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Terry Baucher sees tax cuts and capital gains back on the agenda, the IRD targeting the hospitality industry, and the OECD reckons international tax reform could collect US$100 bln annually

Terry Baucher sees tax cuts and capital gains back on the agenda, the IRD targeting the hospitality industry, and the OECD reckons international tax reform could collect US$100 bln annually

Last week began with Simon Bridges, the National Party leader, outlining the party's proposed economic platform for the coming year. And in that speech he alluded to the expectation of tax cuts before, in what was possibly a casual use of language, he said that persons on their average wage should not be paying a third of their income in tax.

This prompted a bit of a pile on because it was quickly pointed out that someone earning the average wage of about $65,000 per annum pays on average 19.2% in income tax. And in fact, some nerd calculated only a person earning $3 million or more, would actually have an average income tax rate of 33%.

And this is a reflection, as I explained to Wallace Chapman and the Radio New Zealand panel on Tuesday afternoon of our progressive tax system. As your income rises, the tax rate rises starting at 10.5% before reaching 33% on income over $70,000. But the point I made is that the rates jump quite sharply from 17.5% to 30% at the $48,000 mark. And so, the question should be whether those thresholds and rates are appropriate.

And interestingly, when looking at this in preparation for speaking to Wallace Chapman, I went back and just see how often the tax thresholds have been changed. As I explained, 33% cent has been pretty much been baked in since 1989 with the exception of the period between 1999 and October 2010, when it was increased to 39% before dropping back slightly to 38%.  The threshold has varied obviously during that time, but over the past 30-year period, the top rate threshold has only been adjusted six times by my reckoning. Six changes of thresholds in 30 years is actually quite surprisingly low.

Many other countries adjust for inflation. Britain does. And it's a mandate in the UK tax legislation that if you are not adjusting income tax thresholds, you must specifically legislate to not do so. My view is that something like that should be in our tax legislation, because otherwise politicians are able to claim tax cuts when in fact we're dealing with something which is no more than an inflationary adjustment.

But the tax pressure point for people is not, in my view, around the 33% top rate, even if it is perhaps low by world standards. But on that threshold, around the $48,000, when someone moves from 17.5% to 30%. That's quite a significant jump of twelve and a half percentage points and quite a lot of other things are happening at the same time. Working for families’ abatements are kicking in at 25 cents on the dollar for income above $42,700 dollars. For someone who's on or near average wage or possibly a bit below and maybe receiving working for families’ tax credits, they have a quite significant jump in their marginal tax rate jump.

They go from 17.5% to 30% and then they have an effective 25% on working for families’ abatements.  And it’s not inconceivable they might also have a student loan in which case they lose another 12% of their income anyway if it is just over $20,000. So, it's not impossible for someone earning around $50,000 to have an effective tax rate of 67 % or more. That is 30% income tax, 12% on the student loan and 25% working for families’ abatement.

We're going to see something this election from both sides of the spectrum about tax and this is an area where I believe the parties that want to sell their tax policies on need to focus on. It's that low to middle income earner, moving up through thresholds who is definitely most in need of some form of tax adjustments.

Then at the same time, no fewer than three separate bodies popped up with the capital gains tax issue. And I can probably now say I told you so. Because those who listen to the podcast will know that I said at the start of this decade, not so long ago, that I expect that capital gains tax debate to re-emerge. I have to be honest; I didn't think it would happen so quickly.

We had the Helen Clark Foundation releasing a paper on housing affordability in which it proposed a capital gains tax. There was an interesting snippet in there, which highlighted one of the reasons why our housing is so expensive, but I think also should be of great concern to us economically.   The report said and I quote,

Loose regulation of mortgage lending. Buyers in New Zealand are borrowing up to 7.5 their income, compared to 4.5 times in the United Kingdom has allowed prices to inflate rapidly.

Seven and a half times income is a quite frightening statistic in my mind, because it means that those people who are taking mortgages at that level have absolutely no margin for error if, actually it's not if it's when interest rates rise. So, the hope obviously from that group of people is that the equity in the house keeps ahead of the potential risks that they have an interest rate rise and that their earnings rise substantially to bring down that income ratio.

Then we had Dominic Stephens of Westpac. He highlighted the problem that house price inflation has picked up, again, as he predicted, with the non-implementation of a capital gains tax. 

And finally, we had the United Nations Special Rapporteur Leilani Farha from Canada damning New Zealand's housing crisis, calling it a perfect storm.

And she called for a capital gains tax as well. So, an interesting trifecta of opinions on the matter.

