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Will ACT’s tax policy let you Seymour of your income?

ACT's tax changes would increase income taxes on more people than even the Green Party's 2017 policy, but there is merit to the flat tax.

ANALYSIS: In 1987 a flat tax nearly broke the Fourth Labour Government and it’s David Seymour’s hope that an even more radical version of the tax will put paid to the sixth by returning ACT to power.

This weekend he unveiled a tax proposal that would see personal and company tax rates set at 17.5 percent — that’s a tax increase for people on lower incomes, and a tax cut for people on higher incomes. It’s a cut below the 20 percent flat tax Roger Douglas took to Prime Minister David Lange in 1987, culminating in one of the biggest inter-Cabinet fracas in modern history.

While ACT’s current low polling makes the changes fairly unlikely, that could change. Seymour says the tax changes would be his second highest priority in a coalition agreement with National, right after his education reforms.

He believes the policy will make New Zealand fairer and more productive, citing the fact that top earners make the largest contributions to the tax take. His party’s co-founder Roger Douglas proposed a 20 percent rate in 1987, paired with a Guaranteed Minimum Family Income (a kind of broad-based benefit).

Economists aren’t so sure about the plan — many say it's unfair and hits those on low income hardest. In fact, using Treasury’s modelling tool a flat tax of 17.5 percent would result in a tax increase for everyone earning less than $56,000. However there is agreement that flatter rates encourage compliance and reduce tax avoidance.

Data from stats shows that close to 70 percent of income earners would be worse off under the ACT scheme. Income data broken up into deciles records just 30 percent of earners take in more than $57,000 a year.

ACT's tax plan (orange), against the current scheme (blue). People who will be better off are those whose incomes fall to the right of where the two lines intersect. Source: Treasury.

In fact, for a party that campaigns on lower taxes, the numbers bare an unfortunate comparison with the other parties in Government — even the tax proposals of the allegedly tax-happy Green Party would have resulted in an income tax cut for everyone earning less than $155,000. That would result in a tax cut for more than 90 percent of income earners — the top income decile kicks in at just $94,000.

Seymour said he doesn’t mind the Greens’ 2017 tax plan resulted in greater tax cuts for most earners.

“The Green Party will give people worse incentives than we would,” he said.

The Green Party's 2017 scheme, if implemented today would mean a tax cut for everyone whose incomes fall to the left of where the blue and orange lines intersect. Treasury.

New Zealand income earners are currently taxed at four rates. The first $14,000 people earn is taxed at 10.5 percent, the next lot of income up to $48,000 is taxed at 17.5 percent, and the next lot of income up to $70,000 is taxed at 30 percent. Any income above $70,000 is taxed at a rate of 33 percent.

It’s a common misconception that every dollar of people’s income is taxed at one single rate — for example, someone earning more than $70,000 would have all of their income taxed at 33 percent. In fact, only the income earned above $70,000 would be taxed at that rate — the income below $70,000 would be taxed at the 10.5, 17.5, and 30 percent rates.

This is broadly known as a “progressive” tax system, as the people who earn more income pay more tax. The opposite of a progressive system is known as a “regressive” tax. GST, for example, is often described as a regressive tax; if someone buys a loaf of bread for $3, they pay 45 cents in GST, which doesn’t matter too much if you earn $60,000, but makes a big difference if you’re homeless.

New Zealand’s income is more progressive than some, which have only a few rates and not much space between them, but less progressive than others. Australia exempts the first $18,000 earned from any taxation, and taxes income earned over $180,001 at a rate of 45 percent.

Seymour said that it is unfair that the top 5 percent of taxpayers pay more than a third of all income tax, and the progressive rates remove incentives to climb up the pay scale and earn.

“It is wrong that if a person’s income doubles from $50,000 to $100,000 their tax bill triples,” he said.

