Reference: Rankin, Keith (1997) "An Appropriate Fraction", New Zealand Political Review 6(2):8-11.
An Appropriate Fraction
Keith Rankin, 29 January, 1997
Nothing shows so clearly the character of a society and its civilisation as does the fiscal policy it adopts.
Åsa Gunnarsson, Senior Lecturer in Tax Law, University of Umeå, Sweden; quoting Joseph Schumpeter.
On the eve of World War I, England's House of Lords tried to block progressive taxes, which it regarded as contradictory to the notion of equality before the law.
Daniel Cohen, The Misfortunes of Prosperity, 1995.
In March this year (March 16-19), the Department of Social Welfare is holding an international conference at the Auckland's Sheraton Hotel on the topic of welfare dependency. The full title of the conference is "Beyond Dependency, a Watershed for Welfare; a unique international conference overviewing successful and innovative solutions to the problems of welfare dependency."
The conference costs $1,675 to attend in full, or $650 per day. Not only does this cost prohibit the attendance and participation of most of the customers of the Social Welfare Department, but it is also prohibitive to university personnel. In 1992 I participated in an economic history conference in Perth. The total cost, including airfares and accommodation, was less than the registration cost for Beyond Dependency. The facilities at the beautiful Western Australia campus were excellent, and delegates spent a day sightseeing as part of the conference programme. Conferences do not have to cost over $500 per day. That a conference ostensibly addressing the problems associated with impoverishment should cost so much to attend represents a neat illustration of the paradoxes of our brave new world.
Before conference participants can solve the benefit problem, they must specify it properly. They have to look at all benefits, taken together, including benefits hidden within the tax system.
Under a graduated income tax scale (ie with at least two tax rates), all tax-payers become beneficiaries. Tax payers receive benefits that are not normally called benefits because they are delivered, like Family Support, through Inland Revenue rather than through Social Welfare. They are tax concessions, allowances, rebates and credits. Here, I call them simply "tax benefits". This approach helps us to see that tax cuts are actually benefit increases.
Historically, we have tended to regard the tax system and the benefit system as polar opposites. Taxes are public revenue; they belong to an arcane masculine domain. Benefits, however, represent public largesse. They represent expenditure on behalf of the public family, more traditionally a feminine activity. Thus, the first woman Cabinet Minister in Great Britain, Margaret Bondfield, became Minister of Social Security in 1929. She was given the unenviable task of cutting unemployment benefits during the peak of the Great Depression.
Taxes are the legitimate earnings of the sovereign, or the state. Libertarian economists of the eighteenth century such as François Quesnay promoted the view that the sovereign's revenue should amount to about one third of net national product. For him, the net product was the equivalent to the produce of nature, and would pass to a proprietorial class comprised of landlords and sovereign. Men of other classes would receive only subsistence incomes. Subsistence income would be tax-exempt. John Stuart Mill, one hundred years after Quesnay, fully agreed with this basic proposition that earnings at the subsistence level should not be taxed, and he favoured a generous definition of the 'social minimum'.
This classical tax formula - one third of all national income in excess of subsistence - can be practically reformulated as "one third of gross domestic product, less a refundable tax credit of one-third of the social minimum, payable to every man".
Women and children were traditionally regarded as a part of a man's subsistence. A more appropriate version of the formula for today is to replace the word "man" with "adult". Furthermore, given the expansion of the public domain - especially as new technology and increased knowledge arising from the industrial and scientific revolutions - one-third should be regarded not as an optimum but as a minimum share of GDP to be classed as public revenue.
Incredibly, the classical formula is almost exactly what happens in New Zealand today, with the government grossing 33 percent of GDP, very close to the one-third minimum share. In New Zealand today, the formula is:
Tax payable equals 33% of gross income, less $3,933.
33% is fractionally less than one-third, and $3,933 is fractionally less than one-third of $12,000. $12,000 is a good measure of the social minimum. It is equivalent to the new after-tax minimum wage. And it is the approximate income of an unemployment beneficiary living alone and earning the allowable amount of pocket money.
The $3,933 is a tax benefit; the maximum ordinary tax benefit. The current formula deviates from the position of the classical libertarians, however, in that this tax benefit is not mandated as a universal benefit; as a social dividend. In New Zealand it is more like a targeted benefit. It is paid in full only to people grossing over $34,200. Many people earning below average incomes receive total benefits of less that $3,933. A few citizens, receiving no market income, receive no benefits.
