Taxation and the Limits of Government PDF
Preview Taxation and the Limits of Government
TAXATION AND THE LIMITS OF GOVERNMENT TAXATI ON AND THE LIMITS OF GOVERNMENT edited by Gerald W. Scully The University of Texas at Dallas USA and Patrick J. Caragata McCallum Petterson Financial Diagnostics Ltd. New Zealand Springer Science+Business Media, LLC Library of Congress Cataloging-in-Publication Data Taxation and the Iimits of governmentledited by GeraJd W. Scully and Patrick J. Caragata. p.cm. A collection of 14 papers by the author-editors and other researchers. IncIudes bibliographical references and index. ISBN 978-1-4613-6996-7 ISBN 978-1-4615-4433-3 (eBook) DOI 10.1007/978-1-4615-4433-3 1. Taxation--New Zealand. 2. Fiscal policy--New Zealand. 3. Finance, Public-New Zealand. 4. New Zealand--Economic policy. 1. Scully, Gerard W. II. Caragata, Patrick James, 1948- HJ3180.5 .T392ooo 336.2'00993--dc21 00-027800 Copyright CI 2000 Springer Science+Business Media New York OriginaJly published by Kluwer Academic Publishers, New York in 2000 Softcover reprint ofthe hardcover Ist edition 2000 AII rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, mechanicaJ, photo-copying, recording, or otherwise, without the prior written permission of the publisher, Springer Science+Business Media, LLC. Printed on acid-free paper. CONTENTS List of Authors vii Part 1 Background 1. An Introduction to Reform and the Economic Effects of Taxation in New Zealand 3 Gerald W. Scully and Patrick J. Caragata Part 2 Taxation and Economic Growth 2. The Optimal Size Fiscal State 19 Gerald W. Scully 3. Taxation and Economic Growth in New Zealand 37 Johannah Branson and CA. Knox Lovell 4. The Effect of Aggregate Tax Levels on Output Growth in New Zealand 89 John Small and Patrick J. Caragata Part 3 The Marginal Cost of Taxation 5. The Deadweight Costs of Taxation in New Zealand 99 W. Erwin Diewert and Denis A. Lawrence 6. The Distribution of Estimates of the Marginal Cost of Taxation 115 John Small Part 4 Taxation and Employment 7. Taxation and Employment in New Zealand 129 Gerald W. Scully Part 5 Income Distribution 8. Income and Tax Distributions for Individual New Zealand Taxpayers, 1991-94 147 Paul V. Dunmore 9. The Equity-Efficiency Trade-off in New Zealand: A Preliminary Analysis 173 Gerald W. Scully and AdolfH Stroombergen Part 6 The Hidden Economy 10. Modelling the Hidden Economy and Tax-Gap in New Zealand 195 David E.A. Giles 11. Simulating the Relationship Between the Hidden Economy and the Tax Level and Tax Mix in New Zealand 221 Patrick J. Caragata and David E.A. Giles Part 7 Risk Profiling and Effective Tax Rates 12. Modelling the Tax Compliance Profiles of New Zealand Firms 243 David E.A. Giles 13. Taxation and Bankruptcy: Distress Prediction for Inland Revenue 271 Paul V. Dunmore and Shee Boon Law 14. Regression Based Estimation of Effective Tax Rates 289 John P. Small and Patrick J. Caragata Subject Index 307 LIST OF AUTHORS Johannah Branson is with the Agricultural Economics Unit, University of Exeter, Exeter, Devon, United Kingdom. Patrick J. Caragata is Managing Director, McCallum Petterson Finiancial Diagnostics, Wellington, New Zealand. W. Erwin Diewert is Professor of Economics, Department of Economics, University of British Columbia, Vancouver, British Columbia, Canada. Paul V. Dunmore is Associate Professor of Accounting, School of Accounting and Commercial Law, Victoria University of Wellington, Wellington, New Zealand. David E. A. Giles is Professor of Economics, Department of Economics, University of Victoria, Victoria, British Columbia, Canada. Shee Boon Law is Lecture in Accounting, School of Accounting and Commercial Law, Victoria University of Wellington, Wellington, New Zealand. Denis A. Lawrence is Director, Tasman Asia Pacific, Lyneham, ACT, Australia. C. A. Knox Lovell is Professor of Economics, School of Economics, University of New South Wales, Sydney, Australia and Department of Economics, Terry College of Business, University of Georgia, Athens, Georgia, USA. Gerald W. Scully is Professor of Economics, School of Management, University of Texas at Dallas, Richardson, Texas, USA. John Small is Senior Lecturer in Economics, School of Business, Auckland University, Auckland, New Zealand. AdolfH. Stroombergen is Managing Director, Infometrics, Wellington, New Zealand. PARTl BACKGROUND 1 AN INTRODUCTION TO REFORM AND THE ECONOMIC EFFECTS OF TAXATION IN NEW ZEALAND Gerald W. Scully and Patrick J. Caragata This book consists of a series of essays on the economic effect of taxation in New Zealand. Before discussing the papers in a general way, it will be helpful to the reader to understand a little oft he recent economic history ofN ew Zealand, and the effect of taxation and other matters on that history. The natural division in her modem economic history is the period before and after the reforms of 1984, which transformed New Zealand from a govemment-controlled to a market-based, open economy. Next, we discuss the mandate and the research program within the Inland Revenue Department (1991-1997) that led to the drafting of the papers in this book. The papers, then, are discussed, and some concluding remarks made. 1. THE NEW ZEALAND ECONOMY AND GOVERNMENT POLICY PRIOR TO 1984 There are three salient features about the New Zealand economy that have shaped her economic history and have served as a basis of government policy. These features are (1) a narrow, commodity-based structure of production, which is the principal source of foreign exchange, (2) an economy that is more vulnerable to exogenous shocks than most, and (3) a population deeply egalitarian in outlook. These features led to a broad policy of market intervention by government and the growth of a large fiscal state dedicated to social welfare. New Zealand is a sparsely populated country, about the size of England. It is endowed with natural resources, fertile soil, and a mild climate. Her historical ties to Britain and her natural agricultural advantage led New Zealand to become Britain's farm. In return for the imported capital, machinery, and