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When Is The Right Time?

Posted on 29 Jul 2009

Who gave a speech in 2004 that led The Press to report: "National ... [has] again flagged the need for future Governments to consider raising the retirement age"?

It was only Finance Spokesman for National - John Key - see here.

So why is two Governments later too soon to consider this?

Upping The Standard

Posted on 24 Jul 2009

Labour Party blog The Standard has been posting some graphs about the growth in the GDP per capita gap between Australia and New Zealand, suggesting that the gap has widened as a result of the reforms between 1984 – 1993.

First, their figures are wrong. There are two ways to calculate the GDP Per Capita gap between Australia and New Zealand – one uses Australia as the base, one uses New Zealand. It is clear from the language they use – 'Australia’s economy was 17 percent per person larger than ours' – that they are using New Zealand as the base. Even if they were using Australia as their base, the percentage difference shows a lower, not a higher, percentage difference.

Below is a graph that shows the percentage difference on the data I have obtained:

Their graph has the gap over 40 percent at times, but the data I have obtained suggests it only ever got as high as 35.7 percent. Perhaps they have data that suggests otherwise, but they never directed us to anything more concrete than the IMF’s 'World Economic Outlook', of which there are over 30. No one can actually easily check their figures. For a blog that calls itself The Standard, it sure seems to lack them.

Second, drawing conclusions from a graph like this without considering important events means you may miss the relevant trends. Take 1998 for example. In 1998 there was an Asian Financial Crisis which had severe effects for New Zealand in the short term. But one of the things that we saw moving out of the crisis is that our economy was sufficiently flexible that we adjusted quickly and moved out of recession with pace.

Equally, the increasing size of the gap between Australia and New Zealand between 1984 and 1992 is easily explained by the fact that we had rising unemployment. Of course, some may blame this on the reforms, but I think a more plausible story is that the inability of the fourth Labour Government to deregulate the Labour market created unemployment problems. That is why, after the passage of the Employment Contracts Act, unemployment fell from almost 11 percent to 6 percent in just 4 years.

Third, everyone is aware that policy does not have immediate effects. Take Working for Families. In the first year, it was given to just 39,000 adults. Today it is estimated to go to 688,000 adults. Policies take time to have a full effect – be they good or bad.

I believe a better reading of the data is that by 1992/3, New Zealand had essentially stopped the gap widening, other than in the event of sudden and adverse shocks, such as the Asian Financial Crisis. But ever since big spending returned in 1996, we saw a greater gap emerge that remained persistent, and started to grow around 2005/6.

If you don’t agree with me, that’s fine – data is often hard to interpret, especially because looking at country specific data often means you miss general trends. If you want to see the general trends across all OECD countries, check out the graph on page 9 of this report – it seems to me that the size of Government does influence the rate of economic growth.

For the data and another graph, click here.

Countdown To The Budget - Welfare

Posted on 26 May 2009

New Zealand’s welfare budget soars, despite unemployment reducing sharply over the past nine years. This graph below shows the rise in social welfare payments, occurring at the same time that numbers claiming the Unemployment Benefit more than halved:

Part of the significant drop in the number of people in receipt of – or waiting to receive – the Unemployment Benefit was partially achieved by transferring beneficiaries to other benefits, such as the Invalids and Sickness Benefits (which increased 66 percent and 41 percent respectively under Labour.

Welfare entitlements were originally intended as a safety net for those who lost their job; a way to tide them over until they could re-enter productive employment. Today, welfare dependency is a way of life for many – but, due to the good intentions behind it, welfare seems beyond criticism. We must look beyond intentions and consider results. The real effect of welfare is that its negative incentives damage those who are most vulnerable.

By subsidising individuals not to work, and abating benefits so quickly, effective marginal tax rates are high – meaning the benefit to be gained from actually working is small. Further, mothers often receive more handouts if their partner is not living with her. This is a driving force behind broken families.

Handouts destroy an individual’s independence and sense of dignity. Although designed to assist, the bureaucracy begins to assert control over welfare recipients’ lives – treating them like children, and trapping them in the system. Many are afraid to take jobs that become available because they fear they may it and will then have to wait before being able to go back on welfare. So they stay on welfare. This immense feeling of helplessness has the predictable effect of stifling motivation.

