Back in early April 2020 I made five predictions about how Covid-19 might change the tax world. I suggested tax rates would rise, the debate around the taxation of capital would intensify, environmental taxes would become more important, the corporate tax take would rise, and the power and reach of tax authorities would continue to increase.
How have those predictions played out? Not too badly as it transpires.
1. In the short-term tax rates will rise
This looks like an easy “Yeah, definitely”, as the top personal income tax rate increased to 39% on income over $180,000 on 1st April this year. The Government has also threatened to increase the trustee tax rate from 33% to 39% if evidence emerges of the widespread use of trusts to avoid the increased top rate.
The introduction of the new 39% tax rate was the first change to tax rates and thresholds since 1 October 2010. As far as I can tell this is the longest period in Aotearoa-New Zealand’s post World War Two tax history without any such adjustments. This has meant that the Government’s coffers have benefited from the ongoing effect of fiscal drag, where wage inflation drags earners into higher tax brackets.
Over time fiscal drag as acts an effective tax increase without the tiresome politics of explaining. The recent Half Year Economic and Fiscal Update noted the effect of fiscal drag without quantifying it but based on the Budget numbers it would appear to be at least $400 million a year.
Another way of increasing taxes without apparently doing so is to refer to the increase as something other than a tax. The United Kingdom government has done this with its “health and social care levy” of 1.25% on earnings for employees, the self-employed and employers.
Taxes on dividend income will also rise by 1.25% and the two measures effective from April 2022 are expected to raise £12 billion annually which is to fund extra spending on health and social care services across the UK. Expect to see more governments take similar action over the next few years.
2. The taxation of capital
The Government might have increased personal income tax rates but as predicted it shied away from campaigning on the taxation of capital. However, as so often is the case, kicking the tax can down the road doesn’t mean the issue has gone away. The alarming increase in house prices has given fresh impetus to the debate. Between April 2020 and November 2021, the median house price nationwide rose 39% from $665,000 to $925,000 with the median house price in Auckland now an eye-watering $1.3 million.
Against this backdrop of rising prices and the growing alarm of those fearing they would be locked out of the housing market the Government increased the bright-line test period from five to ten years with effect from 27th March. It also announced the phased withdrawal of interest deductions for residential property investors starting on 1st October prompting a furious reaction from property investors.
The bright-line test was introduced on 1 October 2015 to target property speculators who bought and sold property within two years. With the extension of the test period to ten years it is now to all intents and purposes a de facto capital gains tax (although it should be noted existing tax law does tax certain property disposals which occur within ten years of acquisition).
A capital gains tax (CGT) is often proposed as an answer to the issue of under-taxation of capital. However, CGT is a transactional tax which only arises on the disposal of assets. One concern about CGT is the “lock-in effect” whereby people hold onto assets to avoid triggering a CGT charge. Even if the Tax Working Group’s proposed CGT had come into force on 1st April 2020 as intended, only gains from that date would have been taxed. Furthermore, family homes would have been excluded so CGT’s utility in reining in house prices would be limited.
But Jacinda Ardern has ruled out a CGT for the duration of her time as leader of the Labour Party and combined with the drawbacks of a CGT noted above, it’s very hard to see a general CGT becoming a reality in the near future. The difficult politics and the technical issues with a CGT are why Associate Professor Susan St John and I proposed the alternative Fair Economic Return (FER) which taxes the net equity in housing above a threshold. We consider FER superior to a CGT in that it provides a means of taxing the huge surge in the value of residential property without the drawbacks of the lock-in effect or the definitional issues of excluding the family home.
The debate around the taxation of capital and wealth isn’t just happening here in Aotearoa-New Zealand. In the United Kingdom a wealth tax commission proposed a one-off wealth tax which it estimated would raise £260 billion to help restore the UK’s battered finances. In the United States the Biden administration is proposing an increase in the tax payable on capital gains for those with income exceeding US$1 million. Meanwhile China is about to trial new property taxes in several cities as part of President Xi Jinping’s wish to curb excessive wealth and promote “common prosperity”.
