Most folks agree that in principle returns on all kinds of investments should be taxed the same as earnings from all kinds of employment or running a business. Then no individual is favoured over another, and no kind of activity is discouraged or encouraged against others, by the tax system – it is "neutral".

Irrespective of your views on how much low earners and high earners should pay, which is a whole other debate, that "neutrality" is arguably both the fairest, and most economically efficient, tax principle.

How could we do this? It is actually very simple. Whatever kind of investment you make, your return is made up as follows:


Actual return = income + capital gain - expenses - inflation

Inflation is the erosion of the spending power of your capital as living costs rise.

So to be neutral, all you have to do is tax actual return in all cases. Sadly, there is not one type of investment in New Zealand today that is taxed like that. In other words, right now taxable return is not equal to actual return, so TR =/= AR.

The real world

How far away from "neutrality" are we? As things stand today, some are taxed less, and some are taxed more:

Homeowners are severely undertaxed:
TR = 0, they are completely tax-free on both their occupancy and their capital gains

Landlords outside the brightline test are undertaxed:
TR = I-E , they are untaxed on CG and can't claim their loss from CPI

Landlords under the brightline test are overtaxed:
TR = I+CG-E, but they can't claim their loss from CPI

Bank depositors are severely overtaxed:
TR = I, they have no hope of getting any CG and can't claim CPI.

(On this last one, if you have a bank deposit earning 4 per cent per annum and inflation is 2 per cent per annum, you are paying twice as much tax as you should).

It is interesting to note the lack of a capital gains tax does not mean all investors are undertaxed compared with wage and salary earners.

The lack of neutrality is severe in both directions. And is it any wonder house prices and household debt, dominated by owner-occupiers, have grown so dramatically? Or that there are insufficient bank deposits in New Zealand, and banks have to borrow so much overseas?

The review

This week the Tax Working Group releases its report. You might expect the highest priorities in the report would be the severely overtaxed and severely undertaxed examples above. In other words, perfection is impossible in the real world, so just focus on fixing the worst bits.

The indications are that both "worst bits" will be ignored. Homeowners would throw out any Government who taxed their home, and bank deposit holders mostly don't even realise they are being hit so hard.

So whatever the Government decides to do with the report, it will pretty much be a waste of time and a lost opportunity. The economic and social injustices of our tax system will continue. What a great pity.

- Stuart Pedersen is an investor and former economist and financial adviser, based in Mount Maunganui. He was the Act Party spokesperson on finance and economics, and Tauranga candidate, in the 2017 election. These are his personal views, not necessarily those of the party.