By David Cunliffe
The Tax Working Group report presents a crucial opportunity to make sustainable, systemic change to our tax system.
It is vital the government's response gets it right, but that cannot happen without meeting two fundamental tests: fixing the structural problems around property tax and delivering a result that is fair to all New Zealanders.
Labour is taking the report seriously and is giving the recommendations the careful consideration they deserve. Labour cannot agree, however, to any measures that increase the burden on already hard pressed families at the same time as giving relief for only the highest income earners.
One of the most fundamental problems in our tax system is the fact that returns to investment are not taxed fairly across different classes, and that therefore important signals for the allocation of scarce capital are distorted.
Few economic issues have sparked as much debate in recent years as the role of property investment in our economy.
Capital gain on property is tax-free, but income on a real business is fully taxed. It is no wonder New Zealand's real economy is slowly being bled of investment capital it needs to lift innovation, productivity and exports; and to provide the high wage, high skill jobs of the future that will keep our grand-kids on shore.
Tax incentives also fuel the property cycle, meaning generations X and Y are shut out of the Kiwi dream of home ownership, and existing home owners face the uncertainty of bursting bubbles, as in 2008. Raising interest rates to cool property markets sucks in "carry trade" capital, profiting big banks but driving up exchange rates, and hitting exporters with an often-fatal double whammy.
This in turn worsens our domestic savings gap "“ as we borrow more for mortgages "“ and the external or "˜current account' deficit. Ultimately more of our country is sold off to pay back foreign lenders, or the government is required to run surpluses to cover the difference, which it is obviously no longer able to do. The TWG was well aware of this problem and therefore offered a number of options to bring a greater equity to the tax treatment of property.
Working up from the status quo there is a series of steps available to the Government to close this gap. Starting with options including ring-fencing losses from rental property and increasing in scale with measures such as a risk-free return method for rental housing, all the way up to a land tax, a partial capital gains tax, or a full capital gains tax.
While the pros and cons of these options need to be fully explored and measured, it is clear that sufficient action must be taken to deal with the underlying problem of mis-aligned incentives.
No response to the TWG will meet public expectations unless it rebalances these incentives in a way that is fair to all and meets the revenue requirement of other tax changes. Turning to the equity question, New Zealanders have long accepted that it is fair for those who are able to pay a little more to do so. The observation that "3% of income earners pay 23% of tax" is moderated by the reality that the top 3% earn nearly 20% of total declared income.
In addition to this, New Zealand has a less progressive tax system than Australia.
Closing tax avoidance loopholes is crucial to achieving both equity and an effective, broad-based tax system. The TWG was told by IRD that only half of the 100 wealthiest New Zealanders were on the top tax rate of 38%.
The others legally avoided it "“ no doubt through the traditional "tax planning" techniques of trusts, LAQCs and savings vehicles like PIEs. The TWG argued for alignment of the top personal rate with the trust and company rate (although only Mexico and the Slovak Republic have achieved this alignment).
Further, all TWG scenarios would result in a dramatic and fiscally expensive cut to the top personal rate. Given the Government's reminder that despite the now strong growth forecast (3-4% of GDP), we face six years of fiscal deficits, the requirement for "revenue neutrality" means that the billions given back to top taxpayers would have to be raised elsewhere.
At the heart of the dilemma is whether this can be achieved without shifting the net tax burden to middle income families and the hard working New Zealanders who have struggled bravely through the recession. One thing is certain "“ these issues are fundamental to ensuring the ongoing fairness and sustainability of our tax system in a rapidly changing world.
Ensuring that New Zealanders have enough to make ends meet today while building a better future for our kids is the balance that must be struck by any changes.
* David Cunliffe is the Labour Party Finance Spokesman