Kiwiblog

Grahame Armstrong in the SST writes:

THE GOVERNMENT is putting the finishing touches to its package of tax cuts and is now confident that low and middle income earners will have more money in their pockets – even after paying a higher GST.

The Sunday Star-Times understands the government has settled on lowering the tax rate for those earning between $14,000 to $48,000 – which represents the bulk of wage earners – from 21% to 19%.

The May budget is also expected to lower the tax rate for those earning up to $14,000 from 12.5% to 10%.

The Star-Times also understands the government will, in one hit, lower the top rate for those earning more than $70,000 from 38% to 33%, rather than doing it gradually.

So that would give up three tax brackets – 10% for low income earners, 19% for middle income earners and 33% for higher income earners.

What would be the reduction in income tax for people at various income levels:

• $26,000 – 13.8% or $590
• $30,000 – 13.1% or $670
• $40,000 – 12.1% or $870
• $48,000 – 11.6% or $1,030
• $70,000 – 6.4% or $1,030
• $100,000 – 9.2% or 2,530
• $150,000 – 10.8% or $5,030

That is pretty well targeted. Those on the minimum wage get the largest percentage increase, and everyone earning under $50,000 a year gets a double figure percentage drop in the tax they pay. And in fact, with WFF, many of these people are net tax recipients anyway, not net tax payers.

What would be the fiscal cost?

• Dropping the 38% rich prick rate  to 33% – $500 million a year
• Dropping the 21% to 19% – $780 million a year
• Dropping the bottom tax rate from 12.5% to 10% – $820 million a year

So total foregone revenue is $2.1 billion.

Now how much extra GST might people pay. Let us assume that on average people spend 90% of their after tax income, and that the GST increase of 2.5% will lead to an average price increase of 2.0% (as estimated by Stats NZ). What is the impact at each income level:

• $26k – $391 more GST and $590 less income tax = $199 better
• $30k -$448 more GST and$670 less income tax = $222 better
• $40k -$590 more GST and $870 less income tax = $280 better
• $48k -$704 more GST and $1,030 less income tax = $326 better
• $70k – $969 more GST and $1,030 less income tax = $61 better
• $100k – $1,304 more GST and 2,530 less income tax = $1,226 better
• $150k – $1,862 more GST and $5,030 less income tax = $3,168 better

So it does indeed look like no one would be worse off (even if you assume 100% of after tax income is spent).

Obviously those at the top tax brackets do best in an absolute sense, but they are also the ones most likely to be property investors, and may in fact end up worse off overall. Also worth remembering two that half of the 100 wealthiest people in NZ do not actually pay the 38% tax rate, so will not in fact benefit from its reductions – they will just not need to operate through their family trust.

I have no idea if this is the package the Government will go with, but it looks pretty workable, and affordable. Most of all, it is not meant to be about just the redistribution of any changes, but the large benefits to the economy of increasing the incentives to work, save and invest and reducing the incentive to borrow and spend – plus the shifting of incentive for investment income from property to other areas.

The reason I support tax reform, is because I want higher economic growth for New Zealand. The media tend to focus just on who will pay more or less tax, but Adolf Stroombergen from Infometrics blogs at interest.co.nz:

The policy options currently on the table involve a change in the tax mix that deliver the same amount of revenue to the government. Whether the total tax take is too high or too low – whether government is too big or too small – is a different issue. The aim of the current proposals for tax reform is to find a better way to collect the same amount of tax revenue. What is meant by a better way? One that is more conducive to economic growth, fairer to those who can least afford to pay, easier to understand, more difficult to avoid and cheaper to comply with and administer.

Compared to GST, income tax is easier to avoid, more costly to administer, more complex and, as a result more unfair. Its interaction with welfare benefits warps the incentive to work and thus impedes economic growth. So what sort of advantages might an increase in GST coupled with a revenue neutral reduction in personal income taxes actually deliver?

GST also covers a wider base, such as tourists, not just income earners.

In some preliminary analysis with an economy-wide model I investigated the impacts of raising GST to 15%. This would raise enough revenue to fund a uniform proportional reduction in all personal income tax rates of about 10%. For example the 38% rate would drop to 34% and the 21% rate to about 19%.

The changes may not look like much, but the wider economic effects are quite dramatic:

1. An increase in employment of 17,500 full time equivalent jobs.
2. An increase in real income of an average $250 per person per year.
3. An increase in real household spending of $420 per household per year.
4. An increase in aggregate household savings of $280m, contributing to a lift in aggregate real investment of almost half a billion dollars per annum.

That sounds all very worthwhile to me. Note those increases to income and spending are not from redistribution – they are from the higher economic growth.

The uncertainties notwithstanding, it is clear that the macroeconomic gains are significant for what is in effect a fairly minor shuffle of the tax mix. One wonders what sort of gains could be generated by more fundamental reform of the tax and benefit system. If the incomes of New Zealanders are ever going to catch up with the incomes of Australians, tax reform is likely to be an important step in the process.

A very good point. It is a pity land tax has been ruled out.

The Weekend Herald ran this story:

Pat Baker, a $10 million landlady and grandmother, is bristling about being blamed for wrecking the economy.

The Whangaparaoa retiree owns 53 Hamilton houses, bringing in about $700,000 a year in rent.

Yet she feels persecuted for providing so richly for her retirement after Government moves this month to axe housing’s tax shelter status.

“My husband and I worked hard,” she says

“We never had highly-paid jobs but we did have good opportunities to improve our situation. We saved and invested in something tangible which everyone needs.

“Now I am a 73-year-old widow. I manage very well. I am not a poor old-age pensioner because I took steps when I was younger to invest and accumulate wealth.

“But now property investors are maligned in the media. That’s not fair.

First of all one has to say congratulations to Pat Baker. I think it is commendable she has worked so hard to save for her retirement. I wish more people would do so, rather than reply on the state. I have no criticism of Pat Baker’s drive to do well and be well off, indeed rich.

But this is a debate over whether our tax policy is fair, and I am amazed the Herald did not ask the logical question. Of the $10 million of housing that generates $700,000 a year in rent, how much income tax did you pay on that income last year?

