Taxing business

One subject that seems destined to get little attention in the current election campaign is the appropriate tax rate to be applied to business income.  As I’ve noted previously, our company tax rate is now in the upper third of those in OECD countries.  And if there is any discussion at all in this campaign, it seems more likely to centre on plans to raise more money from companies –  foreign companies anyway.   The government has just announced measures designed to have that effect, and parties on the left seem keen on doing even more, under the cover of OECD-coordinated moves in that direction.

I was talking to some tax people yesterday, which prompted me to dig out the OECD data on company tax rates and company tax revenue.  Both matter.  A country can have quite a high statutory headline company tax rate but also have so many exemptions, deductions etc, that the company tax doesn’t actually raise that much money.  The United States is a good example –  the general government corporate tax rate is 38.9 per cent, the highest in any OECD country, and yet corporate income tax receipts are only 2.2 per cent of GDP, well below the median OECD country.  Corporate tax reform is well overdue in the United States (although my money is on nothing very fundamental happening in the current presidential term).

What about New Zealand?

Here is a chart, using OECD data, showing company tax receipts as a share of GDP for New Zealand and for the median OECD country, all the way back to 1965.

corporate tax revenue

We take a much larger share of GDP in company tax revenue than most OECD countries do.  In fact, in recent years, the only countries that have taken a larger share have been Australia, Chile, Norway, and Luxembourg.   Given the importance of minerals in the first three of those countries, the company tax receipts may include a large chunk of what might be better described as resource rentals  (and in addition production processes in those extractive sectors tend to be quite capital intensive).

But several other things struck me:

  • the rising trend in company tax receipts as a share of GDP over the last 30+ years.  It probably isn’t the impression most people have when you hear all the talk about taxing (or not taxing) multinationals.    Presumably part of the increase will have been accounted for by the larger share in overall national income now accounted for by returns to capital in many countries.
  • just how large the gap was between the New Zealand line and the OECD line at the start of the period (and, hence, how much of a convergence happened during the period when Sir Robert Muldoon was our Minister of Finance –  most of the time from 1967 to 1984).
  • and the substantial rewidening of the gap since the reforms of the late 1980s.  The broad-base low(er) rate strategy seems to have raised a great deal of revenue.

But it does leave me with at least two questions:

  • why has New Zealand typically raised so much more (per cent of GDP) in company tax revenue than most other OECD countries?
  • is this a sensible approach to tax policy, particularly in the context of our long-term structural economic underperformance.

In the earlier decades, a heavily protected economy probably meant a business sector that was ripe for the (headlines of) plucking.    Between the non-tradable service sectors and the highly-protected manufacturing sector, there was plenty of scope to pass increased business costs, in the form of high headline business taxes, on to domestic consumers.  The export sector was mostly based around family farms –  and probably didn’t pay much company tax.  But bear in mind that exports as a share of GDP were shrinking through this period – high internal domestic costs (including business taxes) also help to erode competitiveness.

These days the economy is much less protected, but we are still back to taking a much larger share of GDP in company tax than most other countries do.  Many of our biggest tax paying firms are foreign-owned  (apparently around 40 per cent of all company tax revenue is paid by foreign-controlled firms), which command little public sympathy or support.  The Australian banks are perhaps the most prominent example.   Perhaps it looks like a “free lunch” to tax heavily such operations?

(In principle, our dividend imputation system  –  also adopted in Australia –  may act to make people more relaxed about conducting business through a corporate vehicle, since for domestic shareholders there is no double-taxation of dividends.  I don’t know whether this will be part of the explanation, although I’d be surprised if it explained much, given the other advantages of limited liability.)

And our large share of company tax revenue as a share of GDP isn’t just because New Zealand taxes everyone heavily –  in fact, our tax revenue as a share of GDP doesn’t stand out as being high.  Here is the chart showing company tax revenue as a share of total tax revenue.

coy tax revenue

Our heavy reliance on company tax revenue looks to be a deliberate choice to favour that soource of revenue.

Whatever the reason for why we take such a large share in company tax, it seems unlikely to be a sensible element of a successful economic strategy.    It is well-known that business investment as a share of GDP has been quite low in New Zealand for many decades.  It is one of the more obvious symptoms of our economic underperformance.  We also now have a quite moderate level of inward foreign investment.  It seems at least plausible that the tax regime might be one part of the explanation –  after all, particularly for foreign investors, the choice to operate here (or not) is purely an economic one, influenced largely by the expected after-tax returns, and the risk around those returns.   For foreign investors (who can’t take advantage of imputation credits) the New Zealand company tax rate should matter a lot.    Partly for that reason, the estimated deadweight costs of business taxation are far higher than those for most other taxes. You get less of what you tax, and foreign investment is likely to be particularly sensitive to taxes.

