Written By: - Date published: 4:51 pm, July 12th, 2008 - 61 comments
Categories: tax -
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We have a progressive tax system, whereby the portion of income paid in tax increases with income. Many on the Right argue that moving to a flat tax system, where everyone pays the same portion of tax on income at all income levels, would be fairer. Let’s look at what such a change would entail.
The 3.25 million adult New Zealanders had an average income of $34,800 in 2007, equating to total income of $113 billion. $26 billion in income tax was raised in the last year. That’s 23% of income. So, if we were to introduce a flat income tax, it would have to be set at 23%.
So far, so good. Now, how many Kiwis currently pay more than 23% of their income in tax? If your income is below $50,000 a year, you pay less than 23% of your income in tax. Of 3.25 million taxpayers, 2.55 million earn less than $50,000 a year. That means 78% of people pay less than 23% of their incomes in tax.
S0, if we were to replace the current progressive tax system with a flat tax system, it would put up tax for 78% of Kiwis. And the poorest Kiwis would have the largest increase in tax. A person on an income of $10,000 a year would see their after tax income drop from $8,470 a year to $7,700, a 9% drop. A person on $100,000 would see their after tax income increase from $69,730 to $77,000 a 10% increase. The higher your income, the higher your tax cut would be.
What’s fair about putting up tax on 78% of Kiwis to give a massive tax cuts to the few most wealthy? What’s fair about taking from the poor to give to the rich?
Oh, we could just slash government spending to get income tax lower? You would have to cut revenue by $10 billion to get the flat tax to the 15% the lowest income earners currently pay. It would be the poor that suffer from $10 billion less government spending (which equates to nearly all health spending, or education spending and is more than is spent on superannuation and benefits).
Whatever way you cut it, introducing a flat tax would make most people poorer. Doesn’t sound fair to me.
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Of course, your analysis completely ignores the fact that a flat tax of 23% would almost immediately stop a lot of tax avoidance, and generate more investment and hence may even push-up total tax revenue. It also ignores the benefits of much lower marginal tax rates on providing incentives to improve productivity.
I personally think that (say) the first 10k tax free, with a flat-tax of about 25% after that would be better.
claims about productivity, lower tax avoidance, more investment…..how?
Good post, Steve – but can you please, please proof read it?
(There are plenty of regular readers here who’ll have enough trouble comprehending this one as it is.)
Felix. maybe it’s the hangover, maybe it’s watching the Simpsons but i could only see the one typo. always pleased to have mistakes pointed out.
“Now, how Kiwis currently pay more than 23% of their income in tax?”
That was the other one I spotted. Not trying to hassle a hungover person, just trying to help
Of all the proposals I have ever seen for a flat tax this is the first one that has suggested a flat tax rate of 23% The Baltic countries that have introducted flat taxs have typically gone for a rate between 12% and 15%.
Oliver: Ah yes, the Estonia Proposition. Leaving aside for a moment whether we want to be like Estonia, with unemployment running at about 10% for much of the time since implementing that flat tax, I wonder if you could provide some counter-data to the wikipedia entry, which states:
“The Baltic countries of Estonia, Latvia and Lithuania have had flat taxes of 24%, 25% and 33% respectively with a tax exempt amount, since the mid-1990s.” (
http://en.wikipedia.org/wiki/Flat_tax#Recent_and_current_proposals )
I normally don’t cite wikipedia as an authoritative source, but even so, it’s more authoritative than Some Random Unsubstantiated Statement On A Blog.
L
Back in 2005, IIRC, ACT suggested a split tax @ 15/25%. They said that this would push productivity up and therefore increase the tax take. Being the inquisitive type I plugged their projected growth figures into the spreadsheet as well as appropriate figures from the 2004 budget and came to the conclusion that it would take 14 to 15 years before the tax take would equal what it had been before the cuts. Of course, over that time the government would be seriously down on the needed funding to maintain services. The economy may grow in the first year or two after such a cut while things were still in good repair but after awhile the lack of funds to maintain and improve infrastructure and support services will take their toll and the economy will start to go into decline.
