Keith Rankin: Taxing Questions
Keith Rankin, 4 July 2002
In this election campaign, the tax cut bandwagon seems to have run out of steam. National realises that there are not many votes to be won by offering to cut the 33 and 39 percent top tax rates. Even Act is giving less emphasis to this issue and more to the issue of crime. Crime becomes an issue, not so much when crime rates rise, but when the economy is prospering. It's a kind of standby issue, ready to be wheeled out when there are few other issues to gain an advantage on.
Three parties are however playing up certain specific aspects of the tax system. In each case they are seeking policies that differentiate their parties from the others, much as Act has turned to crime and Winston Peters is once again using immigration.
United, campaigning on behalf of the family, wants income splitting for tax purposes. The Alliance wants to freeze student loan repayments. And the Greens, for their second big issue (putting the lie to the claim that they are a single issue party) is campaigning for a universal child benefit.
These three tax questions are all linked. The points raised by these parties are each a part of a critique of an income tax system; of a system that survives through historical inertia and political expediency rather than through soundly argued principles.
Before taking up the challenge of connecting these three policies, I would like to note some general points about the Greens' tax philosophies.
The Greens' most central principle (yes, at least one party does have principles) is that you should tax "bads" (such as carbon pollution) rather than good things such as "work and enterprise".
Taxes serve two distinct purposes: to modify behaviour, and to raise public revenue. Taxes designed to modify behaviour work most completely when they gather no revenue at all. So it is somewhat stupid to advocate a behaviour-modifying tax as a replacement for a revenue-raising tax. An example of a behaviour-modifying taxes include an environmentally useful carbon tax that will deter people from behaving in ways that release carbon into the atmosphere (while subsidising those whose actions lead to carbon absorption). Another example is protective import tariffs that deter people from buying imports which, like carbon, are on the Greens' list of bads.
Revenue taxes work on the opposite principle. To have a reliable revenue stream, you must nurture your source of revenue. Thus if we depend for public revenue on taxing things that are bad for us, then we would have to ensure that people continued to use those products. Gambling is a good example. We tax gambling heavily not to deter people from gambling but to exploit people who are addicted to gambling. The more we depend on gambling taxes, the more we must nurture the gambling industry. Australia, with some of the world's highest taxes on gambling, is also reputed to have the highest rates of gambling in the world.
An interesting example of this dichotomy between behaviour-modifying taxes and revenue-generating taxes is the fiscal policy of Great Britain in the years from 1846 to 1914. As a nation committed to free trade, Britain did not tax imports in order to deter imports. Nevertheless, Britain did tax imports. Indeed Britain's public revenues came almost entirely from taxes on imports (mostly taxes on tea, wine, tobacco, sugar). Imports were fostered rather than castigated because the revenues of the seat of empire depended on them.
The Greens also get into trouble when they talk of income tax as a tax on "labour". In fact, income tax is a tax on all forms of income, which means that it is a tax on production, which in turn means that it is a tax on the use of resources. It seams to me, as the co-owner of many of the resources that are used to generate income, that the rate of income tax is too low, not too high. In my role as citizen cum public landlord, I receive a dismal return on my share of the public assets that you and I collectively own. I can understand why Taranaki Maori were frustrated by the peppercorn rentals that they used to receive for prime dairy land that they owned.
The Greens want to "introduce a tax-free threshold at the bottom of the income tax scale" to "give low income families more money in their pockets". But only a very small fraction of such a tax cut would come back to low income families with children. If we make the first $5,000 tax free, that would give $1,500 per year to all two-income households, $750 per year to single-income families, and $0 per year to beneficiary families. Further, this is a very "mid-twentieth century" solution (a time when most households were single income families), at a time when the Greens economic policy is supposed to be "Thinking Beyond Tomorrow".
The alternative solution is to move in the direction of a universal basic income, which, to be fair to the Greens, is at least mentioned in their policy manifesto. The problem is that cutting income taxes - and making income tax scales more graduated - is a shift in the opposite direction to that of a universal basic income.
It is however, the idea of a universal basic income (or something like it), that can help us to understand how the tax policies of United, the Alliance and the Greens are related. For this essay, I prefer to use more mainstream terms like "growth dividend" or "tax credit".