It is quite possible that no income tax was paid, as interest on some of the 53 properties was greater than the $700,000 of rental income.

It really is a shame the Herald did not ask the question, because the article is somewhat pointless without it.

Hat Tip: Dim-Post

No Right Turn gives us a great example of the difference between an academic theoretical analysis, and understanding the real word.

He blogs on income distribution:

So, the median income is around the decile 5 boundary of $23,000 a year. …

So, 78% of us don’t even pay the middle tax rate, and the top tax rate is utterly irrelevant to 91% of the population. Remember that next time the government or the media talk about “middle-income” tax cuts – they’re not talking about you, or most of New Zealand. Instead, they’re only talking about themselves.

The Standard have made the same mistake also. You see in New Zealand, we have these things called families and households. What No Right Turn sees as a mass of poor people who will be unaffected by tax cuts, are spouses, older children, many students and even parents of those who do earn more than $23,000 a year, or even $48,000 a year.

If a family has one parent earning $60,000 a year, and one on $15,000 part-time, they both benefit from a change to the 33% tax rate. Because they are a family!!

Likewise most students still get some support from their parents. The income deciles are for adults aged 15 and over, so that covers Year 11 to 13 at school plus full-time tertiary students. And many of those students will have higher salaries once they are not studying.

There are also those on benefits who don’t pay any net income tax. Remember 76% of net income tax is paid by 10% of the population.  But if you are retired and earning just $25,000 a year, that doesn’t mean you are against tax cuts, because you are happy that your adult children will benefit from them.

So ignore the stupid stats and graphs about individual incomes. They are relevant to academic theory, rather than the real world. Household Family income is what affects most people. Now as of June 2009, the median household income was around $64,000. 30% of households have income over $93,000.

If a household is a couple with at least one child, the median annual household income is around $75,000.

Here is what would be a more useful stat. Of households or families that have at least one adult in full-time work, how many of them have at least one adult earning over $48,000 (the threshold for the 33% rate).  It will be a lot more than 22%.

The Herald backs more mining.

The previous government tilted matters too far towards environmental protection. A more balanced approach acknowledges the untapped riches – put at 70 per cent of the country’s potential mineral wealth – tied up in the Crown estate. New Zealand can no more disregard that than it can afford damage to its environmental attributes.

A balanced approach also recognises that not all Crown land is the stuff of pristine scenery or majestic native forest. So large is the Crown estate – it occupies about 30 per cent of New Zealand’s land mass – that there is major potential for mining in selected lower-value areas using modern, relatively non-invasive extraction methods.

This land should not be off limits. Mr Key knows as much. Encouragingly, he is finally showing signs that he also knows the time for prevarication is over.

Even if one built a few dozen mines, they would still cover less than 1% of the conservation estate.

The Press also backs unlocking the land.

… the proposal, as outlined by Key, is sound and sensible, would not be a threat to any land that is really worth protecting, and has much to commend it.

It is not commonly known, though, that New Zealand also has considerable mineral deposits. A geologist’s report two years ago suggested that the in-ground value of metallic minerals and lignite in New Zealand is $240 billion and as the Prime Minister pointed out, in 2008 New Zealand’s third-largest export earner was oil. …

The Government’s careful proposal is not to give carte blanche to extracting this wealth, but rather to free up some of the land where sensitive and undisruptive activity could be undertaken. Some of the land is almost certain to have low or even practically non-existent conservation value. In the vast addition of land to the conservation estate that has taken place in the last decade or more, mostly at the say-so of politicians and bureaucrats with little consultation about it, there is bound to be some that does not need to be there. There can hardly by any objection to low-impact mining in those and other areas, particularly where the potential returns are so great.

This is key – Labour added vast tracts of land to Section 4 – some of which is just gorse. Do not assume all of Section 4 is high conservation value.

The Dominion Post calls for open justice.

Two similar cases, two different outcomes. Is it any wonder people are increasingly questioning whether there are two standards of justice – one for the wealthy, famous and influential and one for everyone else? …

Justice should be administered impartially, regardless of wealth or status. An open justice system and the right to freedom of expression are two of the foundations on which our society is built, as a Law Commission report on suppression made clear last year. “There should be no restriction on publication of information about a court case except in very special circumstances, or for compelling reasons,” it said.

And the ODT supports tax reform:

When all the rorts, loopholes and mechanisms by which a significant proportion of New Zealanders either avoid paying tax – or, quite legally, are not required to – are taken into account, few people would disagree with the proposition, put forward by the Tax Working Group, that the system is “broken”.

They might have varying views on the extent to which this is the case, and almost inevitably will diverge on what the appropriate remedies might be, but Prime Minister John Key and his Government, elected on a platform of tax reform (more popularly described as “tax cuts”) are on solid ground in at least beginning to address the associated issues.

I agree with all four editorials – a fairly rare event

The Herald reports:

The budget will be delivered on May 20 but New Zealanders may get a better idea about the Government’s plans for the tax system next week, Finance Minister Bill English said today.

He said his second budget would focus on improving the economy, getting the Government’s books back in shape and could also address changes to the tax system.

Mr English said Prime Minister John Key would outline the Government’s thinking on tax reform when he opened the parliamentary year on Tuesday. …

“The prime minister will give some indications of direction next week… You do not get too many opportunities to reshape the tax system and right now with the economic challenges we face, tax is a potentially important lever to get our economy focused on earning more than we spend.”

Mr Key also said his opening speech to Parliament would be a quite detailed “shopping list of the economic agenda.”

Mr English today expressed concern that by the end of the decade the average income would be at the top tax rate.

It is pleasing to see a strong focus on economic issues, and the indications are that the Government is not going to settle for the status quo with the tax system.

Mark Keating proposes:

Most countries provide either a nil rate of tax on the lowest level of income or provide rebates and allowances that shelter such small amounts. For instance, Australia imposes no tax on the first $6000 of income earned. Canada provides a rebate for the first $1500 of income.

Only in New Zealand are all taxpayers, including children working part-time jobs, immediately brought into the tax net.

Surely the additional bureaucracy cannot be worth the small amounts of tax collected?

