Guest Post: ACT is wrong on tax indexation

Connor Molloy writes:

ACT claims to be the party of principle, but when it comes to indexing income tax brackets to inflation, it appears they have lost their way. After rightly criticising the National Party for their U-turn on abolishing Labour’s 39% top tax rate last month, ACT has now done a public U-turn of their own.

Last year, David Seymour supported Simon Bridges’s member’s bill to index tax brackets to inflation. Then, in August this year, Mr Seymour said that tax bracket indexation is “a good start” but that it didn’t go far enough. And now ACT has said they don’t support the policy at all. That’s quite a shift in the space of a year.

But Seymour and ACT have it wrong this time.

When inflation occurs, the prices of goods and services increase, which diminishes the purchasing power of each dollar we earn. This means that if you receive a pay rise in line with inflation, you are not actually earning more income in terms of what you can buy but you end up paying more tax.

Governments of all stripes have been happy to cash in on inflation when individuals’ tax bills increase as a result of being pushed into higher tax brackets or paying a higher proportion of their income at their top marginal rate. Without any consultation or justification, the government is able to receive automatic, unlegislated tax hikes by stealth. This is known as ‘tax bracket creep’ and it makes us all poorer.

ACT’s November newsletter argues against tax bracket indexation on the basis that focusing on taxes without reducing spending leads to more government debt, which is effectively just higher taxes in the future. We agree that tax relief should be funded by savings in government expenditure, but ACT misses the point.

Indexation is not a tax cut. Without indexation, governments get a free pass to increase spending because it is already paid for through bracket creep. Indexation does not reduce the total tax take, it simply doesn’t increase it.

ACT’s new found opposition to indexation stems from confusion because they wrongly conflate different policy issues that should be looked at separately – indexation, distribution of the tax burden, and government spending.

In a system that has indexation, there is nothing to prevent a party from implementing policies that shift the tax burden or cut spending.

ACT’s alternative budget addresses the latter two issues by proposing cuts to government spending, significant tax reductions and a simplification of income tax rates. We support the principle of their proposals but the problem of bracket creep will persist.

ACT argues that “[b]racket creep is not a problem in itself, it is a symptom of progressive taxation.” It’s true that if we all paid a single income tax rate, we would not need indexation. But ACT’s proposed tax system is not flat. Mr Seymour has abandoned his own  2019 tax policy of a single income tax rate. Mr Seymour’s 2022 policy is designed in a way that, over time, taxes would steadily increase year on year.

If ACT’s new tax proposal had been in place since 2017, someone earning $80,000 today would be paying $1050 more tax each year than someone on the same real income in 2017.

ACT could easily advocate for their newly proposed two-tier income tax regime to be implemented and then be indexed to inflation to ensure that the real tax rates remain constant unless changed by Parliament.

It is difficult to understand how ACT reached their current position on this policy when they accept that bracket creep is a tax increase by stealth. Each of their concerns arise from other factors that can be addressed through policies that are not incompatible with tax indexation.

If Seymour truly thought his proposed tax settings were the best for New Zealand, he would commit to indexing them. Otherwise he needs to show some courage and campaign for his 2019 flat tax proposal that would fix this issue completely.

Seymour is clearly positioning himself to play a major part in the next Government. But this U-turn is wrong both in terms of principle and in politics. He should rejoin the cause that even the Nats agree with us on: ‘No taxation without indexation!’

Connor Molloy is a Researcher for the Taxpayers’ Union.