One of the issues that provokes a lot more heat than light when opened for debate is the question of tax rates. A hundred years ago we had zero income tax. It didn’t exist. No tax! The country worked. The people worked. You kept your money.
But our forebears decided that they needed more money to run government institutions so in 1891, Premier John Ballance passed New Zealand’s first ever income tax, incorporated in the new Land and Income Tax of that year, and directed primarily at land values and corporate activity. By 1908 New Zealand had the rudiments of a land and income tax – freely and voluntarily gifted to King Edward VII. The rate of tax was one penny in the pound for land value, and sixpence in the pound for income – about three cents in the dollar!
However things have gone a long way down hill since then with Muldoon wanting 66 cents in each dollar (as well as a plethora of other taxes) and now our latest government increasing our taxes and adding more levels to the income tax rates.
A large number of studies comparing the effects on the economy of changes in tax rates all conclude that lower flatter taxes enhance an economy whereas higher progressive taxes are a significant drag on any economy.
These studies are discussed at: http://www.npri.org/taxstudies2003/appendix-b.pdf
In particular they comment:
"In a study of New Zealand somewhat similar to studies done by Richard Vedder and Lowell Gallaway (1998) and by James Gwartney, Robert Lawson, and Randall Holcombe (1998), Gerald Scully (1996) concluded that New Zealand would have to cut its taxes roughly in half to maximize the rate of economic growth, and that "the marginal cost of taxation ... is $2.64 for each extra dollar of taxes collected" showing even greater "deadweight losses" and inefficiencies than Feldstein observed for the U.S."
This makes it clear that to maximize our growth rate and to get back into the top ten wealthy OECD countries we should halve our tax rate and make it flat. Roger Douglass tried to do this in the second "Lange" government but David Lange insisted on stopping for a "cup of tea". Twenty years on and we are still waiting for the tea break to finish. How much effort of our citizens is being wasted by our intransigent governments?
One of the effects of having high tax rates is that many people opt out of the tax system whenever they can. We have all heard of the "black" economy or the "underground" economy. This occurs where people pay by cash or barter and the profits from such transactions don’t show up in their normal business and they pay no tax.
It has been clearly established that the size of this underground economy will grow as the tax rates increase. This has been fully discussed in an article by David E.A. Giles found at this web site:
http://oldfraser.lexi.net/publications/books/fiscal_surplus/chapter5.html
In simple terms – The more the politicians demand from us the more we cheat the system. The losers are the "honest" citizens earning salaries and wages that they can’t hide.
Another very interesting study has been produced by Professor Gerald W. Scully called "Measuring the Burden of High Taxes" and this can be found at: http://www.ncpa.org/studies/s215.html
This study shows that there is an optimum tax rate which will produce the maximum growth in the economy. If we can achieve this maximum rate of growth then the economy grows at its fastest rate and everybody’s wealth increases at the fastest possible rate.
Professor Scully shows that the average salary (for USA citizens) would be around twice what it currently is if the US Government had followed this policy and increased the growth rate from 3.4% to 4.8% from 1950 to 1995. New Zealand had a growth rate of around 1% from 1950 to 1990. Imagine how much wealthier we would all be if our governments had adopted a high growth policy and we had achieved growth of 4% for this period. We would have still been at the wealthy end of the scale – perhaps even second behind the Americans!
And what is this optimum tax rate? Somewhere around 20%! It varies across the different economies of the OECD from 16.6% to 25.2%. It is clear that we should aim at a total tax take for government of 20%. This means less government and since more than 80% of New Zealand citizens voted for this in the last referendum we should have fundamental agreement on this question.
Another interesting finding from his study is contained in this quote:
"In the modern period, however, government has increasingly engaged in the redistribution of income - more often than not from middle-class taxpayers to middle-class beneficiaries rather than from rich to poor. Such transfer programs clearly have the potential to reduce the national wealth"
Human psychology is very interesting, and when workers in our middle class see that they are doing all the work and that there is a large group of beneficiaries living a middle class life style the workers feel aggrieved at the shirkers. This hardly leads to peace in the land.