As former TWG member Professor Craig Elliffe remarked in a recent Te Wiki o te Tāke podcast
there's a pretty reasonable chance that at some point in time in this country, we will have additional tax on capital because the current proposition is largely unsustainable as the population ages. The long-term Treasury forecasts suggest that something has to give.
I agree. It is a matter of when not if that change happens. The debate will continue and intensify.
3. Environmental Taxes will be more important
The recent COP26 summit has highlighted the growing gap between promises of climate action and delivery. At the same time the protests against the “ute tax” have underscored the political difficulties involved. For all the noise and protests I consider it inescapable that taxes will have a key role in meeting Aotearoa-New Zealand’s emissions targets.
The TWG recommended increasing the Waste Disposal Levy at landfills that accept household waste. The Government has proceeded with this recommendation starting with doubling the rate to $20 per tonne as of 1 July, the first of a series of increases which will mean that from 1 July 2024 the levy will be $60 per tonne. Critically, the additional revenue from the waste levy will be used for initiatives that support waste reduction, such as building New Zealand-based recycling infrastructure. This approach of recycling funds raised from environmental taxes seems the best means of overcoming the protests.
Auckland Council’s proposed Climate Action Targeted Rate is another example of this approach. It will raise $574 million over ten years but gain access to another $471 million through central government co-funding and other sources. It will be interesting to see whether other councils choose to follow Auckland’s lead.
The ute tax should be viewed in the context of the Government’s clean car standards and the urgent need to address transport emissions which grew by more than 70% between 1990 and 2016, representing the fastest-growing source of emissions over this period according to the Productivity Commission.
I predicted an increase in Inland Revenue audit activity around compliance with the work-related vehicle exemption but to date that has not emerged. That appears to be a combination of resources diverted elsewhere because of the pandemic and some lack of enthusiasm on the basis of little expected return. Now Inland Revenue has completed its Business Transformation project further resources should be available. It will be interesting to see how this plays out. The scope for using environmental taxes to reduce emissions is significant in my view but their use will only be acceptable if the funds raised are recycled to aid emitters change their behaviour.
4. The corporate tax take will rise
Prior to the pandemic the OECD had been leading an initiative to reform international tax which seemed to be gathering momentum before negotiations stalled in the wake of opposition from the Trump administration. Then Covid-19 happened, and I speculated
For a brief moment, I can see the OECD and the US government's intentions aligning, resulting in a relatively quick agreement on the changes to multinational taxation.
In fact, it took the election of Joe Biden as President to shift the dial at which point things did start to move quickly. The result was agreement by the G20/OECD for a global minimum tax rate of 15% and changes to the taxation of the world’s largest multinationals (the “Pillar One” reforms). Aotearoa-New Zealand stands to benefit from this agreement, particularly in relation to the tax paid by the digital giants such as Facebook and Google.
That wasn’t all. The Biden administration initially wanted an increase in the US corporate tax rate of 21% to 28% although the latest proposals before Congress would mean the tax rate increasing to 26.5%. Elsewhere, the United Kingdom proposes to increase its Corporation Tax rate from 19% to 25% from 1 April 2023 and the Netherlands cancelled a proposed cut in its corporation tax rate.
Here in Aotearoa-New Zealand the corporate income tax rate at 28% is well above the OECD average of 22.9%. However there appears little prospect of a rate cut (particularly after the last rate cut from 30% to 28% showed minimal increases in foreign direct investment into Aotearoa-New Zealand).
Internationally, corporation tax rates have been declining since the 1980s. The pandemic has brought an abrupt halt to that process, and my guess is it is doubtful that trend will resume much before the end of this decade.
