Tuesday, July 25, 2017

Politics and Public Finance in New Zealand’s Election Year

Surely no one likes poverty. Politicians of different parties might share the same preferences, but they have different budget constraints. The recent Green’s stump speeches call for ending poverty by significantly increasing social benefits paid for by higher taxes on the “rich.” Rhetoric aside, a tax increase is not a good economic idea especially when our productivity is already sluggish. Social benefits do not end poverty.

For example, over the period 2001 to 2015, the New Zealand government’s average tax revenue as a percent of GDP (29 percent on average) is higher than Australia (23 percent on average); it is significantly higher than Singapore (13 percent on average), Germany (11 percent on average), and Switzerland (9.5 percent).[1] For New Zealand, the tax revenues are mostly from taxing consumption, labor income and company profits. Australia’s average tax revenue is less than New Zealand’s even though it taxes capital gains and New Zealand doesn’t.[2] The figure below plots the World Bank Development Indicators data (July 2017).

So why does New Zealand, which is the least populated among all these countries, has such high tax revenue/GDP ratio? More spending! Typically, government’s major expenditures are on health, education, social services, and the military. Our military spending is trivial, about 1 percent of GDP so I will ignore it.[3] However, on average over the period from 2001 to 2015, New Zealand spent 9.45 percent of GDP on health (about 26 billion dollars), more than Australia (8.79 percent), only slightly less than Germany (10.7 percent) and Switzerland (10.9 percent) and significantly less than Singapore (3.75 percent).[4] See the figure below.

On education, New Zealand’s spending is the highest, nearly 6.5 percent of GDP (about 16 billion dollars). Australia (5 percent), Germany (4.7 percent) and Switzerland (5 percent) spend less than New Zealand. Singapore spends the least, 3.25 percent only.

The Labour party says (here) that it will “address chronic under-funding of health, education…” even though the data suggest that there is no such under-funding! New Zealand spends more than Australia on health, just as much as Germany and Switzerland, and three times as much as Singapore. On education, spending surpassed all of them.

More public spending on services does not necessarily mean better outcomes. There is a strong empirical evidence for that. In education, our students do not do as well as Singaporeans. Performances in standardized tests such as PISA, for example, indicate that Singapore, which spends much less public money on education, is always on the top of the world.[5]

Also, Singapore’s average annual labor quality growth, although small, 0.9 percent (see the Conference Board data), still the highest comparably.[6] Germany and Switzerland have an average annual growth of labor quality of 0.1 percent only. New Zealand’s average annual labor quality growth is 0.6 percent, still slower than Singapore, but much higher than both Germany and Switzerland. The average annual growth rate of labor quality in Australia is half that of New Zealand (source: Conference Board).

The same is true for public health. Although it is difficult to measure output, there is no credible empirical evidence that more spending on national public health systems improves outcomes.

Government spending is a function of the size and the scope of market failure. The question is how much market failure is there in education and health to justify more public spending. I do not think we answered this question in New Zealand.
Here is the big spending item. OECD data show that average net total social expenditure as a percent of GDP for New Zealand is 16.5 percent (43 billion dollars). New Zealand is not alone: it is 19 percent in Australia, 25.4 percent in Germany, and nearly 22 percent in Switzerland.[7] And here is the difference: Singapore spends only 3.5 percent of its GDP on social programs!  

Nevertheless, some expenditures on social benefits could be justified. However, benefits raise the reservation wage and increase unemployment. Singapore, which spends the least on social benefits has the lowest unemployment rate, 1.7 percent in 2015.[8]    

Before getting excited about increasing social spending, note that taxes reduce labor productivity.[9] The plot below shows that Switzerland, Germany, and Singapore, which tax the least, have higher GDP per capita than us.

My advice to the politicians who advocate more taxes is to consider alternative policies to help the poor without taxing potential productivity of the whole country.  
New Zealand already has the highest tax revenue as a percent of GDP. They could reallocate expenditures, e.g., increase X and reduce Y. There must some waste in the public sector; cut it. Better, think about firm productivity-indexed wage subsidy (See the Nobel Laureate Edmund Phelps).      

[1] I chose Singapore because the data are available. Korea and Hong Kong would be just as good examples to use for comparisons regarding tax and spending issues. I chose Switzerland because there has been some public interest in this country as a model that New Zealand should emulate. 

[2] Since 2009 Germany levies a flat rate tax on private income from capital and capital gains. The tax rate is 25 percent plus 5.5 percent solidarity surcharge. The tax is levied at German sources as capital yields tax. There is a tax refund for personal income tax rate below percent.

[3] Australia spends about 1.8 percent, Germany 1.2, and tiny Singapore spends 3.5 percent of its GDP on defense.

[4] The IMF World Economic Outlook data (2017) estimated GDP at current prices in 2016 to be 261 billion New Zealand dollar.

[6] “Measure of the changes in the composition of the workforce. This indicator is based on underlying data on employment and wages by educational attainment, which are estimated econometrically in some cases.”

[7] Data for Switzerland correspond to 2013 which the last data published on the OECD stats.

[8] The average unemployment rate for the period 1970-2015 (a proxy for the natural rate) is 3.78 percent. Unemployment in Germany, Switzerland and Australia are similar to New Zealand on average.

[9] For international evidence see for example, Razzak and Belkacem (2016), Taxes, Natural Resource Endowments, and the Supply of Labor: New Evidence, in Handbook of Research on Public Finance in Europe and the MENA Region, IGI Global Research Publishing, USA, (eds.,) M. Mustafa Erdoğdu and Bryan Christiansen, Chapter 23, PP 520-544, May 2016.

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