So What Choice Do We Have?

Option A - ACT New Zealand’s Policy:

We do have a choice. We can get this right.

The first thing we would do is end middle-class welfare – that’s schemes like Working for Families – replacing them instead with lower taxes.

For Unemployment, Sickness, and Invalid benefits ACT would devolve funding to the individual to purchase their own risk insurance. ACC or the Ministry of Social Development does not care about you. Only people care – and the people who care most are the individuals closest to you: family and friends. Devolution of funding would lead to competitive risk insurance markets that would provide competition to keep costs down, while also ensuring there was an incentive to encourage people back to work.

For Superannuation, ACT would move to progressively remove the current failing pyramid scheme (Pay-As-You-Go), and replace it with individualised accounts where people are encouraged to save for their retirement. For this purpose Kiwisaver should be streamlined, and greater autonomy given to the individual over their savings. Such a system will increase the amount of income available to those who are retired.

Option B – The Rest:

What will the other Parties do? More of the same. Because welfare has good intentions, other Parties refuse to look beneath the veneer to its actual effects. Centralised bureaucracy will continue to destroy the values that create and bind society together by encouraging more dependence, more rules, and more controls.

Taxes would remain high or increase to fund the welfare state, stifling growth and productivity.

Your Decision:

What would you do if you were the Finance Minister? Which option would you choose? See below for the outcome of your decision.

If You Think Option A Is The Best Move Forward [ACT’s Policy]:

People develop a sense of independence, and finally see the benefits of working hard to get ahead. Those who can get jobs are encouraged to do so. As people return to work, the effects of inter-generational welfare are broken, allowing those whose independence has been broken by welfare to move up.

Those who cannot find employment immediately are assisted through insurance schemes that have incentives to return people to work, ensuring that return-to-work-programmes are in place and adequately functioning.

By putting the onus back on individuals to save for their own retirement via lower taxes, superannuitants are no longer left at the whim of the current lot of politicians, and can plan for themselves.

If You Think Option B Is The Best Move Forward [All the others’ policy]:

The cycle of welfare dependence will continue. Families will remain trapped in the system, unable or unmotivated to break out of dependency. As unemployment rises during a recession, Politicians try and mask the figures by shifting people onto the Sickness and Invalids Benefits.

People’s motivation and self-respect atrophies, creating a permanent underclass that has no stake in society and sees no benefit in working.

Further Reading:

The Negative Income Tax

Friedman on Welfare

Sowell on Welfare

Countdown To The Budget - Tax

Posted on 20 May 2009


Tax is all about expenditure. If the Government spends $70 billion per year, then they have to raise $70 billion per year through taxation, or other fees and duties. If it were to spend only $40 billion, then obviously we would be taxed less.

Any tax put in place to raise revenue is distortionary, but some taxes are more distortionary than others. When looking at tax systems, we must bear in mind two things: incentive effects and income neutrality. Incentive effects refer to the capacity for income taxes to affect how many people choose to enter the workforce, how many hours to work, and whether to spend or save. Income neutrality (otherwise known as horizontal equity) is the idea that those who receive the same amount of income and are in the same circumstances should pay the same amount of tax.

The incentive aspect means that tax policy has a major effect on our economic growth – provided that Government spending is reasonable. Tax influences work place participation and productivity. When after-tax incomes are low, some choose not to work, lowering workplace participation and overall production in the economy. Moreover, steeply progressive tax rates discourage the most productive employees from working hard.

High tax rates discourage hard work, lower capital accumulation, and lower our savings rate. Because incentives matter at the margin, it is more economically effective to lower tax rates rather than move thresholds, as National has focussed on. Lower rates incentivise all those currently paying that tax rate. Threshold changes, while important, only affect those who find themselves at the cusp of the threshold. Over time, if thresholds remain unchanged, then the effect of inflation is to force people into higher tax brackets - as occurred under Labour.