Introducing a small exempt-income threshold or low-income rebate in New Zealand would immediately compensate taxpayers for the small increase in GST proposed.

For instance, making the first $2000 of income exempt would provide an additional $270 to all low-income taxpayers and $420 for taxpayers on the average wage.

This is the most efficient way to ensure vulnerable taxpayers are not the losers under the tax reform proposals.

As a principle, I believe you should pay no taxation until you are earning enough to live on. Otherwise one is churning tax dollars into welfare support which is grossly inefficient.

However to do this, means a total rewrite of the tax and family support rates and policies. It is very difficult to do.

I have long advocated that Dr Cullen should have done what Peter Costello did, and increase the threshold at which you pay tax (it is zero in NZ). But instead he plowed all the money into Working for Families.

I’m not sure if I agree with his assertion that it means $270 for low income earners and $420 for average income earners. If you make the first $2,000 tax free, then it is the marginal rate for that first $2,000, which is 12.5% that counts, so it would mean $250 for every New Zealand who earns at least $2,000 a year.

According to Treasury we have 3.076 million NZers who have taxable income. The annual cost of a $2,000 tax free threshold would be around $750 million. Probably a bit less than that as benefits are calculated net, not gross, so benefit rates would adjust so the net benefit is unchanged.

As I said, I support in principle a tax free threshold. However many low income taxpayers effectively pay no tax at all – they receive far more from other taxpayers through WFF than they pay themselves. So rather than piecemeal introduce a $2,000 tax free threshold I would rather one rejigs the whole system, so that all low income earners pay no tax until they are on the minimum level needed to live on, but with far less money churned through welfare such as WFF. As I said it is a very complex thing to do, especially if you want to minimise “losers” from any change.

Cactus Kate blogs on the recommendations of the Tax Working Group. With respect, I disagree with her on one aspect. She says:

Much has been made of building depreciation. Those who still think this is a starter should read up on the IRD website about “depreciation recovered” . It is erroneous to say that the current system doesn’t already have a clawback on sale where depreciation has been overclaimed. As it does for other fixed assets depreciated in business as well.

Now it is true that when a building is sold, you have to pay back the cost of the tax on the claimed depreciation. Everyone knows this. But Cactus misses the point – you get to have interest free use of that money in the interim – this is like interest free student loans, but even better.

It is effectively lending landlords taxpayers money for free. Residential buildings do not generally depreciate – they appreciate (along with the ladn they are on).

Let me give an example. Say you purchase a house and the building is deemed to be worth $200,000 of the total price. You can claim 3% depreciation diminishing value. In year one that is $6,000. Now if you pay 38% tax, then you effectively end up with $2,280 extra cash.

Now even if you are the worst investor in the world, let us assume you can at least earn the risk free rate of return of 6.29%. So you earn $143.41 of your $2,280.

Now that doesn’t sound much. However in year two you then have $2,423.41 of money to invest plus you claim $5,820 off your income as depreciation, which at 38% which is a further $2,212 to invest. So then your return courtesy of the taxpayer is $291.54.

If you sell your property after ten years, you will have claimed $52,515 off your income, resulting in reduced taxation of $19,956. But you will by then have $28,774 of extra money (at the conservative risk free rate of return), so after paying back the claimed depreciation you still have $8,818 left over.

If you keep your property for 30 years, then after paying back the depreciation you will have $106,639 surplus from being able to use that money interest free. Now this is in nominal terms, so won’t be as much in real terms. But it is still money for nothing and bad economics – just like interest free student loans are bad.

Depreciation is a necessary tax loss, when the asset really does depreciate, as it allows you to fund the cost of replacement. But when we have decades of evidence that residential buildings appreciate, not depreciate, I’d rather not give out interest free loans to property owners to claim a depreciation that doesn’t exist.

Brian Fallow has a nice summary of the pros and cons of various tax options. They are:

RAISING GST

Pro: GST is a robust and efficient tax, and shifting tax from incomes to spending might improve saving.

Con: It is very hard to prevent a rise in GST hitting those on lower incomes harder.

CAPITAL GAINS TAX

Pro: Potentially very lucrative, allowing more tax relief elsewhere.

Con: Lots of practical difficulties and the IRD, which would have to administer it, hates the idea.

LAND TAX

Pro: Broad base, low rate and could bring in billions.

Con: Liable to be undermined by exemptions as in the past. Hard on the retired, Maori trusts and farmers.

RISK FREE RATE OF RETURN FORMULA APPLIED TO RENTAL PROPERTIES

Pro: Targeted at a sector that seems undertaxed now.

Con: Because it is based on equity, it could perversely encourage more gearing in the rental property sector. Could flow through to tenants.

SCRAP BUILDING DEPRECIATION

Pro: Could be done quickly.

Con: It is not easy to distinguish buildings which do depreciate from those which don’t.

I hope the Government will act on at least a couple of these, using the revenue to reduce income taxes. What we tax does matter – not just how much we tax. The best system is broad based and low rate.

John Roughan looks at the current tax system:

Read a few lines further into the Tax Working Group’s report and the picture gets worse. Once you distribute family tax credits, welfare benefits and national superannuation those top 10 per cent of taxpayers have provided 76 per cent of what is left for general public services. Seventy six per cent.

Yep 10% of taxpayers provide 76%. And what happens if more and ore of that 10% go offshore?

The Working for Families refund alone results in 40 per cent of households effectively paying no income tax. It would be cheaper not to tax their wages at all.

It would be. The best system would be that no one pays any tax until they are earning what one regards as the minimum amount needed for a family of their size. Churning money from tax to welfare to inefficient.

A lot of the debate at the moment is on the 38% tax rate. Now this rate was introduced in 2000 by Michael Cullen and has led to huge tax avoidance. Few on the right dispute that the 38% rate should go, or at the very least thre threshold for it increase massively.

But I want to focus also on the 33% rate. You see only should people not be paying a 38% rate, most FT workers shouldn’t even be paying the 33% rate. I’ve done a graph to make my point.

The blue line is the threshold at which people reach the 33% rate, and the purple line is the average FT income. When the top rate was made 33% in 1986, the threshold for it was around double the average FT wage.

