Economics: Tax Attack

If this Labour Government has decided never to reduce the company tax rate, or never to slap ceiling on the top rate for high-income earners, it would seem politic to keep quiet about it. But Finance Minister Michael Cullen went on the offensive in his Budget speech to emphasise what he won’t be doing, and why not, on tax cuts.

First he tackled the assertion that New Zealand is highly taxed by developed country standards.

New Zealand is unusual in having scant social security taxes or levies on either individuals or businesses, he said. Even when comparisons are made with Australia, which has Medicare levies and compulsory superannuation payments, misleading picture can be painted unless all such factors are taken into account.

Dr Cullen cited recent article in the British Economist magazine that compared the total cost to business of corporate taxes, social security levies, local body rates, and excise duties. In the six countries studied the total burden varied from 9.5 percent of GDP (for the USA) to 19 percent of GDP (for France). The comparative figure for New Zealand is about seven percent of GDP.

Another measure mentioned by Cullen showed tax plus our only social security levy, ACC contributions, for single person on the average full-time wage represents about 20.5 percent of gross income in New Zealand. This is lower than 12 out of 15 countries in another recent Economist study.

The minister’s trump card was that New Zealand has more experience of the effects of major cuts to tax rates than almost any other developed nation in the past 15 or so years. Significant cuts to personal taxes in 1986, 1988, 1996 and 1998 and massive cut to the corporate tax rate in 1988 all failed to lift the sustainable growth rate.

The trouble is that tax cuts lead to significant revenue losses, heaping pressure on either expenditure or the Government’s operating balance. Therefore, Cullen argued, the onus of proof rests upon the champions of tax cuts to demonstrate that they will lead to anything other than the unsustainable and inflationary lift in the growth rate that would come from any fiscal loosening.

No, all was not lost for those who grumble about the persistent demands of the tax collector.

The Government has committed itself to simplifying the tax system, especially for small to medium-sized enterprises. And it is committed to clarifying the tax treatment of expenditure on research and development and removing complex rules on company interest deductions.

Tax legislation now before Parliament aims to clarify over- and underpayments, reduce the number of taxpayers exposed to use-of-money interest and allow the pooling of tax payments.
Further work is promised on simplifying the tax obligations of small to medium-sized enterprises. The Government will check whether current legal forms available to small business are appropriate, and develop ways of reducing the tax impact on businesses during different phases of their life cycles.

Underpinning all of these tax issues, according to the Budget speech, “is the need to lift investment in the New Zealand economy”. Cullen would have been tad dismayed, therefore, when given the latest statistics from the Overseas Investment Commission. Perhaps that’s why he hastened to issue press statement to put the figures “into perspective”.

According to the OIC’s records, the commission approved proposed $1.2 billion of “net” investment in New Zealand by overseas people last year. This was 77 percent decline from the $5.3 billion approved in 2000 and was well below the five-year annual average for 1997-2001 of $3.8 billion.

Cullen pointed out that the number of applications from foreigners to invest in New Zealand has remained steady and the reason for the drop in value last year is that the previous year’s figures were inflated by Fletcher Challenge’s sales of several assets to offshore interests during restructuring.

In the 1990s, moreover, the values were lifted by the Government’s privatisation programme, and the sale overseas of large publicly-owned assets. And, said Cullen, too much foreign investment in New Zealand in recent years has been in existing assets and capacity. After all, nothing happens to economic growth when an asset simply changes hands.

“The real value to the New Zealand economy comes when investors bring greenfields investments here, creating new jobs and expanding our productive base,” he argued. He is right of course.

Then the minister said the Government was determined to increase this sort of investment and laid out initiatives in the Budget to do this.
The extent to which tax rates encourage or discourage investment is, however, uncertain despite the existence of welter of studies.

Certainly it can be said that Australian businesses did not rush to re-establish in New Zealand when the company tax rate here was lower than there. This won’t stop business people complaining that Cullen ha s made big mistake by ignoring the initiative that matters most to them.

Bob Edlin is regular contributor to Management magazine.

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