Speech to PricewaterhouseCoopers, Wellington
Thank you for the invitation to speak to you today on the ideas put forward in the Business Tax Review discussion document, which was released for public consultation last week.
The confidence and supply agreement signed between United Future and Labour resulted in the addition of three important items to the government's tax policy work programme.
- the preparation and release of a government discussion paper on the merits of income splitting for families;
- introduction of a new regime for the tax treatment of charities and charitable donations; and
- the Business Tax Review.
Chief of these was the Business Tax Review.
The stated purpose of the Review was to ensure the tax system works to give better incentives for productivity gains and improved competitiveness with Australia.
In the course of the post-election negotiations, United Future laid particular emphasis on business tax reform because of what we regarded as the more pressing need – especially since the advent of Working for Families.
That package has enhanced the financial situation of nearly 350,000 New Zealand families.
But that does not mean that we have closed the door on personal tax reductions – it simply means that because of Working for Families United Future saw business tax reform as the priority at this time.
The discussion document describes a range of possible business tax initiatives that will help to increase productivity and boost New Zealand's international competitiveness.
It also seeks the public's views on other ideas.
One of the most critical challenges facing any New Zealand Government is boosting incomes.
New Zealand's wage rates currently lag behind those in many OECD countries including Australia.
The only way that New Zealand can obtain a sustained growth in wage rates is for labour to become more productive.
Greater labour productivity means that the same amount of labour will provide more GDP.
Labour productivity can be increased in a number of ways.
A forestry worker with an axe is less productive than a worker with a chainsaw.
Increased investment in plant, equipment and buildings can boost productivity.
Similarly, a better educated workforce or more innovative technologies will boost labour productivity.
A critical issue for the government is whether there are ways that New Zealand's tax system impedes growth in labour productivity.
It is also important that New Zealand's capital ends up going to those firms which will use it to generate the best returns for New Zealand as a whole.
Other things being equal, a broad income base and low tax rates encourage capital being acquired by firms that will use it most productively.
If, however, firms cannot capture all of the benefits of their investment, they may undertake too little investment from the point of view of New Zealand as a whole.
In this case, there may be grounds for providing tax incentives to encourage more productive investment from the point of view of New Zealand as a whole.
Our tax system also needs to be internationally competitive, especially in relation to Australia's.
There are many ways in which our tax system is better for business than the Australian tax system is.
For example, New Zealand does not have Australia's general capital gains tax, payroll taxes or stamp duties.
However, we currently have a higher statutory company rate of 33 percent compared with Australia's rate of 30 percent.
In a fundamental review of business taxation, there are many different changes that could conceivably boost productivity and competitiveness.
One option that was considered but rejected was that of deep company rate cuts.
That option has a number of potential problems that are described in more detail in the discussion document.
Deep company tax rate cuts have attractions as a means of enhancing productivity and competitiveness.
However, they can also be very expensive and, if implemented, would require a major replacement source of revenue if New Zealand is to be able to continue to maintain its current level of government services.
Deep company tax rate cuts would also widen the gap between personal and company tax rates, which would increase the benefits of people using companies to shelter income from higher personal tax rates.
The fact that New Zealand has a full imputation system means that deep company rate cuts would provide a permanent benefit to non-resident and non-taxpayer shareholders, but only a timing benefit to domestic taxpayers.
They would also be of benefit only to businesses operating as companies.
There was also the question of a replacement source of revenue.
We considered a payroll tax, possibly in the form of a compulsory superannuation and savings levy, as a possible candidate.
In principle, a payroll tax on all employers as well as the income of the self-employed may be a relatively neutral form of tax. By itself, it would not distort decisions over where labour is used.
It would be costly, however, for smaller firms to comply with such a tax.
Excluding the self-employed and providing thresholds for smaller firms would reduce compliance costs.
At the same time, it would require a higher rate on taxpaying firms, which would bias labour into non-taxed firms.
This would not promote labour productivity.
In the end, we decided that this was an unattractive direction for us to pursue.
These, then, are some the considerations that have led to the range of possible options outlined in the discussion document.
Obviously, tax policy by itself cannot build a high wage, high skill, knowledge-based economy.
