Gareth Morgan explains why Rodney Hide's arguments against corporate tax are dubious and naive; income tax base would collapse; GST rate would have to rise; Hide playing into hands of tax-free capital gains farms

Gareth Morgan explains why Rodney Hide's arguments against corporate tax are dubious and naive; income tax base would collapse; GST rate would have to rise; Hide playing into hands of tax-free capital gains farms

By Gareth Morgan

Lately Rodney Hide has informed us that multinationals equilibrate their after-tax returns across all the markets they operate in.

So if one country (NZ for example) hikes up company taxes then the multinationals simply invest elsewhere where the after-tax return isn’t so high. In other words we cut off our noses to spite ourselves if we dare to tax multinationals, we are so desperate for foreign capital on Rodney’s argument we should be a tax haven.

The evidence seems to be against him. Why aren’t all multinationals sited in Bermuda? The reason is obvious – the markets for multinationals’ goods and services are all over the world, not just in Bermuda. And they pay tax (to varying degrees) where they earn revenue. That limits Bermuda’s prospects. And indeed it also highlights why the race to the bottom by various tax authorities to attract multinational investment by offering corporate tax rates as close to zero as possible, has limited returns for such countries. Tax havens only work to the extent that the tax regimes of other countries have loopholes the multinationals can exploit and shift income. And for sure, many do have such holes.

Rodney has a further argument vis a vis corporate tax that is also of dubious merit. He argues a company is the property of shareholders and hence its income should only be taxed once it arrives in the hands of shareholders - i.e.: as a dividend, or when the firm winds up and proceeds are distributed.

The argument is weak. In Rodney’s world we would all be incentivized to form companies and sell our labour via that company. All our costs of providing labour (such as eating, housing) would be deductible and any surplus could be ‘re-invested’ in whatever we deem as necessary to ensure our “own-labour-company” can pay dividends, albeit as far in the future as possible. For example with this year’s surplus I think I need a holiday in Hawaii to recharge my batteries - definitely an investment in my future ability to happily earn for my company. Or perhaps a second house - one that provides a nice change of scenery to keep my spirits up at the level necessary to keep my labour-only- company earning well into the future. Only once I retire will I sit back and start cashing in all the assets my company has bought over the years. Then, and only then, when my company is distributing, need it produce any taxable income.

The income tax base of the government (currently 65% of all tax collected) would collapse. GST would have to rise to 60% - or as Rodney and his fellow libertarians dream, we could trim the State back to a law and order function only - keep the riff raff at the gate. Let’s ignore the latter agenda, lest we get distracted from the topic - the income tax base.

It’s for this reason that in modern mixed capitalist economies that we have income tax and all income-earning entities (except charities, which is another story well worth expounding on), pay it. So whether you singularly - or with a group of your mates - disguise yourselves as a corporate, rather than simple wage earners, your income will be taxed whether it ends up in your hands personally or in your collective hands within the company arrangement you’ve constructed. This is why a line is drawn around what legitimate business expenses are and what is not deductible for the purposes of taxation. Except in particular circumstances the latter includes food, and housing for the company operands - whether employees, employee-shareholders, or shareholders. And that income is taxed whether distributed or not. 

Our imputation regime tries to ensure it’s not taxed twice. Most countries don’t have imputation regimes, they tax dividends twice. This has led to companies retaining far more earnings than they actually need to insofar as operating the business or even covering investment in reasonable growth opportunities. In response many countries have a differential between the tax rate applying to dividends and that to retained earnings, as an alternative to the imputation regime we deploy. But still, there remains a bias in the income tax regime that encourages companies in those jurisdictions to retain profits. That is economically inefficient, and we get successful companies often using those funds to buy back their own shares - thereby offering  shareholders an opportunity to realise all or some of their stake. 

Plugging leaks in the income tax base is a legitimate endeavour - if you want an income tax base. And before you get excited and think it’s all too hard, that we should just go to GST alone, spare a thought for how much GST is arbitraged away in New Zealand - by all those guys and gals doing cash jobs for folks but still claiming GST on their inputs. GST leaks in conjunction with undeclared income is the most lucrative tax evasion out there.

'Tax-paid profits not only factor in land values'

Now let’s turn to yet another of Rodney’s claims re taxation over recent weeks. This one is that capital gains are taxed already. The argument runs that insofar as the market price for an asset reflects the discounted future income stream, and as that is taxed, then the market price reflects only the present value of tax-paid earnings.

Well if that was always what the market price was he’d have point. But it is not.

