Kiwiblog

The Government has done a very nice job of not repeating their mistake at the beginning of the year when they over-egged expectations and under-delivered – which had Phil Goff reading out in the House my “B” grade to the PM’s beginning of year statement.

The tax cuts in this budget go well beyond what media had been predicting with a huge drop in the second lowest tax rate, and also a welcome drop in the corporate tax rate from 30% to 28% at 1 April 2011. This will help attract investment to NZ and matches Australia. The tax package gets an A- from me.

The tax rate changes from 1 October 2010 are:

• Up to $14K – tax rate goes from 12.5% to 10.5%
  $14K to $48K – tax rate goes from 21.0% to 17.5%
  $48K to $70K – tax rate goes from 33.0% to 30.0%
  $70K+ – tax rate goes from 38.0% to 33.0%

Workers earning around the average full-time wage ($40K to $48k) will, over 18 months, have had their top marginal tax rate go from 33% to 17.5% – almost halved.

Two thirds of the “cost” of tax cuts goes to reducing bottom two rates and 73% of income earners will have a top tax rate of 17.5%. You keep 82.5% of every extra hour you work.

The table above shows the change in income tax for the various tax brackets. They’ve done a very good job of having the reductions fairly smooth across the board as a percentage of existing income tax paid. Those under $70,000 get the largest percentage decrease.

Note the table includes the IETC for non WFF recipients (80% of people). If you exclude that it does not change the absolute savings but the % savings at $30K is 16.4% and $40K is 16.5%.

This table shows the net savings after impact of GST (calculated at 2% CPI increase). As one can see, people at every income level are left no worse off which was the objective.

However the above table only covers income tax and GST. There are also increases in superannuation, benefit adjustments, the changes to depreciation rules and the crack down on LACQs etc. Treasury has estimated the overall impact of tax changes as a percentage of the average disposable income. They estimate:

1 Households earning under $40K will be 0.7% better off
2 Households earning $40K to $85K will be 0.4% better off
3 Households earning over $85K will be 0.7% better off

Some of the other tax changes are:

• No depreciation claims on buildings with an estimated useful life of greater than 50 years
• LAQCs can not deduct losses at the marginal tax rate and pay tax on profits at lower company rate
• Changes to thin capitalization rules to limit foreign multinationals reducing NZ tax liability
• WFF eligibility to exclude investment and rental losses
• Remove the 20% accelerated depreciation loading for new plant and equipment

The property changes will see crown revenue increase by $2.5 billion over four years or an average $600 million a year.

$119 million of funding to IRD for increased audit and compliance is estimated to bring in $745m over four years or $200m a year.

Almost all of that extra $800m will come from higher wealth households.

This is why overall high income households are forecast to, on average, have only a 0.7% increase in disposable income – the same as low income households. One has to not just look at the income tax and GST changes, but the overall package.

And overall one has to conclude it has met the twin aims of both being fair and being good for economic growth.

Martin Kay writes:

MPs are set for tax cuts of at least $57 a week in tomorrow’s Budget, but some with investment properties could be hit in the pocket by other tax changes.

The latest register of MPs’ pecuniary interests, issued yesterday, reveals 71 of Parliament’s 122 MPs have a concern in more than one property, including several who have investment properties.

Tomorrow’s Budget is expected to lower the top income tax rate from 38 to 33 cents in the dollar, bringing the lowest-paid backbench MP a tax break of $57 a week.

Some will be clawed back through the rise in GST, but Finance Minister Bill English is also expected to curb the ability to offset losses and depreciation from investment properties against other tax.

I’ve done a quick calculation of what the assumed changes will mean for an MP who has one (many have more than one) investment property.

If the improvements are valued at $200,000, then they will be claiming $4,000 depreciation which reduces their tax burden by $1,520 or $29 a week.

So that tax break is down to $28 a week. But what about GST. The TWG estimated GST on average is 5% of income for top decile earners, so for salary of $130,000 it is $6,500. If GST increases by 20% (from 12.5% to 15%) the extra GST will be $1,300 or $25 a week.

So an MP who has one investment property is projected to be just $3 a week better off, or $150 a year.