And like I said, at the start of the year, we're going to see more about this. This issue isn't going to go away. Whether or not capital gains tax is an appropriate tool for resolving the housing matter is obviously up for debate. I think it's one of the tools that should be in the box. But I'm also wondering whether there are other options that should need to be engaged as well from the tax side. But never mind that issue. That debate is going to keep strengthen over the coming years.

Moving on, we got an email from Inland Revenue who do like to keep in communication with everyone much more now under their upgraded system.  It told us, quote, “We'll be contacting your clients in the hospitality industry to thank them if they've been keeping their books in order.” Which I thought was a marvelously passive aggressive way of saying ‘if they've been keeping good books in order, great. If not, we'll be asking questions’. And the email actually goes on to say, “we'll also be encouraging our clients to put their records right if they've left anything off their past tax returns”.

Passive aggressive tones aside, this is something we're going to see a lot more of. Inland Revenue is going to get very specific about targeting particular industries and it's going to be very vocal about what it's going to do and how it will go about it. The message will be sent out to tax agents, hospitality industry associations, etc. They'll be told, ‘We're going to look at this, so pass the word along to your members’.

And to be honest, I think that's a good approach because to apply Gresham's law, bad money will drive out good.  Those sorts of operators who are undercutting other taxpayers who are fully compliant are a risk to the whole sector as well as simply leeching off the system in that they expect the full availability of public services but aren't prepared to contribute fully to that. And that, incidentally, is Inland Revenue’s messaging.

I see that, by the way when I get communications from the UK’s H.M. Revenue and Customs they have the same slightly passive aggressive tone to them, saying if you've not paid your tax on time, then you are not funding hospitals, roads, schools, etc.

So the messaging from tax authorities is changing in this area. But the key takeaway here, and you can't say you weren't warned, is that if you're not compliant Inland Revenue will be asking questions. And I really do say that it is a question of will, not if.  It would be foolish to pretend because compliance in the past has been monitored inefficiently that it will continue to be the case. That most definitely isn't the case. Everything I see in my interactions with Inland Revenue at either an operational level or talking at the higher policy level points to much more sharply tuned tools being employed more quickly to deal with matters like this.

And talking about dealing with matters of tax compliance or in this particular case, tax avoidance, the Organisation for Economic Co-operation and Development has just published an estimate of what it thinks will be the potential benefits from reform of the digital economy.

Several matters came out of this. We have this ongoing what they call the Pillars 1 and 2 approach and so far, according to the latest report given to the G20, they are still confident they can nut out something on this matter by the end of the year.  Now what is obviously going to get the tax authorities and governments interested, is that the OECD estimates the combined effect of Pillars 1 and 2 as potentially bringing in up to 4 % of global Inc corporate income tax revenues, which is equivalent of U.S. $100 billion dollars annually.

The interesting thing they also say which will also encourage buy in from governments is that the revenue gains are expected to be broadly similar across high, middle- and low-income economies.

A 4 % increase in corporate income tax take here in New Zealand would amount to if my calculations are correct over $650 million annually based on the current income company income tax take of $16.4 billion, that's a very tidy sum of money.

I have to say, I doubt whether in fact we would benefit as much as that. We're very much a price taker in these matters as those who deal more in this international tax space have pointed out. So, I think the benefit will be substantially less than $650 million annually, but still very much worthwhile for our government to buy into the OECD’s approach. But we shall have to wait and see, and I will keep you informed as news emerges.

Well, that's it for the week in tax. I'm Terry Baucher and you can find this podcast on my website or wherever you get your podcasts. Please send me your feedback and tell your friends and clients. Until next time have a great week. Ka kite āno.

This article is a transcript of the February 21, 2020 edition of The Week In Tax, a podcast by Terry Baucher. This transcript is here with permission and has been lightly edited for clarity.

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Another incisive commentary, great fodder for the week ahead. On Greshams theorum, I think we are already long past the point of that kicking in, the compliance issues in immigration, construction and migrant exploitation top my list of concerns. Is it too much to ask for the specified concrete to actually be used? After all its only the foundations!
On run away house prices, I'd very much like to see a leader come forward and make the captains call we all know has to be made but in our typical kiwi non confrontational manner simply refuse to deal with it even as the problem stares us directly in the face. On indexing income tax really has been baked in and is long over due for a revamp!

Without going into the relative merits, or not of capital gains taxes on residential property, another line of debate leads me to ask if a capital gains tax is the equivalent of the ambulance at the bottom of the cliff? Another commenter on another article (which i cannot currently find easily) suggested that the current housing mess is the result of Governments failing to regulate. So if they regulated properly around foreign buyers, investment into rental properties, vacant properties and rental property standards, and what standards you (as a person) must meet to be able to rent out a property, would the issues around exorbitant housing costs including price, and rent just go away?