There are various ways a market sets the price of an asset, in the valuation game it is common to see three at work – which often leads valuers to adopt triangulation when reaching an assessment of value. One is the present value of future income - that one is critically dependent not just on the forecast accuracy of the earnings stream but also the discount rate applied, and market discount rates are driven by a range of determinants, one of which is the liquidity of the investment. If the market for the asset is deep the discount rate is low, because traders know they can flick the asset easily and before any of those future expectations on earnings are realised or not. This is why sharemarket prices are so volatile - the market is daily reassessing all the drivers of that earnings expectation.

A second common valuation technique is the market price - what are like assets selling for? This is common in the real estate market and of course often augmented by an allowance for trend in market prices. If we’re in a channel of rising prices then the market will often see the trend as its friend and further bid up the prices beyond latest recorded sales. This is all hunky dory until some fundamental pops up and smashes that complacency - often called a “shock”. 

And a third method is to undertake a valuation based on price to earnings ratios. So how many dollars are being paid per dollar of earnings that this asset class is providing? This price will certainly take account of tax on those earnings. 

Now the point is that not all three valuation approaches necessarily provide a market price that incorporates the future tax impost on earnings. The market price methodology pays a lot more attention to what the momentum in market pricing is. If it’s rising then the price is likely to keep rising and vice versa. So when we have a situation where the market is favouring momentum pricing, then there is serious money to be made - either way actually, you just ‘short’ a falling market and buy the asset back later to deliver. Now the market theory would hold that a momentum pricing situation cannot last for long before the reality of earnings come to bear and that check corrects the pricing. But as we have seen in many markets over the last few decades that period can be very long - property and farms are illustrations. Meanwhile there is serious hay to be made by those buying and selling, especially when they manage to escape the IRD denoting them as being ‘traders’. Achieving that’s all in the way you wiggle your hips.

'Naive to think capital gains are taxed'

The important point then is that the gains one makes which are not taxed could well have nothing whatsoever to do with the future taxable earnings of the asset as Rodney asserts. It ain’t necessarily so I’m afraid, and in those situations Bernard Hickey is right - professional (don’t tell the IRD) investors stand to make outrageous tax-free fortunes simply trading on the momentum. Of course Rodney is right and it won’t last forever - it doesn’t need to. Ten or twenty years - as we have seen with residential property - is long enough to profit and fly away before the tax-paid earnings fundamentals come to bear.

It is naive therefore to argue that capital gains are taxed. It is true for the market as a whole, and over a sufficiently long period of time. But I don’t need either of those.

What to do then - what should a responsible taxation authority do to ensure that its income tax regime is not such a leaky boat that the market ridicule is so strong as to misallocate investment and profit all in a drive to avoid tax? The key it would seem to me - and Susan Guthrie and I covered this in our 2011 book on tax and welfare form, “The Big Kahuna” - is to ensure all forms of income are taxed in the year they are earned. This does not mean a capital gains tax, that is way to unwieldy and volatile. But it does mean plugging the loophole in the income tax regime wherein certain forms of income to capital are exempt income tax, namely the income from imputed rent.

Without that, the rentiers will thrive at the expense of all other taxpayers, capital will be misallocated across the economy, an economic growth and income generation will suffer. The comprehensive capital income tax we advocate is a step in closing the loophole that Rodney would far prefer was left ajar.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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I now understand why property investors are rorting the rest of us. The IRD has allowed accounting double-speak gobbledy gook to create loophole for them to avoid paying tax. The IRD should just keep a simple rule on the matter; is not the family home, difference between buying and selling price = capital gain/loss and therefore tax to be calculated. For the rest dare I say it, but I largely agree with him.

Not so fast. Gareth is building a case to tax the rent you "make" by owning your house. His "imputed rent" means that if you own your family house and live in it but it could be rented for $500 a week then you have earned an extra 500x52 = $26000. Hand over the income tax, comrade!

Personally I think his argument is sort of true but pointless. The rort is caused by the bank friendly structure of our society, especially the deduction of interest as an expense, credit creation through fractional reserve banking, depositors being unsecured creditors and a misunderstanding of how modern money works. The problem is you set off all sorts of unexpected difficulties when you start changing things too much and some of these things might be crucial to why our society works reasonably well.

I agree with the argument when you apply it to owning a house. A property investor has the renter pay the costs of ownership plus a profit (if it is not a LAQC), but an owner carries all those costs themselves, and all the liabilities. This is where Gareth's right wing attitude bubbles to the surface and needs to be squashed thoroughly.

.. I see imputed rent being based on the asset value x say the current term deposit rate. So no matter how or where you invest, you still pay some tax. So what is so wrong with that...if we all get caught it has a nil effect across society, it evens out the tax burden. Apply the same to all assets ..if the deemed rate is higher, then you pay the higher tax....

