By Bernard Hickey
Is an interest tax break a good idea?
This week the mandarins in Wellington seemed to agree on the need to look at a tax break for savings in bank accounts and bonds. Both the Treasury and the Reserve Bank said the Savings Working Group is looking at such a tax break and they said it should be considered as part of measures to get New Zealand saving more and reduce the economy's imbalances and vulnerabilities.
Currently interest payments on term deposits and bonds pay tax at regular income tax rates.
Often it is collected by the bank as a withholding tax at the marginal rate specified by the saver. It is the major reason why many savers have chosen rental property and other types of investment in the past. Once inflation has done its dirty work, savers are effectively paying a much higher tax rate than on returns from other sorts of assets.
"At present, the marginal tax rate on the real income earned on a pensioners' modest bank deposits may well be considerably higher than that on a wealthy business person's labour or entrepreneurial income," the Reserve Bank said in its submission to the Savings Working Group.
It added that the other side of the interest coin had added to the demand for rental properties during the boom. Rental property investors are currently able to claim the full nominal interest payments as a cost against taxable income, effectively widening the tax advantage compared with term deposits.
The Reserve Bank suggested that only the real component of interest paid could be claimed as an expense for tax purposes. Treasury estimated this week that savings in bonds and term deposits are paying an effective real tax rate of almost 50%, which is double the effective real tax rate on rental property.
No wonder it has been so popular over the last decade. But what if the inflation component of interest returns was exempted from tax? Currently term deposits pay around 5%. Once the effects of inflation of around 2.5% are taken out that would reduce the tax on interest returns by around 50%.
The Inland Revenue Department has estimated such a tax break would cost the government around NZ$1 billion a year. In the year to June the government reaped NZ$1.8 billion in tax from withholding payments on term deposit interest payments from NZ$92 billion worth of term deposits. Such a tax break would go some way to leveling the playing field with property, but it would be expensive from the government's point of view.
Foreign debt reduction
There are other benefits though.
Encouraging New Zealanders to invest more in term deposits would help reduce the reliance of New Zealand banks on foreign borrowing and short term foreign borrowing in particular. The Reserve Bank's core funding ratio is pushing the banks to raise more of their funding from local term deposit and longer term sources.
This reduces the banks vulnerability in the event of another Lehman-style freeze on global financial markets.
Providing this tax break would also reduce the incentive for many elderly savers to 'chase' higher yields in riskier savings schemes at a time they can least afford it. The finance company collapses are a lesson here.
One counter argument is that it effectively provides a type of government subsidy for savings in banks, thus, in theory, boosting the profits of the Australian owned companies.
It will be a debate that the government considers as it prepares measures to improve savings in the budget next year, the last before the election.
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