Matthew Seddon suggests imposing withholding taxes on organisations that engage independent contractors, including through electronic marketplaces
My guest this week is Matthew Seddon. Matthew is a lawyer at Bell Gully and one of the four finalists for this year’s Tax Policy Charitable Trusts Scholarship competition. He has suggested extending the withholding tax regime to include more independent contractors. Kia Ora Matthew, welcome to the podcast. Thank you for joining us. So how did you get into this and where did your proposal come from?
Matthew Seddon Hi, Terry, thanks for inviting me onto your podcast. It’s great to be here. The Tax Policy Scholarship provides young tax professionals with the ability to set out a proposal for a significant reform in the New Zealand tax system. My proposal is to extend PAYE withholding to independent contractors engaged by persons with an existing PAYE withholding obligation, i.e. employers, and also to those independent contractors engaged through an electronic marketplace.
TB Those electronic marketplaces try and match buyers and service providers. You picked up on something from the Tax Working Group in this space, is that right?
Matthew Seddon Yes, the Tax Working Group in 2018 had identified the rise of self-employed independent contractors as the most likely and most significant challenge facing the integrity and sustainability of the New Zealand tax system. The Tax Working Group’s final report had noted that withholding taxes should be extended as far as practicable in order to ensure greater levels of compliance. Furthermore, the Government’s recent focus on increased compliance activities is another reason which prompted me into this proposal.
TB Yes, because Inland Revenue got $29 million a year. I think they were saying they’re expecting a $700 million return on that. Is that right?
Matthew Seddon Yes, the $29 million I think is over each year and I think $116 million is set across for the four-year period. So their expectation is to raise $702 million over a four-year period from those increased compliance activities. Inland Revenue has also been stating recently that they’re going to focus on taxpayers who have not been complying with their tax obligations. Especially in the hidden economy.
TB Like I was saying the other week, the hibernating bear has woken up and it’s hungry and it’s making moves. Yes, I mean just picking up on that, the Performance Improvement Review recently released on Inland Revenue was quite interesting in its discussion around the tax gap, which the Tax Working Group fenced around a little but didn’t really go into specifics. But this is the area, right on scope of the tax gap, isn’t it?
A billion dollar gap?
Matthew Seddon Indeed, and Terry, just for listeners to understand, the tax gap is the difference between what Inland Revenue should receive in taxes if all taxpayers are fully compliant with their obligations compared to what tax they actually receive. The Tax Working Group had received some research that was commissioned by Inland Revenue on the tax gap for independent contractors, and that research indicated that independent contractors were under reporting their taxable income by about 20% on average. This was resulting in a loss of revenue of $850 million a year.
TB And that’s in 2018 dollars. So now we’re talking potentially over a billion dollars per year.
Matthew Seddon Exactly.
TB Well, if I was Nicola Willis, I’d be very interested in that because that’s a quarter of a percent of GDP. It’s actually a significant number now. So how does your proposal work?
Matthew Seddon So my proposal looks at imposing withholding taxes on organisations which engage significant numbers of independent contractors. For example, a large number of independent contractors operate through electronic marketplaces. A lot of employers engage independent contractors. So it’s by centralising the withholding obligation and imposing it on employers and electronic marketplaces instead of the numerous independent contractors underneath, that provides Inland Revenue with a greater ability to receive those taxes rather than having to chase independent contractors individually.
TB Yes. So I mean we have an extensive withholding tax regime. It’s something that’s I think has always been taken for granted, but we don’t realise actually how very comprehensive it is. But when you look back on it, the sort of sphagnum moss collectors, charges for directors’ fees is a 33% rate I believe. But these withholding tax obligations aren’t updated frequently or as frequently as you might imagine. As the Tax Working Group pointed out, we’ve seen a big growth in this sector. You’re saying we’ve got these existing mechanisms in place and should extend it to this particular group. Is there going to be a de minimis or is it going to be for anyone who’s already got a PAYE obligations or who has employees?
Matthew Seddon That’s right, Terry. So, the starting point is that if you’re an employee, your employer withholds PAYE. If you’re an independent contractor, generally you deal with your own tax obligations. What you’re referencing there about sphagnum moss collectors and directors’ fees are schedular payments and that imposes an obligation to withhold on the payer of those payments. My proposal would be to extend that schedule and the schedular payments regime to include those employers and electronic marketplaces that engage the independent contractors.
Now the reason why I was looking at employers in particular and the reason why I would not have a de minimis, is because employers have the systems and software in place that pay their existing employees and they also make those payments to independent contractors. So the software and systems should only require minor modification and configuration to be able to deal with withholding on payments to those independent contractors. The independent contractors that are engaged by employers and electronic marketplaces. It wouldn’t be all of those independent contractors that are subject to the withholding. It would only be those independent contractors who are principally providing services to the employer or the electronic marketplace such that they are functionally equivalent to employees.
TB Yeah, that’s a really interesting point there because often you find that someone walks out the door on Friday is contracting back on Monday. So this question of functionally acting as an employee – is that going to be a requirement, do you think? Would it perhaps just be extended if a person is providing personal services to a company, would that perhaps be a stronger approach? I think so rather than try to get to a definition that they’re doing the same as if they were an employee because all the employment lawyers listening will be twitching on that one because there is a big case going through the courts at the moment, I believe on that matter.
Matthew Seddon It’s essentially to look at who is providing services to the employer or the electronic marketplace. It’s designed to carve out people who are genuinely supplying goods to an employer or an electronic marketplace. So, you don’t have an overreach of withholding obligations. You could imagine if withholding was made on all payments to independent contractors, it would lead to chaos. There would be withholding on every single payment that’s made by an employer.
Furthermore, proposals to extend withholding to all independent contractors have a significant downside in the fact that you’d be requiring, for example, home owners to withhold tax and pay that to Inland Revenue for a painter that was engaged to paint their house. So this proposal is designed to narrow the focus to the independent contractors who are providing services to employers and electronic marketplaces.
TB That makes perfect sense. It’s a huge area though. But as I said, the scope of this with downsizing that’s been going on through Ministries, for example, this exactly is happening, as I said, some people are probably coming out on Friday as employees and coming back contracting with a different role on the Monday. A flat 20% rate, was that what you are thinking?
Matthew Seddon Yes. The default rate would be 20%. This is in recognition of the fact that independent contractors can claim deductions for income tax purposes. It also aligns with the current voluntary schedular payments regime that already exists.
TB Yes, the voluntary schedular payments regime. So right now, if you were contracting to an employer, you could say take 20% off and the employer or rather the contracting company could do that?
Matthew Seddon Yes, there is a mechanism whereby both parties can agree to undertake a withholding. The one thing I would note about my proposal is that it is simply the default rate of 20%. There is an existing regime for schedular payments which provides that an independent contractor can notify the payer of their name, IRD number and an elected rate no less than 10%. The independent contractor can essentially toggle the rate to reflect their effective tax rates so that they they’re not overpaying tax throughout the year. And they’re not underpaying as well, so that they can get a correct tax outcome by the end of the year.
TB Yes. Our pay-as-you-earn-system is more flexible than it was, but there’s scope for improvement there. I think real time payments are the next step in the evolution of our tax system. Something just popped into my mind. If I recall correctly, if a company is providing hiring, hiring contractors, they have a withholding tax obligation automatically. Is that correct?
Matthew Seddon The labour hire rules in the schedular payments regime, I think it’s a 20% rate.
TB Yes, 20%. And it wouldn’t matter, say a contractor was working individually or through a company. Generally speaking, you can under the schedular payments rules, generally speaking, if you’re working through a company, the payer doesn’t have to withhold tax. What do you think? Would you change that here?
Matthew Seddon I think there’s a company exemption in the schedular payments regime which looks through certain companies. So, I think that could also fit in with this proposal.