You can’t improve productivity if the required government services are either under-funded or non-existent ie, you won’t be able to truck anything from Silverdale to Auckland City if the truck is going to get a broken axle every two kilometers.
Government spending isn’t optional – It’s there to maintain our society and infrastructure so that the economy will work and it needs to be enough to do the job.
Oliver. you’ve got the tax rates in these countries wrong. If you want to find out about the Estonian tax system, go to riik.ee (it has english) or here http://www.worldwide-tax.com/estonia/estonia_tax.asp .
The income tax rate is 22%. Moreover, in Estonia, as most European countries, there’s a social security tax as well as income tax – it’s paid before gross income by the employer but that is a tax on workers (ie there incomes would be higher wihtout it). It’s 33%.
When you add together social security and income taxes you get the ‘tax wedge’ – the difference between the money paid by the employer and the money recieved by the employee. NZ has one of the lowest tax wedges in the world.
Tax wedge- http://en.wikipedia.org/wiki/Tax_wedge
in fact, we have the third lowest tax wedge in the OECD http://www.oecd.org/dataoecd/50/41/36371703.pdf
only Mexico and Korea are lower, and after the tax cuts in October, we might be lower than them
Well I had a bit of a go at this topic. But my question is – why do you bring it up? Do you know something we don’t?
no particular reason just a ‘big issue’ piece. But somethng brought it to mind a few weeks ago – talking to a woman over dinner, ACT-type, wanted a flat tax, she was earning $45K, I said ‘you know, you’re promoting a tax increase for yourself to give me a tax cut’
‘yeah, but in 5 years i’m going to be earning $200K’ she replied.
so I thought I would sit down and work out the figures.
I’ hoping Farrar and co might come to defend wanting a tax cut for themselves when it would put up tax for everyone else, or cut their social services.
I know Farrar would get rid of WfF to fund tax cuts – ie. reduce the after-tax incomes of families to increase his own.
Flat taxes give people an incentive Stevo. Proportionally, those that earn more pay more tax. It is an unfair system because of that. Income tax should lower as income rises. Incentive again Stevo.
Taking money off those who earn it by force isn’t a clever thing Stevo. Best the income tax system is simplified, reduced for all and then we can cut IRD staff by at least half.
Remember Stevo, the pie is not a finite thing that must be shared, people can be incentivised to bake a larger one.
Of course if taxes were lowered and those that your ilk purport to support, people who earn smaller wages, earn’t more because they were incentivised to work harder because of lower taxes, then you wouldn’t have the money to interfere in their lives with crackpot nanny state meddling now would you?
Darren,
Huh? How would the incentive be any different from the current one?
I get a pay rise, I get more money in my pocket, I am pleased. The End.
I think if we cut out some of the more useless tax exemptions there might be room to flattern the tax curve a little afterwards. (that said, I think it’s middle-income earners and those on the minimum wage that need tax relief most) Generally speaking, I dislike tax systems with exceptions- which is why progressive tax systems are actually much simpler, as they reduce the need for lots of exceptions and tax cuts for lower-income earners.
Darren- Taxing people’s income often results in better spending efficiency than leaving it to them. Even with high taxes there’s still plenty of reason to earn more- you still get a lot more money, it’s just a lot of it is spent on roads and public services instead of going directly to your pocket. If you use public transport, have health problems, drive between cities, etc… you’ve benefitted significantly from paying taxes.
because if we were to remove the 39 cent tax rate (that will only apply over $70K form Oct 1) that would inspire the 500,000 workers who earn on the minimum wage or close to it to work harder. I mean, that 6 cent in the dollar reduction in a bracket that most people don’t earn anywhere near would inspire them to work harder – right now they’re content to live on $25K a year working full time, but remove the 39% bracket and they’ll soon be working the 120 odd hours a week they need to get their incomes over $70K.