Now since then, the average wage has increased greatly, but the threshold has only been lifted four times. The end result is that where once you had to earn twice the average wage to pay the 33% rate, under Labour it go to the point where someone earning 80% of the average wage would be paying the 33% marginal rate.

The threshold stayed constant for ten years until 1996.  It then went up to around $34,000 and two years later to $38,000. Then it stayed constant for another ten years until a miniscule $2,000 increase in October 2008. National then increased it by $8,000 in April 2009.

So National has managed to get it back to around the level of the average wage. But it used to be at twice the level. So remember that if National does drop the top tax rate to 33c, so someone earning $100,000 has a top marginal rate of 33% – that back in 1986 someone earning the equivalent of $100,000 (being double the average wage) wouldn’t even be paying the 33% rate of tax.

No, it is not satire, but a couple of useful posts. First he rebuts a cliche:

Tax cuts for rich, paid for by the poor.’

That’s how Marty at The Standard (happy Lynn?) describes the working group recommendations. To me it looks more like tax cuts for the rich and middle class who pay income tax, paid for by the rich and middle class who use loopholes in the property and WFF tax laws to rort the current system. The working group recommends compensating low income earners for GST increases and I don’t think a lot of struggling families and beneficiaries are benefiting from, say, LACQ shelters or depreciation rebates.

Indeed. I think some (not all) on the left just hate the thought of the top income tax rate being reduced. Maybe Danyl’s other post quoting the TWG may convince them:

. . . out of an Inland Revenue sample of 100 of the highest wealth individuals in New Zealand, data indicate that only about half are paying the highest marginal tax rate on their income.

Tax Working Group Report, Page 27

The higher the marginal rate, the larger the incentive to avoid it. When Labour reduced the top tax rate from 66c to 33c in the 1980s, the amount of tax paid actually increased.

If National does reduce the top tax rate to 33c, that will only bring it back to what it was before Cullen increased it.

The Tax Working Group have released their final report. It is a readable 73 pages.

They first cite three major problems with the current tax system:

1. New Zealand relies heavily on the taxes most harmful to growth – particularly corporate and personal taxes on capital income.
   
2. Differences in tax rates and the treatment of entities provide opportunities to divert income and reduce tax liability. This disparity means investment decisions can be about minimising tax rather than the best business investment.
   
3. There are significant risks to the sustainability of the tax revenue base: Compliance is likely to be affected by perceptions that the system is unfair. International competition for capital and labour, especially from Australia, will impact on the sustainability of corporate and personal tax rates.

They have 13 recommendations, in order:

1. The company, top personal and trust tax rates should be aligned to improve the system’s integrity.
2. New Zealand’s company tax rate needs to be competitive with other countries’ company tax rates, particularly that in Australia.
3. The imputation system should be retained.
4. The top personal tax rates of 38% and 33% should be reduced as part of an alignment strategy and to better position the tax system for growth.
5. Base-broadening is required to address some of the existing biases in the tax system and to improve its efficiency and sustainability
6. Most members of the TWG have significant concerns over the practical challenges arising from a comprehensive CGT
7. The majority of the TWG support detailed consideration of taxing returns from capital invested in residential rental properties on the basis of a deemed notional return calculated using a risk-free rate.
8. Most members of the TWG support the introduction of a low-rate land tax as a means of funding other tax rate reductions.
9. The following targeted options for base-broadening should be considered for introduction relatively quickly:
   1. Removing the 20% depreciation loading on new plant and equipment
   2. Removing tax depreciation on buildings (or certain categories of buildings) if empirical evidence shows that they do not depreciate in value
   3. Changing the thin capitalisation rules by lowering the safe harbour threshold to 60% or by reviewing the base for calculating this measure.
10. GST should continue to apply broadly. There should be no exemptions.
11. Most members of the Group consider that increasing the GST rate to 15% would have merit on efficiency grounds because it would result in reducing the taxation bias against saving and investment.
12. There should be a comprehensive review of welfare policy and how it interacts with the tax system, with an objective being to reduce high effective marginal tax rates.
13. Government should introduce institutional arrangements to ensure there is a stronger focus on achieving and sustaining efficiency, fairness, coherence and integrity of the tax system when tax changes are proposed.

There is little in these recommendations I disagree with, and I hope the Government implements most of them.

The removal of the ability to claim depreciation on buildings as a taxable expense is long overdue, considering almost all buildings actually appreciate in value.

Some of the other recommendations such as a deemed rate of return on investment properties and/or a land tax will help prevent future housing bubbles.

And dropping income tax rates is of course highly desirable.

While I would like to see GST increase, I am not sure that a net revenue gain of just $200 million (after compensating lower income families) from going to 15% makes it worthwhile.

The TWG make clear that they all agree that the status quo is unsustainable and not an option. The Government has pretty much said they agree. So the question is not whether there will be some reform, but how much.

Of course the tax side is half the equation. Maintaining discipline on the spending side is crucial also, and there is more there to be done also.

The Herald takes a look at the tax system:

The most significant problems facing the tax system can be simplified as follows:

The mobility of the tax base: New Zealand is heavily reliant on both its corporate tax take and on the personal taxation of high-income earners representing a low percentage of the total workforce. Companies have the third-highest tax burden in the OECD (measuring tax revenue as a percentage of GDP), and the Treasury is still concerned the company tax rate is among the highest in the smaller OECD economies.

The burden of personal tax is also high, with New Zealand again the third-highest in the OECD in percentage terms. In the 2009 Budget the top 1 per cent of taxpayers pay 15 per cent of the tax, while the top 3 per cent pay 26 per cent. It is not known if these high effective rates of tax contribute to our having the highest diaspora (population of New Zealand-born expatriates) of skilled workers in the OECD, but highly skilled people are mobile and sought after in the global economy.

Taxes that damage economic growth: A related problem to our high taxation of business (in particular company) and personal income taxes is that, according to the Treasury, there is growing evidence these types of taxation are bad for productivity and the most negative for growth.

