Tax sytem overhaul a fine art

Seventeenth-century French finance minister Jean-Baptiste Colbert said the art of taxation consisted of so plucking the goose as to obtain the largest possible amount of feathers with the smallest amount of hissing. That is also the challenge facing the Government as it looks to fix a broken system, reports Roeland van den Bergh.

The stage is set for a major overhaul of the tax system which could see the top personal rate fall but a swag of new taxes and increases in existing ones to compensate.

A high-powered government advisory group has spent the past six months debating how to fix New Zealand's lopsided and unfair system.

The Tax Working Group, headed by Victoria University's Pro-Vice-Chancellor Bob Buckle, is due to report its ideas at a public conference on Tuesday, but much of its thinking has been revealed through regular updates.

The review group, which consists of officials, private sector and academic experts, says the current system is "not sustainable" and there are "major growth, fairness, and integrity issues".

However, members differ on what changes are needed to develop a world-class tax system.

Businesses want the company tax rate to be lowered further to better compete with Australia and Asia.

Investors are looking for a levelling of the playing field between the treatment of property versus other types of investment such as shares.

And unions say the real issue is low wages, not the level of the top personal tax rate.

Among the proposals put forward so far are that the top tax rate could be reduced, but other taxes would either increase or new ones introduced to compensate.

Raising GST from 12.5 per cent to as high as 20 per cent has been mooted along with introduction of a capital gains tax on investment property, or a land tax similar to council rates.

Some suggestions will have far-reaching effects, but if the group gets it right, the average person should end up paying about the same amount of tax, spread across a larger number of taxes.

Finance Minister Bill English says the review is not about raising or cutting taxes, but aims to rebalance a system which is too dependent on company and personal income tax which totalled $57 billion last year.

Of the $25b in personal taxes collected each year $10b is paid by just the top 10 per cent of the population.

About half of all households effectively pay no tax, after social welfare benefits like the Working for Families scheme are taken into account.

Such a high dependence on a small part of the population to fund the cost of government leaves the country exposed to a further exodus of skilled workers.

PricewaterhouseCoopers tax expert and group member Geof Nightingale says the group has not found a silver bullet to solve all the problems.

"But what we do know is where we stand today is not sustainable in the future, we are very firm about that.

"The tax system can't continue on the way it is."

Mr Nightingale expects that in general the recommendation will be for lower personal rates, lower company tax rates in time, probably just enough to stay in touch with Australia and an increased reliance on GST and new taxes to fund those reductions. "The average person on an average income, they might get a modest reduction in tax rates with some additional taxes to pay on some of their capital assets."

There will also be some specific "rifle shots" at some problem areas such as tax on rental property and maybe some cross-border issues, Mr Nightingale says.

He favours an increase in GST from 12.5 per cent to help fund lower personal tax rates.

But because most of the additional money raised from a higher GST rate will have to be recycled to compensate lower-income earners, other taxes will have to be introduced.

"Almost certainly there will be a tax on residential property," Mr Nightingale says.

A land tax, of 0.1 per cent, possibly included in council rates, could cost the average homeowner $214 a year, raising more than $460 million and would be enough to fund a cut in the top personal tax rate to 30 cents in the dollar.

But the most important part of the Government's objective to standardise top personal, business and trust tax rates at 30 per cent is that it will remove the incentive to exploit loopholes to minimise tax, Mr Nightingale says. An example of that is the use of losses from residential investment properties to claim against other income.

More than $200b is invested in residential rental property that generates $500m in losses which investors use to claim $150m in tax deductions from other income. However, Prime Minister John Key has all but ruled out a capital gains tax, like all prime ministers of the past 20 years before him. He is not a fan of increasing GST either.

A capital gains tax had not prevented housing booms in Britain, the United States and Australia, he says.

"Unless there was some meteoric evidence coming out of that committee, I wouldn't be voting for it."

Business New Zealand chief executive Phil O'Reilly says lowering the personal tax rate must be the top priority for the Government, along with balancing offsets to pay for them.

Failure to do that will see more people move to Australia.

New Zealand already has one of the most mobile skilled labour forces in the world with about a quarter of it living overseas. That compares with just 4 per cent for Australia. "We have to demonstrate to those people that it is a good idea to stay in New Zealand" and tax is a good lever pull, Mr O'Reilly says.

Council of Trade Unions economist Peter Conway says people are attracted overseas by higher pay rates, and tax plays little part in their decision.

Mr Conway is also opposed to raising GST, which he says will have the greatest impact on low-income earners in the short term at least.

A tax on residential property investment could lead to higher rents, but could encourage more investment in the productive sectors of the economy and away from property, increasing job numbers, he says.

Sharemarket chief executive Mark Weldon, also a tax review group member, says a much simpler tax system has to be developed.

The system should, from an investor's perspective, treat investments in cash, bonds, shares or real estate equally.

The emphasis on taxing highly mobile personal income while land, which is immobile, attracts no tax at all, is "an example of a fundamental lack of logic", Mr Weldon says.

Eliminating the massive tax advantages of investing in rental property must be sorted out as a priority, he says.

A tax system should encourage investors to put their money "where the return is greatest, not where the tax deduction is the highest".

Tax group member, economist Gareth Morgan says a 30 per cent top personal tax rate in the short term is a "real challenge" at a time when government revenue is under pressure.

The Government has been forced to put tax cuts on hold due to the effects of the recession.

Instead it is faced with having to increase revenue by closing loop holes and adding new taxes so that everyone pays a little more by getting away with less.

Inland Revenue estimates that the Government misses out on $300m a year because wage earners divert income into trust accounts or use tax shelters.

In the end, the Government's hand could be forced by the outcome of a review of Australia's tax system, which is due to be completed by Christmas and made public about March.

New Zealand will have to match any Australian tax initiatives that make it more competitive, tax experts say.

On The Rise

Inland Revenue has warned that rising wages mean people on the average wage will be paying the top tax rate in just over a decade unless major changes are made. Within 10 years an average worker with no children, now paying an average 19 per cent tax, will be paying an average 22 per cent, rising to 38 per cent for the top part of their wages by 2022 which is "not sustainable or desirable", IRD says

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