You provide no evidence that adjustments to tax rates alter how hard most people work, why not? because there is none, it’s just wishful thinking to justify taxcuts for the rich.
In fact, as the Incomes Report shows http://www.thestandard.org.nz/?p=2419 cutting taxes for the rich and cutting benefits to pay for it just made the rich richer and the poor poorer in the 1990s.
Dazza: “Taking money off those who earn it by force”
pweet – offside! For consistency’s sake you can’t argue tax is theft and simulataneously argue a flat tax system, unless that tax system is flat at a rate of 0%. If you want to argue that, be my guest.
L
Anita,
> I get a pay rise, I get more money in my pocket, I am pleased. The End.
Actually, if I earn say $35k with 3 kids and get a pay rise, I pay a marginal tax rate of about 51%.
So say I get a $1k pay rise, then I get only $490 of that. Certainly still some incentive to work, but high income people give up at 39%. 51% is getting a bit silly.
Worse at $50k, where earning another $1k I face a tax rate of about 64%. That’s downright nasty.
If I have accomodation supplement also then it is much worse. Best I don’t work it out.
Of course such is the nature of these sorts of tax-based schemes, they are genuinely hard to get right, like maybe impossible.
So I disagree – your argument is that getting a $1000 pay rise and seeing only $360 in the pocket is fine? It isn’t.
> In fact, as the Incomes Report shows http://www.thestandard.org.nz/?p=2419 cutting taxes for the rich and cutting benefits to pay for it just made the rich richer and the poor poorer in the 1990s.
Cutting taxes for the rich doesn’t make the poor poorer, does it? Or are you referring to envy?
My argument was that if I get a pay rise I get more money in my pocket, and that is an incentive to try to earn more.
(Incidentally a decade or so ago when I was on the sickness benefit and working part time when I was well enough, the clawback was so steep that sometimes if I worked more hours than the previous week I earned less money, it was very disheartening!)
The Optimist: Perhaps he should have said `in real terms’.
L
Captcha: “on competing”. Scary.
>> Cutting taxes for the rich doesn’t make the poor poorer, does it? Or are you referring to envy?
> The Optimist: Perhaps he should have said `in real terms’.
‘in real terms’ normally refers to adjusting for inflation.
Maybe he meant ‘in relative terms’. But even that is arguable, since $1 to a poor person is worth more than $1 to a rich person. You would have to have very high tax rates to take a 3% pay rise for someone on $100k down to the same as a 3% pay rise for someone on $20k.
I could be wrong, but I think the claim that tax cuts for the rich make the poor poorer is simply false.
I think you’re wrong.
Rich people and poor people all live in a society. If you reduce the level of that societies output that is allocated to poor people (through services common to all – health, roads, police, education) then you make the poor people poorer.
Some incredibly simple equations I just made up…
Poor person available wealth = personal wealth + societal wealth share
Rich person available wealth = personal wealth + societal wealth share
Obviously, recuding the total tax take will reduce the societal wealth share for all members of society.
Rich people will see their personal wealth go up, because you’ve reduced their tax burden, so the combined available wealth will be greater.
Poor people will see their personal wealth remain unchanged, because they’re on the same tax rate. But because societal wealth has dropped, their combined available wealth has dropped. The poor have become poorer.
Maybe it would be more valid to switch ‘wealth’ for ‘income’, but the idea is pretty obvious.
The Optimist, read the report or the link, people on low incomes saw their incomes drop in real (not relative) terms, because the tax cuts for the rich were funded by cutting benefits.
However you fund tax cuts for the rich whether reduced benefits, reduced social wage (that’s pubic services provided free or nearly free to the consumer, education, health, police etc), or higher tax on lower incomes – the rich get richer and the poor poorer..
T-rex
Feeling sleepy, but let’s ignore for the moment the idea that is it moral to take away someone’s income and call it ‘societal share’.
So let’s agree that poor people don’t get poorer in terms of income, when rich people earn more. You’re saying that they get poorer in terms of their ability to live off other peoples’ income, I think. But really?
