New Zealand workers need higher wages, but simply wishing it will not make it so.

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1 A COMPANY PHASED REDUCTION TAX RATES IN The company tax is the most damaging of all taxes to investment and innovation. Less investment equals less capital per worker, lower productivity, and lower wages for all New Zealanders. ACT proposes dropping the company tax rate by a percentage point each year for eight years, to a target of 20%. That would give a clear signal to investors and entrepreneurs of a future tax structure which encourages investment and productivity growth. The overwhelming message from academic work on the influence of company tax rates on growth, is that countries such as New Zealand should focus on offering low company tax rates. A major benefit will be to attract more foreign investment, boosting jobs, productivity and real wages. Signalling a lower future company tax rate in New Zealand would be a significant step along the way to boosting domestic business investment, attracting more foreign investment, creating more jobs and delivering higher wages. Small countries such as New Zealand have imposed great costs on themselves in terms of lower living standards and lower wages by imposing high taxes on investment and entrepreneurship. Small countries face highly mobile business tax bases, sensitive to relative tax burdens. New Zealand workers need higher wages, but simply wishing it will not make it so. ACT s plan for an eight-year programme of phased reductions in the corporate tax rate would contribute to attracting the capital that will boost productivity and wages in New Zealand. On reasonable assumptions this plan could, in a short time, lift GDP growth by up to 1% per year through increased investment and higher productivity. On the following pages we present: how the NZ company tax rate compares internationally; what the academic research says about the relation between company tax rates and wages, and company tax rates and economic growth; the research on who benefits from competitive tax rates; and how a phased tax cut could be funded. Corporate income taxes are the most harmful for growth as they discourage the activities of firms that are most important for growth: investment in capital and productivity improvements. OECD, Tax Policy Reform and Economic Growth (2010, p. 22)

2 HOW DOES OUR COMPANY TAX RATE COMPARE INTERNATIONALLY? New Zealand has amongst the highest statutory company tax rate of any other OECD member economy of comparable size see figure 1. If we consider a more sophisticated analysis that takes into account company tax imputation, sales taxes and other taxes on investment, it doesn t change the reality that New Zealand has one of the highest tax rates on investment, business and entrepreneurship see figure 2. Figure 1: 1 Selected company tax rates, OECD, 2014 Ireland Netherlands Czech Republic Finland Iceland United Kingdom Sweden Switzerland Denmark Austria Canada Israel Norway New Zealand Australia Belgium 0% 4% 8% 12% 16% 20% 24% 28% 32% 36% Source: OECD tax database. Figure 2: 2 Selected Marginal Effective Tax Rate on Capital Investment, OECD, 2013 Ireland Czech Rep Iceland Israel Sweden Netherlands Switzerland Finland Belgium Canada Denmark New Zealand Norway UK Australia Austria Source: Mintz, J and D. Chen, The U.S. Corporate Effective Tax Rate: Myth and the Fact. Tax Foundation Special Report number 214, Tax Foundation, Washington DC (2014). 2