He also believes that paring taxes back to a flat rate will improve compliance. One of the bugbears of tax policy the world over is that higher rates of tax tend to encourage tax avoidance, as high earners have both the means and incentive to employ expensive tax accountants to hide their income in places the tax man can’t find it.

NZIER economist Peter Wilson told Newsroom that there were “efficiency benefits of a low-rate tax”.

Wilson said he would favour flattening income taxes and deal to inequality by better targeting spending.

“There are advantages to having a system that has reasonably flat income taxes but targets spending based on income and means,’ Wilson said.

“Use your targeted expenditure to do your redistribution — that’s not what New Zealand has done and it’s not what ACT is proposing,” he said.

One of the advantages of the progressive model, paired with a system like Working for Families is that it redistributes income to poorer households. Opponents argue this is a disincentive for those households to work, proponents say it keeps those households healthy. It also has the added economic benefit of boosting consumer spending. Tax cuts at the top end of the income scale tend to increase saving and investment, as wealthy people’s consumer needs are already met.

This has the unwelcome effect of increasing asset prices for things like housing, whereas tax cuts at the lower end of the scale give poorer households more money to spend — which they do, as their existing income doesn’t go far enough to meet their needs. This means there’s more money circulating in the economy, creating more wealth.

Economist Shamubeel Eaqub said that the fact income earned from capital gains was already largely tax-free in New Zealand meant there was already a massive incentive to invest in property in New Zealand

"It just means high income households will have even more disposable income which will be saved, which in and of itself isn’t a bad thing but it’s likely to chase property more than other asset classes,” he said.

His main concern with the flat tax proposal was how the tax burden would be distributed across society. He noted that very few democracies have implemented flat tax systems, perhaps owing to the level of inequality they breed.

Another minor party, another flat tax…

The Opportunities Party, now led by Geoff Simmons, who also went to the 2017 election promising to flatten taxes. It didn’t go so far as to promise a specific rate, but said that working with National or Labour it would flatten the tax system with a view to eventually arriving at a flat tax, which would be accompanied by a Universal Basic Income payment that would help low income households.

But Simmons went one further than Seymour. While Seymour’s system aims to shrink the amount of tax raised (paid for by cutting certain benefits and schemes like fees-free), Simmons’ plan was broadly revenue neutral. Income taxes would be lowered by a third, which would be compensated by adding other forms of income into the tax regime, including a form of capital gains tax.

His proposal was a regular payment, akin to the Tax Working Groups “risk free rate method”. The scheme worked by meaning all assets pay as much as a bank deposit. The advantage of this scheme was that it reduced distortion in the system, and encouraged people to think about where they saved their money, rather than simply ploughing it into the family home where it would accrue massive, untaxed capital gains.

He said he liked the idea of flat taxes, but it needed to be accompanied by some redistribution.

“A flat tax is a neat idea from the simplicity of the tax system position, but unless you have a UBI in place it is pretty horrifically regressive,” Simmons said.

“What ACT’s proposing is really hitting those on low incomes pretty hard,” he said.

Seymour however believes his proposal will increase productivity by cutting the corporate tax rate, currently at 28 percent, to 17.5 percent, and boost the economy. Seymour said businesses would likely invest that extra income in productivity enhancements and wages for staff.

“We can keep having a conversation about how to divide the pie or we can talk about how to grow the pie,” he told Newsroom.

The main difference between Seymour’s plan and many of those that have come before it is that his isn’t a tax-neutral switch and it’s not about broadening the tax base to take income from a hitherto untaxed part of the system. ACT wants to reduce the overall amount of tax collected and it also wants to add incentives for people to earn more, by ensuring that as they move up the tax scale, the percentage of their income paid in tax doesn’t change.

He says New Zealand should head in the direction of low-tax high productivity jurisdictions like Switzerland.

That may be ultimately desirable, but like his predecessor Douglas witnessed, there’s a whole lot of social pain between here and Switzerland — something one can’t imagine a National or Labour government would be happy to wear.