Tax cuts have finally been granted, albeit modest ones. FromOctober full time earners will pay between $12 and $28 dollars per week less intax. Welcome, but hardly cause for wild celebration.
But the magnitude of the cuts is of less concern than themotivation for the cuts. It appears that panic rather than economic good senseinfluenced Michael Cullen’s move to cut tax rates. Only when facing a drubbingat the polls has Dr Cullen conceded to reducing the personal tax burden of allincome earners. Throughout his tenure as finance minister he has refused tobudge on the issue of personal tax cuts. Until recently his Treasury officialswere not even allowed to raise the issue of tax cuts with him.
Dr Cullen is reluctant to acknowledge the economic benefits ofa low tax environment. While his government has aspired to grow the economysufficiently to lift New Zealand back into the top half of the OECD, loweringtaxes has never featured in his strategy to achieve that outcome. The linkbetween taxes and economic growth has been the subject of endless research and thereis growing empirical evidence demonstrating that high taxes slow economicgrowth.
On a recent trip to South Africa I was struck by thecountry’s growing prosperity which invites a comparison between the policies ofthe New Zealand Labour Party and the Republic’s ruling African NationalCongress (ANC). Although both parties’ primary constituencies are lower incomeearners they differ fundamentally on how to achieve social upliftment. The NZ LabourParty tends towards redistribution while the ANC places considerable emphasison growing the economic pie. And in contrast to the Labour party the ANC have alwaysstressed the importance of a low tax environment to achieve the economic growthrequired for social upliftment.
The ANC have cut personal tax rates in almost every budgetsince taking power in 1994. The majority of tax relief has been handed to lowand middle income earners. For example, the tax free threshold has risen from$4,600in 2000 to $10,800 in 2008 (all values are in 2008 NZ dollars usingpurchasing power parity exchange rates to take out the influence of officialexchange rate fluctuations). But substantial tax cuts have also been grantedto high income earners in recognition of their contribution to wealthcreation. The top marginal tax rate of 45% in 2000 (effective for incomeshigher than $38,000 in today’s dollars) has been reduced this year to 40% andonly takes effect on incomes higher than $106,000.
A comparison of the change in average tax rates of an upperincome earner (without children) in New Zealand and South Africa during thisdecade highlights the parties’ different approaches. The average tax rate of aperson earning $80,000 (in constant 2008 dollars) in New Zealand increased from25.1% 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 rateof a person earning the equivalent income in South Africa has declined from36.8% 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 1999growth averaged 2.7%, between 2000 and 2003 it averaged 3.4% and from 2004onwards it has averaged 5.1%. One million new jobs were created between 2001and 2005 and another million in the next two years. The rapid increase inemployment means an increasing number of people are directly enjoying thefruits of economic growth.
A strong economy (which brings healthy government revenue)coupled with a redirection of expenditure to the poor has been the backbone ofthe ANC’s strategy to achieve â€˜A better life for all’. Growing government revenuehas enabled them to build 2 million new houses, bring piped water to 17 millionpeople, sanitation to 7 million and implement a social welfare system which isthe envy of the developing world. The percentage of the population living inpoverty dropped from 41% in 2000 to 32% in 2006. The growth momentum willensure that further gains in poverty alleviation will be achieved in thefuture.
The ANC in South Africa has demonstrated how a low tax environmentis reconcilable with and indeed can contribute to achieving the objective ofsocial upliftment. It is a principle not well appreciated by our Labourgovernment who has favoured redistributive mechanisms to lift the livingstandards of lower income earners. But with little political scope left forfurther redistribution and a stagnating economy the prospects of ongoingstandard of living rises are declining. Our best chances are in growing the economicpie and a lower tax environment is one of the many necessary conditions. Letus hope this week’s tax cuts are the start of an ongoing trend towards lowerpersonal income tax.
Chart: Average tax rate of NZ$80,000 income earner(constant 2008 dollars)