By Alex Tarrant
The government may soon face the difficult choice of changing New Zealand's tax structure to better incentivise savings and investment and further disincentivise property investment, Treasury says.
One of Treasury's immediate priorities is to review how savings and investment are taxed, while the Productivity Commission may also recommend tax changes to help make housing more affordable when it releases its report to the government on March 23.
Poor investment and savings performance in the economy was creating challenges for the government, including New Zealand's tax system, Treasury says in a flow chart accompanying a speech by Secretary Gabriel Makhlouf to the International Fiscal Association in Queenstown on Saturday.
"New Zealanders do not save as much as citizens from other countries. Additionally, the mix of savings may be distorted due to tax reasons. The Productivity Commission is investigating housing affordability and is looking at tax settings," Treasury says.
"Whether or not tax plays a major role in capital allocation is difficult to answer – New Zealand has a culture of property ownership (although perhaps this in itself is driven by tax)," it says.
"Ultimately, there is underlying concern with the allocation of capital in the New Zealand economy. If further work supports substantial reform, Ministers may face a difficult strategic choice between the current well-regarded model and something else," it says.
Changes in tax rates would affect incentives to save and invest: Higher levels of capital investment generally increased productivity and economic growth.
Meanwhile, the level of capital invested by non-residents was considered to be more sensitive to tax than the level of capital invested by residents.
"Different patterns of capital investment, influenced by tax structure, can have different effects on economic growth. Because of the different regimes in place and the effects of inflation, income from different assets is taxed inconsistently," Treasury says.
"Debt instruments are taxed at the highest rates. Owner-occupied housing has a zero percent effective tax rate (no tax on imputed rents and no tax on the capital gains). Other investments fall somewhere in between these," it says.
In its 2010 Budget, the government moved to disincentivise housing investment by taking away property owners' ability to claim depreciation on properties with expected lifespans longer than 50 years, a move it claims has gone some way to achieving its goal.
Finance Minister Bill English has said the government is still looking at whether to index interest rates for inflation, which would make vehicles like term deposits more attractive, and mean property investors would not be able to write off as much mortgage interest against other incomes.
That works by only allowing the real interest rate - adjusted for inflation - be be taxed in the case of term deposits, and onlt the real mortgage interest allowed to be deducted against a property-owner's income.
Cold water on Tobin Tax
Meanwhile a Tobin tax, or a tax on financial transactions, was a solution looking for a problem, and has no place in New Zealand's tax system, Treasury Secretary Gabriel Makhlouf said in his speech.
The idea of a financial transactions tax has taken hold in the European Union, with French President Sarkozy calling for one to be placed on European finanical institutions.
"Nobel-prize winning economist James Tobin came up with the idea. The purpose was to reduce speculation in currency markets, which Tobin thought of as dangerous. Tobin came up with the idea soon after the end of the Bretton Woods system, before which each country maintained its currency within a fixed value of the price of gold," Makhlouf said.
The idea gained popularity after various “capital flight” scenarios in Mexico, Asia, and Russia in the 1990s.
"Somehow, the idea has been resurrected in the aftermath of the financial crisis as a means of raising revenue. Now it seems to be simply an attempt to target banks, or, in some circles, as an anti-globalisation measure. These views seem to ignore the difference between tax liability – who literally pays the tax; and tax incidence – who really bears the cost of the tax," Makhlouf said.
"To the extent the idea is supported by those who oppose globalisation, such support is misguided. Before his death in 2002, Tobin laid out his position [interview with Der Spiegel]:
I am an economist and, like most economists, I support free trade. Furthermore, I am in favour of the International Monetary Fund, the World Bank, the World Trade Organisation. [The Tobin tax supporters have] hijacked my name. ... The tax on foreign exchange transactions was devised to cushion exchange rate fluctuations.
"It’s fair to say that exchange rate fluctuations played next to no part in the financial crisis," Makhlouf said.
"In fact, countries like Iceland, with floating exchange rates and the ability to regain competitiveness by dramatic exchange rate revaluations, are in a much better position than a country like Greece, without the ability to devalue its own currency," he said.
"The Tobin tax is a solution in search of a problem, and we do not see a role for any such tax in New Zealand."
No cut in company tax
And don't expect any further reductions in New Zealand's company tax rate any time soon as the government needed to focus on its main priority of getting the books back to surplus in the 2014/15 year.
"While further company rate cuts may be desirable in the future, in the short term our primary constraint is, of course, fiscal – the need to balance tax revenue with government expenditure. The Government’s strategy is to achieve surplus by 2014/2015, and accordingly, in the short term anyway, reductions in the corporate income tax rate are unlikely," Makhlouf said.
"The second constraint is how we think about alignment between tax on different types of income, and how far we can deviate from the goal of alignment while still retaining income neutrality," he said.
"In an uncomplicated world we would want to align the top personal income tax rate with the corporate income tax rate. Because they are both final rates, we know a six percentage point difference between the top personal rate and the trust rate distorts behaviour and is unfair – the Government changed that in 2010.
"We can live with the current five percentage point difference between the company rate and the top personal rate, with the trust and top personal rates aligned. This is because for New Zealanders, the company rate is an interim rate before any extra tax is paid on dividends. But with a larger non alignment between the company rate and the top personal rate the timing advantage of operating as a company starts to bite," he said.