Michael Littlewood: Fair tax for savers? Unfair for everyone else.

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Retirement policy expert questions a call to reduce tax on KiwiSaver and bank deposits.
A campaign for 'fairness' on KiwiSaver funds really amounts to tax concessions for KiwiSaver and, oddly, just for banks' term deposits, says Michael Littlewood. Photo / Thinkstock
A campaign for 'fairness' on KiwiSaver funds really amounts to tax concessions for KiwiSaver and, oddly, just for banks' term deposits, says Michael Littlewood. Photo / Thinkstock

A group of organisations has launched a campaign to lower tax on investment income earned through KiwiSaver savings and also on banks' term deposits.

The logic for each is a little different.

With KiwiSaver, the campaign suggests that members pay more tax on income than would apply if the income were earned directly.

For term deposits, the argument runs that savers pay tax on the inflation component of income and that's unfair.

Tax should be only on 'real' (after-inflation) income.

Tax issues are very complicated and New Zealand's tax treatment of investment income is actually a mess and needs a major overhaul.

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Campaign to reduce tax on savings

The group 'Fair Tax for Savers' suggests that just two specific parts of the investment landscape deserve special treatment.

Although the campaign is dressed up in a call for 'fairness', what it really amounts to is a call for tax concessions for KiwiSaver and, oddly, just for banks' term deposits.

One of the lobby groups (the Financial Services Council) has a clear commercial interest in the suggestions.

There isn't anything wrong with the FSC's advocacy on behalf of its members but the other group members (Consumer, Age Concern and the Taxpayers' Union) should have thought a bit more deeply about the issues.

The group is really arguing for special tax treatment for two particular investment vehicles - tax concessions when compared with other vehicles performing similar savings objectives.

The group suggests that 78 per cent of New Zealanders want lower taxes on their savings but, with tax, there is no free lunch.

Reducing tax on KiwiSaver and term deposits means that more tax must be collected from elsewhere just so that the government can pay the bills.

Your tax concession is therefore my tax cost.

If the 78 per cent knew that their own taxes would have to be higher, even if they didn't save, support for tax concessions would have melted.

Fair Tax for Savers says it wants the effective tax on KiwiSaver savings to be the same as the tax that savers would pay on their other income and uses investing in a rental property as a comparator.

That's a false comparison, but even if the comparison were fair, that might only mean that rental properties are under-taxed.

Fixing the tax treatment of rental property returns might be a better option.

The suggestion that only after-inflation interest on term deposits should be taxable goes to the heart of the whole income tax framework.

On balance, it's too complicated to exempt the inflation component across the whole tax system.

To grant special, inflation-based treatment to just term deposits is unfair, despite the fact that both the 2011 Savings Working Group and the Retirement Commissioner recommended it.

Here's what should actually happen if Fair Tax for Savers really wants to achieve its objective of taxing savings 'appropriately' - income from all sources and from all vehicles (KiwiSaver, other superannuation, shares, deposits, trusts, etc) should be added together every year for each taxpayer and taxed as part of the taxpayer's total taxable income.

For most KiwiSaver members, that would mean higher tax than now on the KiwiSaver component of their investment income, not lower.

As an aside, taxing all 'income' would also lower the cost of the income-tested Working for Families as more 'income' would be identified to each recipient of the Working for Families tax credits.

If all income were taxed appropriately, the government could lower tax rates for all and that's what Fair Tax for Savers should really be advocating.

There is no international evidence that tax concessions for retirement savings actually increase savings.

There is, however, plenty of international evidence that tax concessions are very expensive, very complicated, regressive (benefit the rich at the expense of the poor), inequitable and distortionary (favouring particular saving vehicles over others).

However, the fact that they don't work seems the worst of their faults.

More than 20 years ago, the Task Force on Private Provision for Retirement decided that giving tax breaks to retirement saving was the worst of three public policy alternatives (incentives, compulsion and voluntary private provision) to improve saving levels.

Subsequent evidence, both international and local, has reinforced that finding.

Fair Tax for Savers thinks that, because KiwiSaver savings are locked up until age 65 ("over-taxation of compound interest"), they deserve special treatment.

Instead of developing special tax rules for KiwiSaver, perhaps we should discuss lifting access restrictions so that savers could withdraw their savings if they needed to.

The Financial Services Council would probably oppose that suggestion.

Consumer, Age Concern and the Taxpayers' Union might support greater flexibility for savers.

'Fair tax for savers'? Unfair for everyone else.

Michael Littlewood is co-director of the Retirement Policy and Research Centre.

- NZ Herald

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