Although intertwined with the issue of capital gains, finding a fairer treatment for retirement savings is arguably the most important objective for the TWG, says Terry Baucher
Rather like Dug in Up almost all the commentary around the Tax Working Group’s (TWG) interim reporthas chased the squirrel of capital gains tax (CGT).
Although probably inevitable, the focus on CGT risks overlooking some of the other issues analysed in what is probably the most comprehensive overview of New Zealand’s tax system in nearly thirty years. These other issues would include land tax, GST and retirement savings.
Although a final decision on the optimum approach to taxing capital gains will wait until the TWG’s final report next February, the Government has accepted that the TWG need not carry out further analysis of areas such as wealth tax, land tax, changes to New Zealand’s petroleum and minerals royalty regimes, GST coverage and a financial transactions tax.
I am very surprised that a land tax is completely off the table, particularly after the Victoria University of Wellington Tax Working Group came out strongly in favour of it in 2010. Reading between the lines, the TWG appears to have decided the politics of a land tax are even more difficult than those around a CGT. Conversely, given the general tenor of the TWG’s comments on the issue of taxing capital, removing the land tax option probably increases the likelihood of either a CGT or taxing capital based on a risk-free rate of return being recommended.
No change for GST
On the other hand it is no surprise that the TWG isn’t recommending changes to the current GST framework. The arguments for exempting food from GST are pretty comprehensively demolished by the following graph illustrating the average weekly benefit for each income decile resulting from removing GST from food:
In order to achieve this benefit, the TWG estimates an exception for food and drink would reduce the GST take by $2.6 billion. As the group notes, if that amount was instead redistributed, each household would receive $28.85 per week, or practically double the benefit of a GST exemption for the lowest two deciles. As the TWG concluded other measures than an exemption, such as welfare transfers, would be likely to produce greater benefits for the same cost.
This point is also borne out when considering an alternative measure, an across the board cut in GST from 15% to 13.5% costing $2 billion annually. The result was indentical to that for introducing a GST exception; there were significantly greater benefits to households in the highest income decile.
The TWG then compared a GST rate reduction with two alternative measures: a tax-free threshold of $7,000 and halving the lowest tax rate from 10.5% to 5.25%.
The conclusion was that based on percentage of income, reducing the GST rate to 13.5% would provide greater benefits to households in the lowest income decile when compared with the suggested income tax changes. However, there were fewer benefits for households in deciles 2-9 and households in the highest income decile would be the biggest winners.
The TWG therefore decided against recommending a reduction in GST rates, suggesting instead:
“If the Government wishes to improve incomes for very low-income households, the best means of doing so will be through welfare transfers.
If the Government wishes to improve incomes for certain groups of low to middle income earners, such as full-time workers on the minimum wage, then changes to make personal income taxes more progressive may be a better option.”
As part of its review the TWG looked at whether financial services such as bank fees should be brought within GST and eventually determined “there are no obviously feasible options for doing so.” Instead, the TWG proposes the Government should monitor international developments.
The TWG also dealt briskly with the idea of a financial transactions tax (or Tobin tax) on tax on the purchase, sale, or transfer of financial instruments. This was proposed by ‘many submitters’ on the basis of improving market stability and discouraging speculative trading. The TWG concluded:
“The revenue potential of a financial transactions tax in New Zealand is likely to be limited, due to the ease with which the tax could be avoided by relocating activity to Australian financial markets…A financial transactions tax is an inefficient tax that is unlikely to raise significant revenue for New Zealand.”
The door isn’t completely shut on a financial transactions tax, with the TWG recommending the ongoing international debate on the issue be monitored.
Changes ahead for KiwiSavers?
In many ways it’s appropriate Sir Michael Cullen is chair of the TWG as his imprint lies directly and indirectly across the current treatment of retirement saving. Sir Michael was part of the Fourth Labour Government’s radical overhaul of savings in the late 1980s which adopted the present Taxed – Taxed – Exempt’ (TTE) basis for retirement savings. In 2007 as Finance Minister in the Fifth Labour Government he introduced KiwiSaver and the Portfolio Investment Entity (PIE) tax regime. Both, were, more than a little ironically, measures aimed at redressing some of the issues which emerged in the wake of the adoption of the TTE regime.
The report’s review of KiwiSaver begins with an interesting analysis of the impact of inflation on taxation. The report observes:
“Although inflation is currently low, nominal interest rates are also low; this has made inflation a larger component of the nominal interest rate and therefore increased the real effective tax rate on debt.”
The effect of inflation is illustrated in the following table:
Table 7.2: The future value of $1,000 invested today after 30 years
No tax
Tax real income
Tax nominal income
17.5%
28%
17.5%
28%
Future value of $1000 in 30 years
$4,322
$3,719
$3,396
$3,362
$2,889
Effective tax rate on nominal income
N/A
10.5%
16.8%
17.5%
28%
Effective tax rate on real income
(after taking account of inflation)
N/A
17.5%
28%
29.2%
46.7%
The report concludes that the member tax credit offsets the impact of taxing nominal income for KiwiSaver members earning up to approximately $100,000 per annum. Above that level of income the member tax credit’s effectiveness diminishes.
