Economists moot bold income tax plan

New Zealand’s ageing population and ballooning welfare and health costs are piling pressure on the public purse.

In response, former Minister of Finance Sir Roger Douglas and University of Auckland economics professor Robert MacCulloch are reimagining their ambitious 2016 proposal to overhaul the country’s tax, health and welfare systems by shifting income taxation to mandatory savings.

In their research article, the pair argue that income tax on earnings up to $60,000 should be redirected into individual savings accounts. These accounts would fund each person’s healthcare, pension and risk cover, replacing much of the current public system with private provision.

By 2060, 26 percent of New Zealanders will be over 65, up from 16 percent in 2021, which will intensify the strain on superannuation and healthcare.

“We need to change the way we’re doing things so government costs can be reduced, quality of outcomes increased, and the plight of low earners, who are most vulnerable to public cuts, improved,” say Douglas and MacCulloch in their paper How to change the welfare state from a taxation to a savings-based model.

The economists attempt a politically feasible plan that maintains total welfare funding from both public and private sources, while opening up more choice and competition in the supply of healthcare services.

“We need to adjust the tax system so the vast majority of New Zealanders of working age can provide for themselves,” says MacCulloch. “The first step is to build mandatory savings accounts for health, pensions and risk cover via the transfer into them of current taxes paid on income up to $60,000.”

According to their model, an individual could save around $21,000 annually: $9,450 into a health account, $7,350 for superannuation, and $4,200 for risk cover.

A drop in corporate taxes would help fund employer contributions, and the government would retain sufficient tax revenues so it could act as ‘insurer of last resort’, paying for people who can’t meet their welfare costs out of their savings accounts.

“Our savings-not-taxation reform offers scope for efficiency gains in healthcare. It does so by opening up choice for individuals,” says MacCulloch.

“Rather than the government dictating where to go, people can choose their preferred public or private supplier.”

The researchers point to Singapore, which employs mandatory savings accounts and has one of the highest-quality healthcare systems in the world, yet spent 5.6 percent of its GDP on healthcare in 2021 (including both public and private sectors), compared to New Zealand’s 10.1 percent.

“Our reform keeps the pension but would raise the retirement age gradually from 65 to 70 years old over a 20-year period,” says MacCulloch.

The authors would do away with fee subsidies and interest-free loans for tertiary students from well-off families. Instead, a means test would see only students from low-income, low-capital families receive aid.

They would scrap grants to the movie industry, winter energy subsidies to wealthy households, favourable tax treatment for owners of rental housing, and allowances to sectors such as forestry, fishing, and bloodstock.

The money saved from these changes would be directed towards helping low earners build savings and cover the welfare needs of those who are chronically unwell.

“Perhaps more than any other feature of our reform, it’s the ‘miracle of compound interest’ that governments like New Zealand’s are not taking proper advantage of,” says MacCulloch. “If we can do this, it’ll help our financial situation.”

MacCulloch notes that the proposal isn’t without flaws, but says bold change and ideas are needed, and fast, if Aotearoa New Zealand is to create a resilient economy in the face of an ageing population.