Figure 1 shows the allocation of benefits to single adults in 1997 and 1998. The allocation is of course more generous (and more complex) for parents. In fact, most adult New Zealanders receive or are entitled to receive $3,933 or more in benefit income. (For example, low-middle income caregivers receive Family Support tax credits in addition to their tax benefits.) The $3,933 is - in practice - very close to being a genuine social dividend, a refundable tax credit that Quesnay and Mill would have approved of.
In 1995, journalist Jane Clifton called the 1996 tax cuts "the long awaited social dividend". In fact the tax cuts were an increase in the tax benefit targeted in favour of higher income recipients. In 1998, this targeting of tax benefits will be repeated, creating a considerable distortion from the classical ideal.
For those eligible for an unemployment benefit and an accommodation supplement, total benefits abate sharply once earnings exceed $80 per week or $4,000 per annum. Benefits reach a minimum at gross incomes around $20,000. Those not entitled to any Social Welfare benefits (eg some homemakers) receive minimum benefits (ie zero) when their incomes are zero.
I have elsewhere described the lack of tax benefit entitlement to low income earners as a "low income surtax"; ie a clawback on what would otherwise be a universal tax benefit. The dip in the middle of Figure 1 shows what I mean. The diminishing benefit payable to people earning $5,000 to $15,000, and low level of benefit payable to people earning in the $15,000 to $25,000 range, constitutes the essence of the 'poverty trap' or 'dependency trap'. The challenge for the Beyond Dependency Conference is to find ways to remove that low-middle income benefit dip.
Figure 1 is like a see-saw, showing benefits targeted to each end of the income spectrum. If the outputs of the Beyond Dependency Conference become part of an international wave of benefit-cutting, as seems possible, then the combined impact of benefit cuts and tax cuts next year will be to readjust the benefit see-saw in favour of those on higher incomes.
On the other hand, a just benefit system - which could be implemented as an alternative tax cut package in 1998 - would guarantee every adult a benefit equal to at least the amount of benefit automatically available to our richest citizens. Figure 2 shows an example, based on a universal tax credit or social dividend set at the level of the present tax benefit ($3,933). This universal approach hits the target: low income workers and non-earning 'spouses'. The see-saw in Figure 2 is clearly balanced in favour of those on lower incomes.
John Stuart Mill opposed graduated tax scales, over and above the graduation implicit in the classical formula. He thought that flat taxes were more fair. His view was reflected in the 1914 decision by the House of Lords. I agree, graduated tax scales are unfair. The difference is that the Lords thought progressive tax scales were unfair to the rich, whereas in fact they are unfair to the poor.
The Lords feared that the introduction of progressive taxation would make it possible to impose high rates of income tax. They were right. The introduction of graduated tax scales did facilitate the shift to income tax vis-à-vis other forms of tax, and did facilitate the raising of tax rates generally, as was required to fund an efficient modern capitalist society. But the new scales also introduced a form of benefit; a tax benefit. Under any such scale, a person earning $15,000 will always get a bigger tax benefit than a person earning $5,000. It is not clear to me that the higher earner either needs or deserves a bigger benefit than the lower earner. Indeed, the lower earner might be making a valuable public contribution outside of the market economy.
In today's public policy dialogue, we have to carefully separate the 'flat tax versus graduated tax debate' from the 'low tax versus high tax debate'. On the point of principle, the Lords were right in 1914; the principle of equality should prevail. The true liberal answer in a modern society with an expanded public domain, is a moderately high flat rate of income tax, combined with a universal tax benefit set at an appropriate fraction of the prevailing social minimum income, combined with means-tested anti-poverty benefits.
If the Beyond Dependency delegates examine all forms of benefit, they will discover that those New Zealanders receiving the least public assistance are not high earners; rather the least supported are either on low wages, or in part-time work, or ineligible for income support, or do not claim benefits for which they are eligible.
In New Zealand, we have legislation to ensure fiscal responsibility. Our parliamentarians should be willing to amend the 1994 Fiscal Responsibility Act on an ongoing basis. In doing so, they should seek to promote dialogue, inside and outside the House, on the principles of fiscal responsibility appropriate to an evolving civil society. Furthermore, they should understand that the payment of benefits is an aspect of fiscal responsibility, much as a man's feeding his family was seen as a responsibility, not as an option, in Mill's time.
© 1997 New Zealand Political Review
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