Embargoed until 4.20pm
Monday 2 August 1999

Michael Cullen
Deputy Leader New Zealand Labour Party

Labour and Tax

Speech by Labour finance spokesperson Michael Cullen to KPMG

Contrary to the hopes of some, the fears of others, and the expectations of many, tax has not emerged as one of the two or three leading issues of the 1999 election. Insofar as it has had any significant impact it appears largely to have been as some kind of branding exercise, reinforcing the core support for the two major parties.

Tax remains an important issue. Indeed much more important than arguments over relatively modest changes in the total tax take would indicate. It is also an issue about which more self serving nonsense has been, and is being, talked than almost any other topic.

In that respect, it is fascinating that those who most rigidly adhere to an economic theory based on the notion that people are motivated almost solely by self-interest signally fail to recognise the self-interest which permeates their views on tax.

The current orthodoxy is that tax rates, and the total tax take, must continue to fall or some kind of economic nuclear winter will descend upon us.

The empirical basis for this view is very hard to find. Some journalists and a few politicians on the far right at least purport to believe that it is almost a self-evident fact.

It is not. Some little while ago IRD commissioned research which has assumed the status of holy writ on the extreme right. This research concluded the growth maximising tax take was about 20 per cent of GDP.

No economist of any repute takes this research seriously. It is riddled with fundamental technical errors. In the end, all it shows is that since the 1930s our growth rate was highest at the time that that was also the tax take.

For that fact there are obvious explanations which are completely unrelated to taxation: the recovery from the Depression, the Second World War, and the Korean War wool boom.

If we compare OECD countries today we can find no clear relationship at all. The only two in which the tax take is less than 25 per cent of GDP are Mexico and Turkey. Amongst the rest it is very hard to draw any conclusions except that where taxation contributes to very high non-wage labour costs this does seem to be associated with high levels of structural unemployment. Even in these cases, such costs are also usually to be found in countries where there are rigid labour markets which may be the more important factor.

A more sophisticated attempt to argue for the costs of taxation in terms of growth is through the concept of the deadweight cost of tax. This is fraught with difficulty. Estimates of the deadweight cost of the same tax can vary widely. The underlying theoretical assumptions are at least questionable.

And, as so often with certain economic models, it takes little account of dynamic effects, particularly those associated with the imponderables of individual attitudes and social interaction.

Let me take an example. Let us suppose that the state's funding of health care comes from a dedicated health tax (incidentally, in my view, a good idea). We might be told that there was a deadweight cost of, say, 15 per cent associated with that. By that is meant that every dollar of health has a cost to the economy as a whole of $1.15.

This can only make sense if we take it to mean that if the state ceased to fund health care and the tax were abolished then the economy would be larger by an amount equivalent to 15 per cent of the total health tax take.

Now let us assume the state does precisely that. What happens next. The economy ought to receive a large growth spurt. That seems unlikely.

What we know will happen is that some people will immediately spend their tax bonanza, much of it on imported consumer durables. The latter spending will increase consumption, but not GDP, and worsen the current account. If the money is spent on domestic goods then the Reserve Bank will move immediately to tighten monetary policy to choke the inflationary consequences.

A great deal, no doubt, would immediately be looking for health insurance to replace the state's funding. No-one will be able to get full catastrophic coverage. Those at higher risk, especially the elderly, will have trouble buying any cover at all at affordable rates.

If we are prepared to follow the logical consequences people, including some of the most productive, will die unnecessarily. Many will postpone simple procedures until complications make treatment much more expensive. The highly productive middle-aged will find themselves (especially women) having to give up paid employment to care for elderly relatives for whom there is now no state provision (and which cannot be afforded at full market rates by any except a relatively small percentage).

Any saving comes from the appalling fact that elderly people will die who otherwise would have had care. Even for the strongest right wing stomach this is a hard gruel. The suspicion must be the benefits of lifting the so-called deadweight costs will rapidly disappear and we shall end up no better off economically and far worse off socially.

I've spent a good deal of time on this matter to make it clear that my view is that tax cuts are largely offered as a cheap political bribe, not because of beneficial economic or social effects. That is conclusively proven by the fact that both the 1996 and 1998 cuts (and the next proposed round) have worsened the overall design of the tax system. The same level of revenue could have been foregone in ways which would not have done this and would, simultaneously, been more advantageous for low and middle-income earners.

