Tax reform Hated to otter problems

Press, 7 April 1982, Page 16

Tax reform Hated to otter problems

By

BRYAN PHILPOTT,

Macarthy Professor of Economics, Victoria

University of Wellington.

Amidst all the strident and, often, ill-informed clamour for reductions in Government expenditure, reductions in taxes and reform of the tax system, there is a grave danger that, as is so often the case, the authorities will fall into the trap of concentrating solely on these . questions in isolation from, instead of in the context of, the complex of economic problems which face us at the present time. The solution of these problems requires a package of interrelated policies of which tax reform is only one aspect.

Interdependent Problems;

At the present time! we have an economy'with persistent high inflation, high and growing unemployment and an increasing overseas ■ balance of payments deficit. None of these problems can or should, in my view, be tackled in isolation; they are all symptoms of our wretchedly low growth rate which itself stems from our inability or unwillingness to come to grips with the control of inflation. The tax burden would not be anywhere near so onerous and there would not be nearly so much clamour for tax reductions, if we were enjoying our normal growth in economic activity and incomes.

Need for Growth: Nor would Government expenditure be so high, nor regarded

with such distaste, in a growing, non-inflationary economy. For one thing, the very high transfer expenditures on unemployment benefits, on supplementary minimum payments, and on superannuation would be much lower or, at least, under control. Furthermore, Government nontransfer expenditure, i.e., expenditure on goods and services, is not much higher in real terms, as a percentage of real G.N.P.', than it was in the sixties or early seventies. and would be lower still if real G.N.P. had been growing. It is true that percentage is high but this is the price we pay (if it is a price) for being a minination of three million people requiring all the appropriate modem Government infrastructure of a nation of thirty million. If we wish to continue as a developed and progressive minination — as I do — then, while there are plenty of arguments for ensuring maximum efficiency in Government spending (no less than in private spending), there, can be no argument on this account for reducing Government expenditure. Indeed, if .we are concerned also with economic growth, reductions in Government nontransfer expenditure may extinguish what little growth there already is in the economy since there is no prospect of the resources released by Government being absorbed by the private sector.

Changing the Tax Mix:

For the above reasons, I see no reason to believe that we can escape paying the same level of total tax as we are at present and the real question is concerned with whether there should be a switch in the . method by which this tax is collected from direct to indirect taxation.

Apart from the inequities and disincentives which arise from the very high progressivity of the present income tax scales, especially under conditions of inflation, the main argument for a switch must be considered in the light of our need to get control of inflation and to stimulate growth of output and employment. This, I consider, will not- be achieved until we put into place a coherent set of incomes and prices policies and the first step 'in.this process must be the forging of a wage-tax trade-off involving reductions in income tax which, for any given money wage rate, raise real after tax wage incomes. Such reductions in income tax, if the aggregate tax take is to be maintained, must be matched by a shift to indirect tax.

What Sort of Indirect Tax?:

Whatever type of indirect tax change is considered, there will be a consequent rise in the price level. The type to choose-then is that which maximises benefits in other directions as an offset to

this disadvantage and, on these grounds, the winner must be .a tax on foreign exchange. We have an endemic balance of payments problem and are short of foreign exchange, the demand for which we want to reduce. We also have a shortage of demand for home produced goods, hence our slow growth and high unemployment. It is logical, therefore, to impose the indirect tax on all uses of foreign exchange including raw material import, services, etc. and not to tax the home produced content of locally produced goods and services. This would, provide the greatest benefit to the balance of payments and to domestic growth — the

latter both from the possible switch in demand as well as the possibility of greater incentives being offered for efficient and necessary import substitution. The opposite approach (which, rumour has it. is being recommended to the Government), i.e. levying a wholesale tax on New Zealand production, is completely illogical since it renders imports cheaper than local products which would impede economic growth and worsen the overseas balance of payments. However, whatever, may be the economic logic of my proposal, it is useful for it to be examined for quantitative, coherence and consistency.-This was done recently in a research exercise at Victoria University, the results of which were published as R, Wallace: “Working ’ Papers 'for Modelling the Foreign Exchange Surcharge In a Tax-Wage Trade; Off,”- in December -1981, These results showed that a 6 per cent tax on foreign exchange combined with a nearly equivalent income tax reduction would reduce the over-all cost-of-living index, improve the balance of payments, and lift employment by about 3 per cent. One of the problems with foreign exchange tax is that its introduction would involve a breach of international obligations and would require specific negotiation with the 1.M.F., not in itself an insuperable obstacle given the economic benefits conferred. One advantage of the exchange tax is that, in due course, when (or if) inflation has been quelled,

it could be replaced by an exchange rate change which would have similar effects as the tax as far as imports are concerned. but would also allow the Government to reduce the budgetary cost of the subsidies on the export side. Leading the field in these export subsidies are the Supplementary Minimum Payments in agriculture. I support the idea of the S.M.P.’s as a method of providing some guarantees and some longer term certainty for farmer planning. Their very high, and expensive, level this year results from some appallingly •bad forecasts, especially of wool prices last year and from the boost given to them in election year. But the major problem with S.M.P.’s is that along with other agricultural subsidies they have, in the event, been capitalised into land values which have risen dramatically over the last year or so. This will always happen as long as we continue to have to subsidise agriculture either by S.M.P.’s or by devaluation and the only way to prevent it is to introduce a fixed, productionbased land tax in agriculture. I have been urging for a decade now, the introduction of such a fixed land tax. the details of which there is not space to give in this article. Such a tax represents the last of my tax proposals. Without it. we will in no time fast, finish up with enormous inequalities and inequities in assets and wealth, such that we certainly won’t have New Zealand the way I want it.