By Bernard Hickey
The Tax Working Group has recommended a range of taxes on property investors to help pay for a cut in the top personal tax rate.
It said in a 74 page report that a comprehensive package of tax reform was needed to broaden and tighten the tax base in a way that would strengthen economic growth and stop a flight of mobile labour and capital to lower tax regimes offshore.
(Update 3 includes link to report and initial reaction from Bill English Also provides more details on RFRM tax, land tax and comments from news conference on GST)
Here are the key recommendations of the group of academics, accountants, lawyers, economists and business leaders;
* Align the top personal tax rate with the family trust rate as a first priority, with the preference eventually for a fully aligned system that includes the corporate tax rate. Options include cutting the 38% and 33% personal tax rates to 30% and cutting the family trust rate to 30%. Another option is a cut in all the rates to 27%.
* Keep the corporate tax rate competitive with Australia, which may mean cutting it from 30% before any Australian move.
* Retain the imputation credit system for tax on dividends, but review it if Australia drops its imputation credit system,
* Tax returns from capital invested in residential rental property through a 'RFRM' tax on equity invested, and a small land tax. The Risk Free Return Method (RFRM) would impose tax equivalent to a risk free return (say 6%) on the equity invested in a rental property. The land tax suggested in earlier working papers was 0.5% with a NZ$50,000 tax free threshold and the ability to defer payment until the property is sold.
* Remove the 20% depreciation loading for new plant and equipment.
* Remove the ability to claim depreciation on buildings as a taxable expense if empirical evidence shows they do not depreciate in value.
* Change the thin capitalisation rules by lowering the debt threshold to 60% from 75%, which would force large foreign owned corporates to pay more in tax.
The Tax Working Group virtually ruled out a GST increase or a Comprehensive Capital Gains Tax, arguing they were administratively difficult. Other news outlets reported that a GST increase was recommended, but it was clear from the news conference and the report itself that there was not widespread support for an increase to 15%, given it would have to include compensation and have to involve income tax rebates for the poor.
The net revenue would be around NZ$200 million, which makes such an increase unattractive given the likely compliance and operational costs associated with it.
"Most members of the Group consider that increasing the GST rate to 15% would have merit on efficiency grounds because it would result in reducing the taxation bias against saving and investment. However, any increase in the GST rate would need to be accompanied by compensation to those on lower incomes. This would significantly reduce the net revenue raised from a higher GST," the report said.
System broken
"Put simply, the tax system is broken and needs to be fixed," said Professor Bob Buckle of Victoria University, which coordinated the operation of the Tax Working Group.
"We think there is a once-in-a-generation chance for New Zealand to get a world class tax system, one that's set up to meet the challenges of the 21st century," Buckle said. The report and its recommendations were in line with my preview published last night.
My view
The Tax Working Group has followed its brief of finding a set of tax reforms that would make a difference to the economy and be both revenue netural and politically acceptable. That is no mean feat and will challenge the government to make significant tax reform in the May 2010 budget.
Essentially it is proposing a new set of taxes on property investors to pay for cuts in the top personal income tax rates and possibly a cut in the family trust and corporate tax rates. It has also sensibly steered clear of a wholehearted endorsement of an increase in the GST rate to 15% or a full Capital Gains Tax. Both would be politically distracting from the main task of rebalancing the economy by broadening the tax base to property investment and removing massive incentives to avoid tax.
Heartening comments from John Key yesterday (who read the draft of the 74 page Tax Working Group report over the Summer Holiday) mean there is a significant chance of reform that would make a difference.
The combination of new property taxes and income tax cuts would have a good chance of delivering the longer term boost to economic growth that both John Key wants and the government's budget needs.
The key factoid in the report and the one that shifted the debate is this: NZ$213 billion is invested in rental property and those assets made a combined loss of NZ$500 million in 2008, reducing tax income by as much as NZ$200 million. This is clearly unsustainable.
The amount invested in rental property is four times that invested in the stock market and it is essentially untaxed. Decisions are being made for tax reasons, not because they make economic or business sense.
John Key cannot brush this report aside in the same way as the 2025 Taskforce report was flicked away for being too radical and doctrinaire. The Tax Working Group report is a sober and careful collection of proposals that have the majority backing of technocrats, business leaders and economists. It is essentially apolitical, which makes it impossible to ignore in an MMP environment.
Let's see what John Key and Bill English do now. If they ignore it, they are essentially saying they are not reformers and will not listen to the best advice in the country. The May 2010 budget could be very significant indeed.
Initial reaction
Finance Minister Bill English and Revenue Minister Peter Dunne said the government would carefully consider the report as part of the budget process. The report identifies a number of issues with the structure, coherence and sustainability of the current tax system, and proposes several interesting and practical options for dealing with them, they said.
"The Government's focus in 2010 is increasing New Zealand's economic growth and productivity," English said.
"There is no doubt that good tax policy can play a role in that. For ordinary New Zealanders, we're particularly keen to ensure that our tax system rewards effort, encourages savings and helps families to get ahead," he said.
"At a broader economic level, we also want a tax system that helps move us away from our recent preoccupation with borrowing and consumption, at the same time recognising that any changes must be broadly fiscally neutral given that we face several years of budget deficits."
Dunne said he welcomed the group's call for any changes to be politically sustainable.
"I note the Working Group's concerns regarding the misalignment of tax rates which encourages the use of trusts and companies, with a tax rate of 33 per cent and 30 per cent respectively, to shelter income that would otherwise be taxed at the higher personal tax rate of 38 per cent," Dunne said.
"This is inherently unfair to the wage and salary earner who is then left to bear a disproportionate share of the personal tax burden," he said.
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