Does the tax working group have the answers?
Thomas Coughlan digs into the detail of the tax working report and asks whether it is really likely to result in a fairer tax system, particularly for young and low-income New Zealanders.
It’s a capital gains tax. Could it be anything else, after all?
Labour’s erstwhile election policy, kicked off to a working group, has finally been recommended by that group and is now before the Government, which will decide whether or not to legislate the recommended package of taxes.
Let there be no doubt: the tax working group existed to answer a political question for Labour, which backed a capital gains tax from 2011 to 2014, then dropped it in favour of kicking the issue to a working group.
But the working group was also able to answer some questions of its own, set out in the background paper published a little under a year ago.
Three issues jump out: firstly, the long term integrity of government revenue as an ageing population erodes the tax base; the fairness of the tax system; and New Zealand’s woeful productivity, which keeps thousands of Kiwis trapped in poorly paid jobs.
The grey area
The first issue has, sadly, received scant attention. Of the Government’s roughly $80 billion in tax revenue, 40.2 percent of tax revenue comes from individual earners paying income tax. This is one of the highest proportions of income tax relative to other taxation in the OECD.
It also creates a massive problem for the future. As the shape of the workforce changes, fewer and fewer people will pay income tax. Well-paid older workers will retire, taking their tax revenue with them and adding pressure to government finances in terms of superannuation and health costs.
The group estimates this will lead to a deficit of roughly 1.2 percent of GDP by 2030 and a massive 4 percent of GDP by 2045. Such a deficit would be one of the worst faced in our history — not quite the nearly 9 percent deficit faced during the darkest year of financial crisis — but not far off the 3 and 4 percent deficits of 2010 and 2012.
The biggest and most certain threat faced by the economy isn’t China, earthquakes, a banking crisis or even declining business confidence, it’s grandparents.
This is where the battle for fiscal neutrality will be fought. The proposals put forward by the working group are meant to be broadly revenue neutral, but what constitutes revenue neutral depends on the time the taxes sample.
The capital gains tax as set out in the report is meant to raise $8.3 billion by the 2025/26 financial year. In 2030/31 the tax will raise $5.9 billion, comprising 4.6 percent of total government revenue, and 1.2 percent of GDP.
This is fortuitously the same amount as the deficit government finances face in 2030 - allowing the government to claim the proposal would be fiscally neutral, but over a long time period. It would also preclude Finance Minister Grant Robertson from offering any sweeteners in the form of tax cuts elsewhere in the system that would offset a potentially unpopular capital gains tax.
Those numbers might look like a lot but in its first three years, the capital gains tax will raise less revenue than tobacco excise.
Judging the fairness of the tax system is difficult. The tax system should be broadly progressive so that people who earn more, pay more.
By this measure, our system is unfair compared to other economies. Our tax system is relatively flat. There is no tax free threshold and the top tax rate is both relatively low, at 33 percent, and kicks in relatively low on the pay scale.
Every dollar earned above $70,001 is taxed at the top rate. Even Don Brash, one of the most free-market, 'small government' leaders of the National Party, went into the 2005 election with a more progressive tax policy, believing the top rate should be 39 percent on income over $100,000.
And even in 2011, Labour still believed in the 39 percent top rate, this time on income earned above $150,000. While this looks politically unpalatable in New Zealand, it’s not outlandish by international examples. In Donald Trump’s free-market America, the top federal income tax rate is 37 percent for income over $500,001, and the next level down is 35 percent on income earned over $200,001.
Even when you factor in the likes of Working for Families, New Zealand is still well behind the OECD average when it comes to reducing inequality through the tax system. We achieve a roughly 25 percent reduction in the Gini co-efficient, a measurement of inequality — only slightly better than the United States.
The proposals put forward by the Cullen group suggest an income tax cut is possible by adjusting the lower rates on the income tax scale.
One possibility included the first $5,000 of income being tax exempt, equating to a tax cut of about $10 a week.
But the group is lukewarm on this recommendation, noting that the tax credit and benefit system would be a better way of assisting low-income households. Instead, the group recommends adjusting the lowest income tax threshold from $14,000 to between $20,000 and $30,000 meaning low income earners would see more of their income taxed at the lower rate of 10.5 percent.
Cullen said that while the bracket adjustments would be costly, it would be more than offset by the revenue generated by capital income taxes. This is a patently political move, allowing the Government to offer all income earners a tax cut in return for a capital gains tax that would be felt by the very top earners. But it also risks undermining the group’s first achievement, which was to shore up the integrity of the tax system for the future.