TB Because mainly the fact someone’s running through a company doesn’t mean that they’re actually completely up to date with their obligations, as week after week Inland Revenue tells us what’s going on. And the other thing that you touched on in there was about the fact that as contractors, they have the ability to claim deductions. I think this is where the paper prepared for the Tax Working Group was saying basically that it seems given comparable levels of income there is this gap of about 20% and they identified that on the basis that self-employed or contractors appear to have 20% more discretionary spending than their employee counterparts.
How would you counter that? I know as a small business, when you are dealing with small businesses, people are very keen to claim everything they can, and they don’t always tell you what they’ve claimed or they’re not always as straight up or as accurate as we would all like in this space. I’ve wondered whether we should have standard deductions. What’s your view on that? I know in the UK they did that for self-employed individual. Any thoughts on that particular idea?
Matthew Seddon My proposal primarily focuses on the withholding obligation, that is on the income side of the equation, so by being able to report and withhold on these payments, Inland Revenue is going to see exactly what these independent contractors are earning.
I guess to the extent that independent contractors are claiming sizable amounts of deductions relative to their industry peers. It would allow Inland Revenue to go and look and audit those independent contractors. On the deduction side, it’s something that I have thought about. I know in the GST rules for listed services there are flat rate credits for non-GST registered persons. So, there could be a similar flat rate deduction for independent contractors to align themselves across the board.
TB I deal with quite a number of American clients and their tax returns have what they call a standard deduction of $12,000. But you don’t have to claim that, you can go for what they call itemised deductions which presumably you do so on the basis that you’ve got more to claim.
It just crossed my mind that one of the things coming out of the Performance Improvement Review of Inland Revenue which we discussed a couple of weeks back, they talked about the tax gap, and I think they also talked about making one of its objectives to make the tax system easier and simpler and particularly for small businesses micro businesses. Your proposal basically is in that space, isn’t it? And it does have that benefit.
Matthew Seddon Exactly. It provides greater levels of compliance for those small businesses, those independent contractors. There’s going to be less need for them to engage accountants and third-party providers. There’s going to be less engagement with the provisional tax system. That’s going to be a much simpler experience for those independent contractors. My proposal also recognises that there will be some costs imposed on employers and electronic marketplaces. But by leveraging off the existing PAYE rules and schedular payments rules, it is designed to minimise those compliance costs as much as possible requiring them to just modify and configure their software and systems.
I think it’s important as well to notice that prior to any implementation of this proposal, there should be a sufficient period of time in which engagement can take place between Inland Revenue and these payroll software providers. I know this has recently taken place for the personal tax cut changes which had effect from 31 July.
TB That’s actually quite critical, and wider consultation is always welcomed in this space. Something just came to mind. I mean, obviously what we’re talking about here, this could be a measure that helps to close the tax gap and raise revenue, which is great from Inland Revenue’s perspective and for Treasury, but it’s actually as I see it, and what I find attractive about this is that it’s also a benefit to contractors.
I deal a lot with small businesses here and you know, managing their tax isn’t always easy and everyone is not as diligent about managing their tax as they should be. I’m a big believer in making payments regularly, and in this case, withholding payments seems to me would contribute quite a bit to that. That was something you had that in mind when you were looking at the proposal weren’t you, because that’s one of the judging criteria of the competition.
Matthew Seddon Exactly, minimising compliance costs for taxpayers and also minimising administration costs for Inland Revenue as well.
I think independent contractors, while they might have the benefit of the time value of money by only making provisional tax payments three times a year, as they currently have no withholding may allow them to have less tax obligations in the first place, as it’s all dealt with by their employer or the electronic marketplace and really allows them to focus on doing what they do best, and that’s running their own business.
TB Yeah, I’d endorse that approach. I do recommend to a lot of my clients, they run businesses, they’re shareholder-employees, we don’t often use the shareholder-employee regime and I tell them, go through the pay-as-you-earn system making your payments regularly, so you keep on top of your tax payments. That’s one of the things, as I mentioned a minute or two ago, I like about the more frequently people make their tax payments, they’re going to be more compliant, get up to date and they will have less stress about it. It’s one of the things about managing small businesses. There’s a lot to deal with and there’s not much that you can actually do, there’s an irreducible minimum you’re dealing with at times and withholding payments helps in that space.
Slightly related topic, what about GST? Now it’s not directly in scope, but to me, I think this is the next frontier of tax could be compulsory zero-rating which would be easy for both the employer or the contracting company and the contractor. What’s your thoughts on that?
Matthew Seddon Yeah, that’s right. It’s not directly included in my proposal, but I think when thinking holistically about the tax obligations of these independent contractors and how they can be automated as much as possible. GST is obviously another area to consider. I think zero-rating, there might be some scope for that. It would mean there’s less obligations on the independent contractor and would not be required to return the GST amount and they’d still be able to claim some GST credits.
The alternative I was thinking about was potentially having the carve out for employment apply to these independent contractors who are functionally equivalent to employees. You should ideally end up with a scenario where if you’ve got an employee and an independent contractor sitting across from the table from one another at their employers’ offices, they should be treated as similarly as possible so that there’s horizontal equity between the two.
TB So what’s next for you? 1500 words was your initial proposal. So now you’ve got the 4000 words which means you’re in the money, you’re going to come away with a medal of some sort. As they say, it’s always good to make the medal rounds. So it’s in mid-October sometime. You’ve got to finalise your entry and what’s involved in that?
Matthew Seddon The final oral presentation is in October and our 4000-word submission is due in September. The 4000 words is essentially branching out and expanding on our initial 1500-word proposal. The 1500-word proposal was a teaser to the judges to set out what the concept was and how it met the relevant judging criteria. The 4000 words will expand on this initial idea.
TB It’s not many though, 4000 words, really when you think about it and then obviously your oral presentation, you’ll be in front of several gurus of tax. That would be interesting, I’d say.
Matthew Seddon Indeed, it will be interesting to hear the judge’s comments and questions in person.
TB Well, I’m sure you’re looking forward to it. I am. I think it’s a very interesting proposal. It sounds mundane, but it’s actually quite important. Thank you very much, Matthew Seddon. Thank you for coming along. Good luck for October for this scholarship, we’ll watch with interest.
Matthew Seddon Thanks Terry.
TB And on that note, that’s all for this week. We’d like to thank Matthew Seddon again for joining us and wish him all the best for the scholarship. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
The just concluded UK general election was the first general election held in July since 1945, when coincidentally the Labour Party also won by a landslide ending Sir Winston Churchill’s wartime prime ministership. Before he became Prime Minister again in 1951, Churchill started writing his monumental six volume history of the Second World War, the first volume of which was titled The Gathering Storm.
And if you’ll pardon the somewhat laboured analogy, this is very much what’s happening with Inland Revenue at the moment. There’s a very clear gathering storm approaching as Inland Revenue pulls together and beefs up its investigation resources. We saw signs of this a couple of weeks back with its commentary about targeting smaller liquor outlets. Now last Wednesday, an Inland Revenue media release announced it is “honing in on customers who are actively dealing in crypto assets but not declaring income from them in their tax returns.”
By way of background, back in 2020, Inland Revenue updated its guidance on the tax treatment of crypto assets. Clearly that was part of a plan to follow through and check on who was trading and investing in crypto but not reporting the income. However, first COVID and then the cost-of-living crisis got in in the way of Inland Revenue’s intentions to follow through up its guidance.
Targeting non-compliance
But those immediate crises have passed now, and it appears that Inland Revenue has been busy investigating potential non-compliance because according to the media release late last year, it wrote to “a group of high-risk customers and gave them the chance to fix any non-compliance issues before facing audit.” This is a standard tactic of Inland Revenue. It basically puts it out to taxpayers without being too specific that it is aware of potential non-compliance and “invites”, that is the terminology used, the taxpayers involved to come forward and make a voluntary disclosure. If the taxpayers do so, then the potential to be charged shortfall penalties is likely to be greatly reduced.
Following on from these “invitations”, the next stage if the taxpayers don’t come forward is directly targeted follow up action. This appears to have just happened, as Inland Revenue is saying it has “just sent another round of letters to those Inland Revenue believes are not complying.
