By Bernard Hickey The Tax Working Group is set to suggest in a report on Wednesday afternoon that the government broaden and tighten the tax system to reduce the incentives that are unbalancing the economy in favour of property investing and against business investing. But the group of academics, business leaders, economists and bureaucrats that were asked to suggest revenue neutral tax changes will stop short of recommending radical reform, or anything that would break Prime Minister John Key's election promises. It is possible the government could adopt some of the reform proposals in its May 2010 budget. Working papers prepared for the group and comments over recent months from the members of the group suggest they have settled on a series of tax reform options ranging from the politically and economically easier to the most difficult. The group's report is due at 1pm on Wednesday. I will be in Wellington covering its release. What's likely to be in The likely reform options in order of political and fiscal pain include;
* Denying depreciation of buildings as an expense for tax purposes, which would increase tax revenues by NZ$1.3 billion; * Removing the ability to claim an accelerated depreciation rate on new buildings, also described as removing depreciation loading. This would generate an extra NZ$600 million in revenue; * Tightening the 'thin capitalisation threshold' for debt on foreign owned assets to 60% of assets from 75%, which means foreign owned companies could not claim as much interest as a taxable expense. This would lift revenue by around NZ$180 million. * Introducing a tax on property investors' equity using the Risk Free Rate of Return Method, which could raise up to NZ$760 million per year. * Introducing a land tax of 0.25% with a relatively high tax free threshold of NZ$50,000 per hectare to avoid penalising farmers, foresters and Maori trusts. Pensioners owning high value land but having little income would be able to defer the tax until sale or death. Such a tax could raise around NZ$1 billion per annum * Cutting the 38% top income tax rate to equalise with the 33% family trust rate, or cutting them both to match the corporate tax rate at 30%. A cut in the top income tax rate and family trust rate to 30% from 38% and 33% respectively would cost NZ$1.6 billion. * Aligning the top income tax rate, the corporate tax rate and the family trust rate at 27%, which would cost NZ$3.1 billion. * Introducing a tax on the realisation of capital gains that excludes owner-occupied homes, which would raise around NZ$3.9 billion. What's likely to be out The Tax Working Group also considered a range of other reforms which are unlikely to be suggested to the government, either because of a lack of consensus or because the consensus was they were unworkable. These include; * An increase in the GST rate to 15% from 12.5%, which would only raise an extra NZ$200 million after income tax rebates for poorer consumers and risk compounding the compliance and marginal tax nightmare created by Working for Families. * A broad capital tax, as suggested by group member Gareth Morgan in his 'Big Kahuna' proposal, which also included a guaranteed minimum income to replace all benefits. This was seen as potentially chasing away more mobile investment and also was outside the brief of the working group to focus on revenue neutral tax reform rather than government spending reform. * A comprehensive capital gains tax that included residential property, which would be broader, fairer and better reduce economic distortions. It was seen as difficult to administer and 'locking in' many property owners reluctant to pay the tax. The unspoken problem is that it was also politically unacceptable to Prime Minister John Key. * A 1% land tax without a tax free threshold or the ability to defer payment until death. This is seen as too tough on farmers, low income pensioners and potentially land prices, which could fall 15% on such a tax. House (and land) prices could fall 4-8% on such a tax. A 0.25% tax with the ability to defer and a tax free threshold is seen as more politically acceptable and unlikely to move land prices much. What the government could adopt in Budget 2010 John Key has returned from his holiday (where he read a draft version of the Tax Working Group report) more determined to reform the tax system to promote economic growth. He has indicated he favours income tax cuts. There is a collection of reforms that would not break his election promises, would significantly rebalance the economy, and would be revenue neutral. Assuming Key and Finance Minister Bill English maintain a politically conservative stance, my bet is the following package could be included in the May 2010 budget: * A package of smallish taxes aimed at property investors to raise NZ$2.1 billion, including the changes to claiming depreciation as a taxable expense and the thin capitalisation change. * This would fund the NZ$1.6 billion needed for a cut in the 38% top income tax rate and the 33% family trust rate to match the corporate tax rate at 30%. If Key and English were to take a more aggressive approach, they could do all of the above plus: * Introduce a 0.25% land tax with a NZ$50,000 per hectare tax free threshold and the ability to defer payment, raising NZ$1 billion and not hitting land prices much; * Introduce a tax on equity invested in property using the RFRM method to raise NZ$760 million; * These would help pay the extra NZ$1.6 billion needed for an equalised cut in the income tax rates to 27%. This may be needed to match an expected cut in the Australian corporate tax rate to 25%. My view I would like to see the government introduce all of the more aggressive options above, but with the addition of a capital gains tax on residential property to help pay for a cut in the income tax rates to 25%.