The 1997 Rankin File: #13

© 1997 Keith Rankin

Tax Cuts as Growth Dividends.

Thursday, 9 October, 1997

"Since these [1996-98 tax] cuts will be financed from substantial and structural budget surpluses, they represent true dividends of growth, not borrowings from future generations."

"Tax is a defining issue in politics."

Economic growth arises from a combination of public and private sources. Private sources include more labour, and more private capital such as machines and buildings. Other sources of growth are essentially public.

Taxes represent public revenue. Thus tax cuts, as a growth dividend, are a return on the public contribution to economic growth. Private growth dividends, on the other hand, are represented by such things as higher real wages, and by increased company dividends.

Growth dividends as tax cuts, representing additional public income, can be thought of as additions to existing social dividends.

Sometimes the difference between public and private contributions runs counter to intuition. For example, any growth arising from the Employment Contracts Act is publicly sourced. Legislation is a public contribution. Workers work harder while receiving fewer wages as a result of such legislation. The additional "surplus value" arising from this circumstance should be thought of as public income, and therefore should rightfully be distributed by way of an increased social dividend.

It is easy to account for the current round of tax cuts as growth dividends. Before 1 July 1996, workers on above-average incomes received tax concessions of $2,779 per annum; tax concessions that easily fit the criteria of "social dividend":

Net Income = Gross Income less 33% tax plus $2,779

From 1 July 1996 to 30 June 1998 the formula for higher income recipients was changed to:

Net Income = Gross Income less 33% tax plus $3,933

From 1 July 1998 the formula for higher income recipients will be changed to:

Net Income = Gross Income less 33% tax plus $5,130

It is readily apparent that the public growth dividend paid in the 1996/97 year was $1,154 ($3,933 minus $2,779). And the public growth dividend to be paid in the 1998/99 year will be $1,197.

There is a problem with the above analysis. Lower income earners, who are also members of the public, have been excluded. They have received smaller growth dividends. Why should they get less?

It gets worse. Many homemakers and caregivers received no growth dividends at all. These people are equal owners of the public property and social inheritance which form the basis of our public wealth. And their public contributions - measured by what they do for little or no pay, and by what they sacrifice - are the equal of the public contributions of the higher income earners.

Thus, as it stands, tax cuts are not true growth dividends. Rather, they act as ways of converting our publicly generated incomes into additional private incomes to those with the highest private incomes. Nevertheless, there is a way we can think of these income tax cuts as public growth dividends. We can say that every adult not receiving a benefit conforms with the formula:

Net Income = Gross Income less 33% tax plus $3,933 minus LIS

LIS stands for "Low Income Surtax" and is a balancing item in the formula. Currently LIS is zero for all adults grossing $34,200 or more, about the average annual individual wage. LIS is positive for adults grossing less than $34,200, and can be interpreted as a partial confiscation of the social dividends (and hence the growth dividends) of lower income workers.

The tax cuts of 1996 and 1998 were explicitly claimed to have been targeted at low-middle income earners. What happens with tax cuts targeted at high income recipients; for example the 1988 tax cuts? The essence of the 1988 tax cut was a cut in the top rate (and the corporate rate) from 48% to 33%.

Minister of Finance Bill Birch has suggested (Sunday Star-Times, 5 October) a tax cut similar to that of 1988 to follow the 1998 tax cut. Presumably it will be offered as a cherry for the 1999 election, and will be implemented in two stages, one in 1999, the other in 2000. Mr Birch proposed a cut in the top rate from 33% to 25%. In the same newspaper, Roger Kerr, chief executive of the New Zealand Business Roundtable, suggested a flat rate of 20%, which amounts to an extension of Mr Birch's proposal. And Dr Brash, in a speech on 6 October, also suggested a 20% tax rate, while carefully avoiding terms like "flat tax".

From Mr Birch's comments, it seems that he has in mind a 15% tax rate up to $21,000 of income (as at present), and 25% for all earnings in excess of $21,000. If we continue to take 33% - the present corporate tax rate - as the value of public inputs into private production, we can express the situation in the year 2000 of an individual grossing $38,000 as:

Net Income = Gross Income less 33% tax plus $5,140

This would constitute a growth dividend for such an earner of precisely $10 ($5,140 minus $5,130). There would be small growth dividends for persons grossing between $9,500 and $37,750. And very big growth dividends for people grossing significantly more than $38,000.

It would be more natural however to regard such a tax cut as a devaluation of the public contribution to economic growth. Or, to put it another way, as a privatisation of the social dividend. The formula could be expressed instead as:

Net Income = Gross Income less 25% tax plus $2,100

This formula would apply to all incomes in excess of $21,000. This tax cut would amount to a reduction of the social dividend, from $5,130 to $2,100. No growth dividend can result from this kind of tax cut. Rather, it would be a privatisation of $3,030 of the pre-existing social dividend. The big 1988 tax cut can thus be interpreted as a privatisation of the quite high social dividends paid throughout the majority of the post-war era.

A flat tax proposal such as that of Roger Douglas in 1987 and Roger Kerr in 1997 would amount to a complete privatisation of the social dividend, with huge gains for those on higher incomes; gains made possible mainly as a result of our social inheritance - our social capital if you will - and current public contributions; publicly sourced gains accounted for as private windfalls. By far the biggest private windfalls would pass to the highest earning 10% of the population.

There is nothing wrong with a flat rate of income tax, per se. It is just that a flat tax needs to be accompanied by an explicit social dividend, a cash payment paid in full to all adults; a payment that would increase with the growth of the national economy; a true growth dividend. Such a social dividend would in turn contribute to economic growth, acting as an incentive to further public contributions; as an incentive to the accumulation of social capital.

An appropriate flat tax - an efficient and socially just flat tax - should never be allowed to fall below 33%. The public contribution to private production cannot realistically be assessed as less than one-third.

The recent spate of commissioned reports (eg the Scully Report commissioned by Inland Revenue, and the Sieper Report commissioned by Treasury) that purport to claim that economic growth rates will increase with tax rates of 20% or less have either missed the boat, or have been widely misinterpreted.

The main way in which many economists miss the boat is to treat taxation as a "burden", as a cost but not as an offsetting public income. Such studies make no sense at all when we come to see taxation as a legitimate return on a set of critically important social assets, and when we come to see taxation distributed in part in the form of social dividends, and in part in the form of non-cash social wage entitlements such as public education and public health care provision. The social wage is a fundamental part of everybody's incomes in Norway, for example, as many New Zealand viewers were able to observe from Television New Zealand's Sixty Minutes programme on October 5.

There are some ironies in the present tax debate. Donald Brash made the following faux pas just at a time when television viewers in New Zealand were being treated to a glimpse of the high tax, high social wage, high living standard, high growth Norwegian economy. And at a time when the South East Asian countries are facing the double jeopardy of financial debacle and environmental tragedy:

"Mr Ian Macfarlane, Governor of the Reserve Bank of Australia, noted in a recent speech that, between June 1991 and December 1996, both New Zealand and Australia had enjoyed economic growth of 3.6 percent, and that that growth had been faster than growth in any of the other 16 developed countries against which he compared us with the exception of Norway and Ireland. ... I myself do not know why countries with relatively low tax burdens appear to grow more quickly than those with relatively high tax burdens, or indeed whether there is any causal relationship between low tax levels and high growth. But it does seem clear that the East Asian countries where economic growth has recently been most rapid are also countries where the ratio of tax revenue to GDP is very much lower than it is in New Zealand or other developed economies."

Tax is not a "burden" in Norway. But it is a defining issue.


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