An concise summary. Labour will wail if the top tax rate is dropped that this is giving tax cuts to millionaires, but tax reform is not about redistributing income, as much as it is about better economic growth so everyone does better. Plus as the Herald reports NZ is dangerously reliant on what Cullen calls the rich pricks.

The Dom Post editorial:

The tax working group established by the Government doesn’t expect to report its findings before Christmas, but it is clear already that ministers will get more than they bargained for.

The group, set up to explore ways of aligning the top personal tax rate with company and trust rates, has carried out a root and branch review of the tax system. Its findings make for sobering reading.

The system is inefficient, counter-productive and unfair. The tax burden is being disproportionately borne by wage and salary earners who cannot restructure their affairs to take advantage of vagaries in the system.

The high proportion of the total tax take gathered from company and income tax increases the incentive for individuals and businesses to shift overseas. And the differing rates at which earnings on different types of investment are taxed is distorting investment decisions.

Yep, the current tax system is sub-optimal at best.

The group’s goal is not just to broaden the tax base but to make the system fairer and more efficient and to reduce the incentives for people and businesses to shift overseas by taxing things that are fixed, such as land and buildings, rather than things that are mobile, such as capital and labour.

This is pretty important. The more you tax capital and labour, the less there is to tax.

A property or land tax would have the added benefit of encouraging investment in productive enterprise by making investment in property less attractive.

Well it is not so much that there will be less investment in property, but a land tax will encourage land owners to get higher economic returns from their land, which is one way to lift economic growth.

The best tax brains in the country have given the Government a chance to make the system fairer and the economy more efficient. Doing so is in the long-term interests of everyone. The Government should grasp the opportunity.

I agree. It would be easier to do, if the crown accounts were in surplus. But even without that luxury, some change must happen.

Brian Fallow writes:

There was a whiff of incrementalism, even complacency, about Finance Minister Bill English’s comments to the tax working group’s conference on Tuesday. …

Had he been able to stay for the rest of the conference and listen to the presentation by some of the working group’s members he would have got a clear message that the tax system has deteriorated beyond the point where tinkering and tweaking are enough.

I hope the Govt does more than tinker.

From the standpoint of maximising economic growth and living standards, the worst things to tax are those which can up stakes and leave, like capital and labour.

Labour sees lowering the top tax rate as opportunity for the politics of envy. But it is about getting the incentives right.

Taxing consumption is better, but tends to be regressive.

Actually over someone’s lifetime, GST is not as regressive as people think.

The best, least-distortionary thing to tax is something which is immobile and the supply of which is not sensitive to taxation, like land.

If it allows income tax to be lowered, I support a land tax. Not only does it provide an incentive to get better economic use out of land, it also brings foreign land owners into the tax base.

One feature of the status quo English singled out as unacceptable is that, within little more than a decade, fiscal drag will have pulled someone on the average wage into the top tax bracket.

Our top marginal tax rate cuts in at a massively low level compared to other countries.

Colin Espiner writes:

Top personal tax rates could fall but homeowners may pay higher rates under the latest proposals from the Government’s advisory group on changes to the tax system.

In its final deliberations before reporting to the Government, the Tax Working Group says the current system is “not sustainable” and there are “major growth, fairness, and integrity issues”.

Good to hear strong language, as that makes it harder for the Government to do nothing.

TAXING TIMES: THE OPTIONS

* Cut top personal tax rate in line with corporate and trust tax rates

* Cut taxes on capital income and remove ability to offset wage and salary income

* Close tax shelter loopholes

* Raise property taxes and/or GST

* Adjust tax rates on interest payments for inflation

* Increase rates to push down property prices and ring-fence losses on rental properties

* Make income on capital investments tax-free until money is withdrawn

Also good to see this comment:

Labour’s finance spokesman, David Cunliffe, said Labour agreed the current tax system was unfair. The party was opposed to a capital gains tax on a first home but would enter in “good faith” discussions on any other proposals.

National and Labour may not be able to agree on what particular tax rates should be, but it would be good if they could agree on the basics such as better to tax immobile stuff such as land rather than labour and capital which is mobile and can move offshore.

The ODT reports:

Personal tax cuts are back on the agenda of Prime Minister John Key and his enthusiasm for the cuts appear to indicate they could be part of National’s 2011 election manifesto.

Speaking to the Otago Daily Times yesterday, Mr Key talked about how a reformed tax system – rewarding people for hard work and risk-taking – could help productivity, along with other measures the Government was considering.

“A lot of work is being undertaken by the tax working group which is due to report by the end of 2010.”

The tax group would make recommendations, some of which would not be palatable to the Government but others would have merit, he said.

What was true was that the group was concerned about holes in the tax system, particularly around the $200 billion of rental properties from which the Crown lost $150 million in revenue.

Mr Key did not support a capital gains tax but he did favour putting some boundaries around investment property.

“On the tax front, the Crown aims to be tax neutral. If we end up plugging some holes then we can recycle the money through tax cuts.”

Sounds promising.

Asked if he could see a time when he could confidently talk about the reintroduction of the tax cuts postponed once the recession hit, Mr Key said he could but the ability to deliver them depended on the size of the fiscal deficits in the future.

However, tax cuts could be part of the overall tax mix.

All of the academic research he had seen out of Treasury pointed to lower personal tax rates as being the strongest impetus to economic growth.

Research from the United States also confirmed that.

And that is key. How we structure the tax system, can have a major effect on economic growth. And only by growing the cake, can we afford superannuation, health care, education etc.

We should ideally have a tax structure that maximises economic growth, and then use the welfare system to deal with inequalities that need addressing. The problem is people see the tax system as the way to address inequality, and that often proves counter-productive.

The SST reports:

Finance minister Bill English has signalled the government will next year get tough with tax-dodgers by closing loopholes that allow wage earners to avoid paying their share of tax.

The IRD says the government is missing out on $300 million a year because of wage earners who squirrel away money into trust accounts to avoid paying the top income tax rate. More is lost because of earnings that are “sheltered” by a company created solely to avoid tax.

Not sure how you can legislate to fix that.

The IRD, in its latest submission to the Tax Working Group, says the problem is that New Zealand’s multitude of tax rates is encouraging bad behaviour.

Oh I am sure it is.

