Close property loopholes to fix system, says tax group

Close the loopholes that favour property investment, says the new tax working group report. Photo / Richard Robinson.

Raising GST to 15 per cent and closing down around $2 billion a year in tax loopholes on property ownership would help pay for tax reforms that could cut the top personal tax rate to 30 per cent and the company tax rate to 25 per cent, says the Tax Working Group in its final report, released today.

Such reforms are essential to rewarding work and productive investment while improving New Zealand's competitiveness, especially against Australia, says the Victoria University-led working group.

Treasury and tax department officials were part of the project, which is expected to have a major impact on tax reforms being considered for the Budget, in May.

"The tax system is broken and it needs to be fixed," said Professor Bob Buckle, chair of the group, citing growing unfairness, loss of integrity, undue discouragement of work and bias against productive investment.

The report proposes the most fundamental tax reforms since 1987, when GST was introduced and personal tax rates were slashed. It says New Zealand must shift to "taxing those tax bases that are least likely to be subject to behavioural change from the imposition of a tax", as well as re-committing to a tax system based on low tax rates applied as broadly across the economy as possible.

Ideally, it recommends that the top personal income tax rate should aligned at 30 per cent (currently 38 per cent), with the same rate applying to companies (30 per cent at present), trusts and superannuation funds (33 per cent at present), and investment vehicles such as PIEs (0 per cent, 19.5 per cent or 30 per cent at present).

However, alignment is unlikely if Australia lowers its company tax rate, as is widely expected from a similarly fundamental tax review occurring there at present, so it makes detailed proposals for a non-aligned system with new measures to stop widely used tax minimisation methods.

The report also attacks the $200 billion residential rental property market, which reported total losses of $500 million last year, at a cost to the taxpayer of $150 million, and recommends a "risk free rate of return" approach which would be expected to raise $700 million a year by calculating rents at a standardised rate for tax purposes.

More simply, the report also strongly recommends axing the depreciation charges currently available for building owners, "if empirical evidence shows that they do not depreciate in value" - a move the TWG estimates would deliver $1.3 billion in tax revenue annually.

This would be on top of an additional $1.9 billion from raising GST to 15 per cent, although this would be soaked up in compensating tax cuts and benefit increases to compensate lower income earners.

The GST move would be justified because of the tax's efficiency and the fact that it taxes consumption, consistent with the principle that taxes on productive activity reduce New Zealand's international competitiveness. Tax cuts would be required to offset the impact of a higher rate of GST, the report says, but it does not attempt to show how such a package could be constructed.

Instead, it poses various scenarios where the company tax rate is set at either 27 per cent or 25 per cent, and the top personal and trust tax rates are set at either 33 per cent or 30 per cent respectively. The 33:33:27 option would cost an estimated $1.1 billion in tax foregone, while the 30:30:25 option is estimated to cost $2.3 billion.

While a majority of the working group favoured the simplicity and fairness of a land tax applied to all land at a relatively low rate - a 0.5 per cent land tax would raise $2.3 billion a year - the case for it is no slam-dunk because of its potential to lower land prices, hit farmers and the elderly harder, and be eroded by excluding certain classes of land.

Other proposed changes that would offset lower company tax rates are a proposal to stop front-loading a 20 per cent depreciation charge on new equipment at a cost of around $200 million in lost revenue annually, and reducing the ease with which foreign investors can take income out of New Zealand to be taxed at lower rates elsewhere.

On the personal tax front, the report stresses the balance required between closing current loopholes for top income earners and encouraging skilled, high-earning people to remain in New Zealand.

"It is important that our personal tax settings do not worsen an already substantial wage gap with Australia," the report says. Unless you earned more than $240,000 a year, "individuals in New Zealand ... will pay on average more income tax than those on equivalent salaries in Australia".

On one hand, a mish-mash of tax rates has allowed high income earners to pay tax at a rate lower than the personal tax rate, through taking income from trusts, tightly held privately companies, and exploiting at the thresholds where Working for Families benefits become available.

At the same time, however, the tax system has become increasingly - and unsustainably - reliant on high income earners, the report says.

Some 44 per cent of all income tax now being paid by the top 10 per cent of income earners, or a net 76 per cent when tax levied on superannuation and other benefit entitlements is excluded.

The group also makes the case for an equally sweeping review of social welfare benefits, and highlights the way that Working for Families can expose low and middle-income earners to very high effective tax rates. However, it makes no specific recommendations for reform.

One significant complication for any reform package is the future of dividend imputation, which ensures company dividends are not double-taxed. The report strongly recommends keeping the system, but says it may not be able to survive if, as is possible, it is dropped by Australia.