I believe roads are funded by petrol taxes, and health is severely rationed already. I doubt removing the higher tax rates would affect the police. Education is a right based on age I think, so no affect there. You didn’t mention welfare, but again that doesn’t apply since these people are working.
What exactly is in that societal share that the low income person will lose when the high income person pays less tax? Obviously you are assuming a reduction in government spending, but beyond that I am not sure.
I’m thinking ‘envy’ is the real issue here. Come on, you can tell me, I can keep a secret am I right?
Very bloody optimistic.
For the sake of clarity, can you please restate your reasons for ignoring the health, welfare and education budgets in your “calculations”?
It’s just that in the real world, quite a lot of things hinge on these 3 areas so we can’t just pretend they don’t exist to make our numbers add up.
This has been wrongly attributed to the author shown, it really has no proven provenance. There’s something in this for all sides of the debate to think about.
Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that’s what they decided to do. The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve.
“Since you are all such good customers, he said, I’m going to reduce the cost of your daily beer by $20. Drinks for the ten now cost just $80.
The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men – the paying customers?
How could they divide the $20 windfall so that everyone would get his “fair share”? They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay.
And so now:
The fifth man, like the first four, now paid nothing (100% savings)
The sixth now paid $2 instead of $3 (33%savings)
The seventh now pay $5 instead of $7 (28%savings)
The eighth now paid $9 instead of $12 (25% savings)
The ninth now paid $14 instead of $18 (22% savings)
The tenth now paid $49 instead of $59 (16% savings)
Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.
“I only got a dollar out of the $20,”declared the sixth man. He pointed to the tenth man,” but he got $10!”
“Yeah, that?s right,” exclaimed the fifth man. “I only saved a dollar, too. It?s unfair that he got ten times more than I!”
“That?s true!!” shouted the seventh man. “Why should he get $10 back when I got only two? The wealthy get all the breaks!”
“Wait a minute,” yelled the first four men in unison. “We didn’t get anything at all. The system exploits the poor!”
The nine men surrounded the tenth and beat him up.
The next night the tenth man didn’t show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!
And that, boys and girls, journalists, college professors, fellow workers is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction.
Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.
David R. Kamerschen, Ph.D.
Professor of Economics, University of Georgia
So, all the rich pricks leave the country because they don’t want to pay tax. Their businesses, farms etc all fall into disrepair because no ones working them as they were closed down so that the rich pricks didn’t have to pay tax. They, of course, still all have mortgages and loans that they can’t pay anymore so the banks foreclose. The banks, though, are in a bit of a bind as the only people who want to buy the businesses and farms are the poor. After some discussion between the poor and the banks the community buys the farms and businesses up for pennies on the dollar. After this small investment the communities all become massively rich, there’s no poverty, unemployment is unheard of and the most anybody works is 4 hours per day giving plenty of time to be with the family/whanau as well as to up skill down at the community funded university.
Suits me fine.
BTW, if that was POS written up by a professor he (and anyone who agrees with him) needs to go do a class in remedial logic. There are several other ways I can rip it to shreds.
I’ll give you a hint: “The rich do not produce wealth.” Adam Smith in The Wealth of Nations
Here are a couple of interesting links:
http://www.treasury.govt.nz/budget/2008/execsumm/07.htm
On this first one, the key question the hypothetical taxpayer asks themselves is “why is the second largest bite out of my pocket wff and benefits?” Wouldn’t it be more efficient for me to keep at least the wff part of it?
http://www.treasury.govt.nz/budget/2008/taxpayers/b08-taxpayers.pdf
And on this one, many interesting parts but the most intriguing the table showing percentage of total tax paid by income band. You see that the 2% of the population earning 150k+ (2% of population) pays 17% of the overall income tax take. They also pay a large share of GST. If the 51,000 people earning 150k+ all leave overseas try plugging a 4.5 billion hole in the PAYE take plus all the multiplier effects from GST, lower business investment, less entrepreneurial job, fewer employees working. What would it be – a $10 billion hit? More? These are the “rich pricks” our Finance Minister alludes to. They are actually indispensable to our society and to suggest otherwise is to play the politics of envy card, And in the same way National can’t ignore people at the bottom of the income scale, Labour can’t ignore those at the top.