The neutrality aspect was a significant driver of tax reform in the past. In 1984 we had a tax system which was steeply progressive - the top rate was 66 percent. However, because cash income was taxed while payments in kind - i.e., being given a company car, or a low-rate mortgage to buy a home - were not, there was widespread avoidance. By focussing on neutrality, our tax base was broadened by the introduction of a Fringe Benefit Tax, and a Goods and Services Tax.

Unfortunately, Labour failed to learn the lesson that neutrality was important – that all income should be taxed at the same marginal rate regardless of how your affairs were structured. By having a top personal tax rate of 39 percent, a trustee tax rate of 33 percent, and a company tax rate of 30 percent, people have been incentivised to structure their affairs in different ways to achieve tax advantage, without actually producing any economic gain. If you don’t believe that tax rates are creating an incentive for people to tax plan, then the graph below plainly shows the spike of income just before the 39 percent tax rate kicks in – a spike that was nowhere to be found in 1999, when there was no 39 percent tax rate:

In addition, tax rebate schemes have ensured that people face a roller-coaster set of effective marginal tax rates. The effective marginal tax rate calculates the cost of earning an extra dollar. When you earn an extra dollar, the Government taxes that dollar and also takes away some of the benefits you receive, such as Working for Families. This results in effective marginal tax rates in excess of 100 percent for some. While that is the extreme scenario, thousands of families now have effective marginal tax rates in excess of 50 percent. In other words, for every extra dollar they earn, they lose more than 50 percent of it. The graph below sets out the effective marginal tax rates:

Programs like WFF could be delivered by reducing tax rates, creating positive incentives rather than perverse incentives.

The current debate going on is whether tax cuts are affordable. Something is missing from the debate. What is missing is the fact that every budget has two sides – a column for revenue (tax), and a column for expenditure. In other words, tax cuts can be made affordable by dealing to Government waste, and that also means restructuring Government spending to deliver value for money in health and education, as previously outlined.

So What Choice Do We Have?

Option A - ACT New Zealand’s Policy:

Sizeable tax cuts require a commitment to cutting waste – such as the Families and Charities Commission, and the corporate welfare carried out by the Ministry of Economic Development – as well as restructuring health and education to increase choice and reduce costs.

ACT is dedicated to delivering tax cuts to the New Zealand public, but only to those who want lower taxes in exchange for personal responsibility. If you like the current system of high tax rates and Government monopoly, you can stay with it. Otherwise, you can opt out.

We would make the first $30,000 of income tax free, with an additional tax free allowance for non-working dependents (be that a non-working partner or children). This tax-free threshold will be indexed to inflation to ensure that inflation does not push low-income individuals into the higher tax bracket, as Labour allowed. Beyond $30,000, everyone will pay a flat rate, declining over the next 15 years to 15 percent. This 15 percent tax rate will be the personal income, corporate, and the trustee tax rate. There will be little incentive to tax plan.

These sharp reductions in tax rates and substantial tax-free threshold will be achieved by putting the onus back on individuals to provide for their health, superannuation and risk insurance. People will be encouraged to take out catastrophic health insurance. For superannuation, individuals would be expected to save for their retirement. Risk-insurance to protect against job loss and accidents would be available through the market.

Option B – The Rest:

The other parties will continue to promise tax cuts, only to dash your hopes before they arrive. That’s what Michael Cullen did, taking away the stingy $10 a week he offered. That’s what Bill English is setting you up for.

We’ll be told that tax cuts are unaffordable. Tax cuts are never unaffordable – only Government spending is unaffordable. When you are told tax cuts are unaffordable, what politicians really mean is that they would rather waste money on corporate handouts and handwringing reports put out by Commissions that should not exist.

Because health, education, and welfare programs will continue without major reform, Government spending will have to increase – and sooner or later, that means higher taxes.

Every other party believes that tax cuts are a zero-sum game – that the money is not raised because of tax cuts, or it is raised and spent on the latest pet project. But, as outlined above, tax cuts have incentive effects that improve productivity and make us all wealthier.

Your Decision:

What would you do if you were the Finance Minister? Which option would you choose?

