Changes to tax on bank savings not ruled out

Bill English. Photo / Sarah Ivey

The Government has immediately ruled out one of the savings working group's proposed tax changes, a further switch from income tax to GST, but another, indexation, remains under consideration.

The group believes tax distortions accounted for half the recent property bubble. Without a capital gains tax, which was expressly excluded in its terms of reference, the only way to reduce the tax distortions on property prices would be to reduce taxes on financial assets, its final report says.

It recommends savers be taxed on the real or inflation-adjusted interest income they earn, and that businesses and property investors only be allowed to claim a deduction of the real portion of their interest expense.

The idea was considered and rejected in the 1980s but has more recently been advocated by the Reserve Bank as something which would make its task, and borrowers' lives, easier.

At the moment, with inflation at 4 per cent, someone who is earning 6 per cent on a bank deposit and who has a marginal income tax rate of 33 per cent will get no real return at all.

The proposal is that a standard inflation rate of, say, 2 per cent, will be set for tax purposes and both taxable interest income and deductible interest expenses be reduced accordingly.

The working group said it was incongruous that the simplest savings products - bank deposits - faced the highest real effective tax rates.

Finance Minister Bill English agrees. "If we can do something about that it would be good," he said.

Indexation was an interesting idea, English said. "I wouldn't rule it out."

But reducing the ability of businesses and property investors to claim a deduction for the full nominal amount of interest they pay, might encounter resistance.

Business New Zealand said while it would not be completely against indexing interest expenses, it would add further complexity and compliance cost and it would prefer the Government to lessen the distortion by cutting tax rates.

For some companies the impact would be offset by an associated change to allow depreciation to be inflation-adjusted as well.

Andrew King, vice-president of the Property Investors Federation, said allowing only real interest costs to be deducted, coming on top of the Budget's scrapping a depreciation deduction on buildings, could force some landlords to sell.

A survey the federation undertook after the depreciation change found only 5 per cent saying they would sell because of it but another 32 per cent said they had dropped plans to buy another property.

The interest deduction is a bigger deal than depreciation, especially in the early years of an investment, he said. Labour's finance spokesman, David Cunliffe, said on the face of it there was a good case that savings were overtaxed and returns on property undertaxed. Whether indexation was the best means of evening that out would require careful consideration.

The working group argued for a further rise in the GST rate to 17.5 per cent, with compensating changes to income tax and benefits.

After-tax returns to savings are higher under expenditure taxes than income taxes, because the income from saving is allowed to compound through time before it is taxed under an expenditure tax, whereas it is taxed as it compounds under an income tax.

"Moreover in comparison with an income tax where certain forms of capital income are not taxed (for example capital gains and the returns to owner-occupied housing) or are taxed at different rates, expenditure taxes are applied equally to all forms of capital income."

But English said the Government was not interested in considering another increase in GST. Cunliffe rejected it, too.