Time to revisit benefit as well as tax regimes

Susan St John Independent 25 July 2001
 

The McLeod Committee Taxation Report is a radical document, but not because of its views on housing. While the sensible proposal of a tax on the risk-free rate of return on net assets is now off-limits for discussion, let us hope there is more openness and sensible debate about the other parts of the report, especially the section devoted to resuscitating the Roger Douglas arguments for flat tax.

The committee can expect wide agreement when they identify that the lack of synchronization of the company tax rate and the top rate provides a serious problem of tax avoidance. They are also on safe ground when they highlight the large difference between the middle rate of 21% and the two top rates of 33% and 39%. This disparity has proved a major headache for the taxation of superannuation funds and it has encouraged the use of trusts. The mid 1990s reforms produced these conundrums by reducing the middle rate from 28% to 21%. Rather than questioning whether this reduction was wise, in a surprise leap of logic the committee claims that the difference between the 21% and 15% rate is now so small that it brings into question the need to have a bottom tax bracket of 15% at all! While they clearly would prefer a flat 25% tax, in a cursory acknowledgement of its unfairness, they are recommending a two-step tax system. Alternatives are canvassed which would deliver the same tax revenue as the current scale, for instance, 20% up to $29,5000 and 31% beyond that.

Leaving aside the fact that their two-step system does not address the problems of having a wide difference between the two tax rates, they essentially claim we can forget about the pain of increased taxes on low incomes because:

• Beneficiaries without other income are not affected by the tax rate as they get an inflation-adjusted net benefit
• Many people on low incomes are part of high income households and are not poor
• The poor are best helped 'through spending, rather than by increasing the progressivity of the personal tax scale'.

Those attempting to eke out a family income with low-paid part time work would see things differently. Raising the first tax rate would further discourage those on benefits from working, and part-time low-paid work is often all there is. Secondary earners or students are not likely to be happy with even less return for their efforts just because they come from a high-income household. The current rate of 15% on low earnings is already very high compared to other countries where often there is a tax-free first bracket. The impact of poverty traps over long income ranges seemingly eludes the McLeod committee who state 'the reality is that most decisions people make imply bigger step changes than a single dollar, eg a new job'. Thus the steep abatement of family support over an income range of at least $12,000 does not matter as people can just get a better job and simply climb over the 'tower' of high effective marginal tax rates (EMTRs). Stating the obvious, that 'all taxpayers face EMTRs from tax rates', they claim only 250,000 tax payers face marginal tax rates of over 50%. This figure is meaningful only if you ignore beneficiaries and secondary earners who are so discouraged they don't work in taxable jobs at all.

Despite many submissions highlighting the need to view both the tax and benefit system together as part of the whole redistributive system, the interface between the two systems has been given only perfunctory consideration. With a breathtakingsophistry, the committee claims that flat tax is OK because government spending is the best way to help the poor. This spending presumably comprises tax credits, benefits, accommodation supplement and so forth, but the effects on effective marginal tax rates can be ignored as such 'spending' falls outside of their brief.

Genuine issues of fairness and distribution cannot be debated in a vacuum that looks just at tax. An integrated focus would look at benefits and taxes as opposite sides of the same coin. Had this approach been taken, the committee might have been lead to consider the need for a surtax on better-off superannuitants. Universal pensions and low flat tax do not make any sense. Well-off superannuitants, now with generous universal inflation adjusted pensions, greatly benefited from the tax cuts of 1996 and would do even better under the McLeod recommendations. Seemingly we can afford to give poorest one child family on a desperately low income a maximum tax credit of only $47 a week, while the wealthiest couple over 65, get a minimum of $261 after tax from the state pension.

The idea that households with children should be recognised in the tax system on horizontal equity grounds also fails to get a mention despite the clear evidence that NZ is out of step with other developed countries. A couple with one earner and one child on the average wage pays the same tax as a single earner without dependents. We should forget about emulating other countries' paid parental leave until we address the lack of support for young families on an ongoing basis. Why does the committee ignore the effect of children on their parents' ability to pay tax?

The committee also fails to discuss the impact of inflation on the tax system, despite numerous submissions on this issue. At even low rates of inflation the erosion from unadjusted brackets, family tax credits and thresholds for abatement can be serious. After a time there may be ad hoc adjustments such as occurred with the tax cuts of 1996. It is interesting to ponder what might have been the situation today if these tax cuts had not occurred and the tax system set up in 1988 with 2 statutory rates of 24 and 33% had simply been adjusted each year for the effects of inflation.

After allowing for the low income earners rebate (set to disappear in the McLeod model) the tax system had three effective tax rates in 1988 of 15%, 28% and 33%. After adjusting for inflation, the top of the bottom tax bracket would now be $13,000 and the top tax rate would apply to incomes over $42,000. The table shows the 1988 scale adjusted for inflation compared to today's scale. Using rough estimates of taxpayers in each bracket, the 1988 scale would be delivering around an extra billion dollars more of tax than today's system in spite of not having a 39% top tax rate. Meantime, most of the 750,000 tax-payers with incomes between $9,500 and $16,000 would be better off. While middle income people would pay more, inflation adjustments to family tax credits and their thresholds for abatement could provide compensation. Indeed the extra billion dollars revenue should be used to provide for a much greater recognition of the costs of children in the tax system by increasing family support, especially for the first child, and extending the child tax credit to all children.

There would still be revenue left over; maybe enough to abolish the clumsy community services card and make primary health free, providing significant savings in direct health costs and health insurance for people affected by the higher 28% rate. To facilitate this, part of the middle tax bracket tax rate of 28%, say 1.5% could be designated a 'Medicare tax. Without reintroducing too much disparity between the 28% and the top rate, a 1.5% Medicare tax could then be added to all incomes in the 33% bracket. Given the government's promise to review healthcare funding and the desperate state of primary healthcare, such considerations should not be off-limits.

Let's hope that the McLeod committee considers such alternatives to their two-step scale. They must also consider the case for indexation of all parts of the tax and benefit system. An integrated view needs to be taken of the tax-benefit system so that parts are not arbitrarily designated off limits. The quality of their final report will reflect the willingness of New Zealanders to provide critical comment over the next few months.
 

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