If You Think Option A Is The Best Move Forward [ACT’s Policy]:

By choosing ACT’s plan, you allow individuals to opt out of the current failing model, and instead take control over their own lives. People opt out in droves, revelling in the lower rates of tax and re-asserting control over their own lives.
Because low taxes allow people to keep the fruits of their own labours, people have the incentive to work hard and save. Economic freedom creates a flexible economy that creates jobs, boosts incomes, and delivers real gains in the standard of living. As people are now purchasing their own healthcare coverage, the costs of healthcare decline rapidly, as hospitals compete for business. Moreover, income insurance to protect against job losses creates a competitive market that encourages people to find new work, rather than spend years on the benefit. Superannuation savings accounts ensure that people retire with more money in the bank than Government super would have ever provided.

Because tax rates are flat and treat income equally, there is little incentive for people to avoid paying tax or spend time re-structuring their affairs to achieve a tax advantage. Tax lawyers and accountants are redeployed into the productive economy.

If You Think Option B Is The Best Move Forward [All the others’ policy]:

Tax rates remain high, although there are occasional changes around the edges. The poor incentives that taxes create – combined with the continued subsidisation of non-work – encourage more people out of the workforce. With the number of dependents set to increase, caused by the retiring babyboomers, tax rates will rise to cover the cost. Many leave New Zealand to avoid being punished for success.

High tax rates inhibit productivity growth, which sees New Zealand slip further down the OECD ladder. As New Zealanders lose their relative position in the world, more redistribution of income is called for to help those at the bottom. As tax rates rise to cover the increased costs of health, superannuation, and the new redistribution programmes, people see the level of taxation as unduly burdensome. This further encourages people to engage in unproductive tax planning, enriching tax lawyers and accountants.

As our corporate tax rates are higher than those found overseas, we struggle to attract investment. Lower capital investment reinforces the trend towards low productivity growth.

Further Reading:

A Brief Guide to the Flat Tax

The Global Flat Tax Revolution

The Global Flat Tax Revolution: Lessons for Policy Makers


The Budget – What You Should Know

Posted on 14 May 2009

In the weeks leading up to the Budget ACT New Zealand Finance Spokesman Sir Roger Douglas will release an educational series on what everyone should know about the Budget.

This first article establishes the principles of good fiscal management. Next week, Sir Roger will concentrate on specific areas that he believes need to be addressed, including: health, education, welfare, and student support.

This is intended to help the public understand the Budget and realise what is at stake.

Budget Day is coming up. Finance Minister Bill English has promised that this will be ‘responsible Budget’ - but what does that actually mean? How can we tell if a Budget is responsible or reckless? Unless we understand some fundamental economic truths, then we will not be able to determine whether Mr English delivers on his promise. Set out below are 10 principles we must keep in mind when assessing a Budget.

Principle One: There is no free lunch
Governments should only take an extra dollar from the private sector if it can show that doing so will return more to New Zealand than it would have had, had that dollar been left in the private sector.

Every dollar the Government spends must be paid for through taxation and is a dollar that cannot be spent by an individual. Government spending has costs – if the Government borrows to spend money, it is only deferring tax increases.

In fact, Government spending of $1 costs the private sector more than $1. To raise revenue the Government incurs extra costs to collect it. In addition, people change their behaviour in response to taxes – they may work fewer hours, structure deals differently to lower their tax burden, or even break the law to avoid paying tax. These losses are known as deadweight losses. Treasury conservatively estimates that raising $1 in revenue costs the economy $1.20. Essentially this means Government spending must deliver benefits over and above the dollar value of the spending to be worth the cost.

While the Government’s annual spend today is $40 billion more than in 1999, the cost of gaining that revenue is much higher – about $48 billion. If that is then spent on things that deliver poor returns – such as the kind of corporate welfare administered through New Zealand Trade and Enterprise – is it any wonder that we have declining productivity and that our economic growth has been stagnant?

Principle Two: All spending has an opportunity cost
The Government has only a limited quantity of resources to use and, therefore, must carefully decide where to use them – eg spending in health versus spending on roads.

Money the Government spends can’t be spent elsewhere. Householders know money spent on washing powder can’t be spent on chocolate – but this concept is poorly understood by most politicians.