5. The power and reach of tax authorities will increase
A recent Taxation Review Authority decision highlighted the extent and global reach of Inland Revenue’s powers. As part of an investigation into the sales of five properties made by an individual claiming to act under a power of attorney on behalf of Chinese residents it contacted the Chinese State Taxation Administration (the STA) for confirmation this was the case. The information supplied by the STA contradicted the claims of the individual and Inland Revenue therefore assessed him for almost $950,000 in tax and penalties. The TRA upheld the assessments.
Inland Revenue used a specific existing power under the double tax agreement with China. This is the first time I’ve seen this power used in what was a relatively routine investigation, generally these information gathering powers are used in transfer pricing cases involving multinationals. But it is a good example of the powers available and how they can be employed.
Quite apart from the powers available to tax authorities under various international agreements anti-money laundering initiatives have seen many countries including the United Kingdom establish registers of trusts. In the wake of the Panama Papers the Government introduced a register for foreign trusts which promptly saw the number of such trusts decline sharply. There is a growing debate over whether these registers should be open to the public in the same manner as the Companies Office register.
The Government has not proposed a central register of trusts but late last year granted additional powers to Inland Revenue as part of the tax bill introducing the new 39% rate. The first requires trustees to include more detailed financial information when filing a trust’s tax return for the year ended 31st March 2022. However, the legislation contains a provision that if Inland Revenue reviews a return and finds something of concern, it can request the same information for the previous eight income years, which means it could go as far back as the year ended 31st March 2015. This new power was introduced to buttress Inland Revenue’s monitoring of attempts to circumvent the new 39% tax rate after the Government chose to ignore Inland Revenue’s recommendation to also increase the trustee income tax rate to 39%.
The second provision enabled Inland Revenue to request information for the purposes of determining tax policy. This was the precursor to Inland Revenue’s High Wealth Individual research project into the 400 richest individuals in Aotearoa-New Zealand. The project is intended “to fill a gap in our knowledge of effective tax rates in relation to economic measures of income, particularly for high-wealth individuals.”
Both initiatives have provoked fierce criticism which will probably intensify when Inland Revenue begins its work in earnest. However, against the backdrop of the global expansion of these powers I suspect it is already too late to reverse these initiatives.
It’s only just begun…
Incredible as it sounds, we have just entered the third year since the pandemic began. The fiscal impact of the pandemic on government budgets all around the world has been immense. Governments have had to spend up large to support businesses and individuals affected by the pandemic whilst simultaneously their tax revenues shrank. So far Aotearoa-New Zealand has managed this relatively well – the economy has proved stronger than expected and as a result tax revenue has rebounded strongly and is expected to exceed $100 billion for the first time in the current year to 30th June 2022.
However, apart from the immediate financial cost of the pandemic, Covid-19 has also highlighted other fiscal pressures which have largely been ignored until now. The pandemic delayed publication of Treasury’s Statement on the Long-term Fiscal Position on Aotearoa-New Zealand’s fiscal position over the next 40 years until September this year. In it Treasury concluded
The impacts of an ageing population, climate change and historical trends mean governments have important choices to make to ensure debt remains prudent and supports higher living standards for future generations.
As if this wasn’t warning enough, prominent economist Brian Easton believed Treasury had not accounted for the “rising public demand for environmental services; that means increased government spending”. Easton concluded this increased spending would inevitably lead to tax increases.
Ongoing issues such as housing, climate change and inequality together with the longer-term fiscal outlook suggest that changes to the tax system and increases are inevitable in the wake of the pandemic. However, this apparently unstoppable wave has to overcome the immovable objects of the difficult politics of raising taxes and massive self-interest. I suggest now is the time to begin serious discussions about how the tax system will evolve to meet these growing pressures.
Terry Baucher is an Auckland-based tax specialist with 25 years experience. He works with individuals and entities who have complex tax issues. Prior to starting his own business, he spent six years with one of the "Big Four' accountancy firms including a period advising Australian businesses how to do business in New Zealand. You can contact him here.