Steve Forbes: Positive spinoffs all round when tax rates are low

COMMENT

Economists and public officials too often forget that taxes are not just a means of raising revenues for a government. They are also a price and a burden.

The tax you pay on income is the price you pay for working. The tax you pay on profits and capital gains is the price you pay for taking risks that succeed, for being profitable and productive.

The idea is very simple: the lower the price and burden on good things like productive work and risk-taking, the more you get of them; the higher the price, the less of them.

Thus, the key to judging tax changes is simple: do they lower the tax rate you pay on your next dollar of income? That rate is known among economists as the marginal tax rate. If marginal tax rates on personal incomes go down, people strive to do better. It's called incentive.

In the United States, every time we've reduced tax rates, the economy has blossomed and the government revenues have come in above expectations.

In the early 1960s, for example, President John F. Kennedy proposed an across-the-board reduction in personal income tax of about 22 per cent. On paper, that should have meant a corresponding decline in federal government receipts.

Instead, when the reduction was enacted, government revenues reached record levels. And the economy expanded mightily.

President Ronald Reagan slashed income tax rates by 25 per cent soon after he took office. By the time he left the presidency, the American economy had enjoyed the longest peacetime expansion in its history. Federal revenues doubled.

There were large budget deficits during those years but they were a result of the fact that Congress spent the extra money and then spent some more. That's equivalent to an individual receiving a $10,000 raise and then spending $20,000.

There is another positive impact of Kennedy-Reagan type of tax cuts - the rich pay more. When Ronald Reagan became president, the top 1 per cent of income-earners in America paid 19 per cent of the federal income tax. Now, the top 1 per cent pay more than 35 per cent of the income taxes.

Last [northern] spring, President George W. Bush cut capital gains taxes (from 20 per cent to 15 per cent) and the dividend tax (from 38 per cent to 15 per cent). Personal income tax rates also declined.

Since those reductions, the American economy has picked up steam with real annual growth rates exceeding 4 per cent.

Business investment is now growing at double-digit percentage rates. Personal incomes are rising. The American stock market has expanded by more than US$2 trillion ($3 trillion) in value. Job creation is currently a big issue, but it will diminish as this expansion continues.

New Zealand should go for a single-rate income tax system - the flat tax. There would be generous exemptions for adults and children and a single, low rate of tax when your income exceeds those deductions.

Hong Kong has had such a successful system for 40 years. Russia put one in three years ago and income tax receipts have burgeoned. Other countries with such a system now include Latvia, Estonia, Ukraine, Slovakia and Iraq.

It's amazing how hard it is for leaders around the world to accept the proposition that low tax rates increase prosperity and government revenues and lead to better opportunities for all.

* Steve Forbes, the president and chief executive of Forbes Inc and editor-in-chief of Forbes magazine, will address the Act party conference by video link tomorrow.