According to Inland Revenue it has data which has enabled it to identify “227,000 unique crypto asset uses in New Zealand undertaking around 7 million transactions with a value of about $7.8 billion.” There’s a potentially sizable sum of tax on the line here.
Pay up, or else…
The media release continues with a rather veiled threat
“Cryptoasset values have reached new highs, so now is a good time for people to think seriously about tax on their crypto asset activity. The high value also means customers are well positioned to pay their tax for the 2024 tax year and earlier.”
In other words, Inland Revenue is saying as values have recovered that means taxpayers can’t plead poverty when it comes to paying the tax due on their profits.
The media release goes on to explain something that we’ve said frequently; Inland Revenue has more data available to it than people realise.
“We want customers and tax agents to know that we are stepping up our compliance activity for customers with cryptoassets. Despite popular thinking – people are not invisible on blockchain and we have the tools and analytics capabilities to identify and expose cryptoasset activities.”
So there it is, very clearly stated ‘We know more than you think we know and we are coming for you.’ Part of this, by the way, is that New Zealand and therefore Inland Revenue has signed up to the new Crypto-Asset Reporting Framework (CARF) recently developed by the Organisation for Economic Cooperation and Development. This is yet another example of the growing international cooperation on the exchange of information, a regular topic on this podcast.
Under CARF the first set of reporting is due to apply from the 2026/27 tax year which will lead through to increased tax revenue. In fact, according to the Budget, the expectation is that CARF will deliver $50 million of additional tax revenue in the June 2028 year..
That’s in the future. What’s happening right now is that Inland Revenue has used its existing network of information exchanges and data sharing almost certainly by tax treaty partners such as Australia, the UK and the US, to obtain data about transactions carried out by New Zealand based crypto-asset investors and traders. It’s now going to put the squeeze on those it considers non-compliant.
It’ll be interesting to see what comes out of it and we will watch with interest and bring you news of developments. In the meantime you have been warned and this is of course the latest sign of the gathering storm of Inland Revenue investigations.
Inland Revenue kilometre rates for 2023-24
Moving on, Inland Revenue has just published its kilometre rates for the 2023-2024 income year. Unsurprisingly, given the recent rise in fuel prices, the so-called tier one rates show an increase in vehicle running costs that are allowable for the year. These rates may be used to calculate the deductible running costs for a vehicle.
Note that the Tier 1 rate of $1.04 for the first 14,000 kilometres applies to all vehicles whether petrol, diesel, hybrid or electric. The Tier 2 rates above the first 14,000 km DO vary between vehicle type.
This is good to know, but I do wonder whether it might be a bit more useful to have this sort of information earlier in the relevant tax year. Inland Revenue obviously wants to be accurate, but a different approach perhaps might be to adopt an interim rate and index that for inflation. Anyway, these are the rates that are now applicable for the 2023-24 tax year if you wish to claim the relevant deduction.
Are we raising enough tax?
And finally, this week, the Tax Policy Charitable Trust held an event on Thursday last night to announce its four finalists for this year’s Tax policy scholarship prize. The first half of the event was a panel discussion on New Zealand’s tax revenue sufficiency. Ably chaired by Geof Nightingale, a member of the last two Tax Working Groups, the four panellists that joined him were Talia Harvey and Matt Wooley, joint winners of the scholarship prize in 2017, Nigel Jemson, the winner in 2020 and Vivian Lei, the winner in 2022. You may recall Vivien, have previously been a guest on the podcast.
L-R Matt Woolley, Geof Nightingale, Vivien Lei, Talia Harvey and Nigel Jemson
Now, this was a fascinating panel discussion conducted under Chatham House rules, focusing on the scale of fiscal challenges for the next few decades and how could we meet those? Does this mean for example, some new taxes might be required such as capital gains tax? What about boosting Inland Revenue’s investigation efforts? And then on the spending side of the equation what do we do about rising health care and superannuation costs? Do we perhaps increase the age for eligibility or (re)introduce some forms of mean testing for New Zealand Superannuation? All these points were raised for discussion.
The panel discussed ‘the tax gap’, the gap between what we think the tax collection should be and what’s not being collected. There’s a lot of work to be done in this space, because we really don’t have a clear handle on the extent of this particular issue. Some work carried out several years ago by Inland Revenue suggested that when you look at the consumption patterns between self-employed persons and employees, there might be as much as a 20% gap. In other words, self-employed people appear to have about 20% higher levels of consumption than employees on ostensibly similar levels of income. This is a topic which actually might be worth a podcast episode in itself.
And the finalists are…
It was then followed by the announcement of the four finalists of this year’s Tax Policy Charitable Trust scholarship prize. Every two years the Tax Policy Charitable Trust invites young professionals (anyone under 35 on 1 January 2024) to submit proposals for review, improving any aspect of New Zealand’s tax system. Entrants submit a 1500 word overview proposal on any part of the tax system from which the judges choose four finalists will be selected to go through for the final main scholarship prize, which is worth $10,000.
Submissions are judged for their creativity, original thinking and sound and reasoned research and analysis. In addition the judges take the following factors into consideration:
Impact on the New Zealand economy, including GDP and business growth.
Social (including distributional equity) and environmental acceptability.
Feasibility of introduction, including political and public acceptability.
Impact on simplicity of tax system.
Ease of administration by taxpayers and Inland Revenue, or other relevant government agencies, and impact on compliance costs.
This year, there were 17 entrants and the four finalists chosen are
Matthew Handford, who proposes an Independent Tax Law Commission aimed at improving the Generic Tax Policy Process, or GTPP. The GTPP is a cornerstone of tax policy and is internationally well regarded, but it’s now 30 years old, so is due a reconsideration. I look forward to hearing more about Matthew’s proposal.
Claudia Siriwardena, who is suggesting a simplified FBT regime for small and medium enterprises. This gets a big tick from me, and I’m very interested in hearing more about this one.
Matthew Seddon, who proposes extending the independent contractor withholding tax regime. Mathew’s suggestion picks up the point just raised about the tax gap and deals with it by improving compliance. Again, another interesting proposal.
Finally, Andrew Paynter who is putting forward a proposal to increase the GST rate from GST but also tackle the regressivity of GST with a rebate for low and middle income earners. I’ve seen some international papers on this particular topic, so I’m very, very interested to hear more about what Andrew’s proposing here.
My intention is to get all four scholarship finalists on the podcast to talk about their ideas before the winner is announced in October, so stay tuned for developments. In the meantime, congratulations to Matthew, Claudia, Matthew and Andrew and to everyone else who entered. No doubt there were some interesting ideas put forward that did make the cut this time, but overall, it’s a great sign of the healthy state of tax policy debate in New Zealand.
And on that note, that’s all for this week, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
(Originally loaded to Soundcloud 6 July 2024. On interest.co.nz 8 July 2024).
The aim is to develop a corporate tax database which is going to be available to tax policy researchers and policy makers about corporate tax rates, effective tax rates, tax incentives for research and development and other topics such as withholding taxes. Increasingly, the amount of information includes anonymised and aggregated country by country reporting data, which provides an overview of the global tax and economic activities of thousands of large multinational enterprises operating worldwide. This year’s report covers 8000 such enterprises.
The detailed statistics in the report are mostly from the 2021 calendar year although some 2022 data is included. The report does take into account the statutory tax rates currently in force.
Increased country by country reporting and more reporting generally is part of the 15 actions within BEPS. The report sets out why this is important:
“Action 11 noted the lack of available and high-quality data on corporate taxation is a major limitation to the measurement and monitoring of the scale of BEPS and the impact of the measures agreed to be implemented under the OECD/G20 BEPS Project.”
Corporate tax rates are stabilising
The headline summary is that corporate tax revenues remain important, but statutory corporate tax rates as the report are now showing signs of having stabilised after pretty near two decades of decline. During the period between 2000 and 2024 the average statutory tax rate declined from about 28% in 2000 to 21.7% in 2019. However, between 2019 and through to 2024, it has remained relatively stable at a rate of 21.7% in 2019 and 21.1% in 2024. I think stabilisation is a trend that’s going to continue.
