Fran O'Sullivan: The forgotten underclass

By Fran O'Sullivan

I'm going to beat up on the Finance Minister about a rising new underclass.

Not John Key's underclass - the families living dead-end lives who the National leader rightly says comprise an "underclass" of Kiwis living in streets plagued by crime and drugs. This social underclass certainly deserves all the help we can give, particularly at the aspirational level.

Michael Cullen's new underclass is not the stuff of headlines or television grabs.

The self-employed - particularly sole traders - who are trying to make a buck for themselves as they create new businesses, are frequently just too busy getting the next contract and filling out compliance forms to work out that they are now the losers in an environment where the Government has skewed many new benefits and tax breaks to employees.

But their relative disadvantage is arguably the upshot of the Government's decision to "get its hands dirty" and introduce new policies that make winners of some and losers of others rather than opt for a more neutral system.

The self-employed lend themselves to the cute PR opportunities Key exploited so well when he invited 12-year-old Aroha Ireland to leave the mean street of McGehan Close and accompany him to the Waitangi celebrations.

But so far no politician seems to have cottoned on to the opportunities which could be derived from shining a public spotlight on the business underclass.

Perhaps it's just not sexy enough.

But as the Finance Minister prepares to add another notch to his belt through the introduction of the KiwiSaver scheme, he might care to pay some attention to the distortions being created by leaving the "self-employed" - particularly sole traders - out of the equation.

The self-employed are not eligible for the implicit tax break wage and salary earners will score through the Government's decision to make employer's contributions free from SSWCT (specified superannuation contribution withholding tax) up to 4 per cent of an employee's gross salary or wages.

In essence, an employee getting a nominal salary of $70,000 who puts 4 per cent of his/her salary into KiwiSaver - some $2800 - and gets his employer to match the 4 per cent with a $2800 contribution to his/her superannuation account will in effect be scoring a tax break equivalent to $1092 annually on the overall earnings of $74,000 (salary and employer's superannuation contribution) when the top tax rate of 39c in the dollar is factored in.

But the self-employed person who decides to put $8000 annually into his/her KiwiSaver scheme misses out on the $1200 Government tax break altogether.

The Government has bowed to political pressure and agreed to extend the tax-break to existing workplace super schemes - but that just increases the size of the injury to the new underclass.

Then there are the tax credits that are available to families which are explicitly not available to the self-employed unless one parent is a wage or salary earner.

Take Working for Families - the big-ticket scheme that Labour expanded by a further $1.5 billion during last year's election campaign to expand a tax-credits scheme to higher income earners.

When the scheme was unveiled, it was seen as a mechanism to help young working families get ahead.

Cullen explicitly rejected an across-the-board tax break that would also have been available to single people and families whose children have passed the dependent stage.

A working childless couple on $35,000 who decide to have a baby can get $6900 a year back from IRD for their first child. As the family grows - so does the size of the tax break.

It's not a bad thing for societies to assist in such a fashion.

Some 300,000 "working families" were receiving the tax credits when the scheme kicked in. A further 100,000 were beneficiaries.

Another 50,000 were added to the state's teat when Labour's election expansion kicked in last April.

But self-employed men and women who are supporting families miss out.

This creates an extraordinary injustice for those whose incomes are both at the lower end - and often ropy - when they are establishing their businesses.

Should such people be penalised twice by paying their taxes in the first place - and also paying towards the tax credits others get but they don't?

Doesn't seem much like social justice to me.

Then there's the corporate tax cuts which Cullen will introduce in his Budget.

Lowering the top corporate rate to 30c is an important indicator - particularly where foreign investors are concerned.

But as the Treasury has advised Cullen, the growth kicker really comes in when personal income taxes are reduced.

There's no indication that Cullen intends to do more than lower the threshold at which individual progressive tax rates kick in.

But if he wants to even the score as far as small traders are concerned, he may want to work out how they can be cut in to the upside through introducing different tax breaks - or holidays - for smaller businesses.

Trouble is all these distortions basically get in the way of, first, employers paying employees a decent rate for their efforts (why should they when they know Nanny State will top up pay packets), and, second, self-employed people who turn their attention to the various tax mechanisms they might use to reduce their overall liabilities or gain tax-breaks by turning themselves into quasi-employees instead of concentrating on developing their businesses.

Toss in the other imposts on the self-employed: the need to insure against ill-health and disability and provide ACC contributions and it's not hard to work out why many decide to throw in the towel and become employees again.

But the business underclass needs to stay aspirational.

Ensuring this underclass has the right incentives to stay in business is just as important overall to New Zealand's future as the underclass that is now the stuff of headlines.

* Fran O'Sullivan is going on holiday. Her column returns on March 21.

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