Infometrics
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PUBLIC ACCESS:
More tax cuts please
Fri 23 May 2008 by Andrew Whiteford.

Tax cuts have finally been granted, albeit modest ones.   From October full time earners will pay between $12 and $28 dollars per week less in tax.   Welcome, but hardly cause for wild celebration.

But the magnitude of the cuts is of less concern than the motivation for the cuts.   It appears that panic rather than economic good sense influenced Michael Cullen’s move to cut tax rates.   Only when facing a drubbing at the polls has Dr Cullen conceded to reducing the personal tax burden of all income earners.   Throughout his tenure as finance minister he has refused to budge on the issue of personal tax cuts.   Until recently his Treasury officials were not even allowed to raise the issue of tax cuts with him.

Dr Cullen is reluctant to acknowledge the economic benefits of a low tax environment.   While his government has aspired to grow the economy sufficiently to lift New Zealand back into the top half of the OECD, lowering taxes has never featured in his strategy to achieve that outcome.   The link between taxes and economic growth has been the subject of endless research and there is growing empirical evidence demonstrating that high taxes slow economic growth.

On a recent trip to South Africa I was struck by the country’s growing prosperity which invites a comparison between the policies of the New Zealand Labour Party and the Republic’s ruling African National Congress (ANC).   Although both parties’ primary constituencies are lower income earners they differ fundamentally on how to achieve social upliftment. The NZ Labour Party tends towards redistribution while the ANC places considerable emphasis on growing the economic pie.   And in contrast to the Labour party the ANC have always stressed the importance of a low tax environment to achieve the economic growth required for social upliftment.

The ANC have cut personal tax rates in almost every budget since taking power in 1994. The majority of tax relief has been handed to low and middle income earners.   For example, the tax free threshold has risen from $4,600 in 2000 to $10,800 in 2008 (all values are in 2008 NZ dollars using purchasing power parity exchange rates to take out the influence of official exchange rate fluctuations).   But substantial tax cuts have also been granted to high income earners in recognition of their contribution to wealth creation.     The top marginal tax rate of 45% in 2000 (effective for incomes higher than $38,000 in today’s dollars) has been reduced this year to 40% and only takes effect on incomes higher than $106,000.

A comparison of the change in average tax rates of an upper income earner (without children) in New Zealand and South Africa during this decade highlights the parties’ different approaches.   The average tax rate of a person earning $80,000 (in constant 2008 dollars) in New Zealand increased from 25.1% in 2000 to 28.1% in the last tax year through the effect of fiscal drag. It will drop to 26.3% from October this year.   In contrast the average tax rate of a person earning the equivalent income in South Africa has declined from 36.8% to 24.1% over the same period (see chart).

The gradual reduction of tax rates in South Africa has been accompanied by a ratcheting up of economic growth.   Between 1994 and 1999 growth averaged 2.7%, between 2000 and 2003 it averaged 3.4% and from 2004 onwards it has averaged 5.1%. One million new jobs were created between 2001 and 2005 and another million in the next two years.   The rapid increase in employment means an increasing number of people are directly enjoying the fruits of economic growth.

A strong economy (which brings healthy government revenue)coupled with a redirection of expenditure to the poor has been the backbone of the ANC’s strategy to achieve 'A better life for all’.   Growing government revenue has enabled them to build 2 million new houses, bring piped water to 17 million people, sanitation to 7 million and implement a social welfare system which is the envy of the developing world.     The percentage of the population living in poverty dropped from 41% in 2000 to 32% in 2006.   The growth momentum will ensure that further gains in poverty alleviation will be achieved in the future.

The ANC in South Africa has demonstrated how a low tax environment is reconcilable with and indeed can contribute to achieving the objective of social upliftment.     It is a principle not well appreciated by our Labour government who has favoured redistributive mechanisms to lift the living standards of lower income earners.   But with little political scope left for further redistribution and a stagnating economy the prospects of ongoing standard of living rises are declining.   Our best chances are in growing the economic pie and a lower tax environment is one of the many necessary conditions.   Let us hope this week’s tax cuts are the start of an ongoing trend towards lower personal income tax.

Chart: Average tax rate of NZ$80,000 income earner (constant 2008 dollars)

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