Who knows, though, if the possible re-election of Donald Trump may change this. But I think governments balance sheets worldwide have been weakened considerably by the double whammy of the Global Financial Crisis and then the pandemic. I therefore think the opportunities to actually cut corporate tax rates further are quite limited, but we shall see.
Just to put New Zealand in context, back in 2000, our corporate tax rate was 33%. With effect from 1st April 2008, it was reduced to 30% and then on 1st April 2011 it was reduced to its current level of 28%. Across the ditch Australia has had a 30% corporate tax rate since 2001.
There’s interesting data about the importance of the corporate tax take. On average for the 2021 year, which was also a pandemic affected year, corporate tax revenue represented 16% of all tax revenues. New Zealand is in line with that average, but as a percentage of GDP, the OECD average was 3.3% whereas here it was considerably higher at 5.7%.
The report also considers effective average tax rates (EATRs) and examines the effect of tax incentives such as more generous tax depreciation compared with true economic deprecation. Again, according to the report effective average tax rates have remained relatively stable falling slightly from 20.9% in 2019 to 20.2% in 2023. Median effective average tax rates were 22.8% in 2019 and practically unchanged at 22.7% in 2023. Meanwhile, New Zealand’s effective marginal effective average tax rate is still relatively close to our statutory tax rate of 28%.
But…a narrowing tax base?
Chapter 4 of the report discusses effective and marginal tax rates and has some interesting commentary around declines of effective marginal tax rates (EMTRs). The report notes
“The stability of EATRs combined with declines in EMTRs suggests a narrowing of tax bases in the sample, notably through an increase in the generosity of depreciation provisions. Examining the asset breakdown shows these trends have been driven by increased generosity of depreciation of tangible and intangible assets, as opposed to buildings and inventories.”
I think some of this might be part of the response to the pandemic. New Zealand is noted being alongside Argentina, Japan, Papua New Guinea and Peru as having a higher effective marginal tax rate because we’ve got less generous depreciation rules. (This has become more so with the imminent withdrawal of building depreciation).
Research and development incentives
Chapter 5 looks at tax incentives for research and development, noting that they’ve become more generous over the past 20 years or so. 33 out of 38 OECD jurisdictions offer tax relief from R&D expenditures in 2023, compared with 19 in 2000. New Zealand is one of the new jurisdictions now offering R&D incentives. These are becoming more generous over time.
From a New Zealand perspective, we discuss the importance of R&D in boosting our productivity and we still could do more in that space. I’m inclined to the view I heard recently expressed that it’s better to give a tax incentive for it rather than get involved in the grant process. Because with a grant process, the companies can be restrained in what they have to spend because of the application process. Also, there’s a lot of effort involved with applying grants, less so with an R&D tax incentive, subject to Inland Revenue monitoring.
According to the report the level of direct government funding and tax support for business R&D in 2021 was about .12% of GDP, well below the OECD average of .2 of GDP. So, there’s still room for improvement although that’s something that’s been acknowledged across the board.
Chapter 6 looks at BEPS actions and notes that there’s a large number of controlled foreign corporation or control foreign company rules with apparently 53 jurisdictions having it in place in 2024. There’s also growth in the use of interest limitation rules. This is part of a growing trend in tax policy around the world to consider imposing restrictions on the deductibility of interest. Apparently, there are now over 100 interest limitation rules in place up from 67 jurisdictions back in 2019.
The dangers of following Ireland’s example
Chapter 7 has a breakdown of country by country reporting statistics with 52 jurisdictions out of a possible 101 submitting statistics to the OECD. As I mentioned earlier, this report includes the activities of over 8000 multinationals so there’s a lot of detail in here.
Several commentators including the New Zealand Initiative have recently mentioned Ireland as a potential model to follow. As is well known, Ireland has a very low corporate tax rate. I was therefore very intrigued by figure 7.2 on page 81 of the report, which illustrates the multinational enterprises contribution to local corporate income tax revenues in 2020.
As can be seen, 87% of Ireland’s corporate tax came from multinationals, and the vast majority of those multinationals were local affiliates owned by foreign multinationals. In fact, the Irish Treasury and the European Commission have expressed concern about the sustainability of Ireland’s corporate tax revenue because of the dependency on a few large multinationals.
New Zealand is near the opposite end of the scale with only 24% of corporate tax revenue coming from multinationals, probably three-quarters of which look to be from overseas owned. I think this is an extremely interesting stat which makes me wonder about whether New Zealand is attracting enough investment and whether we should have more multinationals of our own based overseas.
Yes, but is BEPS working?
In summarising key insights on BEPS from the Country by Country Report data the report makes this observation”
“There is evidence of misalignment between the location where profits are reported and the location where economic activities occur. The data show continuing differences in the distribution across jurisdiction groups of employees, tangible assets, and profits.” [page 87]
In other words, the report is basically saying there appears to be some profit shifting going on, but we don’t quite know enough about it. This gets to the heart of the idea behind the BEPS initiative, find out more about what’s happening and then fix it.
As I said the OECD’s corporate database is constantly being expanded so if you’re a bit of a stats guru there’s plenty to dive into and research. Overall, another interesting report highlighting how New Zealand’s corporate tax rate is at the higher end, but noting it also raises a lot of revenue relative to other jurisdictions.
Is that asset depreciable?
Moving on and picking up on depreciation one of the issues covered by the OECD stats, Inland Revenue has just released a draft interpretation statement for comment on identifying the relative relevant item or property for depreciation purposes. This is quite important because our depreciation regime is extremely detailed with a myriad of available rates across several categories.
This draft ties into several other related items of guidance such as residential rental properties depreciation, the question of deductibility of repairs and maintenance – if expenses are not deductible are they depreciable instead? There’s also QB 20/01 – can owners of existing residential parental properties claim deductions for costs incurred to meet healthy home standards? And finally, Interpretation Statement IS 22/04 relating to claiming depreciation on buildings. The imminent withdrawal (again) of building depreciation makes it very important now to maximise depreciation and to identify whether in fact that asset is part of the building or can be claimed separately. This draft is therefore pretty relevant.
The draft runs to 40 pages the last 15 or so pages of which are examples. There’s also a useful 6 page fact sheet accompanying it. Submissions are open until 29th August.
A post-hibernation bear is hungry…
Finally, as we discussed last week, one of the things that came out of Inland Revenue’s recent performance improvement review was for it to be more prominent in promoting what actions it has taken against non-compliant taxpayers. We’re seeing more of that this week when Inland Revenue was announced that an Auckland couple have been sentenced to three years in prison on tax evasion charges. The pair committed 69 tax related offences involving income tax and GST evasion amounting to about $750,000, together with another $80,000 in unaccounted for PAYE. The judge described it as very deliberate offending including deliberate under reporting of business income filing false returns, and even failing to file false returns once under investigation. The couple withheld information from their accountants and concealed the existence of what were described as “highly relevant bank accounts.” So pretty clear case here of tax evasion.
One thing of note that does slightly concern me is this offending occurred over a six year period between 2010 and 2015. That’s quite some time ago and I think Inland Revenue is much more on the case now. Even so you would hope that it doesn’t take 7-8 years or more to bring people to justice on this in the future.
The taxman cometh…
For an idea of how Inland Revenue’s increased activities might play out for your average person, this week’s episode of RNZ’s podcast The Detail discussed how Inland Revenue plans to utilise its additional funding. The episode focuses on the construction industry because of the sector’s long association with the proliferation of the “cashie”. Inland Revenue apparently gets 7,000 anonymous tip offs a year, many of which relate to tradies.
There’s some very interesting commentary from Malcolm Fleming, the New Zealand Certified Builders Association chief executive. He rightly points the finger back at the public for this issue. As he notes, nobody asks their accountant or lawyer ‘Well, how much is it for cash?’ On the other hand, the public seems to be happy to try this tactic with builders and others in the construction industry. On the question of tax evasion and cashies, maybe quite a few people should be looking in the mirror about that rather than pointing the finger elsewhere. It’s a very valid point.
