ACT has been busy. The party released its Immigration Policy on Thursday, setting out how ACT would make New Zealand competitive with the likes of Australia and Canada in the war for talent. ACT’s Truancy Policy came out on Sunday, calling for fines for parents, truancy officers for schools, and daily national reporting of truancy figures to maintain a national focus.


A few weeks back we got great feedback on our explanation of why a tax free threshold sounds like a great idea, but is a very bad idea once you dig into it.

The short version is that a tax free threshold has to be made up with higher tax rates on higher income, so almost everyone pays more tax on their next dollar and there’s less reason to work, save and invest to earn another dollar.

This week we get into the equally important argument about indexing tax thresholds to inflation. It’s a policy ACT once supported but no longer, and here’s why.

If you don’t like paragraphs filled with numbers, feel free to skip the next four. Long story short, you are now paying more of your income in tax even though you can only buy the same stuff.

Here’s how bracket creep works. You move from paying 10.5 per cent to 17.5 per cent when your income ticks over $14,000. Then you move to 30 per cent when you tick over 48,000. 33 per cent at 70,000, and so on. The thing is, these numbers were set in 2010, and $14,000 doesn’t buy what it used to.

In 2010 you could buy all sorts of things for $14,000, and you only paid 10.5 per cent tax. To be exact, you paid $1,470 in tax.

Today, to buy the same stuff you now need $18,323 because inflation’s gone up 31 per cent since then. But if you earn $18,323, some of your income is over $14,000. It’s taxed at the 17.5 rate. You now pay $2,227 of tax, and your average tax rate has gone up to 12 per cent from 10.5 per cent.

People who should know better are saying ‘that’s easy, just move the tax threshold. In this case, the 17.5 rate would kick in at $18,323, so all the income needed to buy what used to cost $14,000 would still be taxed at 10.5 per cent, just like in 2010!’

They then go on to say adjusting the brackets for inflation not just a way to pay less tax but morally right as well. They say it stops the Government stealthily increasing taxes in any given year without openly asking permission. That’s true, but taxes are not the whole problem.

Government spending is the real issue. All Government spending has to be made up by taxes or borrowing this year, borrowing is really just tax in a future year.

What’s worse, focusing on taxes without limiting spending can lead to more spending. The Republicans tried this for 30 years and got bigger spending and more debt. They called it ‘starve the beast,’ and it didn’t work. The late great public choice economist Bill Niskanen put it this way in his paper ‘Limiting Government: The failure of Starve the Beast.’

“[Government] spending is better described as buying government services at a discount equal to the deficit, the costs of which will be borne by someone sometime in the future.”

In other words, limiting taxes without limiting spending means voters get the spending, but not the taxes. Government spending seems cheaper from a voters’ point of view, so they don’t care about spending.

That’s exactly what will happen with tax bracket indexation. At the moment the bottom 48 per cent of taxpayers pay only 8 per cent of income tax. Government spending is basically free from their point of view. At the other end of the scale, just 8 per cent of tax payers pay 42 per cent of all income tax. To them it’s not so cheap.

Indexing the tax brackets just keeps Government spending cheap for most voters. The tax thresholds move up and those reporting low incomes stay on low rates instead of drifting into higher ones. In other words, indexation maintains progressive taxation.

Indexing tax brackets means that Government spending remains something that other people pay for. Why not get the benefits of more Government spending and make those rich pricks pay?

Other things being equal, the deficit grows and the culture of voting for other people’s money is strengthened. The dark underbelly of our culture, tall poppy syndrome, is embedded in the tax code.

Some will argue that the Public Finance Act prevents the New Zealand Government borrowing too much and running big deficits. It certainly worked well until recently.

Unfortunately it’s stopped working lately with Government borrowing $106 billion or a third of GDP in four years. Whether or not the Public Finance Act is what it used to be, keeping Government spending cheap for most voters by indexing tax thresholds won’t help.

So, if tax bracket indexation perpetuates progressive taxation, tall poppy syndrome, and deficits, the answer becomes obvious. Bracket creep is not a problem in itself, it is a symptom of progressive taxation. It’s what happens when there are five different tax rates from 10.5 up to 39. The right thing to do is cut those higher rates.

That’s what ACT’s fully costed Alternative Budget for Real Change does. It takes the five rates on personal income tax and reduces them to two, just 17.5 and 28. Doing so also aligns the top personal rate with the company and trust rate, removing the incentive for complex tax planning and avoidance activity.

That of course means reducing Government spending. To do anything else means keeping Labour’s levels of spending, which are around 15 per cent higher than they inherited from the previous Government. It’s not credible to say all of Labour’s spending is justified.

The benefit is that people across the income spectrum face a lower tax rate on their next dollar. When people do the things everyone says they should to raise productivity -train, work, save, and invest to earn more, they get to keep more of their own money.

Bracket indexation, like a tax free threshold, is a seductive idea that does the opposite of what is promised. Instead of indexing tax thresholds to inflation, the next Government should cut and flatten the tax structure to make New Zealand a more aspirational and wealthy place.

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