The OECD data on company tax rates does not go back as far.  But here is how our rates have compared to those of:

  • the median OECD country, and
  • the median “poor” OECD country (ie those who’ve had consistently lower GDP per capita or productivity than New Zealand).

corporate tax rates Of the “poor” OECD countries, only Mexico and Portugal now have higher company tax rates than we do.  Whereas most of the “poor” countries are closing the income/productivity gaps to the richer OECD countries, Mexico and Portugal (and New Zealand) aren’t.  I’m not suggesting it is the only factor by any means, just highlighting the choice that the more successful converging countries have been making.

In much of the debate around these issues, all the focus is one who writes the cheque, not on who actually bears the burden of the tax (the incidence).  Foreign investors, for example, will have target after-tax rates of return.  Higher tax rates discourage reinvestment in the business, discourage new investment, and in time result in lower average productivity and lower wage rates.    By contrast, lowering business taxation is a pro-growth, pro working people, policy.

Again, there is a tendency to discount this point with a response along the lines of “look at all the existing investment; cut taxes on the profits on those businesses and it is just a windfall transfer to existing owners”.     That often seems particularly unappealing if the owners are foreign –  as if it was a pure welfare loss to New Zealanders.     The banks are good example of what bothers people –  mostly owned by big Australian operations.  But actually, the banks are a sector where lower tax rates offer the prospect of genuine savings across the board, for all users of financial services in New Zealand, even if the size of the banking sector itself doesn’t change much.   Cut taxes on banks’ profits and, over time, you’ll find fees and interest margins falling.  Not from the goodness of a bank’s heart, but from the competitive process at work, as each competes for market share and finds they can discount their pricing a bit more and still deliver on Sydney or Melbourne’s after-tax return expectations.

I don’t think we should be making tax policy specifically to favour foreign investors over domestic ones –  which would be the effect of simply cutting the company tax rate – but I do think there is a good case for materially lower taxes on business income.  I’ve argued prevously for a Nordic system, in which capital income is taxed at a lower rate than labour income.  A more ambitious approach still would be to work towards the development of a progressive consumption tax.   Whatever the precise solution, the current arrangements –  high rates of company tax, high shares of GDP taken in company tax – don’t look like the right answer if we serious about lifting economic performance in New Zealand, and with it raising the capital intensity of production in New Zealand.

(Commenters on previous posts have asked whether I’m being consistent, in calling for lower business tax rates and at the same time noting the serious limitations of our remoteness.   I certainly accept that if we were adopt the Irish company tax policy it would not have the scale of benefits for us it has had for Ireland.  But an integrated economic strategy for New Zealand would also involve lower real interest rates and a lower real exchange rate, and in conjunction with lower business tax rates, that would be likely to bring forth quite a range of new business investment –  in some cases in new sectors (or retaining firms in New Zealand that might otherwise relocate), and in other cases, adopting more capital intensive (ie higher labour productivity) modes of production in existing sectors, including agriculture.)

The Labour Party is campaigning on establishing a tax working group if it forms the next government.  I hope they envisage something more than just a tidy-up and a recommendation for a capital gains tax, and that in thinking now about the possible terms of reference for the proposed tax working group –  which they will presumably want to move quickly on once in office –  they are willing to cast the net rather wider, and invite the proposed group to consider connnections between the design and balance of our tax system and our overall economic performance.   Higher taxes on business – especially the dreaded multinationals – might be some sort of “progressive” shibboleth, but in fact lower business taxes should be an option that any seriously progressive government, concerned to lift living standards for all, takes very seriously.

 

24 thoughts on “Taxing business

  1. The problem with comparing tax rates is that in NZ the tax pool is used for everything whereas in many countries the retirement component is taken care of separately and is a separate fund from the tax pool. Eg NZ Universal super comes out of our taxes. In Singapore there is a compulsory Company Super contribution. Corporate tax in Singapore is 17.5% but the company super contribution is also 17%. Therefore it is actually wrong to compare NZ corporate tax rate with many countries that have compulsory company Super contributions. Australia as well has a 10% compulsory company superannuation contribution.

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    • yes, comparisons depend on lots of things. but I think there is little doubt that the (effective business income) gap between us and other countries has widened over the last 15 years.

      the compulsory super contributions aren’t relevant here because they are a tax on labour (cheque written businesses) not a tax on business profits. Same goes for employer social security levies in many countries.
      That would be one option to consider here – lower all marginal income tax rates, including company tax, by say 6 percentage points, and impose a 6 percentage point social security levy on wage income. Do that and our system would look a little more conventional.