It would seem to be a good wager that Labour has already in mind some new tax mechanism(s) a wealth tax on land value ranging through to the re-introduction of death duties. For certain not all of the frustrated ambitions of the Clark/Cullen government were tabled by the working group, far from it. If the current PM should step aside mid term, then that reopens the CGT potential and if it ends up being a government of solely Labour and the Greens it will undoubtedly be a full frontal attack on every eligible NZ tax payer who is above the breadline.

Foxy, I understand the point you are making, but you don't answer my question. Tax and specifically CGT is a very crude tool, which IMHO, won't achieve much other than give some socialists a degree of satisfaction, so I ask if a better, and fairer outcome could be achieved through regulation?

tks Murray and agree my post my usual sort of generalisation and in this case that Labour, apart from the Lange/Douglas government, view an increased tax take as some great panacea. From my point of view the other end of the stick is more important, that being reining in the utter squandering & extravagance of national and local governments and lifting NZ’s productivity and thus lower the dependency on welfare.

I think a lot of socialists think tax is some kind of panacea, but in reality it is rooted in envy/jealousy. I suggest a much better and fairer outcome would be achieved by better, robust regulation.

Thanks again Terry. A tax overview for dummies like me to understand & hopefully learn from. Re housing; It's a land tax from me for the future. They're not making much more of it so it demands & deserves a premium. Land owning is the wealth of choice throughout the ages. As for income tax, I'm being screwed so any help here would be welcome.

Given we can't manage land supplies as they stand, there's a huge agency issue in giving public bodies with no meaningful incentive to keep costs down the ability to levy on a resource they've shown a total inability to allocate sensibly.

Eh, it worked in NZ's history before, has been used elsewhere too, and as Milton Friedman points out, it has the advantage of being impossible to evade.

It would be good to tax a little more of the easy money and tax productive business a little less to encourage more human enterprise and drive.

I'm always surprised that there is no 0% tax bracket, and that it is handled by collecting it then paying it back in tax credits. Surely there would be a reduction in admin overhead cost if that wasn't the case?

I also assume that you can structure things in such a way that your income for the purposes of RWT is $48,000 but that you get dividends from your company through a portfolio investment entity at 28%, so you would never pay 30% or 33% on your income even if you earned millions?

You are still liable to pay the tax on the dividend on your personal marginal tax rate. It has to go in your tax return and the tax difference paid. However, I do not know if this is something important for the IRD and whether non-compliance is deterred through robust policing.

1 ) Tax thresholds - I've often wondered why we simply don't use a continuous function (sloping line) for tax rates. For any marginal tax rate your actual tax payable would be half (1/2 * base * height). If needed, beyond a certain income it could be flat lined, eg 33c/$.

2) Capital Gains Tax - no point implementing until the RMA & housing supply is sorted. A CGT would simply increase house ownership and decrease available rentals, pushing up the costs for the most vulnerable.

If the Government had introduced a CGT prior to all the tenancy changes, then landlords would be thinking twice about selling up just because owning a residential investment property got hard. They would have to balance the cost of updating their properties with the tax they would be paying if they sold. They also wouldn't be able to just push rents up unreasonably to pay for the maintenance and renewals.

Ha ha CGT, more for the lower & mid income? then increase the rent & housing.. CGT.. dare you.. says Greta..

What were the main points again as to why CGT wasn't implemented when it was indicated as desirable by the Tax Working Group that we paid for?

Its a fallacy government spend money better than consumers.

Other option for paye tax could be calculated on the basis of an hourly rate (inclusive of allowances), rather than gross income. This would encourage hard work.

Of course we need tax reform ......................take less from working folk , and we may not have to give people their own hard-earned money the money back in hardship allowances, accommodation subsidies and have the problem of needing middle class welfare

Something that we haven't heard of for a while. A Tobin Tax. Why not? 0.1 _ 0.2% on all transactions would make no difference to real world transactions. $100 million on $100 billion. We used to be told that enormous sums of money flowed through the country by way of currency trading and other forms of non productive activity, so these could give a very large return and or reduce the impact that that these flows have on our currency and economy.
When it was raised originally, John Key's reaction was more visceral than I have ever seen from him. His veneer slipped really badly. His loyalties lie with the slithering big boy money manipulators. (Ex Merrill Lynch head of currency trading - What more can I say) That makes me think that his reaction is good reason why we should look at it very closely.