It is significant also that Treasury has failed to produce any research showing that the 1996 and 1998 cuts had any beneficial effects on growth. That really should not surprise. The fundamental structural failings of the New Zealand economy will not be cured, and often worsened, by politically motivated tax cuts.

Those structural failings include the high current account deficit, poor export growth, low savings rates, inadequate venture capital provision, poorly focussed skills development, low research and development investment, and weak long term focus and confidence.

Any changes to the tax system need to address these as well as more specific matters such as compliance costs, ease of understanding of the law and the taxpayer's obligations, and more traditional concerns such as fairness.

Taking these factors into account as well as changing technology, growing globalisation, and the increasing complexity of the tax system we consider it is time for a broad structural review of the tax system.

This will also enable consideration to be given to the various ideas which are in the public arena for major structural changes to the system including wealth taxes, resource taxes, turnover taxes, financial transactions taxes, and cashflow taxes to name just some.

A comprehensive review of the tax system will, therefore, be undertaken during Labour's first term of office.

I want to emphasise as strongly as I can that this review is not a Trojan horse for some particular agenda or another. It is, indeed, a great pity that most political debate about taxation (whether by politicians or otherwise) is usually carried out at an infantile level which makes it very difficult to take a sensible, broad, and long term view of the issues.

Any structural changes proposed as a result of the review will be carefully considered by the Labour Government. If it is deemed appropriate, they will be adopted as policy to be put to voters at the 2002 General Election. No such changes will be legislated for in the first term of office as the public will not have had a chance to vote on them.

That means that changes such as estate duty or new forms of capital gains taxes will not be legislated for in the next three year term of Parliament as they are not part of present Labour policy.

Obviously there are things that we will do in that term. The best known is to insert a new step in the personal tax scale of 39 cents in the dollar on each dollar of income above $60,000. This means that we will lose our unique position as the only OECD nation where the top tax rate equals the company tax rate. This distinction will be left to such countries as Russia and Uganda.

The spread of six cents between the two rates is not large by international standards. In any case, my firm view is that over the long term it is likely that downwards pressure will be exerted on the company tax rate by international factors. It is, therefore, important that the appropriate anti-avoidance mechanisms are developed to preserve future policy options in that respect.

The one change that we have concluded must flow from the altered top tax rate is to adjust the FBT rate accordingly. As I have indicated on a number of occasions, we do not wish to extract more revenue as a consequence of this change so that we will wish to discuss with stakeholders how to offset the increase.

The Employers Federation, somewhat unwisely in my view, has rushed to reject consideration of a multi-tiered FBT system which would have the added advantage of removing present inequities attached to FBT. Should they continue in that stance after the election is over then other options will need to be considered.

At the same time, Labour will strengthen and rigorously enforce anti-avoidance legislation so that every New Zealander actually pays their fair share of tax. Unfair tax avoidance is the rich person's equivalent of benefit fraud and should be clamped down on just as strongly.

It is not our wish, however, to penalise the honest tax payer. Nor are we impressed by efforts to cut costs which simply consist in passing those costs on to the private business sector.

At the same time we are likely to inherit an Inland Revenue Department facing a crisis of confidence. Excessive rounds of restructuring, staff lay-offs, rapid legislative changes, and difficulties with some of that legislation have led to significant administrative problems, including relationships with the public.

Those in their turn have given credence to a raft of exaggerated claims and politically motivated attacks which have often shown scant regard for the facts or the credibility of some of those involved.

There are real problems that must be addressed. In a sense, it can be argued that IRD has simultaneously been too hard and too soft. It has often waited too long before taking firm action against dilatory taxpayers. On the other hand, it is clear from the evidence to the select committee inquiry that the Commissioner needs greater discretionary powers to cope better with individual circumstances.

In order to improve IRD's services Labour will:

· Reestablish face to face personal customer service
· Consider providing clinics in outlying areas as the need occasions
· Reestablish problem resolution officers positions within IRD.

We also wish to establish a special tax code for small businesses and, with respect to the large corporates, investigate the feasibility of a more contractual approach to their tax liabilities.

There is much else I could talk about. I hope I have said enough to convince you we take the issues seriously. This is the most complex area of public policy. It deserves to be treated as such.

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