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Frank Newman

The Future of Tax

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The Government appointed Tax Working Group has released the Future of Tax, a background paper to assist those wanting to make submissions to the Group. The full report can be seen HERE. The Group is chaired by Sir Michael Cullen, former Labour Party Finance Minister during the Helen Clark era.

The Executive Summary says the purpose of the Group is, “to examine further improvements to the structure, fairness, and balance of the tax system. The Group has also been directed to apply a particular focus on the future to its work, with a view to exploring the major challenges, risks, and opportunities facing the tax system over the next decade and beyond.”

Those who expect the Working Group to produce a comprehensive and impartial review of our tax system will be disappointed. It’s not that kind of project. It is quite obvious from the report that the Group’s role is to provide options within the government’s agenda.

That agenda is to advance their social objectives and broaden the tax base. This is evident in the Group’s terms of reference, which are to report:

  • whether a system of taxing capital gains or land (not applying to the family home or the land under it), or other housing tax measures, would improve the tax system;
  • whether a progressive company tax (with a lower rate for small companies) would improve the tax system and the business environment;
  • what role the taxation system can play in delivering positive environmental and ecological outcomes;
  • whether to remove GST from any particular goods.

The need to increase revenue is highlighted in the Group’s report (page 10) when they forecast the government’s primary expenses to rise from 28.4% of Gross Domestic Product (GDP) currently, to 31.1% by 2030 and 33.8% by 2045. This increase is contrasted to National’s stated goal of reducing government spending to 25% of GDP.

Clearly, the new government intends spending (and therefore taxing) more than National had proposed. Cancelling National’s proposed tax cuts that were to have come into effect on 1 April this year, was a clear signal of this policy shift.

The key themes throughout the Background Paper are:

  • Wealth redistribution,
  • Advantaging those engaged in what they call the “Maori economy”,
  • Achieving positive environmental outcomes, and
  • Making homes more affordable by using the tax system to make investment in rental property less attractive.

What is striking about the report is how it is turning to tax policy to address social issues. It’s like Karl Marx has gone to the pantry and found a new box of cereal called “Tax”.

That signals a shift from the approach to date, and conventional thinking in prosperous countries, that tax policy is primarily about gathering revenue in a fair and equitable manner without killing the Golden Goose. That’s why most countries are lowering tax rates. Those rational thinking countries take the view that social objectives are achieved via government spending. Muddling those approaches will bring about a seismic shift in the way our central Government collects its revenue.

The major challenges the Group considers relevant include:

  • changing demographics, particularly the aging population and a disproportionate  increase in the Maori and Pacific Island populations that typically are the most socially disadvantaged and require greater welfare support;
  • the role of the Maori economy in lifting New Zealand’s overall living standards;
  • falling company tax rates around the world;
  • environmental challenges, including climate change and loss of ecosystem services and species;
  • growing concern about inequality; and
  • the impacts of globalisation and changes in its patterns.

The Paper has some interesting facts and figures like:

  • The top 20% of households have an average net worth of $1.35m (including the home). The bottom 20% have a net worth of $8,000. When the home is excluded, those figures fall to $601,800 and minus $100 respectively. Home ownership is a significant factor in wealth accumulation.
  • The bottom 50% of income earners receive more in tax transfers (like Working for Families tax credits and NZ Superannuation) than they pay in tax.

Where the report becomes a party political manifesto is by qualifying those facts with presumptions like, “Income inequality is often used as a measure of fairness across society”. 

To presume a fair society is one where everyone earns the same regardless of effort or skill would be abhorrent to anyone who believes people should be rewarded according to what they achieve. What is fair about an indolent spendthrift being rewarded at the expense of the diligent and thrifty?

The issue of fairness is one to be debated rather than presumed. It seems the Group has already formed the view that fairness is a society where the tax system creates income equality. It’s a presumption that needs to be challenged, and I would encourage readers to make a submission to the Tax Working Group to that effect.

With respect to the way property is currently taxed, they say,

Rental property investments are taxed on the ‘net rental income stream’ … but any capital gains…the rental property are normally untaxed…

Any capital gains on non-owner-occupied properties that are bought and sold within [five] years are currently taxable under the bright-line test.

Land affected by changes to zoning, consents, or other specified changes may be taxed on sale, if the sale is within 10 years of acquisition, and at least 20% of the gain on disposal arises from the change…

Land disposals may be taxed if an undertaking or scheme involving more than minor development or division was commenced within 10 years of the land being acquired. Land disposals may also be taxed if…there has been an undertaking or scheme of division or development involving significant expenditure…

In addition, if someone is a dealer in property, or it is their purpose or intention to sell the property for a profit, their gains are taxed as ordinary income.”

