The immediate issue for tax in the May budget was the 2010 and 2011 personal tax cuts promised before – and after – the election. There is bigger work ahead.
Personal tax cuts in part just undo tax rises. During Michael Cullen’s time, tax rose as proportion of income not just because he raised the top rate to 39c, but because he did not raise the thresholds at which higher rates cut in.
So more people paid more of their income in tax, even if their gross incomes had only kept pace with inflation. The proportion paying 39c more than doubled and the marginal rate for someone on average earnings went from 19.5c to 33c.
In other words, Cullen in effect raised tax rates year by year just by doing nothing. Inflation did it for him.
United Future’s Gordon Copeland advocated indexing tax thresholds to wage inflation. He got Cullen to write into his 2005 budget that in 2008 thresholds would be adjusted up by six percent, three times the two percent midpoint in the Reserve Bank’s inflation target range.
But since the Reserve Bank has mostly run inflation above the midpoint, that was tepid indexation. It left unaddressed the big tax increases of 1999-2005. And Cullen didn’t keep his word.
Inflation indexing is used to adjust benefits and the pension and some fees (which are, in effect, taxes), for example. But there is scant interest among MPs, even in the new cabinet, for the discipline indexation would impose. Besides, by making show of raising thresholds, politicians can appear to give something when actually they are giving back what they have already stealthily taken.
There are three other major issues.
One is whether all income, including from the capital gain of appreciating assets, such as investment properties, should be taxed (and losses deducted). There is no principled reason why some income is taxed and some not. But no government here is game to apply that principle, even though it could then cut the overall rate.
A second issue is the alignment, or not, of the top rate with the company tax rate and with the investment rate. At 38c, Bill English’s top personal income tax rate is above the 33c rate for some investments and the 30c rate for companies. That provides incentive for tax avoidance.
A third issue is deeper. It applies particularly to small, open economies such as this one. People and companies can choose to live and invest here or go somewhere else.
In globalised labour and goods and services markets people and companies, at least international companies, are “mobile”. They don’t have to pay tax here if they can pay less tax somewhere else on the same earnings.
That is not conducive to attracting investment of human and financial capital here. And that is not conducive to citizens getting richer, as John Key and English insist they want.
So there is rising argument that suggests such mobile items should be taxed less and immobile items such as land and roads and most retail spending should be taxed more.
A halfway house would be to emulate some Scandinavian countries and tax investment at lower rate than income.
That’s the present. What about the future? Resources, rubbish, pollution and climate change have gradually become less acceptable to modern, rich-country citizens. Even rampant, dirty China worries about pollution, waste and rivers reduced to trickles (though recently has subordinated those worries to stimulating sagging economic growth).
There is waxing argument (led by, but not confined to, the Greens) that cardinal tax principle should be to tax less the things you want to happen, such as people working and earning and companies investing, and tax more the things you don’t want to happen, such as environmental degradation and plunder of the “commons”, such as water.
Moreover, tax breaks could be used to provide incentives to emerging economic activities such as ecosystem services. With its alleged clean-green brand, this country could exploit expanding eco-markets.
English has set up working group of economists, officials and others, coordinated by the Centre for Accounting, Governance and Taxation Research. He has told it to be bold and inventive to feed into the 2010 budget.
If the report is bold, English’s challenge will boomerang and that will test the Government’s mettle, far more than threshold and rate movement or two and some chiselling of state spending. And if the report tinkers … well, that’s New Zealand.
Colin James is New Zealand’s leading political commentator and NZ Management’s regular political columnist.
