Shift to income tax
Over the 25 years from 1960 the burden of taxation had shifted so that a heavier load was carried by personal income tax. This happened through what is known as ‘fiscal drag’. The tax scale did not change, but incomes increased, elevating people into higher tax brackets each year. While they earned more money, they paid higher tax rates, and in real terms inflation eroded their purchasing power. By 1985 middle-income earners, such as school teachers, were paying high marginal income tax rates. Fiscal drag had severe political consequences.
Uneven tax distribution
By the early 1980s tax revenues had reached 30% of GDP and the distribution of the tax burden was very uneven. Some people paid a lot, others very little. Company tax revenues had withered, due largely to avoidance through the concessions, incentives and loopholes. Some people, particularly ordinary wage earners, paid high rates of tax, while others, like farmers and the self employed, were able to avoid most tax.
Broadening the tax base
The solution preferred by most tax experts in New Zealand and elsewhere was to broaden the tax base. This meant having greater indirect taxation. Closing loopholes in income taxation would allow reductions in the top rates of income tax. (This was essentially the advice given some 20 years earlier by the 1967 Ross report on taxation.)
The incoming Labour government of 1984 did this. Between 1984 and 1993, the tax system moved from a narrow-base, high-rate regime, in the direction of a broad-base, low-rate regime.
Don’t tax my house, mate
New Zealand is unusual in lacking a capital gains tax, and although this has been proposed no pgovernmeny has been brave or foolhardy enough to impose one. For most New Zealanders their house is their biggest asset (and investment), and a tax on its (usually) rising value would be unpalatable for much of the electorate.
Goods and services tax
The tax base was broadened by such measures as taxing fringe benefits from 1985. This is a tax on benefits that employees receive as a result of their employment (like work cars or contributions to superannuation schemes). Labour eliminated the tax incentives for business. It introduced a goods and services tax (GST) of 10% on 1 October 1986 (increased to 12.5% in 1989 and to 15% in 2010).
The flip side of introducing new indirect taxes was to drop income tax rates – initially from 66% to 48% for the highest earners. Finance minister Roger Douglas tried to go further with a flat tax proposal in December 1987. The result was a civil war within the Labour party. A compromise saw a two-step income tax scale of 24% on incomes up to $30,000, and 33% above that – 33% was the lowest top marginal tax rate since the early 1930s, a massive drop.
Douglas rejected any idea that wealth redistribution had been abandoned. He argued that he was replacing a system that appeared progressive with one that actually was, with loopholes for tax evasion and avoidance now closed.
The modern inheritance
The reforms of the 1980s and early 1990s strengthened the legislative ability to counter tax avoidance. A tax review carried out in 2001, chaired by tax specialist and businessman Rob McLeod, spoke of the restored credibility of company tax since 1981. Tax rates had fallen, from 45% for resident companies and 50% for non-resident companies, to 33% for all. Meanwhile company tax as a percentage of total tax revenue had increased from 5% to 15%.
Fifth Labour government, 1999 to 2008
The election of the fifth Labour government in 1999 ended the slight downward drift in tax revenues that had set in during the 1990s. Tax rates increased, with a new top income tax rate of 39%. Fiscal drag did its work and total tax revenues, including local government, increased from 33.6% of GDP in 2000 to 36.5% by 2006.