The episode is well worth a listen; it highlights more of what Inland Revenue is currently doing. It’s now doing unannounced site visits to construction sites, for example, which I’m sure would alarm some businesses. But to be fair it also points out most small businesses are run on the straight and narrow. They are perhaps poorly capitalised with overworked owners who are also the main administrator. In many cases the question of tax arrears is more one of poor administration rather than in the case of the couple who were jailed, deliberate malfeasance.
And on that note, that’s all for this week, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
The just concluded UK general election was the first general election held in July since 1945, when coincidentally the Labour Party also won by a landslide ending Sir Winston Churchill’s wartime prime ministership. Before he became Prime Minister again in 1951, Churchill started writing his monumental six volume history of the Second World War, the first volume of which was titled The Gathering Storm.
And if you’ll pardon the somewhat laboured analogy, this is very much what’s happening with Inland Revenue at the moment. There’s a very clear gathering storm approaching as Inland Revenue pulls together and beefs up its investigation resources. We saw signs of this a couple of weeks back with its commentary about targeting smaller liquor outlets. Now last Wednesday, an Inland Revenue media release announced it is “honing in on customers who are actively dealing in crypto assets but not declaring income from them in their tax returns.”
By way of background, back in 2020, Inland Revenue updated its guidance on the tax treatment of crypto assets. Clearly that was part of a plan to follow through and check on who was trading and investing in crypto but not reporting the income. However, first COVID and then the cost-of-living crisis got in in the way of Inland Revenue’s intentions to follow through up its guidance.
Targeting non-compliance
But those immediate crises have passed now, and it appears that Inland Revenue has been busy investigating potential non-compliance because according to the media release late last year, it wrote to “a group of high-risk customers and gave them the chance to fix any non-compliance issues before facing audit.” This is a standard tactic of Inland Revenue. It basically puts it out to taxpayers without being too specific that it is aware of potential non-compliance and “invites”, that is the terminology used, the taxpayers involved to come forward and make a voluntary disclosure. If the taxpayers do so, then the potential to be charged shortfall penalties is likely to be greatly reduced.
Following on from these “invitations”, the next stage if the taxpayers don’t come forward is directly targeted follow up action. This appears to have just happened, as Inland Revenue is saying it has “just sent another round of letters to those Inland Revenue believes are not complying.
According to Inland Revenue it has data which has enabled it to identify “227,000 unique crypto asset uses in New Zealand undertaking around 7 million transactions with a value of about $7.8 billion.” There’s a potentially sizable sum of tax on the line here.
Pay up, or else…
The media release continues with a rather veiled threat
“Cryptoasset values have reached new highs, so now is a good time for people to think seriously about tax on their crypto asset activity. The high value also means customers are well positioned to pay their tax for the 2024 tax year and earlier.”
In other words, Inland Revenue is saying as values have recovered that means taxpayers can’t plead poverty when it comes to paying the tax due on their profits.
The media release goes on to explain something that we’ve said frequently; Inland Revenue has more data available to it than people realise.
“We want customers and tax agents to know that we are stepping up our compliance activity for customers with cryptoassets. Despite popular thinking – people are not invisible on blockchain and we have the tools and analytics capabilities to identify and expose cryptoasset activities.”
So there it is, very clearly stated ‘We know more than you think we know and we are coming for you.’ Part of this, by the way, is that New Zealand and therefore Inland Revenue has signed up to the new Crypto-Asset Reporting Framework (CARF) recently developed by the Organisation for Economic Cooperation and Development. This is yet another example of the growing international cooperation on the exchange of information, a regular topic on this podcast.
Under CARF the first set of reporting is due to apply from the 2026/27 tax year which will lead through to increased tax revenue. In fact, according to the Budget, the expectation is that CARF will deliver $50 million of additional tax revenue in the June 2028 year..
That’s in the future. What’s happening right now is that Inland Revenue has used its existing network of information exchanges and data sharing almost certainly by tax treaty partners such as Australia, the UK and the US, to obtain data about transactions carried out by New Zealand based crypto-asset investors and traders. It’s now going to put the squeeze on those it considers non-compliant.
It’ll be interesting to see what comes out of it and we will watch with interest and bring you news of developments. In the meantime you have been warned and this is of course the latest sign of the gathering storm of Inland Revenue investigations.
Inland Revenue kilometre rates for 2023-24
Moving on, Inland Revenue has just published its kilometre rates for the 2023-2024 income year. Unsurprisingly, given the recent rise in fuel prices, the so-called tier one rates show an increase in vehicle running costs that are allowable for the year. These rates may be used to calculate the deductible running costs for a vehicle.
Note that the Tier 1 rate of $1.04 for the first 14,000 kilometres applies to all vehicles whether petrol, diesel, hybrid or electric. The Tier 2 rates above the first 14,000 km DO vary between vehicle type.
This is good to know, but I do wonder whether it might be a bit more useful to have this sort of information earlier in the relevant tax year. Inland Revenue obviously wants to be accurate, but a different approach perhaps might be to adopt an interim rate and index that for inflation. Anyway, these are the rates that are now applicable for the 2023-24 tax year if you wish to claim the relevant deduction.
Are we raising enough tax?
And finally, this week, the Tax Policy Charitable Trust held an event on Thursday last night to announce its four finalists for this year’s Tax policy scholarship prize. The first half of the event was a panel discussion on New Zealand’s tax revenue sufficiency. Ably chaired by Geof Nightingale, a member of the last two Tax Working Groups, the four panellists that joined him were Talia Harvey and Matt Wooley, joint winners of the scholarship prize in 2017, Nigel Jemson, the winner in 2020 and Vivian Lei, the winner in 2022. You may recall Vivien, have previously been a guest on the podcast.
Now, this was a fascinating panel discussion conducted under Chatham House rules, focusing on the scale of fiscal challenges for the next few decades and how could we meet those? Does this mean for example, some new taxes might be required such as capital gains tax? What about boosting Inland Revenue’s investigation efforts? And then on the spending side of the equation what do we do about rising health care and superannuation costs? Do we perhaps increase the age for eligibility or (re)introduce some forms of mean testing for New Zealand Superannuation? All these points were raised for discussion.
The panel discussed ‘the tax gap’, the gap between what we think the tax collection should be and what’s not being collected. There’s a lot of work to be done in this space, because we really don’t have a clear handle on the extent of this particular issue. Some work carried out several years ago by Inland Revenue suggested that when you look at the consumption patterns between self-employed persons and employees, there might be as much as a 20% gap. In other words, self-employed people appear to have about 20% higher levels of consumption than employees on ostensibly similar levels of income. This is a topic which actually might be worth a podcast episode in itself.
And the finalists are…
It was then followed by the announcement of the four finalists of this year’s Tax Policy Charitable Trust scholarship prize. Every two years the Tax Policy Charitable Trust invites young professionals (anyone under 35 on 1 January 2024) to submit proposals for review, improving any aspect of New Zealand’s tax system. Entrants submit a 1500 word overview proposal on any part of the tax system from which the judges choose four finalists will be selected to go through for the final main scholarship prize, which is worth $10,000.
Submissions are judged for their creativity, original thinking and sound and reasoned research and analysis. In addition the judges take the following factors into consideration:
Impact on the New Zealand economy, including GDP and business growth.
Social (including distributional equity) and environmental acceptability.
Feasibility of introduction, including political and public acceptability.
Impact on simplicity of tax system.
Ease of administration by taxpayers and Inland Revenue, or other relevant government agencies, and impact on compliance costs.
This year, there were 17 entrants and the four finalists chosen are
Matthew Handford, who proposes an Independent Tax Law Commission aimed at improving the Generic Tax Policy Process, or GTPP. The GTPP is a cornerstone of tax policy and is internationally well regarded, but it’s now 30 years old, so is due a reconsideration. I look forward to hearing more about Matthew’s proposal.
