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April 10 newsletter

Putting some context around the possible tax changes

The Tax Working Group (TWG) released their recommendations (PDF download - http://www.victoria.ac.nz/sacl/cagtr/pdf/tax-report-website.pdf) on changes to the New Zealand tax system in January.

While there has been the expected avalanche of criticism of some recommendations, we thought it would be useful to pass on some thoughts about the report including the context in which the recommendations were made.

The major recommendations of the TWG and possible acceptance or not of those recommendations by the Government have been reported with varying levels of vigor by the general media. These include aligning the corporate, top personal and trustee tax rates, implementing a land tax and making changes to some depreciation rates. However it was the ideas of increasing GST and lowering the top personal tax rate that had the media in a frenzy.

The purpose of this newsletter is not to weigh into the debate on whether the proposed changes disproportionately affect certain parts of society but to highlight the thinking of the TWG on why they made the recommendations they did. And more importantly why their recommendations were based on sound reasoning and were not an attack on the less well off.

Who was the Tax Working Group and what did they say?

First who were the members of the TWG? A bunch of guys that included Arthur Grimes, Gareth Morgan, John Shewan and Mark Weldon. They were ably assisted by some smart people from the Inland Revenue and Treasury. “Other attendees included” Alan Bollard, Peter Conway and Susan St John. The point is that it included some smart, knowledgeable people.

The TWG essentially said the current New Zealand tax system is broken. “The tax system lacks coherence, integrity and fairness”. For example, they argue that the wealthy can structure their “affairs through trusts and companies to shelter income”. Further, relying on personal income tax is dangerous to the health and growth of the economy. The TWG believed that there are “significant risks to the sustainability of the tax revenue base”. Simply put, those who pay the most in income tax are the most qualified and mobile and can head to warmer climates faster than you can say “who is going to pay for the Gold Card Waiheke ferry perks Winston?”

Reducing the personal tax rates encourages effort, increases economic growth and will help retain in New Zealand the group of tax payers who do actually pay most of the tax. “The top 10% of income earners now pay 44% of all personal income tax” (if the impact of benefits is included they “now pay 76% of net tax”). You really want them to stay.

What about the Working for Families (W4Fs) abatement rate of 20%? A family with an income above $50,000 who receive W4Fs has a marginal tax rate of 53% not 33%. So for each extra dollar they earn, they pay tax at 53%. Might that stifle the incentive to work extra hours or study for a promotion? But maybe what really is a concern is that “Working for Families means that over 40% of households pay no income tax or receive net transfers”.

If it's broke, what could we do?

If we accept that there is a problem with tax system, what can we do about it? The TWG made a number of proposals. These proposals were designed to broaden the tax base, which would help increase economic growth and ensure the sustainability of the tax base over the longer term.

The Government is, with varying degrees of enthusiasm, considering increasing the level of GST, reducing personal income tax rates, aligning the personal, corporate and trustee tax rates and removing some depreciation. What they may add to that list is some form of capital gains tax on residential property. the Shape of Money liked ring-fencing losses on residential property but apparently that is too easy to beat. Finally, we were surprised that land tax was not included. If they thought that was a political hot potato, then increasing GST is a red-hot poker (literally and figuratively we suspect).

Why you should stay awake in class

In summary I wasn’t the guy asleep on page 8 of the report. But critics of the report and proposed recommendations are asleep to the long-term risks of where the future health, welfare and education funding will come from. For those who disagree with the recommendations of the TWG and want to propose their own ideas, a good place to start is by reading the background papers (pages 68 and 69 of the report).