The Case against Tax Cuts

 2 April 2002

For several years now, there has been agitation in the business press for lower taxes. This call is misplaced, and, in some cases, disingenuous.

New Zealand is not a high tax country. When you compare apples with apples, average tax rates in New Zealand are at about the average of the countries we compare ourselves with. New Zealand is in the middle of the OECD tax league.

What is unusual in New Zealand is the extent to which relatively poor people are taxed. Indeed, it is the taxation of low incomes that makes the average seem high. A New Zealander earning $15,000 per year pays over 17 percent income tax ($2,580). An Australian on the same income pays less than half as much. A British person with the same income would pay $28.

Top rates of personal tax in New Zealand (39%) are lower than in, for example, Australia (47%) and Britain (40%).

Economists regard cash benefits and tax credits as negative taxes. Thus, as Bill English has pointed out, the introduction of the means-tested "child tax credit" was an integral part of the tax cuts of 1996 and 1998. So, if there are to be tax cuts in New Zealand, they could be personal tax credits which would benefit the poor.

Most advocates of tax cuts, however, want company tax and the top personal rates cut. They rarely acknowledge that it is the poor who are overtaxed.

The usual reason given as to why it is better to put more money in the pockets of the rich than the poor is that the rich have higher savings rates. This is true but irrelevant. What matters are marginal rates of saving. Low and middle-income recipients tend to have debt. Tax cuts enable debts to be repaid. Repayment of debt is one form of saving.

If we are to have tax cuts they should favour low-income recipients. There are, however, a number of arguments against having any tax cuts.

Taxes are necessary to fund collective goods: systems of public administration and law, defence, social security, national parks, roads, public health and healthcare, and education.

In a liberal economy, governed by the principle of consumer sovereignty, purchases are made in two different ways. We buy private goods in markets, and we buy collective goods through the political process.

If we want more collective goods more than we want more individual goods - and I believe that we do - then tax cuts will give us the opposite of what we want. They will force us to consume more individual goods and fewer collective goods. Further, we will be obliged to buy more healthcare and education as private goods, at a considerable loss of economic efficiency. (We only have to note just how much of a burden private healthcare costs are to Americans.)

Some people argue that it is more important to raise the rate of economic growth than to increase economic efficiency or equity. To that extent, they will argue that we need more investment, and less consumption by both households and government.

Once again, this can be an argument for more taxes not less. Many of our collective goods are forms of social investment. History shows that growth in the last 200 years has depended critically on the growth of publicly accessible knowledge, public health, social capital, democratic government and public investment in education, environmental care and infrastructure.

Because of its direct link to social investment, taxation can be as important (or more important) to growth than personal savings. Some of the countries with the highest living standards and growth rates in recent years can attribute much of their growth to public investment. Finland is a good example.

We usually view taxes as a necessary evil that should be used only to fund the collective goods that we demand of our governments and the social investments needed to facilitate modern economic growth. This perspective dates from the time of Adam Smith (the 1770s). In Smith's time much tax revenue went into royal courts, war-making, and various corrupt purposes.

Before Smith's time, sovereigns would tax whatever their subjects would bear. Tax revenues represented the "property right" of the state. Undemocratic states routinely abused this right.

Today libertarians argue that income taxes per se represent an infringement of property rights. They regard the modern social- democratic state as a kleptocracy. In conservative policy think tanks, private property rights have emerged as the central faith of efficient resource allocation.

If we develop the property rights approach a bit further, however, we find that the right of the public to generate (and inherit) income from public property is no different to the right of private individuals to generate (and inherit) income from private property.

The late Herbert Simon, 1978 Nobel prizewinner in economics, suggested that over 70 percent of developed nations' incomes derive from public rather than private capital. If so, the logical implication is that we should have a flat rate of income tax of 70 per cent. Part of that revenue would fund social investment and collective goods. The remainder would be paid in equal instalments to the people, much as Vector dividends are.

I am not arguing for a 70 percent tax rate. But the idea I started with, of collecting more rather than less tax and giving some back as tax credits is fully consistent with this property rights approach.

Whether we are motivated by economic efficiency, economic growth or property rights, the argument for tax cuts is weak. Public poverty solves nothing.

There is another argument for cutting taxes. It is that we must do it because other countries do it. That argument is morally bankrupt. The wrongs of others do not excuse our wrongs.

 NZ Herald version, 2 April 2002

Lower, flatter tax format key to success Roger Kerr, NZ Herald 2 April 2002

UBI and the Flat Tax Boston Review October/November 2000

© 2002   Keith Rankin

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