National's 2008 Tax Reformby Keith Rankin, 30 May 2008
John Key, in his recent statements, talks not merely of tax cuts, but of more widespread changes to the structure of personal income tax. Thus, he is (or at least he says he is) planning tax reform, and not merely a lowering of average tax rates under the present structure.
New Zealand has seen no significant income tax reform since the 1970s. The basic scale of personal income tax rates was introduced by Robert Muldoon in 1978. Since then the rates and thresholds have been changed a few times, with the biggest single change being the progressive reduction of the top tax rate from 60% in 1981 to 33% in 1988.
(Muldoon in 1982 raised the top 60% rate to 66% as a temporary surcharge to make what was generally a large tax cut to high earners more politically palatable. The Lange/Douglas government clung on to the 66% rate until 1986, enabling a very substantial increase in government spending in the 1985/86 fiscal year. If Muldoon had presented a Budget in 1984, almost certainly that surcharge on the top two tax rates would have gone.)
The only attempt at reform of personal income tax since 1978 was Roger Douglas' statement of 19 December 1987, proclaiming that New Zealand would move to a flat rate of personal income tax. David Lange had no choice but to scupper Douglas' plan because it would simultaneously raise taxes for low income recipients while giving a third (following 1982 and 1986) huge cut for higher income recipients. Further Douglas' scheme was flawed in that it proposed a rate of tax at about 24%, clearly too low to be sustainable.
In the 2008 Budget, Michael Cullen has introduced a watered-down version of National's 2005 tax-cut package. This has created the opportunity for National to differentiate itself by proposing something quite different in 2008. So I would like to remind National's policy strategists of my article "Taking a step forward from the past?" in the Independent Financial Review of 29 November 2006. (Plus my two articles: "An Income Tax Proposal for New Zealand" and "New Zealand Income Tax Policy 1973-1982 and its Legacy", both published in the New Zealand Journal of Taxation Law and Policy, March 2007 and March 2006).
The suggested proposal makes one significant change to the structure of income tax, while also removing the 39% top tax rate. Further, my proposals advocate a significant change to Working for Families. While the In-Work-Tax-Credit is very generous to single-income families in full-time employment, it discriminates heavily against two-income families (they generally earn too much) and families dependent on either one part-time income or on a benefit.
This discrimination is likely to feature as a major election issue in October. With rising unemployment, many more families will come to find themselves dependent on a part-time income or a benefit. Such families will therefore lose their In-Work-Tax-Credits as well as losing their wages.
Further, a number of families with two full-time breadwinners will experience redundancy this year. Many will find themselves not that much worse off. They will question why, before the redundancy, they had bothered to work so hard for so little extra reward.
My published proposal is to eliminate the bottom two tax rates (now 12.5% and 21% as announced in the May 22 Budget) and replace them with a personal tax rebate. In order for nobody to be worse off in 2009 than they would be after Cullen's fine-tuning, the personal tax rebate would have to be $6,000 per year ($115 per week). This would, in effect, make the first $18,000 of earnings untaxed. Much of the revenue lost in this income range would be recouped, however, as tax-payers earning more than $18,000 would pay a 33% marginal rate.
The second part of my proposal is to remove the 39% tax rate on higher incomes, thereby creating a flat tax of 33%.
The third part of my proposal is to remove the discriminatory element of the In-Work-Tax-Credit (while keeping Family Tax Credits intact), and renaming it Child Allowance. Indeed, in real terms, such a universal child allowance would be of similar value to a 2-child family as the Family Benefit was when Robert Muldoon raised it to $6 per week per child in the early 1980s.
It might be too much of a fiscal stimulus to implement all three proposals in full on 1 April 2009 (although if the present downturn deepens into a substantial recession, the full stimulus might well be required as soon as this October). Rather, John Key and Bill English could implement the proposal in two or three stages.
For Year 1 (2009), a National-led Government could eliminate the new 12.5% tax bracket, replacing it with an annual personal tax rebate of $1,200 ($23 per week). This would mean that zero tax would be payable on the first $5,700 of earnings, and would make everyone earning less than $14,000 per year better off in 2009 than under Labour's 2008 Budget proposal.
In addition, for 2009, a transitional child allowance of $20 per week per child could be paid to all families who, because they work too few hours (or too many hours) do not currently receive In-Work-Tax-Credits.
Further, the 39% tax rate could be reduced to 37%.
For Year 2 (2010), the personal tax rebate could be raised by $2,400 to $3,600 ($69 per week), to be offset by a rise in the bottom tax rate from 21% to 27%. This would provide further tax cuts to persons earning less than $40,000 per year. The 37% top tax rate could come down to 35%, and the transitional child allowance increase to $25 per week per child.
For Year 3 (2011), the personal tax rebate could be raised by another $2,400 from $3,600 to $6,000. This would be offset by a rise in the bottom tax rate from 27% to 33%. The 35% tax rate would come down to 33%. The child allowance could be raised to $30 per week per child, and, in 2011, completely replace the In-Work-Tax-Credit.
From this date (1 April 2011) the reform would be complete, with the essential ingredients being a flat rate of income tax set at 33%, a personal tax rebate of $6,000, and a Child Allowance of $30 per week per child. Family Tax Credits, currently payable to all low income families with children regardless of the source of income, would remain.
The result would be fair, easily understood by voters, politicians and journalists. The personal tax rebate of $6,000 would mean that persons earning less than $18,000 per year would pay no income tax. This would be a great boon to the many women who support their families through substantial part-time employment.
In the May 2011 election-year Budget, National could then outline its tax proposals for the following three years. Most likely National's priority would be to cut the 33% tax rate to 30%, maybe by 1% per year from 2012 to 2014, giving workers a tax cut in direct proportion to their earnings. Labour, on the other hand, might go to the 2011 election with a proposal to lift the personal tax rebate from $6,000 to just over $7,000, a growth dividend to every taxpayer of exactly $20 per week.
An additional advantage of laying-out a program of tax reform covering a period of two-and-a-half years is that, if there is an unforeseen downturn in the economy, then tax cuts already legislated-for could simply be brought forward to create a timely additional stimulus for the economy. (Likewise, if there were to be an unforeseen expansion which would lead to too great a risk of interest rate increases, such legislated-for tax cuts could be postponed. Indeed, such a postponement occurred in 1997.)
The above proposal is simple, transparent, and fiscally responsible. Above all, it would be an election vote-winner.
Keith Rankin (krankin @ unitec.ac.nz) teaches economics at Auckland's Unitec Institute of Technology.