3 COMPANY WAGES TAX RATES AND Many studies demonstrate that higher company tax rates result in lower wages. Workers have less capital to work with (Gordon and Hines (2002) 1 ; Auerbach ; Gentry ). Studies of the incidence of corporate taxation in an open economy suggest that a company tax more than fully shifts to wages of workers Harberger (1995, 2006) 4. Wages have increased in lower company tax jurisdictions such as Canada, Denmark, Finland, the UK, Sweden, Switzerland, Iceland and Ireland because their workers have more capital and modern technology to work with COMPANY paid for by the additional TAX RATES investment, AND foreign and domestic. GROWTH Academic research suggests that lower company taxes have powerful influence on 1 Gordon, Roger H. & Hines, J. International taxation, in Handbook of Public Economics vol.4a, A Auerbach and M Feldstein (ed.) (2002): Auerbach, A. "Who Bears the Corporate Tax? A Review of What We Know, in Tax Policy and the Economy vol. 20. National Bureau of Economic Research, Inc. (2006): Gentry, W. A Review of the Evidence on the Incidence of the Corporate Income Tax, U.S. Department of the Treasury Office of Tax Analysis Paper no. 101 (December 2007). 4 Harberger, A. The ABCs of Corporate Tax Incidence: Insights into the Open-Economy Case, in Tax Policy and Economic Growth: Proceedings of a Symposium sponsored by the American Council for Capital Formation, Center for Policy Research, Washington (1995): 51-73; and Harberger, A. Corporate Tax Incidence: Reflections on What Is Known, Unknown and Unknowable, in Fundamental Tax Reforms: Issues, Choices, and Implications J Diamond and G Zodrow (eds) MIT Press (2006): economic growth rates and wages. The evidence is particularly strong regarding small open economies. Some examples of such research are: Fehr, Jokisch, Kambhampati, and Kotlikoff (2014) 5 found that lowering the U.S. corporate tax rate from 35% to 9% and eliminating corporate tax loopholes would raise the U.S. capital stock (machines and buildings) by 15%, output by 5% and the real wages of both unskilled and skilled workers by 8%. David and Christina Romer (2010) 6 found that a tax increase of 1 percent of GDP lowers real GDP by about 3 percent after about two years. The largest effect they found is from tax changes meant to promote economic growth, and the main channel is investment. Mertens and Ravn (2013) found that a one percentage point cut in the U.S. corporate tax rate increased GDP per capita by 0.4% in the first quarter and by 0.6% within one year. Lee and Gordon (2005) 7 reviewed 70 countries to find that a cut in the company tax rate of 10 percentage points raises annual GDP growth per capita by between 1.1% and 1.8%. Djankov et al (2010) 8 analysed the taxation of similar sectors of 85 economies. They found that higher corporate income tax rates greatly discouraged entrepreneurship, foreign 5 Fehr, H., Jokisch, S., Kambhampati, A., and Kotlikoff, L. Simulating the Elimination of the U.S. Corporate Income Tax. NBER Working Paper No (December 2013). 6 Romer, C. and Romer, D. The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks, American Economic Review 100, no ): Lee, Y. and Gordon, R. Tax Structure and Economic Growth, 89 Journal of Public Economics (2005): Djankov, S., Ganser, T., McLiesh, C., Ramalho, R., and Shleifer, S. The Effect of Corporate Taxes on Investment and Entrepreneurship, American Economic Journal: Macroeconomics 2. No. 3(2010):

4 direct investment and economic growth. They found that a 10 percentage point increase in the corporate tax rate reduces the ratio of investment to GDP ratio by 10% and the entry rate of new firms by 18%. Kotlikoff and Miao (2013) 9 and Cullen and Gordon (2007) 10 found that company taxes act as a success tax. Company taxes discourage the higherability entrepreneurs from expanding their businesses and going public to diversify their business risks. These THE high-ability entrepreneurs stay small and exposed to more risk rather than DIVIDEND GROWTH making the IS most LARGER AND WAGE of their FOR talents. SMALL OPEN ECONOMIES The effect of the company tax on capital and labour mobility in New Zealand has much in common with the state, provincial and municipal company taxes in the USA, Canada and Germany. The provincial and municipal company taxes in these countries speak to the high capital mobility facing a small open economy. In the USA, Canada and Germany, investors, workers and entrepreneurs can easily cross a municipal, state or provincial border to lower their business taxes. This situation is similar to New Zealand with one integrated Trans-Tasman labour and investment market. Relevant research includes: 9 Kotlikoff, L., and Miao, J. What Does the Corporate Income Tax? A Simple Model Without Capital, Annals of Economics and Finance 14 (May 2013): Cullen, J., and Gordon, R. Taxes and entrepreneurial risk-taking: theory and evidence for the U.S. Journal of Public Economics 9, no. 7 (2007): Ferede and Dahlby (2012) 11 update the cross-country results of Lee and Gordon (2012) with data on company tax rates in Canadian provinces from 1977 to They found that a 10% cut in the company tax rate in Canada raised the annual per-capita growth rate by 1 to 2 percentage points. Fuest, Peichl, and Siegloch (May 2013) 12 reviewed municipal business taxes in Germany. From 1998 to 2008, on average 8% of the 11,441 German municipalities adjusted their local business tax rates. These local and range from 7% to 17%. Fuest, Peichl, and Siegloch (May 2013) 13 found that a 1% increase in a German municipal business tax rate (in Germany local corporate taxes account for over 50% of business profits taxes) leads to a 0.3% to 0.5% decrease in local wages. Arulampalam, Devereux, and Maffini (2012) 14 analysed the tax liabilities of 55,082 companies in nine European countries between 1996 and 2003 to find that a $1 rise in company tax liabilities reduced wages by 49 cents. Felix and Hines Jr., (2009) 15 found that a 1% lower state corporate tax rate increased union wages by 0.36% increase. They also found that state taxes have significantly greater effects on the wages of workers in the more capital-intensive industries. 11 Ferede, E. and Dahlby, B. The Impact of Tax Cuts on Economic Growth: Evidence from the Canadian Provinces, 65 National Tax Journal (2012) Fuest, C., Peichl, A. and Siegloch, S. Do Higher Corporate Taxes Reduce Wages? Micro Evidence from Germany, IZA Discussion Papers 7390, Institute for the Study of Labor (IZA) (2013). 13 Ibid. 14 Arulampalam, W., Devereux, M. and Maffini, G. The direct incidence of corporate income tax on wages, European Economic Review 56 or no. 6 (2012): Felix. R.A. and Hines, Jr., J. Corporate Taxes and Union Wages in the United States, NBER Working Papers (2009). 4