As the TWG report notes the TTE basis of taxation was, and remains, a significant divergence from the ‘Exempt – Exempt – Taxed’ (EET) basis common in many OECD countries. However, reverting to EET would be a very expensive move: the report estimates the annual fiscal cost of doing so would be at least $2.5 billion initially.
Even with strict limits on contributions most of the tax benefits of moving to an EET system would flow through to high-income earners. The TWG, rightly in my view, considers there is “little value in providing incentives to high income-earners, who are likely to be saving adequately in any case.” (Part of the reason for high income-earners being better savers is that they are more likely to be property owners).
This background of inflation and the potentially expensive and regressive risks of saving concessions led the TWG to:
“Focus on options that are targeted towards low- and middle-income earners – which, in turn, will disproportionately benefit women (who are more likely than men to be on lower incomes, due to part-time work or time out of the paid workforce for caring responsibilities).”
The TWG’s two main proposals are therefore:
Remove the Employer Superannuation Contribution Tax (ESCT) on the employer’s matching contribution of 3% of salary to KiwiSaver for members earning up to $48,000 per year; and
Reduce the lower PIE rates for KiwiSaver funds by five percentage points each.
The ESCT proposal would reverse the change introduced in the 2011 Budget and revert the treatment of employer contributions back to what it was when KiwiSaver was established at an estimated annual cost of $180 million. The reduction in PIE rates for KiwiSaver funds would cost a modest $35 million annually.
The TWG also considered the implications for KiwiSaver funds of taxing gains on New Zealand and Australian shares, a matter raised by National MP Paul Goldsmith in Parliament last week. The measure would impose tax of approximately $15 million per annum for those KiwiSaver members with income below $48,000, far outweighed by the proposed changes.
However, the change would cost approximately $45 million per annum for higher income KiwiSaver members. As a counter to this, the TWG suggests the member tax credit could be increased from its present 50 cents per dollar to 60 cents per dollar at an annual cost of $190 million.
Although intertwined with the issue of capital gains, finding a fairer treatment of retirement savings is arguably the most important objective for the TWG. This is because there are now almost 2.9 million KiwiSaver members, 1.3 million (46%) of whom are under the age of 35.
The sums involved with KiwiSaver are large and growing: in the twelve months to August 2018 employer and employee contributions exceeded $5.4 billion with Member Tax Credits contributing a further $785 million. Employees and employers contributed a record $612 million in August 2018 alone.
The TWG proposals for retirement savings therefore will have a significant impact for a large and growing number of New Zealanders long into the future. The interim TWG proposals are modest but do represent a positive step forward. More than just property owners will be watching and awaiting the TWG’s final recommendations.
Terry Baucher hopes to see the Tax Working Group signal a break from the past, either in the form of a Capital Gains Tax or something else such as a land tax
Does the news that the Tax Working Group’s interim report due very shortly won’t specifically recommend a capital gains tax (CGT) mean it will be the fifth such group in the past 50 years to have considered the issue before concluding “Yeah, nah”?
Not yet. Firstly, this is an interim report which is intended to invite further commentary on the TWG’s initial proposals. This is broadly similar to the process followed by the McLeod Tax Review in 2001. My understanding is that the interim report will analyse in some detail not only the merits or otherwise of a CGT but also how it might work in practice. It will probably be the most comprehensive review of the issues around CGT since the Consultative Document on the Taxation of Income from Capital in 1990.
Although the issue of CGT is dominating attention, the TWG has a very wide brief and its interim report will examine other issues such as the overall design and fairness of the tax system, environmental taxes, the taxation of savings, GST exemptions for particular goods, the taxation of companies and multinationals, the possibility of a land tax and taxpayer rights in dealing with Inland Revenue. The resulting report will be substantial and is probably likely to run to over 200 pages. Yet, for all that the focus will be on the TWG’s proposals around the taxation of capital.
Rather like Banquo’s Ghost the issue of CGT has been an unwelcome guest for every tax review over the past fifty years. During that time the debate over CGT has developed a Groundhog Day quality to it. Every few years a review of New Zealand’s tax system is announced. Some months later, after due deliberation, a report is released which includes passages summarising the pros and cons of a CGT before concluding, somewhat reluctantly, it is not appropriate.
In between each review a major change is introduced widening the scope of income tax to include transactions previously treated as exempt capital gains. These legislative changes essentially undermine the previous review’s reasoning against a CGT. At frequent intervals, international organisations such as the OECD and the IMF will call for a CGT to address imbalances in New Zealand’s economy around housing and saving. The IMF’s recommendation in March 2017 for a CGT was just the latest such instance.
Meantime, as if thumbing their noses at each tax review’s arguments against a CGT, the list of countriesintroducing capital gains tax legislation grows: Canada in 1972, Australia in 1985 and South Africa in 2001.
