The joy of (low) tax

Monday 1st October 2001

When the company tax rate falls from 33% to 20% everyone is happier - and the government is not out of pocket. "No, really", say employers.

It was nail-biting stuff. Alasdair Thompson, northern chief executive of the Employers & Manufacturers Association (EMA), had booked a time to present his case for cutting company tax rates to the McLeod tax review panel back in mid-August. Trouble was, he had no case. He needed to show that a low tax would not only win votes, it would actually keep revenue intact for the government - only the numbers were still being crunched by economists in Wellington.

But Thompson doesn't usually let a hair fall out of place, let alone front up empty-handed. Completing the papers only the night before, Thompson let rip: the time has come to cut company tax.

He reckons progressively dropping the company tax rate by 2% each year, to 20% by 2008/09, will lift business activity and foreign investment. "If Labour decided it wanted to kickstart the economy and really do something constructive, this would give it a quick payback by boosting economic growth," says Thompson. Adding to the pressure, in July Australia cut its corporate tax rate from 34% to 30%, leaving New Zealand's 3% higher.

The EMA is bound to win votes from its constituents. Business surveys show that taxes and compliance costs are the top concerns of most companies.

Less enthusiastic are its sparring partners. The Council of Trade Unions (CTU) argues there is no evidence a lower rate would benefit workers. CTU economist Peter Conway says he's pleased this proposal, unlike others in the past, is aiming to have no impact on government revenue. But he's still concerned that it relies heavily on assumptions in its modelling - such as government savings on its purchase of goods and services - which may or may not pan out.

Alliance leader Jim Anderton also doubts employers can have their cake and eat it. Lowering the corporate rate simply requires a corresponding drop in funding for hospitals and schools, he says.

EMA stands by its case. It employed consultants Infometrics to assess the costs of the tax cut, by updating the "business as usual" scenario it uses for modelling the economy. This considers a range of factors, from the employment rate to world export demand and the fiscal surplus. It projects that scenario out to 2005/06 and then applies "the shock" - in this case, the impact of a 20% company tax.

It estimated the direct cost to government would be a revenue loss of $958 million. But, says Infometrics, balanced against this is an increased tax take due to higher company profits, increased personal income tax from growth in the economy, lower welfare payments through more people being employed, and reduced inflation.

Even then, there would be a shortfall of $48 million. One way of achieving the balance could be to increase the personal income tax rate a tad, between 0.03% and 0.06%. Infometrics assumed the company tax base would rise in value by 10%, as a lower rate leads to companies electing to pay more of their tax in New Zealand (as happened after the rate was dropped to 33% in 1986). Now, company tax accounts for 20% of direct taxes and 13% of the total tax take.

To cap it all off, Thompson reckons there are some favourable macroeconomic effects. Compared to the "business as usual" scenario, Infometrics calculated that a 20% corporate tax rate would cause a 3.6% increase in gross investment, a 1.5% increase in exports balanced against a 0.09% increase in imports, and a minor change of just 0.1% in private consumption.

The bottom line, says Thompson, is that a lower corporate rate would deliver more economic growth than any other tax cut, through greater investment by both foreign and local companies. That additional investment is particularly relevant in New Zealand because of the small scale of business here, with more than 35,000 businesses employing less than 50 full-time staff.

See, the grass does grow greener.

Thompson may be convinced, but it's now his job to convince the public and politicians. He has his work cut out. The tax review team, due to present its final report in October, has already said there is a strong case for aligning the company tax rate with the top marginal rate (lifted to 39% and out of alignment when Labour came into office). Having the two rates the same removes the opportunity to shelter personal income in companies. Thompson argues we could simply adopt the best anti-avoidance measures used by tax regimes with differential rates.

The review team also said it would not be appropriate for the company tax rate to be out of step with international norms. By comparison, other rates in the Pacific rim are: Australia 30%, Hong Kong 16%, Japan 34.5%, Korea 28%, Taiwan 25% and Singapore 26%.

On the political front, support is not particularly forthcoming either. ACT thinks a 20% company tax rate is a good idea - though MP Rodney Hide says aligning the personal tax rate at 20% is an even better idea. National supports an immediate 3% reduction in the company tax rate to match Australia, but finance spokesman Bill English says his party is yet to decide if a 20% rate is affordable. One of the problems, he says, is that a large gap between company and personal rates leads to the tax avoidance industry that has already sprung up since Labour lifted the top personal rate 6% above the company rate.

Finance Minister Michael Cullen has been lukewarm toward the idea. He rejected calls for a company tax cut in the June Budget, saying there was no money for such a move and that it would be discussed as part of a wider tax review. But he has since conceded that New Zealand is unlikely to sustain its 33% rate given the global trend toward lower rates.

The EMA took heart from a recent speech given on Cullen's behalf by revenue under-secretary John Wright. While warning that a lower company tax rate was not a quick-fix panacea, Cullen did say there appeared to be two arguments for lowering the corporate tax rate that need to be seriously considered. One was to attract foreign investment. The other was the threat of companies moving to other, more favourable, jurisdictions.

Cullen reckoned lowering the company tax rate by 1% would cost the government about $125 million a year, with about $45 million to $50 million of that going to foreign-owned companies. "The fiscal costs are very certain, but the benefits are less so."

The drive for lower taxes comes amid a healthy tax take from the corporate sector, especially from export industries. Company income tax receipts for the year to June 2001 were $484 million, nearly 12% higher than the previous year.

The government has promised not to implement any significant tax changes without first seeking a mandate at next year's election. Employers and manufacturers are frantically lobbying for voters to be asked the question.

Fiona Rotherham
fiona@unlimited.net.nz

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