It said the trust account and company tax rates were too far out of line with income tax rates. Taxpayers were placing income in a trust account, paying 33 cents for every dollar earned, rather than the top rate of 38c. Another common ploy was for individual taxpayers to “shelter” their money by creating a company so that they paid 30 cents of every dollar earned in tax rather than the top rate.

The preferred solution is to lower the top tax rate – in fact that is the Govt’s official goal – to have a top tax rate of 30% for individuals, companies and trusts.

The IRD says that when the top income tax rate of 39 cents (now 38 cents) was applied to earnings of $60,000+ in 2000, a flood of taxpayers rearranged their finances to avoid the new regime.

I understand the number of people who declared they earned exactly $60,000 increased literally exponentially.

English said large-scale “legitimate avoidance behaviour” by higher-income earners undermined the goodwill of lower-income earners.

“It’s quite telling that there has been virtually no growth in the number of people paying tax on $1 million of annual income, since the 39 cent top personal tax rate was introduced 10 years ago.

So reduce the incentives for avoidance and cut the top tax rate. When Muldoon’s top tax rate of 66% was dropped to 33%, it killed off much of the avoidance industry. Cullen recreated it.

Also some of the reason for no growth in people paying tax on a million dollars of income, is they have gone overseas.

“As a country, we want families, businesses, accountants and lawyers looking at how to unlock greater income and productivity, not working out how to minimise their tax.

“We don’t want people spending their time and resources trying to avoid tax. We also don’t want IRD devoting all its time to chasing tax and compliance issues.”

Then again drop the top tax rate!

The Dom Post reports:

Low-income earners would have to be compensated if GST was increased as a result of the current tax review, Finance Minister Bill English says. …

“Low-income earners, in particular, would have to be compensated for any increase in GST,” he said in a speech to chartered accountants in Auckland. “The tax working group will have to come up with some fairly compelling reasons to convince us of the overall benefits of further property-related taxes or an increase in GST.”

“We don’t want to go down the route of raising taxes,” he said. “The Government has a strong preference not to increase taxes to close the deficit. We prefer more efficient taxes over higher taxes.”

Most forms of income should be covered and, where possible, loopholes that allowed income to be sheltered from tax should be closed.

With one of the most mobile workforces among developed countries, New Zealand’s tax system must help attract and retain people, businesses and investment.

I of course agree that spending restraint should be used to close the deficit rather than higher taxes. But a more “efficient” tax system which contributes to higher economic growth is very desirable.

The NZ Institute of Chartered Accountants (and Tax Mgmt NZ Ltd) has produced a report recommending a major simplification of taxation for micro and small businesses.

Their goal is for a small business to only have to spend one hour a month filing a single tax return.

For micro-businesses (defined as earning under $60,000 with no employees except owner), they propose that they simply pay 15% of their turnover as taxation (incl ACC levies).  This means no having to work out exact expenses (estimated to be 50% of turnover). It will also make it easier to collect tax on cash income.

The tax would be payable to IRD at least annually but more often if desired. An option to would be to designate to a bank your work account and have the bank automatically transfer 15% of all deposits to the IRD so you can’t spend it and get into arrears.

A small business is defined as turnover less than $1.2 million, registered for GST. Their proposal is to eliminate the need to monitor dividends and salaries to owners, and an imputation credit account. The business simply pays income tax alongside GST at the rate the owners are liable for.

Also no provisional tax, FBT or entertainment tax, and trading stock is dealth with on a cash basis, so no stocktakes.

These changes could affect many businesses. 90% have less than five employees and two thirds of those are run by owner operators.

NZICA make the point that the corner dairy faces the same rules as the largest corporates. Some will argue that is a good thing, but the compliance costs are considerable.

They propose both models be opt-in, so businesses could continue with the status quo if they wanted to.

You can provide feedback at www.smetax.co.nz.

I like the micro-business proposal especially. It really would only apply to people starting their business up, but that is when you want things to be simple.

I see some merits in the small business proposal, but not sure it reduces complexity as much as desired.

The Herald reports:

Bold tax reforms and changes to the mix of monetary and fiscal policy are needed if New Zealand is to rebalance its economy and close the gap with Australia, according to the Treasury’s head.

New Zealand needs to overhaul its tax system, bringing down income tax and potentially increasing GST or imposing a land tax, Treasury Secretary John Whitehead told a business audience in Queenstown last month.

I agree.

A summary and papers from the third session of the Tax Working Group are online at Vic Uni. Some extracts from the work:

Capital Gains Tax:

• Treasury estimate a realisation based CGT on residential property excluding owner occupied would bring in $1.5 billion a year. This would allow the top income tax rate and company tax rate t be lowered to 30c.
• CGT would make tax system more progressive as the wealthier benefit more from it (and the wealthier would benefit most from drop to 30c income tax so overall effect on progressivity might be limited)
• IRD say an accrual based CGT not viable but an realisation based CGT may reduce economic efficiency as it will distort decisions on land-use decisions
• Overall IRD say the benefits of a CGT would not outweigh its disadvantages
• Some worry that as a CGT is so progressive, it might encourage wealthy people to leave NZ. Recommended that if there is a CGT, it apply at same levels as income tax for individuals

Land Tax

• Very efficient as land is immobile. More efficient than a property tax.We have much lower land and property taxes than most countries.
• A land tax would lead to a one off decline in value of land, which would increase home ownership rates.
• The taxable land base is $460 billion so a 0.1% annual tax would raise $460 million a year.If you exclude agricultural land, forestry land and owner occupied land then revenue would be only $160 million a year.
• Average farm land value is $1 million and average residential land value $200,000 so a 0.1% land tax would cost average farmer $1,000 a year and average home owner $200 a year.
• Retired persons might be most disadvantaged as they benefit less from reductions in income tax to compensate
• A land tax will bring foreign owners of land into the tax base, and has high degree of integrity as hard to avoid.

Rental Property

• The tax revenue from the $200 billion rental property sector is negative and has trended down since the 39% tax rate came in.
• An option is to remove income tax from rental of land, and also remove deductibility of expenses relating to the investment, replacing both with income tax on a risk free rate of return on the equity of the property.
• Also discussion on whether rental housing and commercial properties really do depreciate, and should such depreciation be able to be claimed off tax. Depreciation on buildings is worth $1.3 billion a year of foregone income.

