Fran O'Sullivan: Two-pronged tax attack

The Government accounts are awash with cash and Finance Minister Michael Cullen is about to face pressure from an unexpected quarter - the unions - to bring forward his own paltry $360 million Budget tax cuts to keep aspirational higher-paid "workers" happy.

It's not often that labour sings from capital's hymn sheet.

But leading unionist Peter Conway's admission (to this columnist) that Cullen should move sooner, not later, to lift the thresholds at which individual tax rates bite will be music to many ears.

Conway - who is emphatic his words should not yet be read as a "clarion call" - admits many of the Council of Trade Unions' members want tax cuts. Particularly those who will not be on the receiving end of Labour's election bribe to roll out the Working for Families programme to another 60,000 families.

Unfortunately, unions were too cynical to mount this position during the election as they campaigned for Labour's return. But when the maths are done at CTU HQ (as Conway has) it's pretty clear there is plenty of fiscal wriggle room for Cullen to keep faith with Labour's voters but also assuage other New Zealanders' genuine concern at being cut out of the action.

It's fair to say that Conway believes the cry for tax cuts initially grew out of misperceptions that the Government was sitting on a huge wodge of spare taxpayers' cash tied up in a much-misunderstood Budget surplus. But perception is reality and Labour's vote bribes will not just make the issue go away.

PriceWaterhouseCoopers chairman John Shewan foreshadows screaming headlines down the track. "What's going to happen when people wake up to the fact that the Working for Families package means a large number of New Zealanders won't be paying any net tax at all? They'll object.

"We already have a situation where the top 3 per cent pay 25 per cent of all tax. Well that will skyrocket. We'll end up with, I guess, about the top 5 per cent of taxpayers paying about 55 per cent of tax and that's just obscene.

"That will cause a real pushback."

Like Conway, Shewan would not be surprised to see the Government start nibbling away at the 33 per cent rate - or even move on the 39 per cent threshold - as it takes on board the clear message from the electorate. Conway suggests the December fiscal update would be the time for a clarification statement.

Cullen's ears may still be deaf to the tax-cuts tune. But it's a sure bet that Prime Minister Helen Clark will be reading the signals as she weighs up whether to box Cullen in with a more business-savvy deputy.

Cullen has suggested that this might be his last term. After 21 years in Parliament he can expect an extremely generous superannuation payout, which, combined with a desire to reduce his golf score, will be an incentive to join Clark in moving on in three years. Or so the political drum goes.

As if this blatant ingratitude is not enough for our famously scrooge-like Finance Minister, companies are also gearing up for another push to get the corporate tax rate below 33 per cent to ensure New Zealand remains a competitive destination for investment capital.

They may even get help from a most unexpected corner - the Inland Revenue Department - as IRD concerns grow that some Australian companies will simply "transfer profits" across the Tasman, further eroding New Zealand's corporate tax base, if the company rate is not cut to match's Australia's 30 per cent.

After three years of Cullen's intransigence over the company rate, nifty accountants have declared it's "open season for duck shooting" as they assist some Australian companies with substantial investments here to use combinations of balance sheet gearing, transfer pricing and our lax thin capitalisation rules to reduce the amount of corporate tax paid.

It doesn't take a genius IQ to load up NZ subsidiaries with debt levels close to the 75 per cent maximum and extract what is arguably "profit" to be taxed at Australia's lower rate.

National's John Key - who scored large with the electorate when he promoted a $3.9 billion tax cuts package - is concerned at the level of financial manoeuvring as transnational companies reduce their tax burdens. But National's own cynical political considerations saw it opt to bribe voters with personal tax cuts first, leaving a reduction in company tax until 2008.

Cullen is fully aware of the impending crisis. The IRD is expected to focus on the issue in its post-election briefing papers.

But the big philosophical debate will be around whether the Government uses the "carrot or the stick" to stymie the erosion.

Shewan - who prefers the carrot approach - warns that if Cullen does not act to bring down NZ company rates quickly, more Australian corporates will simply "transfer profits" out of here. "We're the only country in the world that's collecting more and more company tax - that can't last. Company tax will fall."

Canadian figures elsewhere on this page illustrate the problem.

A study published in the Auckland University Business Review into international transfer pricing practices in New Zealand showed foreign companies were clear that transfer-pricing decisions must comply with tax law and regulations. But local managers also faced an imperative to ensure overall profit to the multinational groups.

Cullen has floated cutting corporate rates, but only if companies take on Australian imposts like payroll or capital gains taxes. This runs against NZ's 20-year-old trend towards tax neutrality, but payroll taxes would clip the wings of those foreign companies which are big employers and who otherwise might not pay much local tax.

Complicating the transtasman debate is the difficulty New Zealand's policy-makers have had persuading Australian Treasurer Peter Costello to face up to some tricky issues around mutual recognition of dividends or franking credits. And increasing competitive pressure for a new round of Australian tax reductions.

New figures out today are expected to show Australia's "footprint" has grown markedly since the last statistics which showed Australia was the source of nearly half of the $64.3 billion in direct foreign investment recorded at March 2004. Bank of New Zealand chairman Kerry McDonald - who co-chairs the Australian New Zealand Leadership Forum - is adamant Cullen must move to make New Zealand more competitive or face companies shifting head offices to Sydney to reduce their burden.

My bet is that if the Government continues to sit on its hands, it will not be long before politicians like Winston Peters start to figure there is another "winebox" type scandal in the making - with New Zealand starring in the Cook Islands' role.

Unfortunately, it will be New Zealand's steadily reducing number of net taxpayers who will foot the bills.