The best way to share the pain of economic downturn is to lift personal tax rates for the better off, for as long as it takes to get unemployment back to pre-crisis rates, writes Dr Simon Chapple of Victoria University of Wellington.
We’re moving deeper into lockdown (albeit at a lower level) and thinking harder about addressing the adverse economic consequences it will have for many New Zealanders who have lost their livelihoods and will need support in coming years to find new ways of making their living.
The issue of sharing the burden of the virus and its global economic fallout across the wider community is coming increasingly to the fore.
Prime Minister Jacinda Ardern started addressing the issue several days ago by instituting pay cuts for her ministers and departmental chief executives. These cuts are slated to last a mere six months. However virtuous a signal Ardern’s actions represent, her response of cutting incomes for this tiny handful of New Zealanders should not be generalised as desirable across all wage and salary earners.
Wider wage cuts across society to share the burden, under current circumstances, are not actually a great idea. Ignoring the serious coordination problems involved in generating such one-off cuts across different people and jobs (we walked away from the last institutional remnants of centralised wage fixing of this form nearly three decades ago when the Bolger government passed the Employment Contracts Act in 1991), they risk creating deflation, which could have many unintended negative consequences.
Deflation would redistribute income between debtors and creditors in ways that could discourage much-needed real investment and could bankrupt many people unnecessarily. It would also cause strong rises in real interest rates – nominal interest rates (currently put in cold storage by the Reserve Bank) less the rate of inflation (which goes negative with deflation – and remember from your high school maths: a double minus is a positive). This real interest rise could further depress private investment and potentially exacerbate deflation.
In this sense, I hope the pay cuts for the handful of top government earners announced by Ardern are not infectious – that is to say, they are not picked up as a general and desirable labour market response by employers. There are, however, suggestions it may be, with media companies MediaWorks, Stuff and NZME, for example, asking employees to take a 15 percent pay cut. A further problem with what Ardern has done is her announced cuts are time limited, rather than related to the state of society.
The most efficacious and obvious way of sharing the burden of the shock, which could be readily implemented under the current policy framework, is via taxation of those who have not been as greatly impacted by the shock. These people are easily identified and targeted. They’re people on higher PAYE incomes who haven’t lost their work – both in the public and private sector – and retired people with high private retirement incomes. That’s people, like, well, me.
The readiest tool in the box and the most equitably appealing solution here to share the burden of the virus is simply legislating for more temporary steps in the personal income tax system and a more progressive marginal income tax rate. We could have, for example, an income tax rate of 40 cents in the dollar from 70K (up seven cents in the dollar), 50 cents in the dollars from 100K (up 17 cents in the dollar) and 60 cents from 150K (up 27 cents in the dollar). The top rate of 60 cents would apply also to all trust income – if you’re well off enough to generate income from a trust, you’re well enough off to share 60 cents of that with the less fortunate. Company taxes could stay the same as they are currently, encouraging businesses to retain and reinvest profits.
It is worth pointing out this proposed top personal marginal rate is not one plucked out from cloud-cuckoo land – Sweden, Finland, Slovenia and Belgium all have similar permanent top marginal tax rates to those proposed here.
It is also worth pointing out many low and middle income earners currently face higher effective marginal personal tax rates than this 60 cents, as the government reduces Working for Families payments and housing benefits as people’s gross earnings rise, as well as taxing them out of gross earnings at their personal tax rate. These current effective marginal rates can be as much as 90 percent or more.
My proposed taxation rise would, as emphasised, be temporary. However, unlike Ardern’s pay cuts for top politicians and public servants, the rise would not be time limited and certainly not for six months. This crisis is almost certainly going to last longer than six months. Rather, removing the rise in top tax rates would be tied to achieving a positive state of the world. It would continue until that state was achieved. Higher temporary taxation would continue until the pain at the bottom of society was over – or more precisely when the likely greatest single longer-term source of pain returned to its pre-crisis level.
My suggestion is to tie these proposed temporary top tax increases to the unemployment rate. The pre-crisis unemployment rate was around 4 percent. The higher temporary taxes should stay in place until the unemployment rate has returned to 4 percent, or below, for four consecutive quarters.
The prospect of again returning to higher disposable income will provide a considerable constructive and positive incentive for higher income earners to develop and support innovative policies to get those less fortunate in society back on their own feet as rapidly as possible. Only then would elites be able to pat themselves on their backs and say job well done.
Following the 2008 global financial crisis, as a society we accepted an unemployment rate well above what we should have been at, for nearly nine years. The likely coming recession threatens to be worse. We should never inflict that sort of pain on people at the bottom of our society again.
High income earners, let the prospect of lower after-tax income concentrate your minds! You have lost nothing but your regular winter holiday in Bali.