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Dr Muriel Newman

Less tax not new tax was the election pledge

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The Tax Working Group released its report on proposed changes to our tax system on Wednesday to a respectful response from the government. This is in sharp contrast to the dismissive reaction the 2025 Taskforce received to their report on ways for New Zealand to catch up with Australia.

The difference of course, is that while the terms of reference of the Tax Working Group were tightly controlled by the government, those of the 2025 Taskforce were not. This enabled the 2025 Taskforce to take a comprehensive approach and recommend some game changing options. Prime amongst these was their suggestion that government spending should be reduced back to 2004 levels so that taxes could be cut to 20 percent: “Cutting core Crown expenses to 29 percent of GDP would, for example, allow the maximum personal tax rate, and the company and trust tax rates, all to be reduced to 20 percent”.[1]

This suggestion, which would transform New Zealand’s future, did not go down well with the Key Government, which seems inexplicably wedded to the former Labour Government’s reckless spending programme. Even the Secretary of the Treasury, John Whitehead, has criticised the present level of government spending, estimating that an astonishing 65 percent – some $40 billion – of the government’s $62 billion budget is of a questionable quality. What this means is that those who are critical of a reduction in government spending should be reminded that according to the expert, more than two-thirds of all taxpayers’ money is being spent in an inefficient and wasteful manner.

When the Tax Working Group was set up last May to undertake a strategic review of the tax system, a strong caveat was imposed. The Group was tasked with finding sufficient alternative sources of tax to compensate the government for the revenue loss associated with aligning the top income taxes, corporate taxes and trust taxes at 30 percent. In other words, the whole exercise had to be “revenue neutral”. And that’s the rub. This was not a “blue skies” review of our tax system in the sense of a panel being free to examine the way our taxes are structured, collected and spent. Instead they were constrained by the need to find more cash. Any analysis of how our taxes are being spent, or indeed how much too much the government is spending, was completely off limits.

The Tax Working Group concluded that our tax system, which back in 1989 was heralded as one of the least distortionary in the OECD – with internationally competitive tax rates – has now become “incoherent, unfair, lacks integrity, unduly discourages work participation and biases investment decisions”.[2] The question is how on earth has the situation deteriorated so quickly?

The answer, as explained by this week’s NZCPR Guest Commentator Roger Kerr of the Business Roundtable, in his article Tax Working Group Report Over-hyped, is “Michael Cullen”!

“The rot began with the first decision to raise the top personal income tax rate from 33% to 39%. This move was unnecessary (the government did not need the extra revenue), it increased economic costs (high marginal tax rates are most damaging to growth), and an apparently simple move increased the complexity of the system (some 50 pages of new tax legislation were needed to implement it).

“Subsequent moves by the Clark-Cullen government had similar effects. The Working for Families scheme increased effective marginal tax rates, with the abatement rate of 30% (now 20%) being added to the 33% and 39% personal tax rates. Several new distortionary tax concessions were introduced, ranging from KiwiSaver subsidies to racing industry tax concessions. The Portfolio Investment Entity (PIE) schemes further fragmented the income tax system. And while the cut in company tax to 30% was a positive move, the top personal rates were not reduced at the same time, which increased incentives to shelter personal income in company structures.”

With most of Dr Cullen’s changes to the tax system contrary to the advice of tax experts at the time, Roger Kerr has found the criticism of them by the Tax Working Group unsurprising. In fact, he concludes that the report itself is “over-hyped”. To read Roger Kerr’s excellent analysis of the report, click the sidebar link

The point is that whichever way you slice and dice it, the New Zealand Government is spending too much money and New Zealanders are paying too much tax. In other words, the government sector has grown so big it is impoverishing the country.

The numbers tell the story.

In 2004, core government spending amounted to 28.9 percent of all economic activity in New Zealand (GDP). However, as a result of a spending spree by Labour, as well as the effects of the recession and the decision by National to continue on with much of that wasteful spending, core government spending in 2010 has now reached 36.7 percent of GDP.

