Tax Cuts and the Social Wage
Keith Rankin, October 1995
Published in the PSA Journal; the journal of the NZ Public Service Association.
From past experience, tax cuts have been a means of giving something to those on higher incomes while increased public expenditure on "social wage" items such as education and health care have been favoured as a means of giving something to all sections of the community.
Today, the challenge is to broaden the concept of social wage - retaining its underlying equality, while allowing it to include a monetary dividend. Tax cuts, of an appropriate kind can fulfil this function. But tax cuts will not be of an appropriate kind unless we get used to thinking about taxes in a new way.
We can define total gross public revenue as: gross income tax plus goods and services tax (GST) plus profits of state owned enterprises plus income from incentive taxes.
Gross income tax is defined here as 33% (the company and upper personal tax rate) of New Zealand's gross domestic product (GDP), and incentive taxes are all the miscellaneous taxes such as customs duties, tobacco and alcohol tax which are imposed as much to modify our spending patterns as to raise revenue. Each person's social wage is an equal share of gross public revenue. The gross public revenue is not collected in its entirety; it is nevertheless a powerful accounting concept. All of the gross public revenue not collected comprises tax concessions.
While it is possible that the coming tax cuts will include a cut in GST - eg to 10% - attention is rightly being focussed on income tax. There are two ways of cutting income tax: either cutting the 33% "base tax rate" (BTR) or by increasing the level of tax concessions.
At present we have a standard concessionary rate of 24% for the first $30,875 dollars earned per annum. This translates to a standard tax concession or "standard tax credit" (STC) of $2,779 ($53.45 per week), payable in full to all individuals who earn more than $30,875 per annum. Their net incomes can be calculated by a simple formula: net income equals gross income less BTR (33%) plus STC ($2,779).
The STC is part of the social wage. In addition to higher income earners, it is payable in full to all beneficiaries, as part of their benefits. The benefit abatement problem can be resolved by allowing beneficiaries to keep the STC component of their benefits when they move into employment.
The problem we face with our system of taxation, is that people earning less than the average wage have part of their STC clawed back. Persons earning $20,000 per annum get an income tax credit of $2,235. In other words they pay a "low income surtax" (LIS) of $544 [$2,779 minus $2,235]. The low income surtax gets bigger as a person's income falls; thus a homemaker or student fully dependent on spouse or parent effectively pays a maximum LIS of $2,779. They get no tax credit at all.
The general formula for the net incomes of non-beneficiaries earning less than $30,875 per annum is: net income equals gross income less BTR (33%) plus STC ($2,779) minus LIS.
Legal income splitting between family members is one way of enabling some people to get around the LIS problem. The more general way is to pay standard tax concessions as dollar amounts rather than as percentages of earnings, which amounts to the same thing as removing the LIS. This means that it would be possible for persons to have a net income in excess of their gross earnings; a situation that already applies to most people receiving benefits.
The 1996 tax cuts should be seen to be an addition to the social wage; not a cut in the base tax rate.
The first step is to remove the low income surtax, ensuring that every adult (over 17?) receives the full STC. The fiscal cost of ensuring that all low-middle income earners get the present $2,779 is small - perhaps $300 million - because most New Zealanders already get all or most of it. The removal of the LIS should be accompanied by the abolition of the bureaucratic accommodation supplement.
The second step is to raise the standard tax credit. Thus the bulk of the 1996 tax cut should be a rise in the STC; eg to $3,779. In that event, every adult - including beneficiaries - would receive a tax cut of $1,000. The fiscal cost would be $2.7 billion.
The third step would be to fix the STC as a percentage of New Zealand's per capita GDP. That would ensure that everyone will benefit from future economic growth.
Following the implementation of such tax reforms, we would expect future populist political parties to campaign on a platform of raising the social wage, including raising the STC relative to GDP. Funding would be through rises in the base tax rate. Conservative parties would emphasise the desirability of keeping the base tax rate low, as it now is.