High taxes lead to an inefficient and poor economy with a large central bureaucracy and more politicians than are necessary. The general population senses this quite correctly and in fact voted overwhelmingly in a referendum to limit the number of politicians to 100 only. Our servants in parliament, of course, just simply ignored our wishes and continued to provide themselves with higher salaries, more staff to create spin, and an unlimited expense account!
We are here to put a stop to this nonsense. If you would like to help us in this work then please make your donation using the on-line facilities provided.
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As a matter of interest, I thought I would reproduce here the Executive Summary from Professor Scully’s report. I do recommend that you read the full report at: http://www.ncpa.org/studies/s215.html
Executive Summary
Taxes are collected for two basic purposes: to provide public goods such as national defense and a legal system and to redistribute income.
Over some range of taxation, the provision of government goods and services makes private economic activity more productive. For example, America's current level of productivity would not be possible without the infrastructure, protection of property and educational level of the workforce we have. Thus, up to some level, reducing private goods by a dollar yields more than a dollar increase in total output. Beyond some point, especially when taxes are used mainly for transfer payments, they reduce incentives to produce enough that they lower the rate of economic progress. Then, reducing private goods by a dollar yields less than a dollar increase in total output.
Using an economic model, we find a tax rate that will maximize economic growth. A higher tax rate will result in a loss of potential output for society as a whole. Using data for the 46-year period from 1950 through 1995, the model finds:
The tax rate that would have maximized economic growth for the United States is 21 percent of gross domestic product (GDP); this tax rate would have produced average annual real economic growth of 4.8 percent.
However, taxes took 24.2 percent of GDP in 1950 and continued to rise thereafter; as a result, the actual growth rate over the period averaged only 3.4 percent.
The additional 1.4 percentage points of growth would have resulted in workers now producing (measured in 1992 dollars) $107,900 in per capita output instead of $54,100. This means that the average person would have twice the real income he or she has today. The resulting increase in taxes paid could have paid for all government programs and left the nation debt free!
If the 21 percent tax rate had been in effect, cumulative real GDP (measured in 1992 dollars) during 1950-95 would have totaled $88 trillion more than the actual $173.5 trillion. On the average, each dollar of tax collected caused a $1.71 loss of private wealth over the 46-year period.
However, the higher the tax burden, the higher the cost to the economy; specifically, each additional dollar of tax is causing a loss of $3.44 of GDP (output that was never produced).
A tax rate well above the optimal rate is common among other industrialized nations as well. The resulting loss in a number of other countries for which data are available has retarded economic growth in those nations, too. On the average, the growth-maximizing tax rate is about 20 percent of GDP among developed countries - ranging from 16.6 percent for Sweden to 25.2 percent for the United Kingdom. Current levels of taxation, however, range from 34.1 percent in the United Kingdom to 51.6 percent in Denmark.
The marginal cost of taxation for each unit of local currency is 5.70 in Denmark, 3.34 in the United Kingdom, 1.59 in Italy, 4.20 in Sweden, 1.76 in Finland and 3.43 in New Zealand.
Not only would Americans have a higher standard of living if the tax rate had been at 21 percent of GDP, but based on public spending and indicators of social progress, it appears that the marginal benefit of taxation in the United States has been far less than the marginal cost. There is evidence that government spending prior to 1960 led to measurable improvements in social indicators. However, the explosive growth in government spending after 1960 has been accompanied by only modest improvement.
Many European nations take an even higher percentage of GDP in taxes than does the United States. Their experience suggests that in any economy where the marginal cost of taxation exceeds the marginal benefit, the eventual result is lower economic growth, reduced job formation and increased unemployment.
About the Author
Gerald W. Scully is a Senior Fellow of the National Center for Policy Analysis and a professor of economics in the School of Management at the University of Texas at Dallas. His articles have appeared in the American Economic Review, the Journal of Political Economy, the Journal of Law and Economics, Public Choice and other scholarly journals.
© Copyright; Foundation for Economic Growth and various authors. Individual authors retain their own copyright.
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