May was Budget season, with Finance Ministers on both sides of the Tasman delivering their latest plans for the coming financial years.

One of the more notable points was news of a further increase in income tax rates in Australia.

This was targeted at higher income earners, with Australian workers earning above A$180,000 paying a marginal tax rate of 49% in 2014-15. In the A$37,001-$80,000 bracket, the marginal tax rate was unchanged at 34.5% (including Medicare levy in each case).

This is in stark contrast to income tax rates in New Zealand.

In NZ, those earning over $70,000 will pay a 34.5% marginal tax rate in 2014-15, including the ACC earners’ levy. In the $48,001-$70,000 bracket our marginal tax rate is 31.5%. These rates are modestly (0.25%) lower than in 2013-14, reflecting a reduction in the ACC earners’ levy.

What is very interesting is that despite these much higher personal tax rates, the Australian government effectively generates lower tax revenue.

According to the OECD, total tax revenue (across the various levels of government) as a share of GDP was 26.5% in Australia compared to 31.5% in NZ. This was in 2011, which is the most recent year for which the OECD publishes data.

Projected tax for the 2014-15 year collected from individuals in Australia is also lower, as a share of GDP, than in NZ.

So what is driving the lower revenue share for the Australian government?

There are many aspects including a lower GST rate (10% vs 15%), and a more complex tax system that allows for more personal deductions.

In addition, an important part of the answer lies in the state of our respective labour markets.

The unemployment rate in both countries is at a similar level – 5.8% in Australia and 6% in NZ.

However a much lower proportion of Australians actually participate in the labour force.

If we look at the share of employed workers in the population aged 15 and over (called the employment-to-population ratio), this currently stands at 60.9% in Australia, against 65.1% in NZ.

So while we pay less tax as a share of our personal incomes in NZ, there are more of us working. This makes it much easier for our government to balance its books.

What investment themes can we draw from this?

For NZ, high participation in the workforce is another aspect to our relatively upbeat economic position at present.

For Australia, we believe this is a structural problem. Evidence of this lies in the fact that the gap between employment to population ratios in Australia and NZ has persisted for over two decades.

Anecdotally, investors are often told by international companies that labour market regulation in Australia is amongst the most difficult they encounter globally.

Addressing this problem in Australia is a complex task and likely requires significant reform to the labour market and tax system, among others.

Is the current coalition government willing and able to implement this type of structural reform? This seems unlikely, especially in light of the popular backlash we have witnessed to the recent Budget.

Potentially, if Australia really wants to fix this they need a crisis or recession. Then a government might get the mandate to make more difficult and painful long-term changes in these areas.

But just as likely in that scenario is an alternate solution of borrowing, using the very low level of Australian government debt at present, to attempt to spend Australia’s way out of a crisis.

It seems to us that some of these labour market and tax raising issues are likely to persist in the Australian economy for some time.

David Lewis
Portfolio Manager