8 June. This is 22 days earlier than 2011 when it fell on 30 June. But since the earthquake had such a major impact last year, it is best to look at 2009 when it fell on June 6 and 2010, when it fell on June 7. This shows that the trend has been in the wrong direction!

This broader measure of the tax burden also enables us to compare ourselves with other western countries. Doing so highlights the extent to which we are a relatively high-taxed country. Compared with New Zealand, Tax Freedom Day on the broader measure comes over six weeks earlier in Korea (23 April), more than a month earlier in Australia (3 May) and Switzerland (5 May), and about two to three weeks earlier in Turkey (12 May), the Slovak Republic (18 May) and Estonia (23 May).  Tax Freedom Day will occur in a further six OECD countries, including the United States (30 May) and Japan (3 June), before it arrives in New Zealand.

For the OECD as a whole, Tax Freedom Day falls on 7 June, a day earlier than in New Zealand.

The fast-growing Asian and other nations that have levels of government spending and tax burdens well below the OECD average, have a significant competitive advantage over New Zealand. This is a serious risk that Treasury identified in their briefing paper to the in-coming government, when they warned, “the increasing mobility of global capital and New Zealand workers – together with the downward trend in international company tax rates – continues to apply pressure to the competitiveness of New Zealand’s personal and company tax rates.” They recommend on-going reductions in government spending along with further tax cuts to improve incentives to work, save and invest.

In looking at the heavy tax burden we presently face it is important to remember that it has not always been this way. I invited this week’s NZCPR Guest Commentator, economic policy analyst Dr Bryce Wilkinson, the director of the economic consultancy Capital Economics and a former Treasury principal, to provide an analysis of New Zealand’s tax burden over the years. In his paper Why taxes are so high, Bryce explains:

“During the last hundred years, central government taxes per capita rose 20 times faster than consumer prices – from around $660 in 1910 to $13,198 in 2010 in year ended March 2011 dollars.  Meanwhile real GDP per capita only rose roughly 4-fold.  The fact that taxes rose roughly 5 times faster than incomes is reflected in the rise in taxes from 6.3 percent of GDP in 1910 to around 30.8 percent in 2010.”

Bryce puts the changes into an historical perspective: “Real taxes per capita almost doubled during the decades in which World Wars I and II occurred.  They more than doubled again in the decade of the 1930s – which encompassed the Great Depression.   Increases in taxes per capita more or less matched the increase in GDP per capita between 1950 and 1970, with the tax revenue ratio being of the order of 24-25 percent of GDP.  The next 20 years saw another big lift in real taxes per capita, both absolutely and relative to GDP.  High rates of inflation drove taxpayers up the progressive tax rate scales during this period.  The decade of the 1990s provided some respite in that it was the first since the 1920s on this dataset in which taxes per capita did not rise between the beginning and end points.  The last decade has seen another big increase.”

The changing rates of taxation and government spending reflect the enormous shift in the role of government that has taken place in New Zealand since the early 1900s. Originally limited in its core government function of providing basic public goods such as law and order, defence, education, pensions, along with infrastructure – road, rail, public buildings, and communications – the expanding state with its welfare focus has become an easy touch for generations of interest groups advocating for special privileges and funding. It’s also fair to say politicians themselves have eagerly taken on the elevated role, finding public favour by being profligate rather than frugal.

As Bryce’s article points out, New Zealand’s economic history has become a battle-ground for this on-going struggle.

Last year the Economist produced a special report on the role and size of the state, concluding that big governments get in the way of their nation’s social and economic progress. They cited the experience of Singapore as one that Western nations should study.1

They explained that Singapore now provides better schools and hospitals and safer streets than most Western countries—and all with a state that consumes only 19 percent of GDP. Singapore has opened it arms to global enterprise, building an environment that is attractive to business with excellent infrastructure, a well-educated workforce, open trade routes, the rule of law, a flexible labour market, and low taxes – a top income tax rate of 20 percent and a corporate rate of 17 percent. In fact, Singapore’s main competitive advantage is good, cheap government.

Their main savings comes from the way they provide and fund social services. Their high performing education system only costs 3.3 percent of GDP – less than half of what New Zealand spends on education. In addition, teaching is a highly sought after profession with good rewards for good teachers.

A small welfare safety net to cover the very poor and the very sick does exist, but in general, people are expected to draw on their own personal and family resources to look after themselves. The country’s leaders have a fundamental dislike of the sort of free universal welfare benefits that have become unaffordable and entrenched in most Western nations.

Of course, Singapore has the Central Provident Fund, which requires every worker to pay a fifth of their salary into their CPF account, with their employer contributing another 15.5 percent. That provides Singaporeans with the capital to pay for their own housing, pensions and health care, and their children’s tertiary education.

The global economic crisis and the difficult times being faced by countries around the world is an opportune time to reflect on how best to deliver a brighter future for a nation. Our present government is committed to lower government spending and a fundamental realignment of the welfare system. But ultimately, that will not be enough. Reducing taxes to a top rate of 20 percent – along the lines suggested by the 2025 Taskforce – to match Singapore, Hong Kong, and many other high performing nations, would provide the step change that this country so desperately needs. The question is does any political party have the vision and courage to move us in that direction?