I am pleased to see the group backing away from a capital gains tax, but more favourable towards a land tax. I think the land tax (so long as income tax is cut to compensate) has considerable merit. I also think there is merit in concluding most buildings do not depreciate (in fact they appreciate massively) and disallowing depreciation in future. Again this is contingent on the overall level of taxation not increasing.

The website above, has papers which go into great details of the pros and cons. One paper looks at a 0.5% property tax if there is elastic supply. It says:

• 33% income tax rate could drop to 30%
• 20% income tax rate to around 18%
• Average house price drop from $384,500 to $378,000
• Average rent from $11,850 to $12,700
• A 1% land tax or a 0.55% property tax would raise $4.6 billion

Hat Tip: Bernard Hickey

NZ Herald reports:

Labour leader Phil Goff says his party is prepared to discuss a capital gains tax with the Government, opening the way for an accord on a tax that has long been a political hot potato.

Mr Goff said the party’s bottom line would be that the tax would not apply to family homes.

This means it would effectively target investment properties.

The issue is being considered by a Government tax working group, and neither Prime Minister John Key nor Finance Minister Bill English will rule it out.

A capital gains tax on property investment is seen as one way to reduce the tax advantages of rental housing, curb house price inflation and send investment into productive sectors of the economy.

It is commendable that Labour are not ruling such a tax out, and saying they will judge any proposal on its merits. That will allow the Government to have a sensible consideration of the pros and cons.

My strong expectation is that any revenue from expanding the tax base, should be offset by reductions in existing tax rates. Certainly that is the remit of the Government taskforce looking at the tax system.

I hope Labour’s flexible stance will extend to the merits of a land tax also.

Also from Q&A today:

PHIL: Well I certainly hope we are coming out of the recession – internationally you’re seeing signs of recovery in economies and really important economies too. It’s like China now – our exports to China have gone up 62% in the last year since our free trade agreement.

That’s the free trade agreement that the Foreign Minister in the last Government campaigned against?

But as I said at the time, Clark and Goff deserve praise for their efforts in securing the China FTA.

GUYON: Let’s look at an area that National has cut back on, and that is the Public Service. Now you’ve been very critical of that, you were in the short speech you made yesterday. In eight consecutive years in Government the Public Service grew 5.5% when economic growth was not much more than half of that. Is that the sort of levels of Public Service explosion really that you want to return to if you should take the reins of Government again?

PHIL: Well we think it’s great that there were 3 or 4,000 extra nurses that were employed in the Public Service while Labour was in Government&that the numbers of Police Officers out on the beat went up by 1,250.

Nurses and police officers are not included in the figures quoted. Guyon is quoting the core public service figures I am pretty sure.

GUYON: Yes, but they’re the glamour examples though. There were a lot of policy analysts and a lot of others.. How can you sustain a 5.5% growth in the Public Service when your economy is only growing at half that level?

PHIL: Because at the time the economy was growing fast

GUYON : at half that rate though.

Here’s the problem though. Labour do not seem to have accepted that there is a need for fiscal restraint in the face of the recession and a decade of deficits. They have opposed every spending cut there has been.

Having been spoilt with a fast growing economy, how will they cope with an economy where tax revenue does not grow massively each year?

GUYON: Can you say whether you would raise personal income tax, can you rule out this morning raising personal income tax should you take power again?

PHIL: It’s not our intention to raise personal income tax, nor GST – it may well be this government’s intention to raise GST.

Now that is a very welcome, and brave statement. I welcome it. Of course this creates the problem that to fund their spending promises, they will have to borrow billions more leaving future taxpayers indebted.

The challenge for Labour in 2011 will be to present an alternative budget that keeps Goff’s promise of no tax increases, but also has NZ on a believable path back to surpluses.

Goff’s ruling out of any increase in income tax or GST is very significant and the first major departure from the Clark years. The challenge is getting people to believe it by having realistic spending promises.

GUYON: You and your party, the Labour party, went after John Key very heavily in the last election campaign, you made the whole campaign about trust – the idea was that you couldn’t trust John Key. The party president was dispatched to try and dig up dirt on decades old deals to try and find some wrong-doing. Is that something that you’re apologising for this weekend as well, the way that you handled that?

PHIL: I think that both sides in Parliament probe the other side to check whether promises being made are promises being made with integrity. That will always happen in an adversarial system. I think the publicity and the looking at the finances around Mr Key at the last election WAS a mistake yes.

A welcome admission.

GUYON: but do you trust him [Key]?

PHIL: Do I believe that what is being said is always what is on the agenda, I’d have to say no. I mean they employ spin doctors, and the role of spin doctors is to have the Prime Minister saying what people want to hear.

Now Goff loses the plot. He doesn’t trust John Key because Key has spin doctors. Goff has several himself, as did Clark.

And just as relevantly, it is pretty obvious to most journalists that Key is one of the least scripted PMs of recent times. In fact the major criticism in recent days has been that Goff is the one who speaks in spin doctor sound bites, unlike Key who speaks normally.

GUYON: You talked about spin doctors, but every party employs them and in fact it looks you are employing them pretty heavily this weekend. I mean it’s an image makeover though isn’t it – you’ve tried desperately to make yourself look more human, look more relaxed, look more casual haven’t you?

PHIL: Ah, look when you talk about spin doctors we don’t have an agency like the Australian agency

Good God, Labour’s obsession with Crosby Textor is driving them demented. National has had a relationship with Mark Textor for almost 20 years.

This is a classic example of Labour still focusing on “Wellington” issues. They’ve tried very hard to have their conference focus on wider issues such as the economy, jobs, healthcare – but if you scratch away a bit, they revert to type. Absolutely no-one outside the Labour and Green Party membership cares about this crap.

