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Dr Muriel Newman

An Idea Whose Time Has Come

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28 October 2007

An Idea Whose Time Has Come

With the average Kiwi family being more than $5,000 better off living in Australia than New Zealand, it is no wonder that almost 500 New Zealanders a week are packing up for life across the Tasman. According to the Australian Immigration statistics, 23,906 people who were born in New Zealand settled in Australia during the 2006-07 year. This is a 25 percent increase on the year earlier.

These statistics follow on from the shocking report published by the OECD in 2005 which showed that almost a quarter of New Zealand’s most highly skilled people had left the country – the biggest exodus of skilled workers from any developed nation. Some 24.2 per cent of people born in New Zealand with a tertiary education now live overseas, compared with only 2.5 per cent of tertiary-educated people born in Australia who live overseas.

In this age of easy travel and competitive global labour markets, these figures are a clear signal that increasing numbers of New Zealand taxpayers are no longer prepared to put up with the Labour government’s lie that the country cannot afford tax cuts. With a strong economy delivering year in, year out surpluses, Labour is now spending $20 billion a year more than they did when they first came to office. To say they cannot afford tax cuts defies logic.

When Labour was elected to government in 1999, the top tax rate was raised from 33 percent to 39 percent for those earning over $60,000. They claimed that only the top 5 percent of taxpayers would have to pay. Over the years, the numbers have swelled from 194,000 to 456,000, with some 14 percent of taxpayers now paying the top tax rate, because Labour has refused to adjust the thresholds.

The failure of the government to adjust the tax thresholds as they promised means that while New Zealand’s gross average hourly wage rose by 22.1 percent between 200 and 2006, the net take home pay increased by only 18.9 percent. In comparison, the gross hourly wage in Australia rose by 34.4 percent with the net take-home pay increasing by 33.6 percent. In other words, the rate of growth of the average wage packet in New Zealand is now around half of that in Australia.

According to a new report by the OECD, New Zealand is the 13th most heavily taxed country of the 30 industrialised nations. In comparison, Australia is the eighth lowest taxing country, and once the $40 billion election tax-cut plan being promised by Prime Minister John Howard – and endorsed by Labour Leader Kevin Rudd – comes into force, the tax gap will widen even more.

The key reason that increasing numbers of Kiwis are flocking to Australia is that it offers better opportunities for families to get ahead. According to a report by the New Zealand Institute for Economic Research, a dump truck operator earning $45,000 to $60,000 in gross wages in Auckland could expect to earn $73,000 to $84,000 in Sydney (NZ$), while a senior doctor earning $90,000 to $150,000 in Auckland, could expect to earn $147,000 to $210,000 in Sydney. (To read the NZIEA report and check out their on-line calculator to convert Kiwi earnings into Aussie incomes, click here )

Much of Labour’s extra spending has gone into “rebuilding public service capacity”. That is political speak for big salaries, flash offices, expensive computers, and nice cars for the tens of thousands of extra bureaucrats that have been hired to administer the large numbers of new regulations and laws that are needed to keep everyone busy. This tsunami of new directives from Wellington has played a major role driving away many New Zealanders who have simply had enough of government interference in their lives.

In the year to the end of June, the government’s surplus stood at $8.7 billion, $2 billion ahead of forecasts. Yet when questioned about tax cuts, the Finance Minister again intimated that ‘proper’ tax cuts are unlikely because they would increase inflationary pressure on the economy.

This week’s NZCPR Guest Commentator is Phil Rennie, a Policy Analyst with the Centre for Independent Studies. Phil refutes the claim that tax cuts are inflationary, pointing out that tax cuts are less inflationary than government spending:

“The important point about tax cuts is that they are actually less inflationary than government spending, for a variety of reasons. Most government spending is on ‘non-traded’ goods and services, which means domestic goods for which there is little competition. Things like electricity, hospital services, tertiary education and local rates have all been key drivers in pushing up inflation, which is why the Reserve Bank has been so concerned about government spending. By contrast, if you give the same amount of money away as tax cuts then not all of the money will be spent. Some will be saved or invested or used to pay off debt, especially if the top rates of tax are reduced. Compare this to government spending which is, by definition, spent – all 100% of it”. To read Phil’s article, click here

In other words, the government has played a key role in driving up inflation, through its spending on ‘non-tradeable’ goods and services. In the absence of proper competition, the non-tradeable sector showed a price rise of 4.1 percent in the year to June 2007, whereas the highly competitive ‘tradeable’ sector, where consumers spend most of their money, showed a price decrease of 0.5 percent (for more information see Tackling the Tax Myths).

