New Zealanders are far more inclined to borrow than to save, and the tax system is a large part of the reason.

So we can only hope that Sir Michael Cullen and the tax review he is to head will see their terms of reference as capacious enough to address that structural weakness in the economy.

Their mandate includes considering "whether the tax system promotes the right balance between the productive and the speculative economy." Clearly it does not. The split between spending and saving, and between consumption and investment, needs to shift in a more provident direction.

The national accounts released last week show that the year to last March was the third in a row in which households collectively spent more than their income, by $4 billion this time.


Household sector dis-saving has been the norm for the past 25 years, the only real exception being the five years following the global financial crisis when the saving rate turned modestly positive.

The flipside of that is abject reliance on importing the savings of foreigners. The banks currently source about a quarter of their funding from abroad, and there are costs and risks attached to that.

There has also been a sustained shift in the composition of households' wealth.

The Reserve Bank publishes an aggregate balance sheet for the household sector going back 18 years. In 1999, 43 per cent of household wealth was in housing and land. Net financial wealth (net, that is, of debt) comprised the other 57 per cent, including deposits, unincorporated businesses, managed funds, shares and bonds.

By the latest March year the split had flipped to 56 per cent in housing and land and only 44 per cent in net financial assets.

The young basically need a long run-up and a trampoline to even clutch the bottom rung of the housing ladder

The debt-to-income ratio is a record 168 per cent for all households and 324 per cent for those with mortgages.

And the young basically need a long run-up and a trampoline to even clutch the bottom rung of the housing ladder.

Meanwhile, business investment looks soft.


Plant, machinery and equipment investment was flat in the latest March year, and although that followed a 12 per cent increase the year before, that had been off recessionary lows.

Investment in intangible assets like computer software, research and development, and mineral exploration was up 9 per cent.

But labour productivity continues to flat-line at internationally unimpressive levels, which suggests not enough capital is being invested per worker and does not bode well for sustained rises in real incomes and living standards.

So must we conclude that we are just hopelessly improvident and feckless as a nation and as a people?

No. People have just been responding rationally to a tax system which says if you want to provide for your old age, don't save money. Instead, borrow money and use it to bid up the price of houses.

Since the tax rules were changed in 1989, New Zealand has treated retirement savings vehicles exceptionally harshly compared with their equivalents in other developed countries and, crucially, compared with owner-occupied housing.

If you entrust some of your hard-earned after-tax income to a fund manager, the returns it generates will be taxed as they accrue, including usually capital gains. When you eventually reach the age when you can access the money, that transaction is not taxed, but as soon as you reinvest it in, say, bank deposits or government stock, the income it generates will be taxed and when you finally spend what is left, it is liable to attract GST.

By contrast, you can take the same initial pot of surplus cash to a bank which will lend you as big a multiple of your equity as the Reserve Bank will allow, to buy a house with it. You can then enjoy all the benefits of leverage in what is almost always a rising market, and the imputed or avoided rents which fall outside the tax system, until you are ready to sell and pocket your untaxed capital gain.

So guess what we do?

Addressing this economically debilitating distortion from the housing side would be challenging, given the vested interests of owner-occupiers.

And indeed, the terms of reference of the tax working group concede this. It is charged with considering "whether taxing capital gains or land (not applying to the family home or the land under it) or other housing tax measures would improve the tax system." The carve-out of the family home reflects the reality of the likely political consequences were the taxman to sling a grappling iron into what is now the majority of household wealth.

For investors in rental property, the rules are already set to become less accommodating, with an extension of the bright line test for capital gains tax from two to five years and moves to ring-fence tax losses and block negative gearing from providing a tax shelter for other income.

As economist Andrew Coleman argues in his paper "Housing, the 'Great Income Tax Experiment' and the intergenerational consequences of the lease", the distortions arising from the adoption of the taxed-taxed-exempt (TTE) treatment of retirement savings vehicles nearly 30 years ago could also be addressed from that side rather than housing investment.

And indeed, if memory serves, while he was Finance Minister, Cullen described TTE as the biggest exercise in intergenerational theft he had seen. It was in the context of justifying allowing a limited tax credit for contributions to KiwiSaver schemes, but that only nibbles at the problem.

Clearly, any moves to level the playing field by adopting a less discouraging and more internationally normal tax treatment of retirement savings would come at a fiscal cost.

In that sense, the Finance Minister is among those who have a vested interest in the status quo.

But when the status quo is one of chronic household dis-saving, high levels of household and foreign debt, sky high house prices, weak business investment and static labour productivity and real wages, someone needs to take a sword to this Gordian knot.