Optimal tax theory and ACT’s taxation policy

Yesterday, the ACT party released their tax policy (further discussion also over at Kiwiblog)

Some key points from ACT’s taxation policy include:

  1. restricting future increases in Government expenditure to inflation and population growth
  2. eventual personal tax rates of 12.5% up to $20,000 and 15% above $20,000
  3. eventual company tax rate of 15%
  4. eventual GST rate of 10%

Tax distorts behaviour. The concept of the ‘excess burden of taxation’ is the economic loss that society suffers as the result of a tax, over and above the revenue it collects. Distortions occur because people or firms change their behaviour in order to reduce the amount of tax they must pay, which results in deadweight loss from taxation.

‘Optimal tax theory’ is the study of how best to design a tax to avoid distortion and inefficiency. Other things being equal, if a tax-payer must choose between two mutually exclusive economic projects (say investments) that face the same pre-tax risk and returns, the one with the lower tax or with a tax break would be chosen by the rational actor. With that insight, economists argue that generally taxes distort behavior.

By lowering general tax rates, as ACT suggest, distortion and inefficiency will be reduced. By adjusting personal tax rates to be in line with company tax rates, we edge closer towards an optimal tax system.

ACT should be commended on their approach to taxation. At a time when the two major parties are having a competition to see who can spend the taxpayers’ money the fastest, it’s refreshing to see a party following economic fundamentals in their policy.


5 replies
  1. Spider_Pig
    Spider_Pig says:

    The policy is fantastic and certainly something to aim for. Imagine the huge benefits to low income people: every extra dollar they earn would be valuable, with no steep abatement rates.

    I particularly like the “opt out” idea. Those that choose to provide for their own health costs should not be forced to pay for everyone else’s.

  2. Matt Nolan
    Matt Nolan says:

    “Its what one would expect from a party where the finance spokesperson is actually economically literate.”

    What do they say about financing it – where are they going to cut spending?

    “I particularly like the “opt out” idea. Those that choose to provide for their own health costs should not be forced to pay for everyone else’s.”

    But what happens if there is an externality from health care. Infectious diseases is a good example of this – where one persons choice to consume health care has a social benefit. Shouldn’t we finance this section of health care?

    Also, what about intrinsic rights – if we believe people have an “intrinsic right” to health care as part of our society then society should fund it, shouldn’t it.

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