By Gareth Morgan*
The top tax rate on income continues to be a political football and is emerging as a key battleground in this election.
Shame it is an outdated and inefficient way to raise extra cash for the Government.
National’s first term saw the infamous tax switch, which dropped the top tax rate to 33%, raising GST to 15% to pay for the change.
Now, predictably Labour and the Greens are pushing for that top tax rate to go back up – to 36% and 40% respectively.
We won’t comment on the quality of their spending plan – that is a subject for other blogs. Nor will we get into the whole ‘higher tax will kill the economy’ argument.
The question here is whether, given the Labour/Green desire to increase public spending, this is the best way of raising the dosh.
And the answer is almost certainly no.
We will briefly look at why the top rate of income tax is such a dud, before briefly looking at some alternatives.
A good tax system is a simple tax system.
To collect the maximum revenue possible with the minimum impact on the economy, the ideal is to tax as many activities as possible, all at a low rate. That way there isn’t an incentive for people to find ways around the tax regime.
The more complex it gets, and the higher the rates, the more sense it makes to pay an accountant to find ways to reduce your tax bill.
And New Zealand has a massive loophole in that we have only a partial tax on the income from capital. In particular capital that doesn’t generate cash returns (owner occupied housing and land are good examples) in effect produces income that slips through the net.
Hiking the top rate of income tax isn’t the best way to raise more revenue, simply because the most well-off New Zealanders don’t pay much income tax.
They are able to arrange their affairs, taking advantage of the widely varying rules about taxing capital, to avoid having a high taxable income.
Don’t believe me? In 2013, 103 of the wealthiest 197 New Zealanders declared an income less than the top threshold.
The top tax rate will simply hit high salary earners, many of whom are far from New Zealand’s wealthiest citizens.
All the more reason for these people to hurry up and invest in property so they can stop working day jobs where they have to pay income tax. That is not the kind of outcome that will get our economy booming – yet it is exactly what our tax regime encourages.
The Labour/Green proposals will only make this worse.
Sure, Labour and the Greens argue that they will tax capital gains, that they are hiking the trust tax rate, and that they will fund Inland Revenue to chase tax evaders.
None of that deals with the problem that one of our biggest asset classes can produce income that hardly gets taxed at all.
A capital gains tax is a terribly clumsy and ineffective way to address that anomaly – even more so because they want to exempt the family home, which is the vast majority of property.
Capital gains taxes are also incredibly complex, and take a long time to raise money. Labour and the Greens know this – that is why they want to bump up the top income tax rate.
What alternatives are there?
The Green’s carbon tax is one example of a corrective tax that would address a problem and generate revenue if that is the objective (not that we’re saying it should be). It’s biggest benefit is that it would encourage people to make low carbon investments at the same time. There are other examples – such as water charges.
But by far the best alternative is to raise money by plugging the holes in our tax system.
In our book the Big Kahuna we canvassed the scope for a comprehensive capital tax.
This is a tax based on the assumption that all assets that don’t earn a cash return are providing value to the owner to the tune of 6% per annum.
The idea is to tax those benefits each and every year.
Account would be taken of the amount of debt people had, so owners would only be taxed on the equity they had in their home for example.
The comprehensive capital tax would be far simpler to administer and generate a lot more revenue than a capital gains tax. In fact, this tax would rake in a lot more cash than Labour and the Greens are looking for, so they could lower all tax rates, have a low comprehensive capital tax rate, or put in an exemption for family homes up to a modest value.
Given the alternatives, why do we face this persistent focus on the top tax rate?
The answer is probably political – it is a tweak of an existing tax so Kiwis understand it, and it satisfies the politics of envy.
While the longstanding belief that the people with means should pay more has a strong list of subscribers including Adam Smith, the father of capitalism – the problem is that increasing the top tax rate really doesn’t achieve that anyway.
A comprehensive capital tax will.