In the final part of a series looking at the tax challenges facing the nation, Craig Elliffe considers the changes that could take place this year
If you get up early, work late, and pay your taxes, you will get ahead - if you strike oil.
- J. Paul Getty
Here is my prediction for the outcome of the tax reform discussions.
ALIGNMENT OF TOP INDIVIDUAL TAX RATE TO CORPORATE, TRUST RATE
Revenue Minister Peter Dunne has indicated he has a preference towards an alignment of the highest marginal personal tax rate, the trustee tax rate and the corporate tax rate (say at the rate of 30 per cent).
Such an alignment will overcome some of the problems that exist in the New Zealand system, in particular the issue of unfairness arising from a lack of horizontal equity between different forms of taxpayers.
Another significant advantage of this reform is that businesspeople and professionals can concentrate on their business without the need to structure the diversion of income to entities that pay a lower rate of tax. This will also reduce the number of taxpaying entities.
A reduction in personal rates will also assist in retaining and attracting highly mobile individuals and it is the view of Treasury that reducing business and personal taxation will increase productivity and the growth of the economy.
Rate alignment, however, does not assist corporate taxation other than to create some headroom for a subsequent reduction in corporate tax if required by international competition in the future.
Of course it is possible to choose a lower rate alignment and some of the scenarios modelled by the Tax Working Group looked at using a rate of 27 per cent or even 25 per cent. I have assumed these lower rates would generate significant political heat.
So how would this reduction in revenue be funded?
It quickly emerged in the discussions at the Victoria University Tax Working Group that any recommended changes to the tax system would have to be revenue-neutral at least. The financial position of the government is such that any proposal that increases the budget deficit is unacceptable.
It would be wrong to view the work that has been done by the Tax Working Group as simply how to fund the proposal of how to align tax rates. It is much more fundamental than that and some of the suggested reforms go much further both in terms of revenue collection and tax policy.
Nevertheless, the alignment of tax rates is expected to have a fiscal cost of $1.61 billion and I think the instinct of Government will be to minimise political risk by making changes sufficient to recover this amount.
Sadly, the risk to the review process is that the recommendations for tax reform will be substantially focused on how to fund this $1.6 billion and not go further.
Finding the $1.6 billion could be by the introduction of new taxes, or changes to the existing rules.
CHANGES IN THE WAY THAT PROPERTY IS TAXED
Despite the fact that property really doesn't have any unique tax rules, it is difficult on policy grounds to accept that such a significant part of the country's wealth ($213 billion) generates negative tax (tax losses of $500 million).
It is my understanding that this information related to the 2008 income tax year which perhaps exaggerates property value, gearing, and interest deductions. The promoters of rental investment seminars have consistently accentuated the tax benefits of property investment.
Intuitively the tax profile for the 2008 income tax year is not an isolated one although it may be a high watermark.
The following tax changes could be introduced:
The "ring fencing" of rental losses. One of the tax features of investment property is the ability to offset tax deductions (particularly non-cash tax deductions such as depreciation) against other sources of income such as employment income or business income.
Removal of this feature would mean simply that rental losses could only be offset against rental income. The estimated revenue from this change is $165 million to $195 million.
The denial of depreciation on rental buildings. The policy ground for this change is that, arguably, while chattels depreciate, the actual depreciation on buildings, if properly maintained, is low (if any at all). If commercial buildings were to be included as well as residential, the estimated revenue from this change could be as much as $1.3 billion.
AN INCREASE TO GST (15 PER CENT) AND COMPENSATION FOR THE IMPACT OF THE INCREASE
The current benefit and transfer system has a number of adjustments that automatically update a number of benefit amounts, thresholds, and abatements for any change in prices.
This means that many social assistance payments will automatically adjust for any increases in price that occur as a result of an increase in the GST rate.
Further work may need to be done to specifically target groups for whom this compensation would be too little or too late. The expected revenue from this change, after compensation, is $200 million.
I am surprised that the expected revenue collection is only estimated at $200 million. An earlier document provided in the July papers to the Tax Working Group indicated a much higher estimated increase in revenue, perhaps as much as $1.9 billion.
The above proposed tax changes reflect what I think will happen given the political realities and natural reluctance for widespread reform. A more bold approach would see the deficit dramatically reduced with the introduction of a capital gains tax, or perhaps more accurately a broadening of the base to include capital income.
There are of course many complex implementation and administration drawbacks to this approach. Some of these, though, can be addressed in the design of the tax.
Aside from the fiscal benefits of increased tax, such a regime would enhance the equity of the tax system, provide integrity and certainty to protect the tax base, have application and progressively tax those who can truly afford it, and would bring New Zealand into line with all the other OECD countries.
A related benefit would be to remove the bias of investment in assets which are expected to create capital gains which may not be as productive or generate growth in the economy.
If this were too bold a move then perhaps the introduction of the risk-free rate of return method to rental property may be another sensible approach. Landlords would be expected to recover the costs of this change from tenants, if the market permitted, minimising the loss in land values.
It is difficult to see that the efficiency of a land tax would outweigh the potential destructive loss in value to a sector of the economy.
Due to the budget deficits, the Tax Working Group could not propose reform that would cost the Government tax funding. One of the problems with tax reform in a revenue-neutral environment is that it is difficult to get away from the vested interests of individuals as they assess the likely impact of any tax change upon their own or their business interests.
It is an obvious requirement of any objective assessment of a tax system that the interests of the individual are set to one side. Higher rate (38 per cent) individual taxpayers ought not to compare the reduction in their income tax with a fresh tax charge elsewhere, but the temptation is overwhelming.
At the tax conference of the Tax Working Group, Susan St John of the University of Auckland questioned whether it was appropriate that the group had embraced the objective of aligning tax rates which aimed at improving efficiency while not making equity (the transfer of taxes to the needy and the poor) any worse.
She asked whether "is not making equity worse" an appropriate equity goal?
It was a poignant question. Maybe it would have been a good idea to have had a wider representation in this review group.
Perhaps someone other than a male earning over $100,000?
Craig Elliffe is the professor of taxation law and policy at the University of Auckland Business School and a consultant to Chapman Tripp, barristers and solicitors. This is the last of three articles. The first article considered problems that exist in the New Zealand tax system. The second looked at alternatives for tax reform considered by the Tax Working Group. Any opinion expressed in these articles is that of the writer and not the University of Auckland or Chapman Tripp.