Remember that tomorrow, as some claim Government MPs are motivated by self interest in supporting a tax reform package.

John Hartevelt reports:

A $300 million tax dodge – by which half the country’s rich don’t pay the top tax rate – will be cracked by changes tipped for tomorrow’s Budget.

Prime Minister John Key said yesterday that tax-avoidance loopholes were being targeted.

The top income tax rate of 38 per cent has encouraged wealthy Kiwis to move their money into family trusts, which pay tax at 33 per cent, or into companies, which attract only 30 per cent tax.

An Inland Revenue sample of 100 of the wealthiest New Zealanders showed that only about half were paying the highest marginal tax rate on their income.

The Tax Working Group says sheltering of income in trusts cost the Government about $300m in tax revenue in 2007.

John Shewan, chairman of PricewaterhouseCoopers and a working group member, said trusts were “breeding like rabbits in the South Island”.

That is a key point to remember – many wealthy people are avoiding the 38% tax rate. And if they have rental property investments, they will probably end up paying more in overall taxation.

“And that’s what happens when you have silly tax rules that provide that incentive. The tax rules have driven people into using companies and trusts.

“People aren’t stupid. The shockingly poorly designed tax package of 2000 has caused all sorts of things to happen.”

Financial author Martin Hawes said he would be surprised if any of the richest Kiwis paid the top income tax rate and, if they did, it would be on only a tiny fraction of their worth.

The lower the tax rates are, the less people try to avoid them.

Mr Key said the Budget would include “a number of areas” in which tax liability was increased.

“You will see we’ve done quite a good job actually of closing down loopholes and making sure there is fairness in the system,” he said.

“We know that roughly half the people on the rich list actually didn’t pay the top personal rate last year, so [we're trying to] get some fairness into the system.”

Mr Shewan said “a great number of wealthy people” would end up paying more tax.

“There is political risk associated with increasing anybody’s tax and some people are not going to be happy with the statements that are going to be made on Budget night.”

Mr Hawes said business people and farmers were among the most common users of family trusts.

“On the tax side, the people who would be affected by any tax changes to trusts will be National Party voters.”

And again it is not about redistributing a small cake. It is about growing a larger cake. Less inventive to avoid tax through trusts and residential property investment. Greater incentive to earn more and save more and invest more in capital markets.

The Dom Post reports:

Prime Minister John Key is urging Kiwis not to be jealous if the rich get more from Thursday’s Budget tax package – because the rich are crucial to the economy.

The top 10% of taxpayers pay 76% of net taxation. Yes 10% pay 76% and 90% pay 24%.

But it is expected to deliver little more than $6 a week extra to low and middle-income earners as across-the-board personal tax cuts are clawed back by a rise to 15 per cent in GST and extra tax from property investors.

Once again – the tax changes are not about redistribution. They are about changing the incentives so there are greater incentives to work, save and invest overall and less of an incentive to invest in property beyond your own home.

Those earning more than $500,000 a year would get a $481-a-week tax cut, and even taking into account their extra GST payments, they will be more than $300 a week better off.

Why choose $500,000 a year – a salary level probably 50 people are on? Why not $800,000 or $1.2 million a year if you really want to get the envy going.

Anyway, some facts:

1. The higher the tax rates, the more it will be (legally) avoided. Hence why only half of the wealthiest 100 NZers are even paying the top tax rate. That NZer on $500K a year may in fact end up losing money through the tax package if his or her income comes through a trust at 33%, as they will have extra GST to pay and no reduction in trust tax.
2. Those who will be hardest hit are those owning multiple residential investment properties. These are not low income people. They will be people in the top tax brackets. They will end up paying more tax overall.
3. Someone on $500,000 a year will still be paying almost $160,000 in income tax and $25,000 in GST. If they shift to Australia that is $165,000 less tax available to fund welfare etc.

The Herald reports:

The cuts are likely to reduce personal tax rates from 38c, 33c, 21c and 12.5c in the dollar to 33c, 19c and 10c.

That would be good.

Mr English said at the weekend that he expected the focus on Budget day to be on people’s cash positions.

“But that is not the purpose of it – to make them a bit better or worse off in cash terms, although of course that is important,” he said.

