The Labour Party elected in 1935 had promised to scrap the sales tax and reduce taxation generally. Instead it retained all the new taxes. Finance Minister Walter Nash reintroduced the graduated land tax at high rates. By 1939, prior to the war, the top rate for income tax was 42.9% (and 57% for ‘unearned income’ such as rent, interest or dividends).
The establishment of the social security fund from 1939 set a course for higher tax revenues. The social security tax was essentially a continuation of an earlier emergency unemployment fund. Labour inherited a 3.33% flat tax and lifted it to 5% on all income, alongside an annual £1 poll tax, which Nash now called a ‘registration fee’.
Second World War
New Zealand’s involvement in the Second World War was costly. Nash resolved to pay for most of it by taxing the nation ‘to the limit that is practicable’1 – which worked out at about 28% of GDP. Nash was reluctant to fund the war effort through borrowing. New Zealand’s involvement in the First World War was largely funded by borrowing, with a legacy of burdensome interest repayments through the 1920s. During the height of the Second World War low income earners paid 12.5% tax, but the highest income earners faced a top rate of 90%.
The 1942 budget, which raised taxes, was the first time Keynesian thinking was explicitly followed in New Zealand. Economist John Maynard Keynes advocated the use of government spending and taxation to influence the performance of the economy. Prime Minister Peter Fraser justified his tax increases partly through the need to restrain inflation, by withdrawing surplus buying power from people’s pockets.
High taxes were particularly acute for small business in the 1940s. New Zealand’s unique progressive company tax scale meant that doubling a £4,000 profit before tax to £8,000 yielded only £434 more for the company, because a higher tax rate kicked in.
Nash gave some tax relief in the election-year budget of 1946, but spent most of a windfall tax revenue on the universal family benefit. With surplus funds in 1948, Nash introduced a new concept – to give every taxpayer a £10 rebate. A rebate is a refund of a fixed amount – this was deducted from people’s income tax bills. If the income tax bill was less than £10, people paid nothing.
Treasury secretary Bernard Ashwin worried about the risks of very high tax rates. He wrote to Walter Nash, saying that the evasion of tax was widespread and likely to get worse.
When the Labour government left office in 1949 the top income tax rate was 76.5%. The working class paid little tax. A top-ranked butcher on £460 ($29,000 in 2008 terms) a year, with two children, paid no income tax after exemptions and rebates. He paid a £34 social security charge, but received £52 a year family benefit for his children. The tax system was very friendly to families.