This rather pusillanimous pattern began with the Ross Committee in 1967 which after declaring “On grounds of equity there is strong justification for taxing realised capital gains,” concluded “we have finally decided against such a recommendation”. The Ross Committee was followed in 1982 by the McCaw Task Force, which opined “The Task Force considers that failure to tax real capital gains is inequitable in principle, and is seen by many to be so.” Ultimately, the McCaw Task Force was “not convinced of the need for a separate capital gains tax, does not propose its introduction, even though capital gains are being made by some which should in principle be taxed.”
The McLeod Tax Review in 2001 detemined “New Zealand should not adopt a general realisation-based capital gains tax. We believe that such a tax would not necessarily make our tax system fairer and more efficient.” It then proceeded to hedge its bets by adding; “Nevertheless, we also remain of the view that the absence of a tax on capital gains does create tensions and problems in specific areas.”
In 2010 it was the turn of the Victoria University of Wellington Tax Working Group. In time-honoured fashion its report concluded:
“The most comprehensive option for base-broadening with respect to the taxation of capital is to introduce a comprehensive capital gains tax (CGT). While some view this as a viable option for base-broadening, most members of the TWG have significant concerns over the practical challenges arising from a comprehensive CGT and the potential distortions and other efficiency implications that may arise from a partial CGT.”
And yet, despite all this previous consideration and rejection, another tax review finds itself confronting the CGT issue anew. There are several key factors as to why this pattern endures but three merit closer review.
Firstly, in the absence of a comprehensive CGT, there is presently no clear legislative framework to deal with the taxation of capital gains in general and the arrival of completely new asset classes such as cryptocurrencies like Bitcoin. This results in confusing uncertainty as some taxpayers report gains as income whilst others treat the gains as tax free. Although issues still arise in other jurisdictions with capital gains regimes, investors know that returns will be taxed either as income or under the relevant CGT regime.
By contrast investors in cryptocurrencies are presently unsure about whether gains are taxable or exempt. This all-or-nothing approach understandably tempts investors to treat gains as tax free sometimes on the most dubious of grounds. Even though the bright-line test relating to sales of residential property has been law now for almost three years, there appears to be widespread non-compliance.
Secondly, as every tax review has acknowledged to varying degrees, the present tax treatment of capital is inequitable and creates unfairness. Differing tax treatment applies to different classes of assets leading to what the 2010 review called ‘incoherence’. The TWG’s brief includes reviewing the overall fairness of the system and in this regard the background issues paper noted that “real property held for more than two years (soon to be five) is undertaxed relative to other investments when there are capital gains”. Since peaking at 73.8 % in 1991 home ownership has fallen steadily to 63.2% in 2016. This means those substantial untaxed capital gains are being derived by fewer people.
Separate from the issue about unfair tax treatment the TWG is also considering the issue of wealth inequality. A background paper on the taxation of capital Income and wealth commented:
“Something that may not have been given enough attention in the discussion until recently has been that wealth ownership has a very skewed distribution, and reducing the tax on capital income may have contributed an increasing level of inequality in many developed countries in recent years.”
This combination of growing wealth inequality and favoured tax treatment for some assets, most notably property, means that the issue of a CGT is unlilkely to fade away even if the TWG decides not to recommend it. At some point the nettle must be grasped either through a comprehensive CGT or some other tax such as a land tax.
Finally there is plain simple self-interest. Not just of groups such as the NZ Property Investors Federation but of our elected representatives. As Thomas Coughlan pointed out earlier this week currently 113 MPs own 306 properties between them or an average of 2.6 each. At a time of falling home ownership only seven MPs do not own any property meaning property owners are greatly over-represented in Parliament. Even if the TWG does recommend a CGT, getting it into law will require a large number of MPs to decide their self-interest in getting re-elected outweighs their pecuniary self-interest.
We’ll know in a few days whether the present TWG is proposing to break the pattern of fifty years or whether we’ll find ourselves re-hashing the same arguments in 10 years time. I’m hopeful that we will see the TWG signal a change of approach, either in the form of a CGT or some other mechanism such as a land tax. For now it’s a question of wait and see.
Terry Baucher crunches the numbers around corporate tax and says anybody expecting the Tax Working Group to suggest a cut in the tax is going to be disappointed
Anyone who thinks the Tax Working Group will suggest a cut in company income tax in its interim report due to be released next month is going to be disappointed. Recently released papers prepared for the TWG concluded a cut was “unlikely to be in New Zealand’s best interests.”
The papers also contain some fascinating data about the size and profitability, or otherwise, of various industry sectors.
To cut or not to cut
At 28% New Zealand’s company tax rate was the 10th highest in the OECD in 2017. It is also above the unweighted OECD average of 24.9% for the same year. However, this doesn’t take into account the imputation regime which means the final tax rate for New Zealand tax resident investors is the shareholder’s marginal tax rate. As a result of the imputation regime the effective tax rate for New Zealand resident shareholders is the sixth lowest in the OECD.