“The point of the tax package is whether four or five years down the track we can influence the choices that people make.

“What we want to do is tilt the economy. It’s not shock treatment. It’s changing the choices that peoplehave and changing the way theythink about those choices.”

This is what Labour never wants to talk about. To them tax is only about redistribution. And of course that is part of it.

But tax is also about incentives and encouraging people to work and save.

The Herald reports:

The average New Zealand earner’s total tax burden is second-lowest in the OECD when superannuation and other compulsory taxes are counted, according to a new report.

This is not a measure of the overall level of taxation in the economy. It is a measure of the difference between gross pay and net pay. There is a huge difference.

The report also said that New Zealand had the smallest tax wedge for  one-earner married couples with two children earning the average wage, at 0.6 per cent.

The OECD report includes welfare payments made through the IRD (working for families) as negative tax.

This does not mean NZ has low levels of tax. It means we have high levels of welfare delivered to families with children.

Many countries had lower tax rates than New Zealand, but had compulsory superannuation and social security payments that increased their tax wedges.

Indeed, so again not apples and apples. KiwiSaver is near de facto compulsory but not included. The Australian compulsory super is included as part of the “tax wedge” even though the amount deducted goes to you personally, not the Government.

The other aspect not included in the tax wedge is indirect taxes such as GST are not included in the tax wedge:

Green Party co-leader Dr Russel Norman said the report showed the Government was misleading people that New Zealand had high taxes, to justify tax cuts for the highest-earners.

This just shows Russel is trying to misled people, or does not understand what a tax wedge is. It is purely a measure of how much the Govt takes out of your pay. It is NOT a measure of the overall level of taxation in the economy.

Again for those who are really really stupid, the tax wedge:

1. does not include indirect taxes (those with GST are shown to be lower)
2. includes deductions made by the Govt, even though they are going to your own personal super account (ie those without compulsory super are shown to be lower)
3. includes welfare payments made through tax system (tax wedge would be much higher if they were done through WINZ)

So if anyone carries on claiming that a low tax wedge means a low level of overall taxation, they are lying.

The better measure to use is the OECD study of the ratio of overall tax revenue to GDP. Now this does have us (thankfully) in the lower half of the OECD, but not second to bottom.  In 2007 tax was 35.7% of GDP and the OECD average was 35.8%.  Note however that amongst OECD pacific countries the average is 30.4%. Australia is 30.8%.

Again comparisons can be difficult as state government revenue should be featured also.

Maxim have released a comprehensive 102 page report on tax policy by Steve Thomas. Its aim is a tax system that maximises economic growth. It notes:

Growth is affected by tax, which is how the government raises its revenue to do the crucial things we need it to, like paying for a police force or a public education system, building roads and supporting the poorest when they need it.

However, when we try to take too much money out of the economy in tax to fund government spending, we risk undermining the very source of that revenue. Also, if government spending is misdirected or of poor value, then we hamstring the economy’s ability to produce what we need and the amount of tax the government is able to collect.

This relationship between tax and the economy therefore needs to be carefully considered. We need to design the tax system so that it allows the government to take the money it requires, while doing the least amount of damage to the economy and so too our potential prosperity.

This is absolutely right. It is a balancing act between economic growth and funding Government services. To take two extremes – an economy with tax rates of 95% would end up like North Korea, while an economy with tax rates of 5% would not be able to fund much in the way of defence, health or education.

Maxim propose a number of policies:

1. A two step personal tax rate system with a top rate of 27%
2. A corporate tax rate of 27%
3. Aligning the trust and PIE rates to the personal and corporate rates
4. Removing tax incentives for KiwiSaver
5. No land tax or capital gains tax
6. GST from 12.5% to 15%
7. An upper limit for central govt spending of say 30% of GDP
8. A benchmark for core govt expenditure on welfare of around 15% of GDP

For me the key thing is No 7. If one can limit spending as a percentage of GDP, then you get options around tax reform. Maxim note:

A 2001 OECD study found that about one half of a percentage point increase in government consumption (the expenditure to GDP ratio) could cause a 0.6 to 0.7% direct reduction in per capita output.