Personally I have made a choice – I am very squarely in the top bracket and think I pay way too much tax. However, I also regard it as the premium I have to pay in order to live in NZ, and have my kids grow up as kiwis rather than expats, and to live in a society where people don’t starve even if it is their own fault. It also means I demand good service from schools, hospitals, police etc. In rational economic terms the reward from my labour is far greater overseas but I ascribe value to many intangible things, hence I came back to NZ. I also don’t want to drive down the road and see abject poverty like I have done in places like Indonesia, the Philippines, Malaysia and Thailand.
My reason why Labour is doing so poorly in the polls is that when working people on modest incomes get squeezed (for whatever reason) they don’t like seeing public money wasted, they don’t like paying taxes for the perception of poor service, they don’t like politicians (of either hue) throwing taxpayer money at non-critical expenditure. No one knows the value of a dollar like a small business owner who has pledged his house as security for the business, or the mother who works when she’d rather be at home caring for the kids but doesn’t have that choice.
ummmm….. have you actually read “The Wealth of Nations”? And I don’t mean just the Wikipedia version. There is actually a real book (with pages and everything) called that.
If you have read adam smith you’d know the society you describe doesn’t work – Adam Smith proved that over 200 years ago, the soviets proved it last century – look around the world there istons of proof. The best model is probably what we have in NZ – broadly open markets and rewards for free enterprise, but an element of wealth re-distribution to keep a cohesive society.
Was NZ really a better under our last Socialist government (Muldoon).
Despite being one of those people you froth at them mouth about Draco, I don’t think NZ is too bad at the moment. Nor would it be for the next three years under either labour or national – there really isn’t a lot of difference between the two.
Yes I have read Adam Smith’s Wealth of Nations. I’ve read quite a bit of Das Kapital as well but I don’t really agree with Marx. I’ve also read Principals of Economics by R.H. Frank and Ben Bernanke. Presently reading Macroeconomics by A.B. Abel, Ben Bernanke and D. Croushore.
What you fail to note is that I didn’t say that it would be a command economy. I would fully expect it to be a market economy – just one without the capitalists.
I also don’t think NZ is bad ATM but that doesn’t mean that it couldn’t be better.
Again I’d call you on that – show me an example of a market economy that has ever functioned without capitalists?
“If you have read adam smith you’d know the society you describe doesn’t work – Adam Smith proved that over 200 years ago,”
The thing about Adam Smith, of course, is that he was an advocate of progressive taxation (his argument was that the rich had more property, so they should pay a greater proportion of their income to the state to protect property rights).
That depends what’s funding the tax cuts and whether everyone gets a roughly equal share of the pie or not. Flat tax cuts generally widen income disparity- whether that’s because they only motivate the rich or because they tend to go hand-in-hand with degradation of the public service would be interesting to know, but not enough to experiment with it.
I also don’t see how tax cuts would incentivise most of the poor to earn more. They’ve already got all the incentive they’re going to get from money- it’s a matter of whether they feel ABLE to move up the ladder or not.
Gomango – My reasoning is actually pretty close to yours, except for the following:
1) I don’t have kids, so I’ve got some freedom to explore the world for a few years before I come back here to bring them up in a nice place.
2) I haven’t read ‘The Wealth of Nations’
3) I’m probably not quite so far into the top bracket
4) I don’t really think I pay too much tax… or if I do I don’t think it’s siginificantly too much. However, I don’t actually think that’s a difference… as you say you think you pay too much tax, but you think it’s the premium you pay for living in a place that gives all the benefits you describe.
It think of it the same way – it’s a premium paid to keep a place worth having. On that basis, I don’t think I pay too much.