Dr Cullen has also stated that he would not consider tax cuts that increase “inequalities of income”. This comment goes to the heart of the tax problem that we face in New Zealand, which is the constraint on growth that a steeply progressive tax system imposes on a small economy. Under Labour’s system, a taxpayer is regarded as rich if they earn over $60,000. They must therefore be punished through the confiscation of 39 percent of their earnings. In fact, the more successful a taxpayer is, the more punitive the tax system becomes.

As a result, hundreds of thousands of skilled New Zealanders have voted on the tax system and the Labour government with their feet, leaving the country for better opportunities abroad. Of those left behind, hundreds of thousands of working families are losing earned income through tax only to have it returned through welfare top-ups. Then there are the hundreds of thousands of beneficiaries who could and should be working, but instead are allowed to stay on welfare despite a critical shortage of workers. Not to mention businesses struggling under crippling compliance costs imposed by local and central government who are looking to relocate abroad.

That is why it is so encouraging to see that more and more countries are turning their backs on the progressive tax systems that were championed by Karl Marx, in favour of proportional tax systems of the kind advocated by Milton Friedman.

A proportional tax system – often called a flat tax system – works by taxing everyone at the same rate using ‘the more you earn, the more you pay’ principle. As many separate taxes as possible are rolled into one and complicating tax relief systems are abolished. The gains are immense as lower marginal tax rates remove disincentives for work and increase disposable income amongst the wealth-creating sections of the economy stimulating investment and economic growth. Tax avoidance all but disappears and massive black economies shrink.

There are now 17 jurisdictions that have some form of flat tax, with Jersey having established their 20 percent flat tax in 1940, Hong Kong adopting a 16 percent rate in 1947, and Guernsey a 20 percent rate in 1960. The flat tax revolution is now sweeping through Eastern Europe starting with Estonia in 1994 with a 22 percent rate, followed by Latvia in 1995, Lithuania in 1996, and then Russia in 2001 with a 13 percent rate.

Eastern European countries that have embraced flat taxes have grown at twice the rate as those without. It is therefore little wonder that many other countries including Germany, Spain, Italy, Greece and the UK are all investigating the merits of a flat tax system. (To find out more read “Flat World, Flat Taxes” by Daniel Mitchell, a Senior Fellow at the Cato Institute )

With New Zealand badly losing the tax competition game to Australia, surely it makes sense for us to consider the merits of a flat tax. While a ‘pure’ flat tax based on a single rate for all types of tax including income tax, corporate tax and consumption tax, is the long-term goal for many countries, it is not unusual for countries to start out with multiple level flat taxes.

In looking at the New Zealand situation, the effective tax rates, when the low income rebates are taken into account are 15c per $1 on income up to $9,500, 21c on income between $9,500 and $38,000, 33c on income between $38,000 and $60,000, and 39c on income over $60,000. GST of course is at 12.5c per $1 and company tax 30c.

It therefore makes sense to look at the affordability of setting a two tiered flat tax rate, around the two lower effective rates of tax – 15c in the $1 and 21c in the $1 – so as not to disadvantage the low-income earners.

A rough estimate of the cost of establishing a two tier system whereby tax on income up to $9,500 remains at 15c in the $1, with tax on income over $9,500 charged at 21c in the $1 would be around $4b. The cost of reducing company tax to 21c in the $1 to align it with income tax would be around $1.8b, and the additional tax collected from raising GST from 12.5c in $1 to 15c to align it with the bottom flat rate of tax would be $1.7b.

That means that the total cost of establishing a two tier flat tax system with income up to $9,500 and GST set at 15 percent and all other income tax and company tax at 21 percent, would be around $4.1b. With this year’s surplus standing at $8.7b, this is not only affordable, but the dynamic affects of lower taxation would bring in unprecedented gains including attracting international businesses and acting like a magnet to bring home skilled Kiwis who want to get ahead. Surely flat tax is an idea whose time has come.

This week’s poll asks: Do you believe a maximum flat rate of tax of 21 cents in the dollar would be good for New Zealand? Go to Poll

Reader’s comments will be posted on the NZCPR Forum page click to view .