For example: Labour supports building the Mt Albert Waterview Tunnel, costing around $3 billion – which could be spent on healthcare, education or tax cuts. Labour’s justification is that it will reduce congestion which, while possibly true, answers the wrong question.

The question isn’t ‘does this spending have benefits?’ Rather, it is ‘does this spending have more benefits than any alternative way of spending this money?’ Would you rather have the $2 billion – the difference between the Waterview Tunnel and a surface route – spent on heart operations and hip replacements, or on a tunnel that helps a few living in Mount Albert?

Principle Three: Incentives matter
Market prices co-ordinate the activity of buyers and sellers, and help balance supply and demand. Without prices we inevitably create shortages. Prices also help eliminate waste by directing resources to their most efficient uses.

Behaviour is determined by incentives. If working pays more than not working, people are likely to work. If the Government punishes hard work through higher taxes, and subsidises idleness through benefits, we shouldn’t be surprised when we see more people out of work.

Incentives’ power can be seen in Labour’s introduction of free physiotherapy as part of ACC in 2004. Originally to cost $9 million, it now costs $139 million – a 1,400 percent increase.

If something is ‘free’ to the consumer, but charged to the taxpayer, the consumer will seek more of it. It doesn’t cost them, and instead the costs are spread across everyone. In reality, overall costs will go up and taxes or levies will rise to meet them.

That’s why promises of ‘free’ services - doctor visits, healthcare, transport for superannuitants, etc - end up costing far more when paid publicly than if paid for by individuals. If we get the incentives wrong, Government spending will rise to cover the cost.

Principle Four: Government must adjust
New Zealand’s current account deficit has ballooned. If Government continues to spend at current levels, the deficit will increase. This will see our credit rating downgraded, and our currency drop even further.

In the current recession New Zealanders know we must stop spending beyond our means. The Government must do the same and distribute resources away from Government spending. We need less Government, and more private enterprise.

Kiwis live beyond their means - our debt is enormous. If the Government continues spending as before, New Zealanders will suffer through higher taxes or increased debt.

But if the Government reduces spending – freeing up resources for tax cuts – it will help New Zealanders get through the recession and make the adjustment more manageable.

In a recession we must tighten our belts and Government must realise this applies to it as much as to us. For example: public servants have received pay rises that have outstripped inflation, and have some of the highest job security. It is appropriate in these circumstances to ensure that everyone – including Government – makes the required adjustments.

Principle Five: Demographics matter
Costs of one generation should be paid by that generation, not loaded on to the next in an unsustainable way. We must ensure that, over the next 40 years, appropriate levels of personal funds are saved so retired people can live in dignity from their personal savings. Unless this occurs, retirees’ welfare will depend on the whim of the politicians in Wellington.

New Zealand’s population is ageing - retiring baby boomers will see health and superannuation costs balloon. The effect of rising health costs combined with an older society will be crippling. Our Pay-As-You-Go Superannuation scheme will see young taxpayers saddled with high taxes to fund the baby boomers’ retirement.

Government has been running superannuation and healthcare as de facto pyramid schemes. All pyramid schemes ultimately fail, unless their population grows faster and faster. That won’t happen. Changes must be made to entitlement programmes, like superannuation and health, to ensure they are affordable in the future.

Continually increasing spending is not viable – it will necessitate higher taxes, which will see us slip further behind countries that encourage investment and innovation.

Principle Six: Focus on the dollars
We must focus on what’s important: looking seriously at big spending items and considering all options. Is what we’re doing working? Is it returning value for money?

Government is undertaking a ‘line-by-line’ review of spending, which has revealed the usual suspects: conferences, travel, training, functions, and other unnecessary small costs. But a line-by-line approach misses the bigger questions: should this department even exist? Or should we open various programmes to a competitive bid process?