5 The impact of state, provincial, and municipal company taxes on wages and investment in the U.S., German and Canadian economies with their easy mobility of capital and labour across borders has much to say to New Zealand. It is clear from the North American, German and other European evidence that high company taxes are a blight on invest ment and wages growth. this evidence implies that the volume of foreign direct investment, and accompanying economic activity and corporate tax bases, is highly responsive to local tax policies. It follows that countries contemplating lowering their corporate income tax rates can reasonably expect to receive significantly greater foreign investment as a consequence. Larry Summers, Chief Economist of the World Bank, , United States Secretary of the Treasury, , and Director of the National Economic Council, The White House, WHO COMPANY BENEFITS TAX RATE FROM COMPETITION? A major benefit of a lower company tax rate in New Zealand would be more foreign investment. This is evident from the behaviour of Ministers of Finance - none welcomes cuts in the company tax rate of rival investment destinations. There is a good reason for that. Analysis by De Mooij and Ederveen (2008) 16 suggests that a 10 percentage-point reduction in a country s effective average corporate tax rate increases its stock of foreign direct investment, on average and in the long run, by over 30%. Ireland was relentlessly bullied by the rest of the European Union and the USA because of its 12.5% company tax, initially on export profits. Ireland more than halved its general company tax to 12.5% to sidestep complaints by other EU member countries of special favours for exporters. High-tax countries view the low company taxes in Ireland, Singapore, Hong Kong or other low tax developed economies as a threat. We are not talking about tax havens. Ireland, Singapore, Hong Kong and the other industrialised countries with low company tax rates are industrialised countries that lure more investment through lower taxes on investment and entrepreneurship. Awareness of the damaging consequences of corporate tax rates is reflected in the fact that at least 26 OECD member nations, including Australia, Canada, France, Germany, Japan and the UK have territorial company tax systems that exempt most or all foreign income from the home country tax (Barrasso 2012). 17 The many attempts at tax harmonisation by the European Union and G20 are motivated by the fear of large capital flows into lower tax jurisdictions. Corporate tax rate cuts have become a major issue in United States because of capital flight. These defensive actions of ministers of finance speak volumes about the dynamic benefits of a company tax rate cut for productivity growth, foreign investment and innovation. 16 De Mooij, R., and Ederveen, S. Corporate Tax Elasticities: A Reader s Guide to Empirical Findings, Oxford Review of Economic Policy, Vol. 24 no. 4 (2008): John Barrasso, Territorial vs. Worldwide Taxation. Senate Republican policy Committee at 5

6 HOW CUTS WOULD BE FUNDED? COMPANY TAX Treasury modelling for the most recent budget suggests that a one point reduction in the company tax rate (excluding Crown owned companies and dividend imputation offsets) would reduce tax revenues by $220 million. The Treasury estimates of the revenue effects of a company tax cut $220 million per percentage point make no provision for second round effects from increased investment and wages that arise from the tax cut. This omission of the behavioural effects of changes in taxes, which is common at ministries of finance, is known as static scoring. Dynamic scoring of tax cuts is the scoring of the cost of revenue of tax cuts which include behavioural effects of higher wages and increased investment. A PLAN FOR THE FUTURE million), and the Primary Growth Partnership ($70 million). We need to give a clear signal to investors and entrepreneurs of the future tax structure, one which will attract more foreign investment, create more jobs, and deliver higher wages. ACT s plan to drop the company tax rate by a percentage point each year for eight years, to a target of 20%, would provide that signal. Some estimates based on work by Mankiw and Weinzierl (2006) suggest that a better estimate of likely costs would be of the order of $ m per year. How might this be funded? The 2014 Budget foreshadowed $1.56 billion for additional spending and/or tax cuts in the 2015 budget. The expectation is the new spending allowance would keep growing at 2 per cent per Budget after that. The Government could commit less than 1/6th of this new policy allowance to cutting the company tax rate by one percentage point every year until 2022, when the rate would reach 20%. This is a modest proposal that will have large positive effects on investment, growth and wages to the benefit of all. Even better, these cuts could be funded from the $1.3 billion of corporate welfare currently spread across a favoured few businesses. Of this $1.3 billion in corporate welfare per year, about $0.5 billion is due to expire over the next few years; the KiwiRail turnaround plan ($198 million), ultrafast broadband ($200 6