Unless a company tax rate cut was accompanied by a reduction in personal income tax rates, the main benefit for New Zealand resident investors would be the opportunity to accumulate income taxed at a lower rate before distribution at which point it would be taxed at personal income tax rates. According to Inland Revenue the existing five percentage points gap between the company tax rate and top individual tax rate has encouraged “a variety of arrangements that…allow taxpayers to avoid the intended taxation of dividends on the distribution of income or assets from companies to their shareholders”. (As the same paper later notes some of these “integrity issues would be reduced if a capital gains tax were introduced.”)
These integrity issues plus additional complexity are also cited as reasons against a lower tax rate for small businesses. In addition, officials consider a small business tax rate is likely to reduce overall productivity, a long-standing problem for New Zealand. There is also the possibility that a small business tax rate might act as a disincentive to growth for businesses, a criticism the Fraser Insitute in Canada raised of a recent Canadian government proposal.
Nevertheless, New Zealand’s comparative position within the OECD is likely to worsen following the dramatic cut in the United States corporate tax rate from 35% to 21% with effect from this year. A cut in company tax rates is sometimes suggested so that New Zealand can remain “competitive”, so at first sight it seems likely pressure for a corporate tax cut may increase as company tax rates fall internationally.
Conversely, one of the key arguments against a company tax cut was the issue of “location-specific economic rents.” Economic rents are the returns over and above those required for investment in New Zealand to take place. As the paper notes these returns are “likely to be larger in a geographically isolated market like New Zealand where supply of certain goods and services is likely to require a physical presence in New Zealand.” In short, such returns can be taxed without discouraging investment as New Zealand’s location means investment remains viable despite taxation. In other words, if overseas investors are making a return with a 28% company tax rate, there is no need to incentivise them to invest with a lower tax rate. In fact as officials noted doing so would not be in New Zealand’s interests as more of the benefit would flow to non-residents.
Another revealing insight was that there appears to be little correlation between a cut in company tax and an increase in foreign direct investment (FDI). Despite a cut in the company tax rate from 33% to 30% in 2008 and then to 28% with effect from 1 April 2011, there was no surge of FDI into New Zealand either absolutely, or relative to Australia as the following graph illustrates:
There may have been other factors at play but as officials noted “it should at least cause us to question any assumptions that company tax cuts are likely to be a silver bullet for increasing the level of FDI into New Zealand.”
A narrow base?
Separate from the issue of company tax rates, another background paper analysed the effective tax rates for companies. Although results were advised as “indicative only” the paper threw up some interesting and at the same time potentially alarming statistics.
The analysis focused on “significant enterprises” (groups of entities with annual consolidated turnover greater than $80 million) over the 2013 to 2016 tax years. Apparently, there are only about 500 such enterprises in New Zealand and between them they are responsible for about 51% of the total income tax paid by companies ($12.6 billion for the year ended 30 June 2017). Furthermore some 20% of these enterprises have either a tax or accounting loss and therefore did not have effective tax rates calculated for the purposes of the paper.
Overall the unweighted average tax rate for those profitable enterprises was 28%, or exactly in line with the company tax rate. However, once adjusted for the relative size of the enterprises, the weighted average rate fell to 20%. That in itself masked substantial variations between industries. 21 industries had effective unweighted company tax rates of less than 25%. In particular, the unweighted average effective company tax rate for the insurance and superannuation fund, residential care services, and motion picture and sound recording activities industries was 16%. Remarkably, 38% of the enterprises within these three industries were making a tax loss even though only 11% reported an accounting loss.
To help explain the variation in effective tax rates, the paper then reviewed the major tax adjustments in the 2015/16 tax year. Based on a sample of large enterprises which had approximately $13 billion in net taxable income for the year, the three most significant adjustments which decreased taxable income relative to accounting profit were untaxed realised capital gains amounting to $2.2 billion, unrealised valuation gains ($1.3 billion) and untaxed overseas dividends of $1 billion.
Conversely, those adjustments which increased taxable income included non-deductible accounting write-downs ($1.1 billion), non-deductible capital losses from sales of fixed assets ($600 million) and other non-deductible expenditure such as goodwill write-offs ($280 million).
The paper also looked at the untaxed capital gains for small and medium companies over the same four tax years. It found the average yearly value of untaxed capital gains was $2.2 billion with companies within the rental, hiring and real estate services averaging gains of $763 million each year. The research also noted that the following four industries had particularly high proportions of untaxed realised gains when compared with the accounting profits of the industry:
Accommodation and food services (64%)
Agriculture (53%)
Rental, hiring and real estate services (40%)
Financial and insurance services (27%)
In something of a throwaway comment the paper remarked that “the majority of small and medium enterprise are in a loss position”. Given the number of small businesses in New Zealand it’s not reassuring to hear that many are in loss.
What does all this mean? Quite apart from reducing the likelihood of a company tax rate cut, the analysis shows the relative importance of untaxed capital gains to several industries. After noting “the primary cause of under-taxation is untaxed capital gains, both realised and unrealised” officials then asked the TWG “Does this information affect the Group’s views on business and company tax”. We’ll know the answer next month when the TWG’s interim report is relased but defenders of the status quo on the taxation of capital gains are likely to have their work cut out.
