COMMENT:

The economy has dodged a bullet with the Government's decision not to proceed with a capital gains tax.

Incomes have to be earned before they can be taxed, and the brutal reality is that we are not all that good at doing that.

On the same day that Sir Michael Cullen delivered the Tax Working Group's final report, the statisticians reported that in the latest year New Zealand's labour productivity — or output per hour worked — grew just 0.3 per cent.

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Not the 1 per cent we have averaged since 2008 or the 1.5 per cent the Treasury likes to assume in its forecasts, but 0.3 per cent.

That meagre increase is from a level of labour productivity that puts us on a par with Slovakia, Slovenia, Israel and Turkey, and about 25 per cent below Australian levels.

Statistics New Zealand also reported that capital deepening — increasing the capital invested per worker — made exactly no contribution to the productivity gain, such as it was, even though we are at a stage in the cycle when the labour market is tight.

Capital shallowness is not the only reason for our low productivity, of course, but it is a central part of any plausible account of it. It would have been a shame to make that problem worse.

Business New Zealand had a point when it argued that levying a capital gains tax on businesses would have negative effects on productivity and innovation, by increasing the hurdle rate of return required for them to make new investments and by reducing the incentive for the next generation of entrepreneurs to take risks.

In the context of a chronically capital-shallow business sector, and the weak productivity and hobbled incomes that flow from that, those would be perverse outcomes.

It was not just special pleading to make that point.

Right now business confidence is low. Not just the headline measure, which reflects businesses' view of the economic environment, which is deeply net negative in both the New Zealand Institute of Economic Research and ANZ surveys, but also what firms are reporting about their own activity.

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The domestic trading activity indicator in NZIER's quarterly survey of business opinion reported earlier this month is at a seven-year low, and the own activity reading from ANZ's monthly business outlook survey is also pretty droopy at just a net 6 per cent positive.

So given a relative high company tax rate, given a low capital-to-labour ratio and given cyclically weak business confidence, it was not surprising the Government rejected the idea of imposing a capital gains tax on productive enterprises.

The decision to not impose one on landlords either is more debatable.

The tax system helps explain why New Zealand has such a high employment rate. Photo / File
The tax system helps explain why New Zealand has such a high employment rate. Photo / File

But many of the advantages of investing in rental properties have already been reduced, with the five-year bright line test, the ring-fencing of tax losses, and the Reserve Bank's loan-to-value ratio restrictions.

Even so, tenants should probably breathe a sigh of relief as well.

And at this late stage in the house price inflation cycle, it might have been years before a CGT on rental properties yielded significant revenues.

The Working Group made a lot of other recommendations as well, including on personal income tax, under its brief of suggesting a revenue-neutral package.

In expressing her disappointment that the Coalition Government could not achieve consensus on a CGT, and in acknowledging the lack of a public mandate as well, Prime Minister Jacinda Ardern used the world "fairness" a lot.

But the equity argument for taxing the returns to capital harder glosses over the fact that New Zealand already taxes corporate income relatively hard — we are in the top quartile of developed countries on that score — and taxes wages relatively lightly.

That last point is reaffirmed by the Organisation for Economic Co-operation and Development's annual Taxing Wages report released last week.

In almost all developed countries employers have to deduct from their employees' take-home pay not only income tax but social security contributions, which average just under 10 per cent of the gross wage.

We don't have that. Instead, New Zealand funds superannuation from the whole tax base, not from social security taxes. It is a positive feature of our tax system in that it avoids a disincentive to hire and helps explain why we have one of the highest employment rates.

So for a single person on the average wage, for example, the "tax wedge" is only half the OECD average.

Income tax takes 18.4 per cent of their gross wage, compared with 15.7 per cent on average across the OECD, but when social security contributions are factored in, the OECD average for the gap between gross wages and their take-home pay rises to 36.1 per cent.

When Working for Families tax credits are included, a couple with two dependent children and one earner on the average wage get to keep 98 per cent of the gross wage (up from 94 per cent last year). The OECD average would be 73 per cent.

In fact if you look across the (inevitably arbitrary) eight different combinations of household composition and wage levels the OECD considers, both the average and the marginal rates in New Zealand are well below the norm for developed countries.

A casualty of the decision not to go ahead with a CGT is the prospect of tax relief at the lower end of the income tax scale which the Cullen review recommended as the quid pro quo part of a revenue-neutral package.

But the Working Group also concluded that improving incomes for households on very low incomes is best done through welfare transfers, rather than the tax system. We have yet to hear what the Welfare Expert Advisory Group recommends on that score.

And when it comes to tax changes which would not come into force until after the next election, the Government has the option of loosening the fiscal corset of the Budget Responsibility Rules.