But what it can do is to remove tax obstacles to achieving that, and ensure that our business tax rules support innovation, business investment and the development of a highly skilled workforce, and that they encourage exporters to break into new markets.
The discussion document suggests a range of tax options for doing just that.
It also invites further suggestions on other options that meet the objectives of the Review.
It will not be possible to progress the full range of options, so informed trade-offs will need to be made.
One of the aims for the discussion document is to generate an informed debate and feedback on the relative merits of the different options.
The first option described in the discussion document is reducing the company tax rate from 33 percent to 30 percent, which would align it with Australia's corporate tax rate.
That would have an estimated cost of $540 million a year.
Reducing the company tax rate to 30 percent would raise our productivity and growth in a number of ways.
It would boost the competitiveness of New Zealand-based companies, and encourage inbound investment by firms that had decided to move to New Zealand.
In turn, that would tend to increase our stock of plant, equipment and building, which would boost labour productivity and wage rates.
On the other hand, there are disadvantages to reducing the company tax rate by itself, and they have to be weighed against the benefits of doing so.
The disadvantages include the problems arising from widening the gap between the company tax rate and the top personal tax rate, and between the company tax rate and the 33 percent tax rate for trusts.
As the discussion document points out, the current gap provides incentives for companies and trusts to be used to shelter income from higher personal tax rates.
Therefore reducing it would increase those incentives.
Clearly, reducing the company tax rate has implications for personal taxation, which we have acknowledged in the discussion document.
We are moving one step at a time, however.
The emphasis in the Review is on business tax because this is the most pressing need and because business tax reforms are more complex and therefore take more time to design and develop.
Once we have made decisions on the matters raised in the Review, we will look at the wider implications in other areas of the tax system.
Decisions on personal taxation will be made within the fiscal confines at that time.
It remains our intention that all the changes arising from this review take effect on 1 April 2008.
The discussion document also suggests a number of tax base initiatives that would improve productivity, business investment and competitiveness.
It raises the possibility of introducing targeted tax credits for R & D activities, export market development and skills improvement in the workforce.
When businesses invest in these areas there are wider benefits to the country as a whole.
The government already provides support for this type of investment by means of various grant programmes, and thinks it worth considering the provision of further support by way of tax concessions.
Businesses invest in R & D to improve their products and processes, and that contributes to productivity and competitiveness.
At present, many businesses under-invest in R & D because they do not capture all the benefits.
R & D tax credits should help to resolve the problem of under-investment in this area.
Tax credits for export market development are another possibility.
They could be a solution to businesses under-investing in developing new markets, which has wider implications for other businesses and for the economy as a whole.
Similarly, raising skill levels should also help to increase productivity.
Employers may be reluctant, at present, to spend more on developing the skills of their employees because they are easily lost to the business when employees change jobs, though the skills are not necessarily lost to New Zealand.
Tax credits for skills enhancement should help to reduce under-investment in skills development as well.
Also on the list of possibilities are adjustments to the depreciation tax rules.
Accelerated depreciation would reduce the cost of investing in assets, which would encourage more businesses to upgrade their plant and equipment.
Using more efficient plant and equipment can make labour more productive and so increase economic output.
The discussion document also outlines further compliance cost reduction measures aimed at raising productivity and improving competitiveness.
The rationale is that the less time and money businesses have to spend on complying with their tax requirements the more they have to expand and invest.
The release of the discussion document is the first step in engaging with business and with the public on how the tax system can contribute most effectively to improving productivity and our ability to compete internationally.
It seeks your views on the possible options, asking you to rank them in order of preference, and welcomes your alternative suggestions.
The significance of this Review should not be under-estimated.
It is the first major look at our business tax system since 1988.
The total cost of the suite of measures outlined in the discussion document is in the order of $2 billion – heading towards $3 billion if consequential adjustments are factored in.
While we will not be able to implement all the proposed measures, the outcome will nevertheless be one of significant change.
That is why we are seeking your input now.
I urge you to take part in the process. Submissions close on 8 September.
Once we have received and analysed your feedback, we will decide on the matters raised in the review and in the feed-back, probably early next year.
I anticipate introducing legislation in May 2007, so that resulting changes can come into force on 1 April 2008.