Claudia Siriwardena, who is suggesting a simplified FBT regime for small and medium enterprises. This gets a big tick from me, and I’m very interested in hearing more about this one.
Matthew Seddon, who proposes extending the independent contractor withholding tax regime. Mathew’s suggestion picks up the point just raised about the tax gap and deals with it by improving compliance. Again, another interesting proposal.
Finally, Andrew Paynter who is putting forward a proposal to increase the GST rate from GST but also tackle the regressivity of GST with a rebate for low and middle income earners. I’ve seen some international papers on this particular topic, so I’m very, very interested to hear more about what Andrew’s proposing here.
My intention is to get all four scholarship finalists on the podcast to talk about their ideas before the winner is announced in October, so stay tuned for developments. In the meantime, congratulations to Matthew, Claudia, Matthew and Andrew and to everyone else who entered. No doubt there were some interesting ideas put forward that did make the cut this time, but overall, it’s a great sign of the healthy state of tax policy debate in New Zealand.
And on that note, that’s all for this week, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
What makes a good tax system and where does New Zealand presently sit?
The current broad-base, low rate approach is under strain. How do we address that? What can we do to keep/ preserve that as far as possible? And more.
Terry Baucher: It is my very great privilege this week to be joined by three of the titans of tax in New Zealand, Rob McLeod, Robin Oliver and Geof Nightingale.
Rob, or more correctly Sir Robert McLeod, KNZM is one of THE gurus of New Zealand tax, has been involved in tax policy at the highest levels since the 1980s. A former chair of EY, he was chair of the 2001 McLeod Tax Review and was also a member of the 2010 Victoria University of Wellington Tax Working Group. He’s currently a consultant, although still very much involved in the tax policy world. He was knighted in 2019 for services to business and Māori. Kia Ora, thank you for joining us.
Robin Oliver, another of the gurus of New Zealand tax, until he retired from Inland Revenue, was Deputy Commissioner of Inland Revenue and head of Tax Policy where he advised the 2001 and 2010 tax working groups. He is now a partner in tax consultancy Oliver Shaw and was a member of the last Tax Working Group. Robin was made a member of the New Zealand Order of Merit in 2009.
Geof Nightingale recently retired from PwC, and when he’s not cycling the length of the South Island, is an independent tax consultant. He was a member of both the 2010 and 2019 tax working groups. Thank you again to all of you for joining us.
What makes a good tax system and where does New Zealand presently sit?
We’ll begin with what was asked at this year’s International Fiscal Association Conference. The three of you spoke on the topic of what makes a good tax system. What does make a good tax system and where does New Zealand presently sit? Rob, would you like to lead off?
Rob Mcleod (RM) Thanks, Terry. Well, I think at its core tax is mainly about raising revenue to finance government programmes. It’s true that tax has peripheral tasks as well, like you know, correcting for market failure. If we think about carbon taxes, the primary purpose of that kind of tax is really to moderate adverse behaviour in the economy, which is not is not really a revenue raising objective. Some would also argue that taxes are there to achieve redistribution goals, transfer income to those that are in need. That too is not so much a revenue raising goal.
“At its core tax is mainly about raising revenue to finance government programmes”
But if you go to the real reason why income tax exists in countries, it’s actually to raise revenue for governments. If governments didn’t need revenue, you wouldn’t have taxes. And chances are you wouldn’t have such a major regime doing these other two things, like corrective taxation, like carbon taxes, or trying to redistribute income without the agenda of raising revenue. I would argue that we wouldn’t have tax systems on the scale that we have them doing those other things. So, I believe that raising revenue is the primary goal of a good tax system and doing it at least cost would be my formulation.
Robin Oliver (RO) I agree with Rob, even more so, that a good tax system is one that works. It raises money for the government. That may seem obvious to people, but you can’t have taxes which fail to raise money. Margaret Thatcher’s poll tax failed to raise money. It was a failure.
“You’ve got to really focus on raising money at least cost”
So it has to raise money at least cost to society and that’s admin costs, compliance costs, but overall economic costs. The cost of disincentivising people from work and savings and so forth. People think that’s “blah blah blah blah” but the estimates in New Zealand and Australia, and used by the Australian Treasury, is that twenty cents in every dollar of tax is lost in economic costs. In other words, not quite, but basically lost output, lost wealth for the country. So, you’ve got to really focus on raising money at least cost.
Rob mentioned redistribution. I think redistribution’s got nothing to do with a good tax system. Government raises money to do good things – health, education, welfare. We’ve lost focus on what tax is about. We’ve got diverted into all sorts of ideas that it could be used for. No, it’s about raising money, at least cost. Every tax proposal should be looked at “Is this the way we could raise some money, effectively, at least the cost to society.”
TB Thanks, Robin. Geof, I think you have a slightly different take on the redistribution issue and I note that the IMF was talking about redistribution in one of its papers recently
Geof Nightingale (GN) Well, Terry, I’d largely, and violently agree with Rob and Robin that the primary function of a good tax system is to raise the revenue that government needs. But it’s how it goes about that where I might differ.
There’s a couple of backgrounds, opening points I’d like to make, and the first is I think it seems, really uncontroversial that our modern democratic states with tax systems and, you know, rule of law-based things. They’ve done more than anything that’s ever been tried to lift living standards. So, broadly, I think they are a good thing that the tax status policy people might call it is a good thing.
“You can only tax by consent”
The second point is, that in those democracies, it’s really important for tax policy people to acknowledge that you can only tax by consent. I mean we impose taxation through the rule of law and through enforcement. But in the end people vote on taxes and people vote governments in and out and tax is often a key election thing. So you can really only tax by consent.
So, whatever the theory may tell you, you have to – I’ve learned over many years now – bring the public with you. That’s the job of the politicians, not the policy people. The policy people have to accept. That general consent point is really important when you start talking about the future of tax in New Zealand.
And then the third thing is there’s no such thing as a perfect tax system and as Robin pointed out, we navigate it, every tax policy choice is a bunch of trade-offs, and we navigate those trade-offs with some well-established principles. You know, equity efficiency, administration etcetera. And those principles can never be applied scientifically. In the end, they come down to, in my view anyway, value judgments at the margin, and that’s where the politics comes into the tax system as it as it should be.
So what is a good tax system? Well as Rob and Robin said, primarily one that raises revenue with the least cost to society. And there are secondary objectives, and those are the distributional impacts. I think those are important for policymakers to take into account. And I think they feedback around into the consent of citizens to be taxed and and the fundamental democratic process actually. and. Most OECD countries, in fact all I think, have progressive tax systems by and large and general voting patterns suggest that that’s the majority view of life across OECD democracies.
The problem with behavioural taxes
Other secondary objectives that Rob and Robin mentioned with behavioural changes, carbon taxes and things and those are very specific instruments of public policy, and they might raise some short term revenues. But they shouldn’t be relied on for long term revenues and it’s almost a different category of taxation to the general tax system because if they work – those behavioural taxes – the revenues will often dry up, will be reallocated into the areas that they’re trying to change.
TB That’s something we’re actually seeing with the tobacco excise duty. It worked and now revenues are falling and now that’s sort of a hole in the finances.
RO But if that works, yeah, it’s the same as environmental taxes. You know you have taxes on degradation of the environment. And if you don’t degrade the environment, you get no money. And it’s perfectly fine. They work, but back to Geof’s point. I totally disagree that redistributions got anything about it. You clearly have to have a democracy; in a democracy you have to have consent. I agree with that. You have to have consent to make the tax system work because of voluntary compliance and all that.
Poll taxes – efficient but unworkable?
But the purpose of tax is to raise the money in the most cost-effective way. And I give the example of that is the poll tax, Margaret Thatcher’s poll tax. I mean poll taxes are loved by economists because it’s thought of as being efficient. But it doesn’t work. I mean if you want to raise New Zealand’s government revenue by poll tax you’ve got to raise about $30,000 per individual. You’re not going to go out to people in South Auckland, a family household, and demand $100,000 from them please. I mean, they don’t have it. And there’s no point in demanding money, which people just don’t have.