Terry Baucher crunches all the tax news in the Budget, and says going into the 2020 election is when we might see changes in tax thresholds
With any major tax initiatives all kicked over to the Tax Working Group for review, unsurprisingly the Budget made no changes to existing tax rates and thresholds.
No increases in thresholds results in extra tax revenue through the effect of ‘fiscal drag’ whereby individuals pay more tax as their earnings ‘drag’ them into higher tax brackets.
For the year to 30 June 2018 the fiscal drag effect is calculated as $276 million. By 30 June 2022, when the total tax take is predicted to rise by almost 25% to over $103 billion, it will be $398 million.
At some stage thresholds, which have not been increased since 2010, will need to be adjusted, but for the moment the government, like its predecessor, is happy to collect the additional revenue.
Two significant tax changes were announced prior to the Budget. The major initiative is the ring-fencing of residential property losses. From 2020 it will no longer be possible to offset losses against other income. Instead the losses must be carried forward for future use. The additional tax collected as a result of this change is $125 million for the June 2021 year rising to $190 million for the June 2022 year.
The other change – and one likely to affect more taxpayers – is the introduction of GST on low-value imported goods from 1 October 2019. The current estimate is for this measure to raise $218 million between 1 October 2019 and 30 June 2022.
In the meantime, Inland Revenue will get a further $31.3 million of funding over the next four years to boost compliance. $23.5 million of this is specifically targeted at ensuring outstanding company tax returns are filed.
Another $3 million is to analyse the potential for improved tax compliance in ‘specific industries’ through better third-party reporting and withholding taxes. This is probably aimed at contractors not currently covered by the PAYE rules.
Overall, Inland Revenue expects to recover approximately an additional $239 million over the four years to 30 June 2022 from enhanced compliance activities.
There’s some more details about the Research and Development tax incentive which will involve $1 billion over four years. Eligible businesses spending more than $100,000 annually on R&D will get a rebate of 12.5 cents for every dollar of R&D spend.
In a nod to the Deputy Prime Minister’s love of racing the bloodstock tax rules will change to allow deductions to be claimed for the “costs of high-quality horses acquired with the intention to breed.” A snip at $4.8 million over the next four years.
Migrants can expect to pay another $113 million in fees over the next four years, and the Immigration Levy is expected to raise another $44.7 million over the same period.
The relative narrowness of our tax base, the implications of the gig economy and technological change, and the international pressure for lower corporate income tax rates to name a few. For me three areas stand out: the scale and potential impact of demographic changes underway; the potential role of environmental taxes; and the taxation of capital and savings.
But my biggest initial impression is how the decision to exclude consideration of taxing the family home, or the land underneath it from the TWG’s terms of reference, hangs over the paper like Banquo’s Ghost.
A demographic timebomb?
My first major conclusion from the Submissions Background Paper is how much the coming fiscal pressures of an ageing population really need to be kept front and centre when considering changes to the tax system.
The paper begins by setting out key risks and challenges for the tax system over the next 30 years or so. A key baseline is the Government’s fiscal objective of maintaining taxation at the historical level of 30% of GDP over time. At the same time the paper identifies the pressure of changing demographics and an ageing population. For example, for the current year to 30 June 2018 New Zealand Superannuation is expected to cost $13.7 billion, “more than all other benefit payments combined”.
As a result of these pressures, the paper projects the Government will have a primary deficit of 1.2% of GDP by 2030 (about $3.4 billion based on current GDP), rising to 4% of GDP in 2045 or $11.4 billion based on current GDP. Very clearly then as the paper warns;
“If the Government is to continue providing healthcare and superannuation at current levels, then the level of taxation will need to increase, or spending on other transfers or publicly provided goods and services will need to fall.”
Against this backdrop the work of the TWG and the recommendations it will make are hugely important. Change is coming and therefore the tax system needs to be ready for that.
Taxing the environment
The environment is hugely important to the New Zealand economy whether it is liveable or for our two largest export earners agriculture and tourism. New Zealand is committed to reducing net emissions 30% below 2005 levels by 2030 so the Background Submissions Paper suggests;
“Using the tax system to ensure that consumers and producers face the costs of emissions and other environmental harm could be one way we can meet our international obligations.”
The paper also notes that New Zealand had “the second highest level of carbon emissions in the OECD per dollar of GDP in 2017”, an alarming statistic which suggests action is needed sooner rather than later if we are to maintain the idea of being clean and green.
At present environmental taxes such as petrol excise duties and waste levies amount to approximately 4.2% of total tax revenue, or about 1.3% of GDP. This puts New Zealand at the low end compared with other OECD countries. For example, almost 15% of Denmark’s total tax revenue is made up of environmental taxes and these represent just over 4% of GDP. Across the Ditch, Australian environmental taxes are just over 2% of GDP, representing 8% of all taxation.