If we can limit spending so that over time it is under 30% of GDP, then there will be a very significant boost to incomes and jobs.

What I would like is both National and Labour to outline desired limits for spending as a percentage of GDP – then voters could choose between them. The limits probably need to be soft (non legislative) to take account of recessions etc, but a soft limit would still be a huge improvement over no limit.

One can get to a limit without massive spending cuts. If one can retain discipline over new spending so that it grows significantly slower than the overall economy, the ratio will reduce over time.

A very good report.I suggest people don’t just argue the recommendations but read the summaries of research about why such tax changes will be good.

Brian Fallow writes:

“We need to stop the tax system creating the wrong incentives,” said Treasury Secretary John Whitehead in a speech last week.

Citing Inland Revenue data, Whitehead said 1996 was the last year that more people made profits than losses from rental properties, yet the number of such properties had increased significantly since then.

I wonder what the total amount of tax losses claimed in those 15 years has been.

“Now why would increasing numbers of people – rational New Zealanders – invest billions of dollars collectively in an area that is unprofitable?” he said.

“It’s hard to believe it’s not because of the tax advantages. People can claim depreciation against their investment properties – even when most real estate was significantly increasing in value. They can deduct tax losses on property against their other income.

“And if they sell a rental property the capital gain they make is usually untaxed.”

The depreciation is reversed at sale, but you may have had interest free use of that money for a decade or more.

A widely quoted passage of the Tax Working Group’s report in January said that in 2008 the $200 billion invested in rental housing yielded net rental losses totalling $500 million.

That meant that collectively landlords not only paid no tax on their rental income, they were able to escape paying around $150 millon of tax on other sources of income they had.

However, Michael Littlewood, of Auckland University’s Retirement Policy and Research Centre, has cast a lot of doubt on the robustness of the $200 billion figure. …

But if he is right to conclude that the true combined value of residential investment properties could well be less than half the $200 billion stated, how much ice is that likely to cut with policymakers?

I doubt it will change decisions, but it will change estimates of how much revenue the Crown may gain from any changes.

It depends what they are most worried about. If their concern is that New Zealanders are over-invested in property and that that is for tax reasons rather than, say, a shortage of other investment opportunities, then Littlewood’s results are highly relevant.

But if the concern is purely fiscal – how to fund the gap between the $2 billion and change that a GST increase would yield and the cost of comprehensive income tax cuts and compensating adjustments to superannuation, benefits and family tax credits – then the focus would be not on how much is invested in rental properties but on the aggregate $500 million of net tax losses.

A bit of both I’d say, with priority on the latter.

The IRD data charted by the tax working group shows a clear downward trend in net rental income for the past decade, and it was 10 years ago that the Labour Government raised the top marginal tax rate from 33 to 39 per cent, increasing the incentive to shelter income through highly geared property investment.

I sometimes wonder if anyone actually pays the (now) 38% tax rate? Much better to reverse Cullen’s envy tax, and clamp down on loopholes.

Bill English has pointed out how the current tax system allows well off people to in fact pay less tax than low income workers. This is one reason why we should have a flatter system, with less loopholes.

Mr English highlighted in Parliament how the current system can allow a household earning $100,000 a year, with two dependent children, to reduce the tax they pay from $27,500 a year to less than $10,000 a year.

Three easy steps:

1. Forming a company owned by another entity (on the current 30 per cent company tax rate), paying themselves a $48,000 salary and reducing their tax bill by $3000.
2. Qualifying for Working for Families on this reduced salary with two dependent children, they would receive an extra entitlement of almost $8500 a year.
3. Using an interest in a leveraged property investment producing, say, tax losses of $20,000 a year, their personal taxable income is further reduced to $28,000.

So what you then have as tax is:

1. $52,000 @ 30c = $15,600
2. $14,000 @ 12.5c = $1,750
3. $14,000 @ 21c = $2,940
4. WFF credit of -$10,726  (on $28k income)

That means a net tax bill of $9,564 on $100,000 or a 9.5% effective tax rate.

If National disallows offsets for property tax losses then the high income earner paying 9.5% effective tax will end up paying $15,990 tax, or 16%.

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.