The tax system isn’t just unfair to earnings, it penalises savings too. Well, it penalises almost all savings apart from equity in the family home. New Zealanders are heavily taxed on savings.
Analysis by Treasury of the marginal effective tax rate of various types of savings shows earnings from a bank account or foreign shares face a 55.7 percent marginal effective tax rate, while PIE and super fund earnings are taxed at 47.2 percent.
Property, on the other hand, is taxed at an effective rate of just 29.4 percent for rentals and a mere 11.3 percent on owner-occupied housing.
Despite the massive barriers that face people who want to enter the housing market, this system reserves the lightest tax regime for the wealthiest people. The 11.3 percent effective rate on owner-occupied housing is only 0.7 percent higher than the lowest income tax bracket — the rate paid by high schoolers working part-time at McDonald’s.
So would the Government’s proposal address this? Not really. The family home is still exempt from taxation, but the equity from rental properties would be taxed at a higher rate.
The change would be slow. Only gains that accrued to the property after valuation day would be taxed. Families who have owned a rental property for decades and sell it in 2023 will only pay tax on the gains accrued between when the tax is implemented and 2023.
National Opposition Spokesperson Amy Adams notes that it will create one of the most “onerous capital taxation regimes in the world”. In many senses, she’s right. Unlike Labour’s 2011 policy, which would tax capital gains at 15 percent, the Cullen proposal is to tax the gain at the owner’s income tax rate.
In other words, if a person earns $58,000 but makes $100,000 from the sale of their property, their income for that year will be calculated as $158,000. As most of that income will fall into the top, 33 percent tax bracket, most will be taxed at 33 percent.
What’s often lost in the rhetoric about the tax being an attack on middle New Zealand is that the exclusion of the family home means it will be borne mostly by the small number of people who own multiple properties.
The group estimates the tax will absorb 7.7 percent of the disposable income of the top ten percent of income earners. The next ten percent of income earners will pay just 1.9 percent of their disposable incomes in the tax.
But the pain will also be disproportionately felt by young people, who are unable to afford their own homes whose savings are in shares and managed funds.
On the matter of equity there can be no question: the capital gains tax works. But the tax should follow the same logic as the rest of the tax system, and apply to a broad base — and that means including the family home.
But equity isn’t the only issue at play. Efficacy is also a concern and on this question the working group is more circumspect.
The current regime directs money away from investment in the productive economy into assets like rental properties, driving up property prices to well beyond their real value. If capital gains were taxed equally across the system, it is believed more investment would flow to New Zealand businesses as there would be less of an incentive to sink money into property to realise untaxed capital gains.
The issue feeds into New Zealand’s productivity problem. New Zealand workers are less productive than many of their peers in the developed world, leading to lower wages.
It’s believed one of the reasons why is that business who want to make productivity-increasing investments often find themselves competing for a shallow pool of capital.
It’s hoped that by taxing capital gains accruing to property more fairly, savings and investment will flow into the productive economy, where it is more useful.
But the group’s report was divided on this point. It’s report noted that a tax on capital income could be beneficial by improving “the allocation of investments across the economy,” but said this could be counterbalanced by the negative impact of “an increase in compliance costs and the effect of lock-in on investment decisions”.
Tax professionals are also doubtful. Deloitte National Technical Director Robyn Walker believes businesses will be incentivised to hold-on to less productive assets as they will have to pay tax on those assets when they are sold. The tax would mean there is is less of an incentive to sell on and upgrade to new, productivity-enhancing equipment.
Large numbers of small businesses owners may also face disincentives. She thinks some businesses owners will be incentivised to reinvest earnings in their family home for tax free gains, rather than in their business.
Does it even matter?
The looming question after the working group’s final report is whether it matters at all. With New Zealand First at the heart of the coalition government, the chances of implementing a capital gains tax are scarcely better than if Labour were in opposition.
Worse still, possible carve outs New Zealand First could gain for the agricultural sector could risk distorting a tax that, with a massive family home exemption, is already at risk of incoherence.
The benefit of working groups is they take politics out of policy. The problem with MMP government is that politics isn’t just something that happens once every three years; it has a seat at the Cabinet table.
As Cullen told journalists on Thursday, “wisdom does not always operate when you are considering the possible ballot box implications”.
More’s the pity.