To understand the periphery of a tax system, you need to have a clear understanding of its core, as a point of reference. And, before advocating changes to a tax system, it pays to clearly understand the system that we already have.
The core of our income tax system is: (i) the 33% company tax rate; (ii) the matching 33% personal tax rate which is applied to additional annual income in the range $38,000 to $60,000; and (iii) the dividend that everyone grossing $38,000 or more receives in full as a consequence of the first $38,000 of income being taxed at a lesser rate of 19.5%.
The dividend can be simply calculated as $38,000*(33%-19.5%) = $5,130 which is $99 per week. If it was really a growth dividend it would be much higher than $99 per week.
For a person earning
$52,000 per annum ($1,000 per week), their core tax is
$12,030 ($231 per week).
($12,030 = 33% of $52,000, minus $5,130)
For a person earning $104,000 per annum ($2,000 per week), their core tax is $29,190 ($561 per week).
For a person earning $0 per annum ($0 per week), their core tax is -$5,130 (a tax credit of $99 per week).
Once we see this core, then we understand that any change to the core of the tax system would be either a change in the 33% rate (which is what both Act and National want) or a change in the size of the $99 growth dividend. (My language is designed to suggest that future growth should lead to an increase in the dividend, and not to a decrease in the tax rate.)
If those 2 things - a 33% tax rate and a $99 weekly dividend - are core, then what is peripheral? By peripheral I don't mean unimportant; I just mean taxes that should be understood through their relationship with the core.
I have done some calculations. I considered households of two adults with no children and with total earnings of $2,000 per week.
- In scenario 1, one adult earns $2,000 per week and the other earns $0. Neither is required to make student loan repayments. After tax they get $1,365.
- In scenario 2, each adult earns $1,000 per week. Both are obliged to make substantial student loan repayments. After tax they get $1,374 per week.
Why does the household without student loans receive less than the household with two hefty student loan repayments? The answer is that the single income household pays two forms of tax surcharge, while the two income household avoids both but pays a third type of surcharge.
A tax surcharge exists when a person's taxes exceed their core tax. Thus the 39% tax rate on incomes over $60,000 can be understood as a tax surcharge; a peripheral tax of 6 cents for every annual dollar earned in excess of $60,000. This surcharge costs the first household $2,640 per year ($51 per week).
A second surcharge exists whenever a person fails to receive their full growth dividend. In this case, the non-earner in household 1 receives nothing. His or her core tax is negative: -$99 per week. S/he receives $0 after tax, representing a tax surcharge of $99 per week. Thus the total weekly tax surcharge of household 1 is $99+$51=$150.
The second household pays neither of these two tax surcharges. But their combined student loan repayments come to $141 per week. Because $150-$141=$9, the second household is better off than the first by $9 per week.
The United policy would relieve the first household of both the tax surcharges it faces, while it would not affect the second household. The Alliance policy would relieve the second household, but not the first. The Green policy of zero-tax on the first $5,000 would benefit the second household by twice as much as the first household.
At first sight, the United policy seems the most just. But it would have much smaller benefits for low single income households than for high single income households. Hence it would be of limited benefit to children.
What should our priorities be? If we are to eliminate all three tax surcharges, in which order should we eliminate them?
In my view, both the 39% tax band and the student loan repayments are low priority. Only those who can afford to pay more are required to pay the 6% extra on their last dollars of income. Further, I have shown that the burden of student loans is less than the burden of supporting non-earners. In fact student loans have given young people more freedom than they ever had in the so-called 'good old days', while the repayment terms are not as onerous as the Alliance and student activists would have us believe.
It is the high tax surcharge (up to $99 per week) on non-earners and low-earners that most urgently needs to be addressed. In particular, it is care-givers, students and part-time workers (employees and self-employed) who get the worst deal. (Fulltime students would take out fewer loans if they were assured of paying minus $99 per week - ie receiving a dividend or tax credit of $99 - as their core tax assessment.)
The Greens are on sound ground when they advocate a universal child benefit, payable to caregivers. Such a benefit is one way of paying at least some of that $99 per week dividend to the many non-earners and part-time paid workers who work very hard to raise the next generation of workers.
As our economy grows, we
should give priority to the universalisation of the $99
growth dividend. Once that is achieved, as our economy
continues to grow, the proceeds of growth should be split
between increased social spending and the decreasing of core
taxes by way of an increase in that $99 tax