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Productivity must accompany tax reforms

Productivity must accompany- Thomas Pippos.jpgThe tax switch sets the foundations for future growth, but it is not a panacea to all economic concerns of New Zealand.

The reduction in personal income tax from October 1 will increase after-tax incomes.

But the increase in GST should result in a tilt in consumer behaviour away from consumption towards savings and investment.

However, the critical driver to economic prosperity is growth in real wages. This package of reforms is a step in the right direction, but to achieve material real wage growth, an increase in productivity is necessary, which cannot be solved by tax measures alone.

Tax cuts would improve workforce participation but the question is, ‘by how much?’

Reductions in income tax rates will put more money in the pocket of all employees. This should have a positive impact on workforce participation as the same amount of effort results in more money in the hand.

The critical issue of high effective marginal tax rates for those receiving Working for Families (WFF), however, remains to be solved. WFF can result in material marginal tax rates that actively discourage workers from looking to improve their income.

As a generalization, they can add another 20% to one’s existing marginal tax rate.

The GST effect

Different retailers will undoubtedly have different reactions for different products to the GST increase.

New Zealand businesses and consumers live in a GST inclusive world.

Businesses must advertise products targeted at end consumers as “GST inclusive” and retail shoppers react by paying (or not paying) that price. GST is just one of the ingredients that make up that price.

In some situations, the price consumers are currently paying may be the top pricing point and they will not be willing to pay more, regardless of whether GST has increased or not.

As an example, more people may be frequenting the office coffee machine if the price of a latte breaks the $5 barrier.

Retailers are likely to focus on maintaining and increasing demand for their product rather than recovering an additional 2% increase in their input costs.

The Budget Package

The tax changes that came into effect on October 1 were part of a wider range of tax reforms announced in the Budget, some of which, like the increase in GST, will offset the benefit of personal tax cuts.

For example, removal of depreciation deductions on most buildings (from 2012 income year) will have the greatest impact on higher income earners, as they are likely to have a greater investment in property.

The extent to which taxpayers will be personally better off in the medium term is effectively dependent on three main factors:

1. Their annual taxable income (which impacts the benefit they derive from the personal income tax cuts)

2. The amount of their income spent on items subject to GST (which results in more GST being paid by them)

3. The amount of depreciation deductions they previously claimed on rental and commercial properties that they will no longer be able to claim.

While it would be hard for taxpayers to get past their own circumstances, it is important to remember that the point of the tax changes is to change the incentives of the tax system to grow the economy overall to everyone’s betterment.

Tax Rate Alignment

The tax rate alignment nirvana where the top personal, trust and corporate tax rates are all aligned is best left to people’s dreams. The global downward gravitational pull on the corporate tax rate is such that it will almost always be below the other rates.

Mitigating this gravitational pull in the near term is the insatiable demand for current revenue by foreign treasuries, brought on by the global financial crisis.

Thomas Pippos is Managing Tax Partner of Deloitte based in Wellington.

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