A recent OECD paper noted that in 2015, outside of road transport, 81% of emissions were untaxed. The report concluded tax rates were below the low-end estimate of climate costs (€30 per tonne of CO2) for 97% of emissions. New Zealand at €0.48 per tonne of CO2, was sixth from bottom of the 42 countries surveyed.
There would therefore appear to be significant opportunity for shifting some part of the tax burden onto environmental taxes. However, as both the Background Submissions Paper and the OECD notes many environmental taxes are “poorly designed and targeted.”
Wealth inequality and savings
The TWG’s terms of reference may have excluded taxing either capital gains from the family home or the land underneath the family home, but considering the taxation of savings is within its remit. So too is the issue of inequality and the Background Submissions Paper has a wealth (pun intended) of charts illustrating the issue of income and wealth inequality. (See Figures 12-19 between pages 33 and 38 of the report).
Ominously, the paper comments that over the past three decades the “inequality-reducing power of the tax and transfer system on market income inequality has steadily declined”. Furthermore, the inequality-reducing power of the tax-benefit system is now below the OECD average.
Tied into the issue of inequality is the taxation of household savings. It’s here that the impact of the terms of reference loom largest. After assuming a risk-free rate of return of 3%, inflation of 2% and a 33% tax rate to determine a marginal effective tax rate, the Background Submissions Paper then applied this to calculate the marginal effective tax rates of various asset classes. Its conclusion: “owner-occupied and rental housing is undertaxed relative to other assets.” The extent of the under-taxation is starkly illustrated by Figure 21 (reproduced below).
At 55.7% the marginal effective tax rate on bank savings is almost five times that of the 11.3% rate applicable for owner-occupied housing equity and nearly double the 29.4% rate for rental property.
The Reserve Bank estimated the value of housing as at 30 September 2017 to be over $1 trillion. Even excluding residential rental property (perhaps a third of the total), this is a huge amount of capital to be left essentially untaxed. The holders of that property are mostly older and wealthier, a growing number of which are receiving New Zealand Superannuation. As Andrew Coleman noted last year, changes to the tax system in the late 1980s established a huge incentive in favour of housing. This created an inter-generational timebomb which will need to be defused at some point.
Much of the immediate debate on the Background Submissions paper has been about the efficacy and impact of a capital gains tax, but there’s been little discussion about the ongoing fiscal impact of continuing to exclude maybe $700 billion of capital from taxation with potentially very adverse outcomes for future generations.
Overall the Submissions Background Paper includes plenty of thought-provoking material to consider. The paper also underlines what was apparent from the outset; excluding the taxation of the family home created a big hole at the heart of the review.
Whatever the final recommendations of the TWG are for addressing the future sustainability of the tax system there’s a danger it will be found as Macbeth warned after killing Duncan to “have scotched the snake, not killed it”. Only time will tell.
Terry Baucher on Google, tractors, tax evasion, cashless society, taxing CO2 emissions, the Swiss cryptocurrency town, really big tax cuts, sugar tax, Nigeria’s census & more
Today’s Top 10 is a guest post from Terry Baucher, an Auckland-based tax specialist and head of Baucher Consulting.
We welcome your additions in the comments below or via email to david.chaston@interest.co.nz.
If you’re interested in contributing the occasional Top 10 yourself, contact gareth.vaughan@interest.co.nz.
1) What’s a tractor in Australia got to do with Google?
“NZ strikes blow for global tax clampdown as Google shifts policy” was the headline in the Financial Times after Google revealed to Parliament’s Finance and Expenditure Select Committee it was going to change how it booked its revenue from New Zealand.
“We intend to shift our business model from this past approach, such that customers will enter into contracts with our New Zealand entity, which will generate revenue from NZ advertising customers, and pay taxes in line with its role in the transaction.”
So, will this mean more tax for New Zealand? Not necessarily because although the advertising revenue will no longer be booked in Singapore, Google New Zealand might still be charged for the right to use Google’s intellectual property.
Intellectual property and the right to use intellectual property is embedded in many more household objects than just smartphones. For example, farmers in Nebraska are demanding the passage of a law to enable them to carry out repairs to tractors which now contain millions of lines of software code.
Australian farmers are increasingly concerned that they may not be able carry out their own repairs on tractors purchased from America.
“If you buy a tractor, you buy a tractor and it’s yours. And the big companies are now trying to say if you buy a tractor, it’s not yours.
How long before Australian and New Zealand farmers may have to follow the lead of farmers in Nebraska and demand the ”right to repair” tractors?
2) Tax evasion.
Two tradies were recently jailed for each evading nearly $1 million in tax.
The tax department said Hamilton plasterer Paul Andrew Mills was sentenced on February 9 to two years and one month prison.
Auckland builder Hamish Paul Aegerter received a sentence of two years and seven months on Friday
“WILSON, a 64-year-old male from Chapel Hill Queensland falsified nine BAS to obtain $217,134 in refunds he was not entitled to. Documents provided at audit were determined to be false. He was convicted on two charges and sentenced to 36 months jail with a non-parole period of 12 months.”
