By Alex Tarrant
An economist instrumental in setting up the Tax Working Group says the process led him to change his view on the taxation of capital gains in New Zealand.
Victoria University Public Finance Chair Norman Gemmell, who won the NZIER 2012 Economist of the Year award this week partly for his work on New Zealand's tax system, told interest.co.nz it had been made clear many people who should have been paying tax on income earned from capital gains had not been doing so.
As Treasury's Principal Advisor on Tax Strategy between 2007 and 2010, Gemmell was part of a team working on providing the government advice on medium-term tax reforms. That team created the 2009 Tax Working Group to provide outside scrutiny and discussion on Treasury and the IRD's thinking behind any potential changes.
While the Tax Working Group was split on whether a more comprehensive capital gains tax was needed in New Zealand, and did not provide a recommendation in its final report to the government, Gemmell said that during the process, he changed his view on taxation of capital gains in New Zealand.
Gemmell came to the Treasury after working as Assistant Director of the UK Inland Revenue's research department from 2003-2006, where he grew disenchanted with the UK's capital gains tax system.
“When I first arrived in New Zealand, I never thought I would recommend a capital gains tax, because the British system was at the time one of the worst examples – lots of carve-outs, all sorts of complications that just made the system very difficult to apply," Gemmell told interest.co.nz.
“[However], in New Zealand, my on-balance view at the time of the Tax Working Group, was that the ability of others to avoid tax, who you would otherwise like to be paying tax, was sufficient to say we ought to look at trying to introduce a capital gains tax, but introducing it around the same rate we would tax any other income," he said.
That was different from setting up a separate tax specifically for capital gains, which the British system had showed could cause all sorts of difficulties, Gemmell said. That meant broadening the definition of income to include capital gains under the umbrella of income tax.
Unfair tax settings
Shortly after the Tax Working Group was formed, the government's Savings Working Group noted the discrepancy between the taxation of gains made on property, and taxation of other capital income in New Zealand.
"Owner-occupied housing – you can do well out of that, tax is zero. Investment housing – the marginal tax rate is pretty low. Foreign and domestic shares – it gets higher. And the highest of the lot – if my grandmother puts NZ$1,000 in a basic savings product to get interest, that incurs the highest tax rate of the lot, which we think is anomalous," Savings Working Group chair Kerry McDonald said in 2010.
The Savings Working Group recommended the government change the way capital income - such as interest earned on term deposits - was taxed, to index the tax paid on that income for inflation.
If that process was too complicated, McDonald suggested the government just set a lower tax rate for savings products as a way of cutting into the discrepancy between the relative rate of taxation of property and savings products.
The Savings Working Group did not offer a view on whether a capital gains tax or land tax would help cut that discrepancy as that would have been outside its terms of reference, McDonald said at the time. However, it did recommend the government broaden the tax base when it released its final report in early 2011.
Will be looked at
Gemmell noted that Victoria University and the Government Economics Network - which he also helped set up as Treasury's chief economist in 2010 - would address the issue of capital taxation in a debate to be held later this year.
When announcing the Public Finance Debates series, Gemmell said one of the debates would discuss New Zealand’s policy of taxing certain capital income at 28%, and whether the rate should be lower.
“In Scandinavia, for example, interest income on deposits in the bank is taxed at about half the rate of earnings to encourage people to save. The Minister of Finance is seeking advice on whether New Zealand should change its tax rate for investments so it’s timely to discuss the issue," Gemmell said on August 16.
Speaking to interest.co.nz on Tuesday, Gemmell said while the rate of taxation on some forms of capital had been cut slightly, others were still taxed at earners' marginal rates. It would be good to have a discussion about what tax rates different types of capital income should attract, he said.
“The Scandinavians have made it work, but they’ve made it work by having all sorts of rules around defining what counts as capital income, and what counts as labour income," Gemmell said.
“We know that when you and I earn income, say, from interest in the bank, that’s fairly obviously capital income – we haven’t been working to earn that money," he said.
"But there’s a whole set of types of income – entrepreneurs earn for example, capital gain-type income; is it all income from capital? How much is it, in a sense, a reward for you for using your brainpower as an individual?"