Brian Fallow: Goff tax plan fails to show us the money

It is hard to see how Phil Goff can claw back $1.3 billion to pay for the tax-free zone. Photo / Sarah Ivey

It is simply not credible for Phil Goff to say that Labour would not have to borrow to pay for a tax-free zone at the bottom of the tax scale. Let's look at the numbers.

There is, according to Treasury figures released on Budget day, $15 billion in the income band up to $5000. It is currently taxed at 10.5c in the dollar so scrapping that tax would cost just under $1.6 billion.

The $1.3 billion figure Labour is using factors in an increased GST take as people spend their tax cuts (on things other than fresh fruit and vegetables).

It tacitly acknowledges that Labour has dropped any idea of reversing the increase in the GST rate to 15 per cent.

Where would they find another $1.3 billion?

How far would a new and higher marginal income tax rate on those with incomes "comfortably into six figures" stretch? Not as far as the politics of envy assumes.

The official figures show $5.4 billion in taxable income of more than $100,000 spread over 141,000 taxpayers or 5 per cent of the total.

The vast majority of it ($4.8 billion) is in income of more than $150,000, earned by 2 per cent of taxpayers.

The Government would have to take another quarter of that income of more than $100,000 - over and above the third it is already entitled to under the existing tax scale - to fully fund the tax cut at the bottom.

It would push the top tax rate to 57 per cent. That is clearly a non-starter so only some fraction of the cost of the tax-free zone could be funded from this source.

Suppose they settled for getting a third of the cost from the top end of the income scale. It would still push the top marginal rate to 41 per cent - and more if the threshold was, as Goff says, "comfortably" above $100,000 and if they want to offset a lower GST take.

That would be the highest the top personal rate has been since Muldoon's days. It would widen the gap with the trust rate (33 per cent) and the company rate (28 per cent in the coming tax year).

It is a recipe for taxpayers to structure their affairs so as to avoid the higher rate, with all the negative effects on efficiency and the integrity of the tax system that the tax working group pointed to as arising from the introduction of the 39c rate at the start of Labour's last term.

"We will make sure these very highest earners do no use trusts to avoid paying the top tax rate," Goff said. "We are waiting with interest to see the Law Commission's work in this area."

In other words: We don't know how to do it but we have every confidence a bunch of really smart lawyers will tell us how.

In any case, that would leave the bulk of the cost of funding a $1.3 billion tax cut still to be met.

The plan seems to be to rely on another brains trust: "The incoming Labour Government would set up a high-powered anti-avoidance taskforce to close tax loopholes."

Apart from being a swipe at the calibre of Inland Revenue's policy advice division, this begs the question of what loopholes Labour has in mind - and why it did not close them when in office.

It is facile and harsh for Goff to describe as a loophole and a dodge the ability of owners of rental properties to offset losses on those investments, as they accrue, against other taxable income.

The tax laws treat someone who buys an investment property as having gone into business - the landlord business. The normal rule is that expenses incurred earning a taxable income (rents) are deductible, including interest, but, since the Budget, no longer depreciation.

A house is one of the few assets within reach of small investors against which the banks will lend a high percentage of value.

It is normal practice to consolidate losses as they accrue with taxable income from other sources and operating losses have tended to be offset, in investors' minds, by the prospect of untaxed capital gains when the property is sold.

In light of all this, officials have looked at "ring-fencing" losses on rental properties.

But they recommended against it as hard to police and unprincipled. It would discriminate arbitrarily against a particular form of investment when it is common for business activity to make losses in the early stages.

Goff says the Treasury estimates "this dodge" costs the country $260 million a year.

But it does not follow that instituting ring-fencing would yield that much extra revenue.

A measure that might be attractive if you want to pre-empt a housing boom is not necessarily clever after one has occurred.

If applied retrospectively, ring-fencing would be odious in principle, an administrative nightmare and would risk a wave of selling in a property market which is fragile, with unpleasant consequences for households and bank-balance sheets.

But a ring-fencing rule for the future might not yield much in the "new normal" environment, in which households are averse to debt, house prices and household-debt levels are still at historically high levels relative to incomes, and in which for all these reasons the prospects of swift and easy capital gains to offset operating losses from rental properties are an increasingly distant memory.

In short, that was then and this is now.

The third leg of the rickety stool on which funding a tax-free band relies is a "crackdown on tax evasion and avoidance". The trouble is the Government is already counting on the same thing.

It likes to say that the tax changes in the last Budget were revenue-neutral but the Budget said otherwise. All of the tax increases - GST, tobacco and changes to depreciation and thin capitalisation rules - are projected to leave it $1.5 billion short over the next four years of the cost of the income tax cuts.

It expects to meet half of that shortfall by increased tax audit activity. If that expected additional revenue, which can hardly be seen as in the bag, is already factored into the projected deficits Labour would have to rely on there being a lot more where it came from.

If Labour does not have credible answers to "where is the money coming from" then it is open to Prime Minister John Key's charge that its tax plan is fiscally irresponsible in the current environment and a recipe for higher interest rates.

In that respect it is not just the financial markets, as represented by ratings agencies, that we have to worry about.

Reserve Bank Governor Alan Bollard pointedly reminded the Government the last time he reviewed the official cash rate that there is, in effect, a see-saw relationship between fiscal and monetary policy.

All else being equal, the looser the former is the tighter the latter would have to be.