And that’s why even an efficient tax system, inevitably given the level of government expenditure we have, will need to be progressive. Because you know the lower income earners just don’t have money to pay the tax that the government needs. But again, the point is, you’re really trying to raise money to spend on health, education and welfare and you want to do it at least cost. And forget about trying to have a secondary objective of redistributing income, that just leads you into bad taxes. And that’s led us from having a good tax system to one which is now pretty awful or going that way.
TB It’s a hell of a topic that. I mean, there is always a redistributive effect of tax, and the recent Treasury paper on the fiscal incidence of taxation was quite interesting in that regard.
RO Yes, good paper.
What about ring-fencing taxes for certain objectives?
TB The Treasury paper showed health and education benefits going to different deciles. They’re essentially redistributed within the system. So just a quick thought about these behavioural taxes Do you actually see much of a role for ring fencing? Tax takes such as, for example, environmental taxation that we raise these, we’re trying to encourage better behaviour, but the funds don’t go into the general pool but are used to mitigate the impact of climate change. Is there a role for that Rob?
RM Yes, I think I think there is. We call this hypothecation and we’ve had hypothecation in the area of fuel taxes for example, which are put on road users and then reinvested back on to roads at various times. But over time, you know, I think that money was ultimately then sent to the consolidated fund.
RO I mean, money is fungible. And therefore, putting it in one pot versus many pots, you can have an argument about whether that’s effective. I think ultimately if governments ensure there is a correlation between how they apply the funds and the taxes they raise, and hypothecation is a solid principle to get that correlation. But I think that the more recent view of governments has been that they can be relied on to effectively finance it all out of a consolidated pot. So yes, hypothecation is certainly there, and we’ve got examples of it.
Economists hate hypothecated taxes, because it ends up government spending money wastefully and low priority areas, because that’s where the money is. But it does serve a purpose, it provides the right incentives. There’s a case for it you know road user charges, Rob said was a good case in point. And you can make other cases like how do we control the level of health expenditure? Well, you could hypothecate GST to health and if people want to spend more on health, GST goes up and everybody has to pay it, so you can end up with arguments for hypothecated taxes. But the economists really hate them.
GN At the risk bringing distributional effects back onto the table, hypothecated taxes can also be highly regressive, so yes, I’ll just leave that there.
TB Yes, a common hypothecated tax around the world, which we don’t now have but once did, was Social Security. You see that many other jurisdictions had that and we’d had that until the late 60s. I think it was Rob Muldoon who decided stuff this we’ll just get rid of it because it was, as Rob described, was just going into the consolidated fund. But looking way back, it was a quite significant part of tax revenues if you look track the history of tax.
The problem with social security taxes
RO And very important in Europe in particular, and the United States of America. And we are very lucky not to have them. Australia and New Zealand, one of the few OECD type countries not to have Social Security payroll taxes, which are linked with the benefits. The reason for that is it results in peoples’ old age pensions, or whatever you call them – New Zealand super being linked with past earnings.
And that means that the poor are really poor, when they are elderly. And that’s the case in the UK. Everybody gets the same in New Zealand which in my view is absolutely a much better system than using your tax system to provide benefits linked with wages. Which means particularly women who are not always in the workforce, but child rearing, skills get really done over. I think we’ve got a much more equitable system of expenditure on welfare because we don’t have that.
The incidence of tax – who is actually bearing the tax burden?
RM Terry, can I just perhaps take us back to redistribution, I think there’s one important point about redistribution which unfortunately is a bit of a technical point. But it’s one that is overlooked not only by lay persons, you know, people not familiar with technical stuff, but also the tax profession itself. Which is the issue of incidence.
So if you just start with the GST as an example, most New Zealanders wouldn’t accept, and rightly, that the GST is not imposed on them. And yet, if you have a look at who pays the GST, they don’t pay it. The consumers do not send cheques to Inland Revenue. The tax is actually imposed on businesses. As a matter of imposition. When we talk about redistribution, we’re inclined to assume that the tax impact is where the law imposes it, but the key principle that’s demonstrated by the GST example is the market actually takes that tax and spreads it around, arguably like margarine, to all of the stakeholders and sometimes non stakeholders, and the and the contract to be affected.
These are such things as gross ups, if you go and slap a tax on somebody and they’ve got market power, they’ll put the price up of what they’re supplying to others. And in so doing, they’ll pass that tax burden on to others. And this is completely ignored in my view, when people are talking about redistribution, because there’s the assumption that the taxes that are actually imposed by the government, is actually borne by the people who send cheques to Inland Revenue Department, is utterly false. And if you try and unravel that mathematically and work out who actually is bearing the tax, the best you can get to on most of it is estimates including the dead weight loss of the 20% that Robin is talking about, it’s there’s a lot of estimation going on to get to those numbers.
There’s no argument that that economic effect is real, and for me that’s a big undercut of why I don’t buy all the redistribution argument, because it tends to proceed on the assumption that the way the government’s levying the tax will ultimately shape and determine the burden of it.
RO We don’t know a lot about the incidence of tax. But what we do know, it’s almost never born entirely by the person paying it. So, you end up with these studies, like the awful IRD study on high wealth, totally ignoring this fact, just totally ignoring it.
And the classic example of economics in the United States is that you have local body bonds, the interest rate is tax free. It’s a subsidy to like City Councils or what, and the federal government doesn’t tax them.
The high wealth individual – the person on the very high rates – ends up owning all these municipal bonds. They don’t pay any tax. But they’re getting a lower interest rate because they’re bidding up the price of these bonds, which is what’s intended and the local City Council get cheap money. And then along comes a bunch of officials measuring their tax burden and finding it zero. Disastrous. Horrible. Well, in fact, they’re paying it through the lower interest rates on it.
And this happens all the time, all through the tax system. You put taxes up on foreigners, that’s a good idea. Foreigners we don’t like, they’re not voting, and we put big tax on foreigners. They just simply demand a higher rate of return or don’t invest here. We end up with lower productivity, lower wages and the economics is absolutely clear. Put your tax on your non-resident investor, it ends up coming out in lower wages. And that’s exactly Rob’s point. The incidence is always shifting and yet we totally ignore this. The political debate just assumes the world is not what it is.
TB Robin, I think we’re going to see more and more of that. Sorry, Geof, you were about to say something.
GN I totally agree with Robin and Rob on incidence, it’s critical. But it comes back to my opening point that you can only tax through consent, eventually. If incidence is not well understood, policymakers – and it’s very hard and very slippery getting your hands on the concept – but policymakers need to think about it. But if you can’t convey that to voters, then it becomes kind of irrelevant.
I remember Sir Rob’s MacLeod committee and the $1,000,000 tax cap for individuals. I thought was a was a great idea because of that sort of argument that we’d be better off with $1,000,000 than not. But that policy is too easy to attack politically from an equity and a sort of a fairness sense. And that’s what happens in the real world as we all know and that’s why we end up in political arguments around the secondary purposes of the tax system, as opposed to really discussing the primary purpose of the tax system Which is least cost revenue raising for government policy. So, I agree with their incidence comments, but it works both ways, I think.
RM Can I just jump in on that one and just observe that in the McLeod Review where we did recommend that to be honest, I think it’s politicians that say that say no to those sorts of things than not, as opposed to public sentiment. Muldoon made the famous quote that Joe Blog, the average person on the street, wouldn’t know fiscal deficit if he tripped over one. And I think that’s a long way back and things weren’t as sophisticated then as perhaps they are now.
But if you think about the complexities of tax and you think about the extent to which the public is actually engaged with that complexity, I think that you are apt to over egg that interaction. Because ultimately politicians and officials and people like ourselves, there is a leadership role we play and the public follows that leadership.