Gets rid of land bankers, those buying expesnsive proeprties and leaving them empty and so on. Lower the tax on labour ...you know, those that do the actual work...hit the leaches playing with loopholes and legal jargon.

So no matter how or where you invest why should buying a home for yourself be an investment? I did it because I didn't want to pay rent into a bottomless black hole. My rent is called insurance, rates, maintenance and depreciation. I don't need some rich prat telling me I should pay tax on what my home is worth. No one can tell me what it is worth right now, it is not on the market, I wouldn't sell it for $5 mil. Besides what happens when the property value goes down, through a market crash or just neglect? This is a BS theory that right wingers are trying on to prop up their own wealth. A better idea would be for their tax rate to go back to 60% when their wealth goes over $1 mil. That'd sort the housing crisis out. Tax on their value not their cash.

...you clearly do not get the concept. This is not a rich prat tax, but a' lets get the tax from the rich prat'!

Why should someone be taxed on their cash in bank, but not on their idle assets? Unless you are a 1%er it will lower your tax (based on the total tax taken remaining neutral). Your paye or whatever your personal income tax is will come down. The less wealthy cannot afford to invest in large tax free assets (eg land banking around awks), but get smacked with paye and rwt on their mediocre savings.

For the record, central govt has placed much burden on your local council, thus your rates are already a tax on your asset..so there is no big change in concept.

But dont sweat it, it will never happen, the 1%ers will never allow it..and so on they sail.

Actually I do get it but I do not believe any pollie will keep it tax neutral or even favour the low end. They haven't until now. This idea is just too idealistic to work. The family home must be kept tax free. You are right about the local councils having too much loaded on to them from the national Government.

Roger.... Don't u think this logic is twisted and actually a nonsense.. there is no truth in it... We live in a family home because we actually need a roof over our head... . Has NOTHING to do with rent or tax free benefit
The family car... can be leased out to earn taxable income ...SO.. there is a tax free benefit in having a family Car..

Taking Holidays.... there is a tax free benefit because u could have been using your time to earn income that is taxed..
How about reirement... We should tax retirees because of the tax free benefit of not working..

This is the same logic that Rodney applies to the , so called , imputed rent on a family home ..
the same kinda logic he applies to the idea that he uses in saying that the Capital gain on a farm is already taxed because of income tax reducing the Capital value of the farm..

Imputed rent on a family home... ????

For Godsake.... where is common sense..

For me... it shows that the use of logic without commonsense ..can lead one down the "rabbit hole"..

....if it is not taxed then it becomes a tax refuge. Being a tax refuge its distorts the investment market. Eg I could by a $mill dollar home and enjoy x% tax free cap gain. Or I could by a $500 k home, invest in something productive...but get taxed. This is one reason the NZ economy is reliant on the house of cards housing game. Tax the lot, and let the money flow to productive assets. And stop panicking, your paye gst, rwt, Etc will be less...its about spreading the tax take, not increasing it.

Hmm, I felt his logic is ok, but that logic is not all it's cracked up to be. A logical argument is based on assumptions, many of which are often not identified. It looks really convincing at first, but it's just like saying if x=ab therefore a=x/b. This sort of nonsense is much beloved by academics who seek to impress with their brilliance rather than inform.

It's always the assumptions that matter. So in my example above "if x=ab" assumes that x,a, and b actually exist and are independently measureable. Often with economic concepts it is unclear if that is the case.

In Gareth's case the concept of imputed rent seems quite valid. There is a benefit in kind from owning a house, and benefits in kind are taxable as income. Therefore the imputed rent should be taxed. Assuming it's a good idea to do so. So Gareth's argument appears sound but his assumption is highly suspect.

Why is it highly suspect, at least to me? Because the rules around property ownership are really fundamental to our society. Really really fundamental. That doesn't mean they are right or optimal but it does justify a certain caution about making radical changes.

Gareth is a bright lad with a disruptive streak, but disruption is not always a good thing.

Is the interest paid on a loan somehow NOT an expense?

As i commented on Bernards post the other day and why Rodnys tax idea is important

The reason there is so much talk about a Universal Basic Income is that the whole economic system is collapsing and this is just one more measure to try and prop it up.

The really big problem facing all economies has been staring us in the face for the past thirty years or more.
It is right in our faces and we cannot see it.

Businesses, large and small, can no longer survive without government intervention.

We all talk about the collapsed middle class, but there is also the class that runs all of our businesses, large and small. I guess we would call them the business classes

The business classes are people of means, they are the rich class and the wealthy class. If they are allowed to collapse, along with the middle class, then there would be no use pretending. It would be all too obvious “The Game Is Over”

While governments have done little to save the collapsing middle classes they are pulling all stops to save the rich and wealthy classes

Here are all the signs of a failed capitalist economy.