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  2. When you have differential tax rates being applied to “companies” versus “labour” you need a system that treats a plumber who forms a limited liability company to house their operations, a Family Trust operating as Acme Plumbers, and Fred Nurk operating as a sole trader Fred Nurk Plumbers

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    • yes, that’s right, and the Nordics have had to grapple with those issues in practice. Personally, I still like the notion of a progressive consumption tax, if it could be made to work effectively and efficiently. It is the old line “tax what people take out of the economy – consumption – not what they put into it – labour or capital”. Slightly twee, but still a worthwhile perspective.

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  3. In Australia as the impost of Compulsory Superannuation employer contributions kicked in, Employer payroll taxes, the costs an difficulties in laying off staff, businesses turned to converting employees into contractors who turned themselves into limited liability companies and it became a huge problem wherein the government tried to legislate against it

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  4. Not sure. If so, we are a little more scrupulous than some countries in having the govt tax itself. that said, even now the assets are 15% of GDP, the average return is around 10% and the company tax rate is 28%, so at most only around 0.4% of GDP of the difference would be explained by that effect.

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    • David Snell from EY made a relevant comment on interest.co.nz today;

      “In response to a question above about volatile investment income returns, I’d emphasize we’re not investment advisors. Take the NZSF as an example of the point I was making. It has a strong track record of investment returns year-on-year. Its effective tax rates vary significantly depending on the make up of those investment returns and things like movements in our exchange rate. And it is big enough to materially affect New Zealand’s total tax take.”

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      • Thanks

        Among my many reasons for not liking the NZSF. It returns look and feel very good at times when we don’t really need the money, and look and feel rather sick in embattled times (eg global econ downturns) when the budget is typically under pressure already.

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  5. How much does company tax really matter here given the imputation regime? I take the point that it’ll affect foreign willingness to invest in NZ firms, but you trade that off against inefficiencies you get from driving a wedge between the company tax rate and the top personal tax rate.

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  6. Somewhat agree but “cut taxes on banks’ profits and, over time, you’ll find fees and interest margins falling”: that could be on a new Tui billboard (!)….I rather suspect P/B ratios would rise on a tax cut announcement…:-)

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  7. That’s why I’m not arguing just for a company tax rate cut. Having said that, the pool of potential foreign investment should be quite large, and as you guys have noted we are now laggards on inward foreign investment (for various reasons I’m sure, not just tax).

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  8. Re banks
    Don’t Aus. banks get a credit for NZ tax against their Austrian tax liability. So the only impact of a NZ tax cut would be a transfer to the Australian Treasury?

    We have tried a tax cut for Aus banks ( well they did with a some egregious avoidance schemes) which meant they paid little in NZ tax for a number of years — no obvious evidence of a flow through into NZ iterst rates etc.

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    • Flow through I thought is fairly obvious. HSBC 18 months lending interest rates are 4.09%. Australian banks cartel lending interest rates are 4.85%, 2 year fixed.

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    • Ian, yes AU do allow an offset for taxes paid in other jurisdictions. The answer to your transfer question is whether there is a differential between AU company tax rates (currently 28½%) and NZ company tax rates (currently 28%)

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    • Its not an imputation issue -that would mean that NZ profits would not incur additional tax in the hands of the ultimate owner. NZ imputation credits are not recognised so there is a degree of double taxation What I was talking about It is a tax credit issue to avoid double taxation at the corporate level.

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  9. Michael, If you haven’t read Joel Slemrod and Jon Bakija’s book “Taxing Ourselves,” (about the US tax system), you will find considerable support for your views about the merits of switching towards consumption taxes, and some support for the Scandinavian approach. (The book is available from the Otago University Bookshop as required reading for the undergraduate course on public economics.) It is very good. The data it presents makes it blatantly obvious that NZ has chosen to tax itself with a very unusual mix of taxes that provides an unusually low impost on labour income and and an unusually high impost on corporate and capital income. Most of the difference comes back to our way of imposing taxes to pay for retirement – either the way we tax retirement income accounts, or our unwillingness to fund New Zealand Superannuation out of social security taxes. Somehow, New Zealand’s policy advising community decided it would restrict most of its attention to the ways income tax could be perfected rather than question whether income taxes (which are particularly distortionary when applied to capital incomes) should be replaced by other taxes. It is almost as if we have the Stockholm Tax Syndrome – fallen in love with a system that abuses us. The question should not be whether dividend imputation is right or not (it is a good system if you must have an income tax) – it is whether the distortions inherent in an income tax system can be reduced by replacing it with other forms of taxation.

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  10. Agree, and would note the role of reinvested corporate profits in many an economic take-off scenario. Of course if you do cut taxes you want to try and ensure that it’s not only a bunch of rent-seeking oligopolies that benefit.

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    • It is not an oligopoly if anyone can seek and obtain entry. There is no market barrier to entry. However with more and more rules imposed by WOF and all sorts of regulation then market entry will be increasingly more difficult.

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