I think you can observe that in history. The differences between countries and the qualities of their tax system often reflect the differential qualities of officials, politicians, et cetera, that’s going on in those countries. So, while I agree that in the concept of democracy, there’s a public underbelly in debate and voting terms, there’s one hell of a space for leadership and tax policy. Otherwise, we might as well pack our bags and go home. And I think that that is very influential and that’s why these debates and these principles of incidence and so on are important and need to be approached in the way we’re doing it.
RO We can see that with GST. We’ve got a flat rate, a good GST system, world class.
I remember back in the 80s Sir Robert Muldoon, the proposals was put to him about that. And he said, “You mean we’re going to tax water?” And he chuckled, “No way.” We put GST on doctor’s bills. People overseas think that’s just totally astonishing. Yet there’s broad support for what we have in GST, a non-progressive tax. Bizarrely we legislated to make it regressive, but it does meet those economic principles and it’s got widespread support. I mean, politicians keep on arguing for GST on no food, but those proposals get put up and get rejected every time.
Rob McLeod’s suggested alternative to a capital gains tax
TB Rob in your review, you raised the possibility of the risk-free rate of return method (RFRM) as an alternative to a capital gains tax. And we’ve seen that in the Foreign Investment Fund regime. Are you still keen on the idea?
RM The RFRM, the McLeod Review, came largely out of the debate around taxing housing. And this was in a discussion document, by the way. It wasn’t the final recommendation; it was abandoned because of what Robin said. Michael Cullen’s switchboard was blown up by the complaints of from telephone callers and we knew that was a pretty strong signal that no government was ever going to support it.
So, we pulled the plug. But basically, the problem with taxing assets that produce, that give sort of imputed income like your motor car or your house or your washing machine, there’s no cash flow to really measure the income. It’s economic income, but it’s hard to measure. And so, the beauty of the RFRM is that you calculate it effectively as a wealth tax, which is applying a percentage, I think we had 4%, against the market value of the of the equity in the asset. It’s quite important. That’s one feature of the RFRM is you’ve got to work out what you’re going to do with debt, debt funding of the asset. And we came to the conclusion we’re best to deal with that by narrowing the tax onto the equity, which is the total value of the asset minus debt associated with it. Which brings in problems because people then start to plan with where they load their debt, right?
But it was simplicity. If we could have made the income tax work on that kind of asset that’s a superior way of going, if you can make it work. I think the only reason you go to RFRM in substitution is there’s easier compliance and administration for taxpayers and the Inland Revenue. The F|IF regime I think Terry came out of the international regime As the child of the CV, the mark-to-market option.
I think you’re thinking of the FDR [fair dividend rate] in today’s terms is probably the most relevant analogy. Fixed dividend rate which I think did come from a an RFRM logic, although it’s a bit screwy because FDR, the RFRM tax principle is you should apply it at the riskless rate of return, and not at the risky rate of return, which is the way FDR works. And also, no deductions which FDR doesn’t abide by in its various option formats. So the concept is much the same but quite different in detail.
What’s surprising in the tax world now?
TB Is there anything in the tax world that surprises you right now?
RO I would say the wealth tax coming on the table, totally unworkable. According to the papers the last government almost legislated for a wealth tax in the last budget, ??? funding and massive reductions in income tax rates. And that wealth tax was completely unworkable and would never get off the ground. It was a total nuclear bomb on our tax system. The fact that people are seriously talking about totally impractical things is a serious concern.
We’ve got to be adults here. There is no fairies at the bottom of the garden. There is no pot of gold at the end of the rainbow. Grow up. Taxes have to be pragmatic and have to be workable, and trying to measure everybody’s wealth on a comprehensive basis every year is not.
GN I remain surprised by the continued acceptance by middle New Zealand of what I consider to be really high effective tax rates on labour income through the combination of GST and [tax] rates. And I remain surprised when you look at their voting patterns, their general resistance to extending taxation into capital income to address that, so not raising taxes as a percentage of GDP, but recycling revenue, shifting the instance of where slightly where that tax is paid, and it continues to surprise me. I think that message came through the high net worth survey that came out last year, but it was obfuscated by the complexity and some of the methodology problems and the way that survey was done. That’s what I’m still surprised at.
TB I think there’s a general lack of awareness of what effective marginal tax rates are and how they interact and how high they are at relatively low incomes. The 30% rate, $48,000 is a real problem threshold.
RM I suppose I am a bit surprised that the fundamental features of what’s been great for the New Zealand tax system, reappear as controversies, in the political realm particularly. Like the high tax rate. The problem is that Europe’s got high tax rates and Australia’s got high tax rates. New Zealand trying to wave the flag in favour of the low tax rate component of the BBLR has been a challenge. And I think it’s actually been because our neighbour has high marginal rates. And Europe has been very influential on people like Robertson and so on in my opinion in the sense that they buy into the idea that we can have government spending and taxes at 50% plus of the GDP. I should say that I’m therefore not surprised by it. But I think that’s been the big disappointment, that our rates structure has been allowed to sort of get up, and in a sense it’s part of narrow base, high rate [NBHR] thinking. They don’t realise that with those high rates comes the NBHR concept.
The other thing I just touched on is I kind of worry about the international – the OECD and the EU – devices through which large countries bully other countries. And the treaty networks and the BEPS regime and all that sort of stuff is typically a mask for powerful big countries grabbing money off other countries. And the more that happens, that’s a source of corruption and cancer for me and can ripple down and reach these national tax systems. And we’ve had more of that in the last five years than we’ve ever had before.
RO The OECD stuff is probably more two big elephants fighting, the US versus Europe and we get squashed in the middle.
TB I think that’s why the Global South is pushing back and trying to get the UN involved led by Nigeria and Pakistan which are small economies globally, but giant populations, you’re talking over 400 million people between them. They’re not buying into Pillar two. There seems to be pressure building in that area.
What one proposal from your respective tax working groups would you like to see implemented?
RM That’s a that’s a good question. Sorry to be boring, but I think I came back to the broad-based low rate. For Geof and Robin who know me well, I am a bit of a bore-a-thon drum beater on base principles, and the thing that I’ve seen is the base principle lose a bit of its grip in New Zealand in the last decade. We’ve taken our personal and our trust rate to 39%, which I do not like.
It’s the fiscal stuff that’s that this government is arguing that I don’t accept that it’s necessary for that, but that’s another big debate point about understanding how balance sheet management in government needs to be separated from profit and loss account management. I don’t think that those two aspects of the debate are properly worked through. We should take the longer road and the longer term to fix our debt issues, obviously try and avoid them from happening in the first place. But debt is not necessarily needed to be paid immediately. And not to be factored immediately into tax rate design in my opinion, which is a mistake that we’re currently going through.
GN I’ll be boringly repetitive, but I think the extension of income tax to more realised capital gains on a realisation basis and then using that revenue to recycle, I think that’s got equity efficiency benefits. And I also think it helps in some ways to resolve those high effective marginal tax rates around our productive sector of our economy, labour productivity. So that’s still what I would do if we were able to do one thing.
RO Oh, I still like Rob’s RFRM on residential rental and get rid of all these bright lines, interest deductions and ring-fencing rules. The other one Geof raised was seriously considered by the Labour government under Michael Cullen, was that you pay a million bucks worth of tax and you’ve done your bit and go away. An anathema now, times have changed. That was acceptable then it seems, but not now.
It was seriously considered by the caucus at the time. The idea is you get someone come and live in New Zealand and pay a million bucks and fund a Children’s Hospital. Doesn’t seem to me to be a bad idea.
RM Like a hypothecated tax, Robin?
RO I wouldn’t mind if it was hypothecated for good healthcare for children. I think that would be good.
TB Well, I think we’ll leave it there. I want to thank my guests this week, Sir Robert McLeod, Robin Oliver and Geof Nightingale. It’s been fantastic talking with you all. Thank you so much for being part of this.
[This is an edited part of the full podcast which readers are encouraged to download and listen to at the link at the top of this page.]
On that note, that’s all for this week, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
