Taxation Strategies For A Successful Future
Taxation Strategies For A Successful Future
Wednesday 1 Sep 2004
Rodney Hide - Speeches - Taxation
Speech to Institute of Chartered Accountants; Auckland; Wednesday September 1, 2004.
I have been asked to speak on tax. Tax is government's fuel. It's through tax that Government gets the money it needs to run. We should always remember that it's taxpayers who provide for politicians and civil servants, not the other way round. Politicians and civil servants all too often forget that.
We don't hand over our tax dollars willingly. It is rather thumped out of us with tough tax laws and draconian penalties. That compares with the money we give to a charity or the money we use to buy groceries at the local supermarket. There we have a choice. We have a choice about whether to spend, how much to spend and what to spend it on.
When it comes to tax we don't have that choice. The Government decides how much it will take and how it will spend it. Taxpayers have little or no say.
Tax is also the fuel of politics. Politicians always make a big song and dance about giving away your money like some Father Christmas. It is done in a noisy and celebratory role as when say Helen Clark sprays taxpayers' money at Hollywood movies or Jim Anderton props up a local business, or when Michael Cullen provides another freebie paid for by others.
The message is simple: vote for me and I will give you things.
That great noise and commotion money creates stands in marked contrast to the way tax is collected. Tax is collected quietly, almost invisibly. We have GST on anything that we buy, hidden in the price. PAYE is taken from workers' pay packets before they even see it. The same with other taxes - petrol, alcohol. Quite what the tax is, no one knows because we only see the final price.
Tax serves to fund government and fuel politics. It does so by shifting resources from the private sector where they are created across into the government or political sector. An extraordinary amount of resource is shifted in this way.
It was just 10 percent of everything that we produced in my grandfather's day. It was 25 percent in my father's day, and it is now 31 percent. One-third of all that we produce is gathered up by the tax system and given across to politicians to spend.
Thumping tax out of taxpayers doesn't come cheap.
First, there is the cost of the resources used to collect taxes and comply with tax legislation.
There has been only one New Zealand study of compliance costs and that was ten years ago by Victoria University's Policy Studies Institute. The study estimated the total cost to business of tax compliance at 2.5 percent of New Zealand's total output. That's about $3.3 billion. That's a lot of money. It is more than five times the cost of running the actual Inland Revenue Department. The total hours taken by business filling out tax forms is equivalent to 23,000 people working full time for a year. That's the entire workforce of Rotorua working fulltime for the year for the IRD. Compliance costs add about 10 cents for every dollar that IRD collects.
The second hidden cost of government spending is even larger. It is known as the "excess burden" or "deadweight" cost of government spending or tax. Deadweight costs arise because taxes increase the cost of trade and make some wealth-creating trades unprofitable. The gains to be had through these trades are lost because of tax. That loss is the deadweight cost of tax.
The cost of tax is not the money transferred to government but the value of the trades that are squeezed out as a result. There will be jobs not offered, businesses not started, projects not undertaken - all because of tax.
The money that government takes in tax isn't lost - it is just shifted from one use to another. But the trades that are squeezed out as a consequence are lost. It's the value of the trades lost that is the true cost of any tax.
For example, imagine I am prepared to pay a tradesman $100 to do a job for me. The tradesman is on the top rate of tax and will get to keep only $61. The Government takes the other $39 in tax. The trade will go ahead only if the tradesman is prepared to do the job for $61 or less.
If the tradesman's opportunity cost is $65, he won't do the job. But without tax, the trade would proceed and the two of us would share the $35 worth of surplus from the trade. We would both be better off. The income tax blocks a wealth-creating trade and the tradesman and I are $35 worse off as a result.
The income tax imposes a deadweight cost because of the "wedge" it creates between the price paid and the price received. As a result of this wedge, fewer trades occur and less tax is paid. The deadweight cost in our example is $35.
Tax imposes a "deadweight" cost because it blocks trade and wealth creation.
The IRD's own study estimated that the last dollar of tax raised imposes a cost of 47 cents. That's very high. That means that it costs 47 cents for the Government to shift an extra dollar from a taxpayer to, say, a welfare beneficiary. It means that a politician must achieve a 47 percent return to justify any additional spending.
Of course, government spending provides nothing like that sort of return. The great bulk of government spending is a net drain on us all. We would be better off if government didn't spend as much but, rather, left it with us to spend and invest.
The less that people get to keep of what they produce, the less they are encouraged to produce for the rest of us. That is why high tax rates hinder economic growth. The converse also applies: the more that people get to keep, the more they are encouraged to work and use resources productively. High taxes sap people's productive potential and encourage them to do jobs "under the counter," join the "brain drain", and undertake unproductive "do-it-yourself".
Impact on growth
Tax takes have gone up around the world. In 1960, government expenditure in developed nations averaged 27 percent of total output. By 1996 they had grown to 48 percent. That's a dramatic increase across all countries.
The evidence is that these tax increases have come at a price. Professors James Gwartney, Randall Holcombe and Robert Lawson analysed the impact that government size has on growth in 23 developed nations for each of the 37 years from 1960 to 1996. They found that an increase in government expenditure of 10 percent of total output dropped growth by one percentage point. That means that an economy growing at three percent growth with a government spending 40 percent of all output would grow at four percent if government cut its spending to 30 percent, all other things being equal. That's a big impact.
