The government-appointed Savings Working Group has released a number of background papers from Inland Revenue on the relationship between tax and savings, including a look at cutting tax rates on net interest income to compensate investors for the effects of inflation.
It estimated the cost of such a tax cut on interest earnings at NZ$1 billion per annum.
In a paper titled "Taxation of savings - partial exclusion option", the IRD pointed to one of the recommendations from the recent Henry tax review in Australia that there should be a 40% savings income discount for non-business releated net interest income, net residential rental income, capital gains (and losses), and interest expenses related to listed shares held by individuals as non-business investments.
"In other words, only 60% of these forms of net capital income would be taxable. This discount was also intended to apply if the income was earned through trusts and partnerships, but would not generally apply to dividends and business income. Marginal tax rates would remain unchanged," it says in the paper.
"The key reason for applying partial exclusion to net interest income would be to adjust for the effects of inflation so that only the real return is taxed. Inflation can increase taxes on savings accumulated for long periods and increase tax biases between different forms of savings. The effective tax rate on accumulating interest income is higher than the statutory rate in these circumstances."
However the paper notes the partial exclusion system would be very expensive and would introduce opportunities for arbitrage when interest expenses are fully deductible.
"Partially excluding interest income has an immediate impact – it would lower revenue materially," it says in the paper.
"The fiscal cost of applying partial exclusion to the net interest income of individuals, trusts and partnerships is estimated to be around NZ$1 billion per annum. There are, however, significant risks associated with this estimate given the size of the interest base (which is around NZ$60 billion), the limitations of the data sources, the underlying variability of interest rates and the fact that there has been a major financial crisis."
Savings working Group member Andrew Coleman has previously advocated adjusting net interest income tax for inflation on interest.co.nz. See here.