other manufactures necessary for continued development and prosperity, New Zealand exported a fairly narrow range of commodities (mainly, wool, sheepmeat, and butter). In 1950, wool, dairy, and meat constituted about 95 percent of the country's exports. Since England purchased most of what New Zealand could produce, government policy was geared to increasing agricultural output, which further encouraged dependence on commodities. New Zealand's commodities, like nearly every other country's, are subject to declining prices relative to imported goods. These declining terms of trade brought with it a raft of government policies designed to increase export prices through the use of central marketing of producer boards, and to stimulate production through subsidies, export and tax incentives, devaluations, and negative real interest rates. Naturally, these policies required increased government expenditure and the taxes necessary to pay for them. Nevertheless, imports continued to exceed exports, the balance of payments deteriorated, and overseas debt as a share ofGDP grew. To stem the tide of a deteriorating balance of payments and to protect domestic producers of importables, several interventions in the import market were undertaken. These included the imposition of quotas (many imports were banned and many more were difficult to obtain without access to foreign exchange or overseas accounts) and high tariffs, the issuing of import licenses, and the control of foreign exchange. These interventionist, "Fortress New Zealand" policies in the 1950s until the early 1980s led to the domestic production of shoddy goods sold at high prices. New Zealand's plantation economy relationship with Britain brought prosperity (about the third highest in the world, in 1950), but all of the vulnerability that a narrowly structured, commodity-based economy is SUbjected. The declining terms of trade that government policy desperately sought to protect living standards from proved stronger than the government policies and expenditures designed to defend it. New Zealand's relative living standard declined to 8th in 1955, 12th in 1965, 17th in 1975, and was about 20th when economic collapse was at hand in 1984. The decline in the relative living standard continues to this day. The economy of New Zealand is more vulnerable to exogenous shocks than most. The two great shocks of the postwar period were Britain's abandonment of its "special" relationship with New Zealand, as she entered the European Common Market, and the oil price shocks of the 1970s. In 1950, the United Kingdom took about two-third's of New Zealand's exports (now, it is well below ten percent). While the United Kingdom remained its largest trading partner in the 1960s, the share of exports going there declined steadily, until it nearly evaporated, with the United Kingdom's entry into the European Common Market. While New Zealand still sells its wool, meat, and dairy products, and some other commodities and services (wines, deer products, kiwifruit, lumber, tourism), it took time to find and develop other markets. New Zealand exports about the same fraction to Europe and North America today as it did in the past, but Australia, Japan, and other Asian countries have replaced 4 the United Kingdom as main export markets. The oil price shocks were particularly harmful to New Zealand. Like many countries, New Zealand responded by trying to protect the economy from the price shock, in part by rationing gasoline. Also, New Zealand attempted to reduce foreign dependence by government investment in "Think Big" projects. Many billions of dollars were invested in these projects, many of which failed. Along with the oil price shock came serious inflation. The jump in the inflation rate was greater in New Zealand than in other industrialized nations, and was of longer duration. One government policy response to the crisis was to impose a wage-price freeze. A steady decline in the inflation rate did not occur until the reform period. In addition to protecting industry through heavy protectionism and subsidy, individuals have been protected through various welfare, social programs, and regulation. New Zealand was an early convert to the idea of social harmony. The Great Depression revealed the vulnerability of the economy to outside economic disaster. This led to the introduction of the Social Security Act in 1938, which expanded the role of the state in guaranteeing incomes and in providing for a variety of social services. Then, and for five decades, an emphasis on equity and "fairness" was encouraged by narrowing income differentials (trade unions, progressive taxation, with a top marginal tax rate reaching 66 percent on a comparatively low income base, transfer payments, and entitlements), protecting individual income from various shocks, and ensuring the education, housing, health, and welfare of its citizens. Security became an overriding policy concern of successive governments, which provided free education, comprehensive health care, unemployment compensation, and pensions. Unemployment was held in check by expanding government ownership of many enterprises (transportation, communications, utilities, banks, insurance and so on). Despite these programs, the unemployment rate rose slowly from 1965 to 1977 (from about.2 to .6 percent), and then dramatically thereafter (above 4 percent in the early 1980s; above 9 percent in the early 1990s). Not trusting market outcomes, successive administrations imposed more and more intervention and regulation. Government was actively involved in collective bargaining, and controlled capital flows. Compulsory unionism and centralized collective bargaining were installed. The result was a narrowing of skill differentials and an inflexible labor market. Wage rate decisions were a matter of politics, not international competitiveness. Producers, operating in protected markets, went along with the policy, since they could pass on wage hikes through increases in their product prices. 5
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