Mary Holm: Who's paying for the free lunch?

Q: Why do people keep insisting on comparing our tax rates with those in countries such as Australia and the UK?

Based on their respective population sizes, they share the tax burden between approximately five and 15 times more people than in New Zealand.

Sure, the cost of running a country will be proportional to population size, but economies of scale cannot be ignored.

If you want to live in a country with a small population such as ours you simply need to be prepared to contribute more than in other countries.

A: I'm sure you're right. We still have a Parliament, various Government departments, roads and so on, which cost a certain amount to run whatever the size of the population.

This doesn't apply only to Government. Most of New Zealand's advantages and disadvantages over other similar countries can be attributed to our smaller population.

In many areas - from the arts to consumer goods - we have less choice. Many of us, though, are willing to trade that for the ease with which we can find a deserted beach. Having to pay more tax per head may be part of the deal.

Q: The worst thing about this tax is the conflicting information that comes out of the Government. That used to be called disinformation, a common tactic to confuse the enemy.

The only conclusion I can reach is that this Government considers anyone who invests with intelligence the enemy.

Yes, I have made my submission opposing this proposal.

A: I hope many others have, too. Next Friday, July 7, is the deadline, so those who haven't made submissions yet had better get a move on. Send them to: Finance and Select Committee Secretariat or mail to the Finance and Select Committee Secretariat, Bowen House, Parliament Buildings, Wellington.

A tip from Mt Maunganui investment adviser Charles Tomlinson: "Try not to denigrate the people involved. Focus on the proposed tax, not the politicians themselves." I quite agree. Abusing people never wins them over.

Abusive or not, though, let's get those submissions in. I really believe that the more the committee receives, the more pressure they will feel to change the proposals.

You can be sure the professionals are having their say, too. Says Cam Watson of ABN Amro Craigs: "We cannot remember a time when the entire investment advisory industry in New Zealand has been so united against an issue, along with a number of independent special interest groups like the NZ Shareholders Association."

Which leads me to the submission from Shareholders Association chairman and accountant Bruce Sheppard. Some excerpts:

"The passing of this bill will not affect me personally to any degree except to the extent that my professional income will increase."

"Every new complex band-aid to the Tax Act creates new avenues for avoidance and mitigation. Remedial bills will be required."

The exclusions of Australian shares and GPG "have been included for political rather than principle reasons, and this is a dangerous reversion for New Zealand. We have not seen such deliberately targeted politically motivated tax and exemptions since the Muldoon years.

"The assumption that investing in foreign equities in some way has a favourable tax treatment is false. In summary this bill will create more investment inequities than it solves both between asset classes and investment structures, and the tax evil that is purported to be fixed by this bill is a figment of the Government's imagination.

"Of those who directly invest in Grey List countries a considerable number will choose to migrate their capital to NZ. It is unlikely that this will find its way into equity markets as pricing is already at historical highs, although a short-term equity price bubble could be fuelled. More likely the flow of investment capital will find its way into net bank liquidity and demand deposits and/or residential property. In effect, both will fuel the property market, one will be demand led and the other will be mortgage lending led."

The next reader's letter, a submission that she also sent to me, backs up Sheppard:

Q: Like many elderly accountant-free investors, I heed the advice of diversification, just as the Cullen Fund does with its 75 per cent invested overseas. I have direct shares (never managed funds) in a few US companies.

If this strange and very complex tax becomes law, it is imperative that IRD put out guides and tax forms immediately thereafter so people can decide how much they want to un-diversify before April 1.

I certainly will pull nearly all my money out of US shares to put it into property here - just what I don't want to do, and I thought that the Government didn't want that either.

A: Complexity, as much as higher taxes, is obviously worrying many, including top accountants, I hear. I've received heaps of letters from readers asking questions about their circumstances that I can't answer, so I quite agree that much guidance will be needed from Inland Revenue.

Unless, that is, the Government sees the light and sets aside its proposals to change international tax.

As another reader's submissions says, "The whole issue of whether, and if so how, capital appreciation should be taxed needs to be considered as a separate issue outside this bill."

Q: What was an optimal portfolio allocation of assets before the Grey List tax will no longer be optimal. Rational investors will rebalance by trimming back Grey List shareholdings.

This creates what economists call a deadweight loss for New Zealand as a whole (including government) since the post-tax New Zealand portfolio will have an inefficient risk-return profile compared to the pre-tax portfolio.

Such a deadweight loss is non-trivial and should be considered in any cost-benefit analysis. Of course, deadweights' costs, like icebergs, are largely hidden from view and therefore slow to be politically appreciated. But don't icebergs sometimes have titanic consequences?

A: It's quite true that any time investment decisions are distorted by unequal taxation, investors won't get as high a return for a given level of risk.

Finance Minister Michael Cullen apparently agrees. "We believe it is important to remove distortions in investment decision-making," he said in a recent speech.

The only trouble is that he thinks the changes will remove differential tax treatment, but that is true only in some situations. In others, the changes create inequalities.

How have we come to this, when intelligent people on both sides see things so differently? That must be a sure sign of extreme complexity.

As for your reference to the Titanic, Henry Wadsworth Longfellow wrote about a "ship of state". Hmmm.

Q: Maybe you could bring out the point in your articles about the total market capitalisation of the Grey List countries v the Rest.

There may be more diversification (if shares in all countries but Australasia are taxed the same, encouraging investors to spread their money throughout the world, as Cullen has suggested).

But it is not substantial unless one plies the far riskier emerging markets, which should not be in the same investment category.

A: According to calculations by ABN Amro Craigs, the market capitalisation - the value of all the shares - in the Grey List countries is about 82 per cent of the world total.

That doesn't leave much room for the rest of the world. And, as you say, many of the other markets are riskier - although officials in France, Switzerland, the Netherlands and Italy might object to that label.

It seems pretty obvious that, if the Grey List goes, most New Zealanders who continue to invest offshore will still concentrate largely on the three giants, US, UK and Japan.

To finish, a few more quotes from the scores of good letters and submissions on the tax changes:

* Free and unencumbered diversification across all forms of investment across the world is essential for New Zealand to minimise the effects of any major shock such as the impact of the inevitable earthquake in Wellington.

* A much-trumpeted Australian exemption has turned into a confusing farce, with News Corp, Australian property trusts (which have high dividend payouts) and Australian unit trusts not included in the exemption.

* I can find no other examples in the world of the calculation of assessable income being driven by changes in unrealised asset values. The nearest is the French wealth tax. We have to ask ourselves: is the French tax system really the direction we want to be heading?

* I know of people who own property in Australia and the UK. Where is their tax on unrealised capital gains? People who have purchased precious metals, such as gold that was mined and held overseas, where is their tax on unrealised capital gains?

* I read with interest a paper that was produced by a fund manager for the Government.

This report actually highlighted the anecdote that gets dragged out at dinner parties: If an investor had put $50,000 into Dell 10 years ago, it would be worth $10 million now and they would have paid no tax on it. This was actually used to support the argument for capital gains tax on overseas portfolio investments!

If this mythical shareholder truly exists, it will turn out to be Michael Dell's grandmother, as who else would have managed to hold on to their shares through the dot.com crash in 2001.

The arguments for CGT are based on fallacies and anecdotes. We should be encouraging diversification not penalising it.

* Enough! As one reader politely puts it, "on reading your column of late some issues seem to be covered on an ongoing basis!"

I make no apology for that. In the years this column has run, there's never been a more worrying proposal by a government or anything like as big an outpouring of letters.

By next Saturday, though, it will be too late to send submissions. So the next column will be tax-change-free.

And until there are new developments I will largely stay away from the topic. Promise.