If local government activity is factored the outlook is increasingly bleak. In 2004, the combined spending of local and central government in New Zealand added up to 38.6 percent of GDP, while in Australia it was lower at 35.1 percent of GDP. In 2010, spending by the New Zealand government sector has blown out to 45.1 percent of GDP, while in Australia it has dropped back to 35 percent!

It is a clear point of difference between our two countries that across the Tasman, the government sector is being held in check, while in New Zealand, the government sector is growing like topsy, dominating almost half of all of the country’s economic activity. We tend to forget that governments don’t create wealth – they consume it! That means that every dollar they spend is a dollar that must be collected from those who create wealth. With big government squeezing private sector wealth creators, it is little wonder that our economy is so fragile, growth so slow, and prosperity so elusive – not to mention the steady stream of Kiwis leaving our shores for more benign tax environments overseas.

Whether National likes it or not, the massive rate of expansion of government in New Zealand and the inextricably linked rise in taxation, is the root cause of our economic problems. And since the Tax Working Group was prevented from exploring this point, the tax debate has been forced to focus on new ways of plundering taxpayers. Surely it is time we collectively said enough is enough and supported the introduction of a cap on government spending like they have in Hong Kong. There, government spending is capped at 20 percent – by convention – and the country prospers as wealth creators dominate the economy.

While introducing such a cap on government spending would clearly need to be a staged process, the fact that National – which argued vehemently against excessive government spending during the nine years it was in opposition – is now failing to cut spending sufficiently to stimulate the economy, but is instead searching for new taxation avenues, means that they cannot be trusted to constrain spending voluntarily. That means a cap on spending may be the only way to protect taxpayers and ensure our economic progress.

There is also something extremely distasteful about the slippery politics being employed in this debate about tax. When the public vote for a government that is promising tax cuts, they believe that it signals a lowering of the total tax burden. National certainly didn’t explain on the campaign trail that they were promising income tax cuts on the one hand, and new property taxes on the other.

What is especially disappointing is the way in which National has starting to use the old socialist “divide and conquer” trick to try to demonise property investors so they can justify penalising them with new tax increases. But it doesn’t wash.

If the Tax Working Group had included property experts on their panel, they could have put the record straight on a number of misapprehensions about property investment. Firstly, there already is a capital gains tax on property for any investor who buys with the intention of selling for a quick profit. Secondly, the debate about depreciation fails to mention that it is a timing issue. Should the asset appreciate in value not depreciate, then the depreciation expense deductions are reclaimed by the IRD at the time the asset is sold. Thirdly, claims have been made that New Zealand investors are over-indulging in property solely for tax advantages. Again, this argument does not hold water.

As property expert Frank Newman wrote for the NZCPR in Taxing Matters, “While tax undoubtedly plays a part, property investment is popular for a number of other reasons. Firstly, it has provided better long-run returns than the alternatives! According to the Real Estate Institute housing price index, residential prices have returned 11.8% a year over the last 17 years, compared with a 7% for New Zealand shares. Secondly, and most critically, people will only invest in things they trust. The Sunday Star Times recently reported the findings of a survey of 1200 people who were asked to rate the level of trust they have in sharebrokers, financial advisers, fund managers, mortgage brokers, insurance advisers, and banks. Only banks scored in positive territory which points to a confidence crisis in the funds management and sharebroking industries. These issues are never factored into the comments of the central bankers, politicians, fund managers and academics who so frequently scold us for “over-investing” in property, and for these reasons property is likely to remain the most preferred long-term investment for New Zealanders.”

There are around 340,000 private rental dwellings in New Zealand, many owned by mum and dad investors who have put their savings into rental property as part of their retirement plan. Any decision by John Key and National to punitively punish these people – because the government can’t get its own spending under control – is contemptible. As is any further attempt to politically portray them as pariahs.

All in all, the Tax Working Group report has served a useful purpose of pointing out that too much of the tax collected in this country is of a form that discourages growth and wealth creation. And while correcting that is a laudable goal, the real answer to our tax problem is that we simply pay too much. Lowering and flattening the tax system in conjunction with the government’s elimination of wasteful and inefficient spending, is the way to prosperity in New Zealand – not introducing land taxes nor any of the other devious suggestions being touted.

1.12025 Taskforce Report
2.Tax Working Group Report