Rather than looking at what’s being spent, we should consider what we want to spend money on. That is achieved by asking:
a) Does this department need to exist?
b) If so, what are its functions and do they need to be continued?
c) Can we make remaining functions contestable – with private contractors able to bid and drive down costs – while improving efficiency and productivity?
d) If not, how can we structure the department to achieve our goals without creating waste and poor incentives?
e) Do we need a line-by-line review?
Without considering all options, spending cuts will be small and politically-motivated – rather than targeted at genuine waste. If Mr English won’t look at ways to make healthcare and education more competitive, Government spending will continue to increase.

The reality is that 66 percent of Government spending is on health, education, and welfare. Refusing to change how we fund or deliver these services is giving up on fiscal prudence. Keep the following graph in mind, and scrutinise where the cuts are coming from:

Principle Seven: Productivity matters
The link between productivity and income is vital to understanding economic growth. Without increased productivity, there can be no increased income or living standards. One of the biggest areas to address productivity is Government-run enterprise where productivity growth has, at times, been negative. Solving this problem will enable us to be wealthier.

Wage growth is caused by productivity growth. Productivity growth is not a result of working harder or longer – it is caused by one of four things: capital investment, technology development, upskilling, and quality public institutions. Encouraging people to produce goods more efficiently is the key – something Labour failed to do.

The Government needs to protect property rights to ensure people want to invest in technology without costly regulation. It must also ensure that contracts are enforced to ensure that people can bargain and determine what is best for them. It must also realise that cutting a dollar of waste releases that dollar to be spent elsewhere. Cutting waste benefits the ordinary person – in higher wages, better jobs, or better goods and services.

Principle Eight: Transaction costs
Reducing transaction costs will let New Zealand achieve higher levels of economic growth. Greater investment in key infrastructure will let us expand our productive capacity. Stripping away man-made barriers to growth – like tariffs – will enable us to achieve gains from trade.

Some costs interfering with our capacity to grow are out of our control: we’re isolated; our communities are often distant; some of communications networks are poor. But these need not defeat us. Investment in key infrastructure can overcome them – Hong Kong is built on a rock with no natural resources to speak of, yet is wealthy.
We can control man-made barriers. Free trade barriers increase the cost of foreign goods and services. Consumers are harmed and we’re made poorer. Excessive regulation hinders growth by preventing production of goods and services. This increases the price of goods.

Principle Nine: Tax cuts
Tax cuts incentivise work and saving. Ensuring all income is treated the same will remove costly distortions in our economy – like those occurring when people set up businesses in different ways to avoid tax. The only way to reduce tax is to reduce Government spending.

Tax rates are important, but are determined by whether we accept principles outlined above. If you believe Government can increase spending, tax rates will be high. If you believe incentives do not matter, tax rates will be steeply progressive and punish success.

If Government spending is controlled, taxes can be low. Mr English calls tax cuts unaffordable. He’s wrong. High levels of Government spending are unaffordable. If we indulge the whim of every special interest group with tax money, taxes will be high.

When we cut taxes, it’s argued that the wealthy benefit most. In reality, progressive tax rates discourage work and innovation from our economy’s most productive. High taxes on the wealthy don’t just mean less money for them – it means fewer goods and services for us all.

Principle Ten: Our economic constitution
Government spending has ballooned in the past 12 years, and should worry anyone who believes in individual liberty. The power used most to interfere with people’s freedom is Government’s ability to tax – but there are few constraints on that. If we are to maintain economic freedom in the future, we must limit Government’s capacity to tax and spend.

There are restraints against the Executive arbitrarily exercising the powers granted by the Legislature. The Legislature has checks on its authority, including a defined legislative process and elections. But there’s little to stop Government spending and taxing too much. The past 12 years demonstrate the Government’s enormous tax and spend appetite.

Government size can be limited through Constitutional restraints. We should limit the growth in spending to inflation and population growth, unless a referendum affirms an increase. This has two benefits: a referendum would make the trade-off between Government spending and tax clear. Also, it would allow the size of Government to reduce as a proportion of GDP, while allowing real Government spending to stay the same. It is not extreme to suggest that Government not spend more per person than it currently does.

The basis of a free society is limited Government. The most obvious interference in the life of the ordinary person is the capacity for the Government to forcibly take money from them to spend on projects. Unless we restrain that capacity, we can be sure the power will be abused and the size of Government will expand.