The professors found that countries with government expenditure of less than 25 percent of total output averaged growth rates of 6.6 percent. As the size of government increased, the average growth rate persistently fell. When the size of government exceeded 60 percent of total output, the growth rate was a poor 1.6 percent. There is a clearly an inverse relationship between year-to-year economic growth and the size of government in developed countries during the years 1960 to 1996.
New Zealand's own Inland Revenue Department commissioned studies from international scholars on the impact that tax has on New Zealand's growth rate. These studies found that New Zealand's economy would grow on average at 5 percent a year at a tax take of 20 percent of total output but had averaged only 3 percent because of excessive tax. The cumulative losses are huge. The IRD study found that New Zealanders would now be twice as wealthy as we are if only successive governments since World War II had held government's tax take to 20 percent of output.
We can boost New Zealand's growth prospects: to do so we need to cut taxes and let people keep more of what they earn.
It's dropping the top rate of tax that gives the best "bang for the buck". Drop the top rate of tax, and we drop the government penalty on investment and entrepreneurship. It's the tax on the next dollar earned that is critical, not the tax on the first dollar or the average dollar.
Let's consider the alternatives. How about eliminating income tax and putting up GST to compensate? That would leave us with one system of taxation, not two. That would be nice. But the problem is that it would take a four-fold increase in GST from 12.5 percent to 50 percent to eliminate income tax. That's because for every dollar the government raises in GST it raises three in income tax. GST at 50 percent is not a goer. That shows though just how much tax government is actually taking.
How about company tax? But it is people who pay taxes, not companies. Our company tax regime is just a withholding tax. It is a tax on the investors in a company, not the company itself. The only significance of the company tax is that it taxes profits as earned by the company, rather than when they are paid out to investors. Dropping company tax doesn't change the incentive to work and to invest.
Tax-free thresholds are also often suggested. That would mean paying no tax on the first dollars that you earn. The disadvantage is that tax-free thresholds make no difference to the penalty that is applied on additional investment and entrepreneurship. It's the tax on the next dollar to be earned that is critical, not the tax on the first dollar.
Tax-free thresholds make little or no difference to economic growth because they don't change the incentives to invest and to do business.
Besides, tax-free thresholds are very expensive for government. There is more than twice as much income in the $0-$10,000 bracket than there is in the $60,000-plus bracket.
The best way to make our tax system fairer and less economically damaging would be to eliminate the 33-cent and 39-cent tax rates. We should drop the personal income tax to 20 percent. The rate of company tax should likewise be dropped to 20 percent. Government revenue would no doubt fall. But by how much?
The most conservative assumption to make is that such a tax reduction produces no extra jobs, no extra investment, and no extra business activity. On this basis, such a tax cut would reduce government revenue by $5.5 billion. That's less than the Government's current surplus. That is, it could be achieved without cutting any government spending - including the wasteful spending.
Of course, reducing the top rate of tax and the company tax to 20 percent would prove a great spur to work, investment and entrepreneurship. We would become more prosperous. Lowering taxes puts more money in taxpayers' pockets and increases New Zealand's prosperity.
Taxing with accountability
The Fiscal Responsibility Act provides a good discipline on politicians' spending promises. What we lack is transparency in just what that spending costs each of us.
Back in 1998, I proposed that taxpayers be told exactly what tax they were paying. The Government was legislating to remove the need for 1.2 million taxpayers to fill out income tax returns. That would save on paper work but further hide what tax taxpayers were actually paying. I suggested that government should at least write to taxpayers to tell them how much tax they had paid and to thank them for their contribution to the cost of government.
Too costly, I was told. Officials said that issuing such letters would "offset the estimated $60 million reduction in taxpayer compliance costs". I couldn't see how the letters could cost that much. I pursued my inquiries. It turned out that the actual cost of printing and issuing the letters was $750,000 or 0.002 percent of the total tax taken.
Finance Minister Bill Birch said that there would be additional costs because some taxpayers would ring or write to the IRD following such a letter. He estimated that my proposal would cost a total of $5.6 million.
The Labour Party didn't agree with my proposal that government write to taxpayers thanking them for their contribution but agreed to support my amendment in an attempt to embarrass the Government. The Government then exercised a fiscal veto to preclude a vote. That was because the additional expenditure would "have more than a minor impact on the Crown's fiscal aggregates".
The worry was not the cost: even $5.6 million was not that great a sum in the context of the total tax take. The concern was that taxpayers would be much harder on politicians if they knew just what they were costing. I still think that such a letter should be sent.
I believe it is important for taxpayers to know just how much government takes from them. I believe that they would be much tougher on politicians as a result.
I have drafted such a letter:
Dear Joe Kiwi
Thank you for your contribution to government over the past financial year.
Government records show that last year you earned $40,087.84. Out of this government took $8,098.99 in income tax and $481.05 in the Accident Compensation Corporation levy. Thank you for that.
The government estimates that you paid an additional $3,639.83 in GST and $1,261.59 in excise tax on petrol, alcohol and tobacco. These figures are the average of what someone with your income would pay in these taxes.
In total, government estimates that you paid $13,481.45 in tax to central government. That's $259.26 a week. Thank you.
Central government took from you 34 per cent of all that you earned.
You might be interested in how government spent it. Government spent $4,395 of your money on welfare and $322 on police.
Thank you for working so hard and giving so much.
Hon Michael Cullen
Minister of Revenue
Our priority should be to drop the top rate of company and personal income tax. The surplus last year showed the government had sufficient to drop the top rate to 20 cents. In the interests of transparency and accountability, government should be telling taxpayers just how much tax they pay.