“The director of a Gloucester security services company, who stole almost half a million pounds in tax, has been jailed for three years after an investigation by HM Revenue and Customs.”
It’s tempting given New Zealand’s ranking as the least corrupt country in the world to think tax evasion is a relatively minor matter.
In fact, as Treasury admitted in 2013: “There are no reliable estimates of the size of the tax gap in New Zealand.”
The same report then went on:
“A reasonable general order of magnitude for the tax gap across OECD countries would be 5 to 20 percent of total tax collections.18 This implies a tax gap for New Zealand of around $3-11bn. We expect New Zealand to be at the lower end of this general range owing to our general broad-base, low-rate tax settings, significant reliance on indirect taxes, and low levels of corruption – all things that are thought to be correlated with a smaller tax gap”.
This seems a naïve attitude but even at the lower end of the scale $3 billion of additional tax is not chump change.
And between 2010 and 2015, the number of cash payments in shops almost halved, from 39% to 20%.
At the same time, electronic payments have surged. Ninety-five per cent of Swedes have access to a debit or credit card, and made an average of 290 card payments a year in 2015. That’s well above the EU average, at 104 card payments per year.
“In Sweden companies can refuse to accept cash payments. This approach is already being used by some restaurants, public transportation and hotels. In Sweden the use of cash is decreasing, and approximately 80 % of all transactions are made electronically, including through new techniques such as smartphones and contactless payment methods. An app developed by banks in Sweden facilitates money transfers between private persons and make payments to companies, which has increased in use from 76 000 transactions in 2012 to 76 million transactions in 2015” (page 23).
As part of an anti-tax evasion programme, Sweden requires that sales must be registered in a cash register connected to a fiscal control unit. The immediate revenue effect once the requirements were introduced was a 5% increase in the reported revenues. This resulted in increased tax revenues of at least SEK 3 billion (€320 million) per annum as a result of reduced tax evasion. Something for Inland Revenue to consider?
4) Tax year end approaches.
The end of the 2017-18 tax year is fast approaching. The 31st of March is also the due date for tax agents to file clients’ tax returns for the March 2017 year. The pressure will ramp up on tax agents to meet the deadline.
In the UK, the deadline for filing 2016-17 tax returns was 31st January. According to HM Revenue and Customs a record 10.7 million “customers” filed before the due date with 92.5% of these completed online. As HMRC noted, it got a bit frantic towards the end.
There were 758,707 people who completed their return on the last day before the deadline and the most popular hour for customers to hit submit was from 4pm to 5pm on 31 January with 60,596 returns received (1,010 per minute, 17 per second).
Thousands of customers avoided any penalties at the last minute as 30,348 customers completed their returns from 11pm to 11:59pm yesterday.
The penalties for late filing can accumulate quickly so naturally people were quick to offer excuses including the following gems:
I couldn’t file my return on time as my wife has been seeing aliens and won’t let me enter the house.
I’ve been far too busy touring the country with my one-man play.
My ex-wife left my tax return upstairs, but I suffer from vertigo and can’t go upstairs to retrieve it.
My business doesn’t really do anything.
I spilt coffee on it.
No doubt Inland Revenue will soon be receiving a few creative excuses. It would be good to know whether aliens are also at work in New Zealand.
5) Taxing CO2 emissions from road transport.
New OECD reports on the taxation of energy use make uncomfortable reading for New Zealanders.
Road transport is taxed relatively highly, but other negative side effects of fuel use in road transport (e.g. local air pollution, congestion), suggest that taxes are still too low in most countries. Fuel taxes dominate price signals, carbon taxes play almost no role.
According to the OECD New Zealand has the lowest rate of taxation on diesel at €1.3 per tonne of CO2. (Road user charges are not taken into consideration). By comparison the UK charges €299.9 per tonne of CO2. When it comes to taxing petrol New Zealand imposes €184.8 per tonne with the UK again the heaviest taxer at €353.4 per tonne. Russia doesn’t tax either diesel or petrol and the US has the third lowest rates of taxation at €21.8 per tonne for diesel and €19.1 per tonne for petrol.
Based on these numbers the taxation of CO2 emissions represents a huge challenge to the New Zealand economy. The greater use of environmental taxes is within the terms of reference of the government’s Tax Working Group. It will be interesting to see what conclusions it reaches.
6) Swiss banking goes crypto.
Investors in cryptocurrency got a rude awakening at the start of the year when what Nouriel Roubini called “The biggest bubble in human history” appeared to burst. The price of bitcoin fell from just under US$20,000 in mid-December to US$6,000 on February 6th. According to CoinMarketCap, the total market capitalisation of cryptocurrencies has fallen by more than half this year, to under $400bn.
However, the volatility of cryptocurrencies doesn’t seem to have deterred the Swiss town of Zug which has been quietly developing into a hub for crypto-services with the encouragement of the Swiss government.
The country should seek to become the “crypto-nation”, said the economy minister, Johann Schneider-Ammann, last month. Zug aims to be the capital of that nation.
