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Is a Reduction in Rates of Taxation Likely to Lead to an Improvement in Productivity? (August 2005)

I have been somewhat bemused over recent months by the amount of media coverage given to the taxation policies of the major political parties, and the way in which taxation has become a vote buyer.


The media and politicians have overlooked two simple facts:

           In the current environment, reductions in rates of taxation on personal income will to a large extent be used for the purchase of consumables and will likely promote inflation; and

           Reductions in the rate of taxation on business income will not necessarily encourage manufacturers to invest in new plant and machinery.


I will let those more knowledgeable debate the likely impact of tax cuts on inflation and instead concentrate on the implications of the proposed tax cuts for manufacturers.


The media are regularly providing us with examples of companies that cannot compete with overseas manufacturers and are shifting production off shore, usually to China. In many instances, they cannot compete because they have obsolete plant and machinery while the Chinese are using the latest technology available to them. Comparative labour rates are also a factor in this equation, but this is not as significant as it was.


A cut in tax rates is not going to help redress the balance. It is a given that the higher a companyís taxable income, the greater the benefit obtained from a reduction in the company tax rate. It is also a given that many new ventures often do not have significant pre-tax profits. As a result they will gain little or no financial benefit from a drop in tax rates, and will have little extra to invest in state of the art plant and machinery.


With many of our major companies being owned by offshore investors, any reduction in rates of taxation will lead to the offshore owners of many New Zealand based companies enjoying substantial benefits. Conversely, the changes will not provide any substantial benefit to many of the New Zealand owned enterprises the government is exhorting to improve their productivity.


What is required is a revision of the whole depreciation regime to more accurately reflect the economic life of plant and machinery. The useful economic life of, say, a lathe fifty years ago bears no relationship to the economic useful life of a current CNC item. Economic obsolescence is a factor today. It was not so to the same extent fifty years ago.


If our competitors are replacing their plant and equipment on a five-yearly cycle, so should we if we are to become internationally competitive. Our depreciation rates should reflect the economic, as opposed to the physical, life of assets. Admittedly this could increase overhead recovery rates for individual businesses, but this should be more than offset by increased productivity.


We are constantly informed that New Zealand companies must raise their productivity if we are to be competitive in international markets. The current emphasis on tax cuts will not encourage this. An intelligent approach to the determination of depreciation rates, and policies aligned with the economic realities of global competitiveness will. It will reward those who invest in new plant and equipment, and assist in raising productivity levels.


In summary:


           Reductions in the rate of taxation on business profits favours companies with high levels of profits;

           A considerable number of New Zealandís largest companies are overseas owned. Reductions in taxation rates could lead to an increase in dividend flows to the offshore owners, not to investment in new plant and machinery in New Zealand.

           Many of New Zealandís new innovative companies have low levels of profit. They will make minimal gains from a reduction in business tax rates.

           Reductions in business tax rates do not in themselves lead to an increase in investment in new capital equipment.

           New Zealandís depreciation regime for tax purposes is predicated on the physical life of assets. This takes no account of their true economic life.

           Economic obsolescence is a fact of life today and we should be looking at significant changes in the depreciation rates applied for tax purposes.

           Accelerated rates of depreciation can be an incentive for manufacturers to maintain modern machinery more in keeping with that used by their overseas competitors.

           Failure to provide incentives for manufacturers to invest in new plant and machinery will see more companies move production offshore.

           The shift of production offshore has a knock-on effect as many of our remaining manufacturers are reliant upon those companies as suppliers or customers.


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