PHIL: No look obviously you think, particularly when you become leader of the opposition, there’s a different role you have to perform, there are different sides of you that people have to see. I’ve spent most of my political career trying to protect my family from politics, I didn’t want them in the full glare of politics. But suddenly people say “look we don’t know anything about you, we don’t know what your family is, we don’t know you’ve got two boys and a girl”. So clearly in the role I’m playing now I’ve got to become a little more open about the sort of things that once upon a time I would’ve like to have kept personal.

I’m pleased to see Phil take my advice that New Zealanders do want to know more about him – and by default his family. Not in a hugely intrusive way, but to understand more about who he is. It is not that easy for either politician, or family, but people do want to feel they know something about the person who may be Prime Minister.

GUYON: You lost the working class at the last election , a good strand of them, in some pretty important seats like Waitakere and other areas, Chris Trotter calls these people the sort of guy who likes to have a few beers on a Sunday afternoon sitting on a deck that he built himself. How do you win those people back next time?

PHIL: It’s a point well made and I think you’ve got to win back those people by those people perceiving you to understand what their concerns are and what there hopes are.

GUYON: And how do you do that?

PHIL: I think by showing that most of us have come up by that same particular route, I wasn’t born with a silver spoon in my mouth, I grew up in a working family – we worked hard for everything we got. I’ve got my family that I’ve worked hard to bring up, I can identify with those people . I’ve got two sons who are tradesmen. They are exactly the sort of people that Chris Trotter gave as a Waitakere man. Those are the sorts of things that they’re interested in – I believe I’m in touch with those things.

Goff is certainly better positioned than Clark and Cullen were to win back that working class vote. In fact of the entire Labour caucus he is probably the best person to try and do that – apart from possibly Shane Jones who has potential appeal there also.

GUYON: But the voters want to know is there a place for Winston Peters in a few years time to become a part of Government?

PHIL: There’s a place for anybody who is prepared to work on-side Labour for the values, the ideals, and the policies that we put forward. I don’t rule out Winston Peters any more than I rule out the Green Party, the Maori Party or the United Future Party and obviously the Progressive Party

There was a missed opportunity there. I’m not saying he should have ruled Peters out (that then becomes the major story) but he could have said that for Labout to work with Peters again, we would have to be convinced that he would conform with the Ministerial and Parliamentary rules on conflicts of interests and disclosures.

The danger for Goff, is that he looks to be saying he will be the same as Clark, and let Winston get away with anything in exchange for the baubles of power.

GUYON: And we have a referendum to this whole electoral system, what is Labour’s position on that? 1997, as Justice Spokesman, you called for a binding referendum on MMP whether we should chuck it out or not, what’s your view now?

PHIL: I think if you’re going to change the system it MUST be with the mandate of the people and that must be by a binding referendum.

GUYON: So you support going for a referendum?

PHIL: yes, we’re not opposing the Government on that at all

That is interesting.

GUYON: ..How would you vote?

PHIL: At this stage I’d probably vote for MMP but we’ve had at this conference quite an interesting discussion about that and the members I’ve talked to have said look we’d like to see fewer list MP’s and more Electorate MP’s. We’d like to see electorates a little bit smaller so that electorate members can give a bit more personal attention to their constituents. Our people tell me that we can do that, we could have as many as 80 electorate MP’s with the balance of 40 being list MPs. It may be that we’re looking for a variation on MMP to make it work better, to use its strengths to counteract its weakness.

More interesting is that he would only “probably” vote for MMP.

Labour need to be very careful of their numbers. Chris Hipkins said yesterday:

The analysis I have seen suggests we could have 90 electorates and 30 list MPs and the proportionality would be preserved. From memory applying that to the 5 MMP elections we have had the biggest overhang would have been 4 extra seats. That’s just from memory though. Someone else might have the actual nos handy.

I responded:

Chris – your memory is faulty on MMP with a 90/30 split. Assuming parties won the same proportion of electorate seats, a 90/30 elect/list split would have seen Labour in 1999 with a 6 seat overhang and in 2002 with a 7 seat overhang. That would be almost as unproportional as SM.

On the plus side it would have meant in 1999 every Labour List MP would have been wiped out so no Cullen and Wilson

Goff is now talking 80/40. If you assume they would have won the same proportion of electorates (which is not that likely) it would in 2002 have left Labour with either 0 or 1 List MPs – very close to overhang.

But what Goff overlooks is that every census the number of electorate seats increases by 1 or 2 as the North Island has faster population growth than the South Island. Hence within a decade that 80/40 could be 84/36 and overhang could well become a regular thing.

And the issue of Maori Party overhang would also get worse. Ironically what Goff is talking about would move MMP closer to an SM system.

Colin James writes:

Three interlocking principles underlie the group’s approach: tax should be fair, efficient and sustainable. Taxpayers should feel they are paying a fair share and everyone else is, too. The tax system should cost no more to run than necessary and should contribute to productivity growth. And it should survive over time with limited need of repair.

To meet these principles the structure should be coherent, should have integrity – there should not be incentives to avoid or minimise tax, for instance, by channelling income through trusts, as large numbers have done this decade – and should be simple to administer and comply with.

During the past 10 years tax changes have chipped away at coherence, integrity and simplicity. The top income tax rate was raised, Working for Families added complexity and high marginal tax rates for some, special rates were set for some long-term saving and KiwiSaver added more complexity.

In addition, aggressive bracket creep lifted the proportion of income ordinary folk paid in income tax. Add that many other countries, including those we most compare ourselves with, have cut some tax rates, notably on personal and company income.

Australia cut tax rates every year for the last eight or so.

Next, note the global movement of people, capital and finance. There is a strong argument for taxing immobile factors, such as land and spending, and not internationally mobile ones, such as company and personal income and investment.

Yep. The challenge is how you do that, without significantly disadvantaging people who have made decisions based on the status quo.

There was a chorus of complaints last week that raising GST would disproportionately hurt the less-well-off. And it would. But over their lifetimes, many less-well-off people increase their incomes. And in any case, the group argues, it is better to compensate the less- well-off through spending measures than by manipulating the tax system. But is the group exploring all options for broadening the tax base?

This is key. The tax system should be as simple and efficient as possible. If that creates problems for those on low incomes, then the welfare system is the better option to use, than having an inefficient tax system.