To that end, Switzerland is maintaining loose rules for crypto-businesses, even as other countries are tightening theirs. An industry is developing to store tangible crypto-assets, such as the hard drives on which cryptographic keys are stored, offline in cold, dry, secret sites complete with rapid-response teams. Where better than a decommissioned military bunker in the Swiss Alps? In Zug, friendliness to crypto-currencies is in evidence all around. “Bitcoin accepted here” stickers adorn the city hall and several shops, including the wine merchant’s. In 2016 Zug became the first place in the world to accept bitcoin for some public services. Residents can get a blockchain-based digital identity.
It was the arrival of the Ethereum Foundation in 2013 which really kick-started Zug’s development. Regardless of the seemingly speculative nature of cryptocurrencies, it’s the potential application of blockchain technology at the core of Ethereum, which is attracting interest. As this E&Y report suggests blockchain technology could transform indirect tax such as GST “by securely establishing the what, where and when of transactions”.
Regulators around the world are struggling to keep up with the pace of developments in cryptocurrencies. My view is that blockchain technology means cryptocurrencies are here to stay. With that in mind, how about making New Zealand a “crypto-nation”? After all, the advantages of Zug as a hub are equally true of New Zealand, only we have better beaches and wines.
7) The biggest tax cut in (American) history?
On the passing of The Tax Cuts and Jobs Act 2017, President Trump declared “It will be the biggest tax decrease, or tax cut, in the history of our country.” Is that so? Not according to several sources including the United States Treasury Department.
The largest tax cuts in American history were President Reagan’s Economic Recovery Act 1981, which cut taxes by 2.89% of GDP (the top rate fell from 70% to 50%). By the same measure President Trump’s cuts would the eighth largest since 1918.
It would therefore appear the President’s claim was wrong. Bigly. (Sorry, not sorry).
But what would be the biggest tax cuts in New Zealand history? Tax rates and thresholds have been remarkably stable over the past 30 years and there have been few genuine tax cutting budgets. (The Budget 2010 income tax cuts were offset by an increase in GST). There were some tax reductions in 1996 and 1998, but for radical income tax cuts those in the mid-1980s when the top rate fell from 66% to 33% are the most radical.
8) “Sugar, sugar, oh honey, honey…”
”Sugar, rum and tobacco are commodities which are nowhere necessaries of life…which are…objects of almost universal consumption, and which are therefore extremely proper subjects of taxation.”
Thus spake Adam Smith, yes THAT Adam Smith, in The Wealth of Nations. However, as the recent spat between health advocates and NZIER demonstrated, taxing sugar is a controversial move.
Although Health Minister David Clark said the government had no immediate plans for a sugar tax, the merits, or otherwise, of such a tax are within the remit of the Tax Working Group to consider.
Meantime, the United Kingdom is introducing a Soft Drinks Industry Levy on 6th April. The levy applies at a rate of 18 pence per litre to drinks containing at least 5 grams of sugar per 100 millilitres. It increases to 24 pence per litre if the sugar content is 8 or more grams of sugar per 100 millilitres. The SDIL is expected to raise £520 million per annum to be spent on increasing the funding of sport in primary schools. Both proponents and opponents of sugar taxes will be watching to see if it achieves its health objectives. Watch this space.
9) Census.
Next Tuesday is Census Day, the 34th in New Zealand since 1851. It will be the first digital census, barring a major IT malfunction such as happened in Australia in 2016 it should pass off without note.
The refusal of the government to accept population census of 1962 prompted the 1963 population census which critics claimed were arrived at by negotiation rather than enumeration. The result was contested at the Supreme Court which ruled that it lacked jurisdiction over the administrative functions of the Federal Government.
The 1973 Census conducted between November 25 and December 2 was not published on the ground of deliberate falsification of the census figures for political and /or ethnic advantages.
Tuesday’s Census will be nowhere near as fraught as Nigeria, but it will be interesting to see how central and local government act on the data gathered.
10) A playlist for preparing your tax return.
Right now, if you ring Inland Revenue and find yourself on hold, there’s a good chance you’ll hear Coconut Rough’s 1983 hit Sierra Leone. In fact, you’ll probably hear it a lot. For the past few weeks some fault, or just plain sadism, has meant that Inland Revenue’s hold music has put Sierra Leone on continuous loop.
It could be worse, though, The Beatles Taxman for instance:
“Let me tell you how it will be
There’s one for you, nineteen for me
‘Cause I’m the taxman, yeah, I’m the taxman”
Here are a couple of collections of music to prepare your tax return by:
Unsurprisingly the Beatles’ Taxman, Pink Floyd’s Money and Abba’s Money, Money, Money feature in both soundtracks. There’s no sign of Blondie’s One Way or Another (its opening lyrics are surely Inland Revenue’s mission statement “One way or another, I’m gonna find ya’, I’m gonna get ya’, get ya’, get ya’, get ya”).
Sierra Leone isn’t anywhere to be heard either. Mercifully.
6) Swiss banking goes crypto.