By Peter Nielson*
We welcome the Chapman Tripp support for the Fair Tax for Savers Campaign proposal to tax only the interest income above the rate of inflation and allow a deduction only for interest costs above the rate of inflation.
The author of the Chapman Tripp Brief wrongly assumes that our proposal is to stop KiwiSavers paying income tax on their KiwiSaver earnings as they are earned and delay payment of tax until the KiwiSaver withdraws their funds at retirement.
No such proposal has been made by the Fair Tax for Savers Campaign.
Chapman Tripp appears to have inadvertently made a “straw man” attack which wrongly assumes that the Fair Tax for Savers Campaign is proposing KiwiSavers pay tax at their marginal tax rate only when they withdraw their savings at retirement, having paid no tax on their KiwiSaver fund earnings prior to that date.
But that is not what we are proposing.
Briefly, we have asked our politicians to “look at making the effective tax rates on savings the same as the marginal tax rates savers pay on their other income”
What this means is that the tax rates on KiwiSaver fund earnings during the period of savings need to be lowered so the impact of tax on those earnings is no greater than the marginal tax rate paid by that KiwiSaver on their other income.
When the Fair Tax for Saver Campaign was launched, along with the media release we distributed copies of the peer reviewed report on “The tax barrier to retirement prosperity in New Zealand” published last year.
That report contains on page 43 the calculations showing that the effective rate of tax on KiwiSaver earnings over 10 to 40 years of saving are considerably greater than the marginal tax rates KiwiSavers pay on their other income.
The Effective Tax Rate impact increases the longer the term of saving
Annual savings required
Impact of tax
Assumptions: 4% real rate of return, 2% inflation, 28% PIR (Prescribed Investor Rate). Required annual savings shown is in 2013 dollars, and is assumed to increase with inflation.
Over 40 years saving someone in KiwiSaver would face an effective tax rate of 54.7% when their KiwiSaver fund tax rate is 28% and the marginal tax rate they pay on their other income is 33%.
You might ask, how can the effective tax rate be so much higher than either the KiwiSaver fund (PIR) tax rate of 28% or the marginal tax rate?
What is the effective tax rate and why does it matter
Suppose your Grandmother gives you a $10,000 gift on your 17th birthday to put in an account earning 6% each year tax free. At a 6% interest rate your savings double every 12 years so 48 years later your account will have grown to $160,000.
Now suppose she gave you $10,000 to put in the same account but now it would face a tax rate of 50% on the earnings, so after tax earnings were just 3%. Now your money only doubles every 24 years, so you get just $40,000 when you get to age 65. As you only receive 25% of the 6% earned tax free your effective tax rate is $120,000 ÷ $160,000 or 75%.
Your marginal tax rate was 50% but the effective tax rate was 75%. The longer you save the higher is your effective tax rate. The tax you pay on your KiwiSaver funds has a huge impact on how fast your savings grow from earnings in the fund as you earn interest on interest.
If we were proposing only to tax accumulated KiwiSaver earnings at the point where the KiwiSaver reaches retirement and at their marginal tax rate, that would be a concession.
However, what the Fair Tax for Savers Campaign is asking is that KiwiSavers not be asked to pay effective tax rates above the marginal tax rates they pay on their other income and to do this by cutting the tax rates KiwiSavers pay on their fund earnings as they are earned.
Last year we modelled the impact of cutting the current KiwiSaver funds tax rates of 28%, 17.5% and 10.5% to 15%, 8% and 4.3% respectively. These reports are available on the FSC website (Can We Fund a Comfortable Retirement for Most New Zealand Employees with a 7% Contribution Rate? and Proposed FSC KiwiSaver Scenarios: The Power of Changing Compound Returns, Taxes & Fees on KiwiSaver Retirement Balances April, 2014 prepared by Infometrics).
Based on 40 years savings these rates bring the effective tax rates close to an individual KiwiSaver’s marginal tax rate. The scenarios for KiwiSavers outlined in the Fair Tax for Savers campaign material used these fund tax rates and kept the current $1,000 upfront incentive and the annual $521 member tax credit.
A 15% KiwiSaver tax rate would be the same as the tax rate Australia levies on its superannuation fund earnings. Australian tax rules recognise the confiscatory effect of high tax rates on long term savings. Australia also has tax concessions for contributions but the Fair Tax for Savers Campaign is not proposing similar concessions for New Zealand.
Our campaign outlines the broad principle but we have undertaken extensive modelling of what is feasible. The 2014 cost of proposed KiwiSaver tax rate cuts would be less than $200m whereas the proposals we have made for indexation of interest income and deductions are estimated to boost Government tax revenue by around $500 million. This is a removal of the over-taxation of KiwiSaver fund earnings and not a concession.
I am happy to defend our actual proposals for KiwiSaver fund taxation as they are much fairer than the arrangements currently in place. I do however, object to being criticised for a proposal we don’t support and did not promote.
Peter Nielson is the chief executive of the Financial Services Council, an organisation that represents the interests of the New Zealand financial services industry. More here.