To make sure that the business classes remain rich and wealthy governments are pumping money into them at an ever increasing rate.

Sale of State Assets at rock bottom prices

Public Private Partnerships that privatize the profits and socialize the losses

Cutting taxes and even giving them tax loopholes to avoid paying tax

Ever tougher Patents and Copyright Laws so they can maintain their monopolies for much longer

Getting the people to pay weekly into super funds to help Hedge Funds survive.

Boosting the transport industry by destroying national rail services

Allowing Casinos to keep 30% while restricting social and sports groups to 10%

Pumping Billions into construction companies by building sports stadiums, convention centres that cant pay their way

Pumping billions in to extravagances like Olympic games and world cups

Never ending wars pumping trillions into businesses that supply military equipment

An ever expanding Surveillance system pumping billions into security firms

Trade agreements like the TPPA and TTiP to protect the Corporates

Trade agreements giving corporations access to low wage economies

Without all this government intervention most of these businesses would fail.

If these businesses fail then the Business classes would collapse making the rich poor and the wealthy just rich

We see a big increase in Lobbyists because businesses are terrified of the consequences if the government should abandon them.

Notice how the government is not chasing businesses the businesses are chasing them, paying them, bribing them.

The whole economy is a Big Bubble blown up by successive governments.

The only question is

Will this government created bubble bust or is it sustainable?

I believe the bubble is nearing bursting point.

Technology is pricking away at this bubble, and although mounting debt cause economic collapse this will pale into insignificance when Technology finally bursts the governments bubble.

The outcome will be a political and economical revolution and a much better world.

So a UBI is just another government puff of air in an already over inflated balloon to slow the tide of change.

And of course Rodneys tax cut is part of the above

Gee, and I thought the collapsing economic system is as a result of it being a huge ponzi scheme...and let's not forget all that created money!

Companies aren't charities, so who actually pays company tax? Personally I think Company Tax is merely a way to raise tax in a less than transparent way, hiding the true burden that individuals face. I'd have no problem getting rid of it, provided suitable rules to prevent untaxed personal enjoyment of company property are in place.

Isn't Sanitarium owned by a charity and pays no taxes? Another rort on the tax payer!

I like Sir Bob Jones' ideas better.

First - Britain had a tax on owner occupiers - Schedual A tax based on notional rent with deductions for repairs etc - was a dog, didn't collect much and was rightly scrapped saving/losing 1000's of unproductive tax fumblers. So much talk & effort is put into ways of raising more tax where the burden on slightly above average income taking into account PAYE/ACC/Petrol Duty/Rates/Alcohol Duty/and of course GST which in many instances is levied on top of those taxes, (in my view any charge you have to pay that is unavoidable if you wish to transact something essential) and is now close to 50% of gross earned income. There is no incentive to save out of taxed income and the limitless waste and lousy decisions of Politicians and Beaurecrats with little or no real accountability is leading to a populace that trusts few traditional organs of state or organizations we have relied on to protect/help us. About time a similar effort was put into identifying such waste removing the cause and put to more productive use the human and physical capital released, I suspect a 10% reduction in public expenditure is possible without the negative impact of ever increasing taxation which lead to either a disincentive to work or a block on creativity. Some 30 years ago if memory is right the Irish Bankers went on strike believing the economy would collapse without them, it didn't as people found ways of transacting without Banks, likewise proposition 13 in California was predicted to lead to a collapse of public services - Fire/Police Etc, again it didn't happen and the result was a booming state which is now bigger economically than many countries.

Yes where is the incentive to save out of taxed income. Deposit money into a bank, get taxed on the interest earned. The bank then on lends your deposit to property investors who take some tax advantage of the interest charged on the mortgage? Seems a bit absurd really.

Just a note: modern money isn't created by fractional reserve banking. Fractional reserve banking requires a portion of a deposit to be held as reserve. No new money is created, instead a proportion of existing money on deposit is loaned out. New money is created by making new loans without a deposit at all. That new loan becomes a deposit at the same bank or another bank when the borrower deposits it in another bank or pays another person the money, who in turn will place it on deposit somewhere. The originating lender must then borrow that deposit back or, borrow overnight from a reserve bank. So you're right in that money expansion happens mostly because of commercial banking but it is not the fractional reserve system that is causing the expansion of the money supply. There is a paper from the BoE that details this process exhaustively.

Or you could read this.

Who on earth listens to the right wing ravings of Rodney Hide? He's an idiot.