Having detailed the multitude of unique ways that gains from the sale of property are treated as income for tax purposes (in contrast to the tax treatment of shares, farmland, and the sale of a business which are not taxed), the report concludes, “real property held for more than [five] years is undertaxed relative to other investments when there are capital gains.”

They arrive at this assumption based on a table of marginal effective tax rates on savings (page 40). This essentially compares the effective tax rate on a range of investments based on the top marginal tax rate and the rate of inflation.[1] However, when considering rental property they assume gains on the sale of a property are not taxed.

The glaring thing about the Group’s marginal tax rate comparison is that it shows that the least taxed investment – the most advantageous from a tax perspective – is owning one’s own home.

There is an inescapable truism in tax policy that no rational person, and few politicians, would dispute: Money flows into the area of least tax.

Because the politicians have categorically excluded the Group from considering a capital gains tax on the family home, a capital gains tax that does not include the family home will result in what is known as the “mansion effect”. The least tax strategy will be to invest in one’s own home, with the intention of down-sizing at some stage in the future to provide a tidy tax-free nest egg.

The inevitably consequence is that houses will be become larger and have more features: swimming pool, tennis court, cinema room, etc. It’s the obvious investment – indulging oneself in luxury and escaping the tax net will be impossible to resist!

Another wealth tax mentioned by the Tax Working Group is land tax (where owner-occupied land, or presumably a curtilage portion of it, would be exempt). They indicate this has the benefit of being easy to administer and would target those owning their wealth in land. More than likely, this tax would be in the form of an additional “rate” paid to central government via local authorities as the collection agents. They ask how Maori land should be treated? They don’t ask what effect it may have on rents when landlords pass those cost on to their tenants.

On the matter of GST, the Group says, “removing GST from some goods and services is often discussed…as a way to ensure people can afford more of these goods and services”. No doubt, the calls for GST to be removed on food will be renewed, but perhaps those who want ‘warmer’ and more ‘affordable’ housing will now call for GST to be removed from home insulation, heat pumps, and building materials.

On environmental challenges, they say, Using the tax system to ensure that consumers and producers face the costs of emissions and other environmental harm could be one way we can meet our international obligations and encourage innovative ways to reduce pollution.” Here they seem to be referring to farmers with greenhouse gas “emitting” livestock. Do you believe agriculture should be included in the Emissions Trading Scheme?

But they don’t stop with methane-belching livestock. “Environmental challenges extend well beyond climate…New Zealanders’ wellbeing is closely linked to the ecosystem services that natural capital provides. Indigenous biodiversity has rapidly declined and continues to be threatened, especially on private land. New Zealand now has one of the highest proportion of native species at risk, and in a review of 71 rare ecosystems in New Zealand 45 species were found to be threatened with extinction. It is possible for pricing and tax instruments to play a role in addressing these challenges”

So it seems, the intention is to use the tax system to meet our climate change obligations and save our biodiversity.

On the taxation of Maori owned businesses, the Group asks for Maori to comment on:

  • Whether the Maori authority tax regime supports or hinders Maori economic and social development.
  • Whether there are parts of the current tax system that warrant review from the point of view of te ao Maori
  • How tikanga Maori might be able to help create a more future-focused tax system.

Clearly, the Group will consider whether tax breaks should be given to Maori, in addition to those that already exist. It is quite conceivable that the group will recommend lower tax rates for businesses involved in the Maori economy. 

They also raise the topic of a “progressive company tax”, in other words, stepped tax rates based on turnover. They ask for comment on how the scheme “might interact with our imputation system (and any proposed CGT on the sale of shares) and what consequential changes would be needed to counteract tax sheltering arrangements”.

There can be little doubt that in contrast to the many previous tax policy reviews, this review is a political instrument to serve the political interests of the Labour and Green parties. That’s even more reason to make a submission. Specific topics to canvas may include:

  • What “fairness” means to you in the context of taxation.
  • The consequences of a capital gains tax that excludes the family home.
  • Whether a capital gains tax should be applied to rental property – in additional to the taxes that already apply.
  • Whether tax laws should favour Maori.
  • Whether the tax laws should be used to achieve environmental outcomes.
  • What GST exemptions should apply, if any.
  • Whether small companies should pay a lower rate of tax than larger companies.
  • Whether ‘wealth’ should be taxed – through a land tax for example.

Submissions must be made by 30 April and can be submitted online HERE or emailed to submissions@taxworkinggroup.govt.nz.

[1]  For example, in the case of a bank deposit returning 5%, a tax rate is 33%, and inflation of 2%, the effective tax rate would be 55% (5% x 0.33 = 1.65% tax vs return of 5% – 2% = 3%. Tax divided by return = 55%). For the sake of simplicity, the tax free rate has been ignored from this example.