Tax and the election

As expected, income tax has raised its head as an election issue. Last month, Labour announced their intention of raising income tax rates. Under Labour, individuals will pay 36 per cent on income earned over $150,000 (currently 33 per cent), and the flat rate of tax that applies to trusts will also increase, from 33 per cent to 36 per cent.

At the time of writing, National had yet to make a formal announcement on its tax policy, although there are reports that John Key has hinted that there may be a tax cut pledge made during the election campaign.

Whatever the merits of tax increases or tax cuts, it is important to scrutinise the political rhetoric that accompanies each announcement. Comments made by politicians don't always tell the whole story and can be interpreted in various ways.

For example, Labour's policy announcement came with a number of interesting statements. David Cunliffe stated that their policy announcement remedies the tax cuts received by higher earners, meaning the reductions made by National from 2010. Those cuts reduced the top tax rate on income earned over $70,000 from 39 per cent to 33 per cent. An alternative view is that the 39 per cent rate was itself an anomaly, as the previous top tax rate was 33 per cent and had applied for over a decade.

Labour also said that an increase in the top marginal rate was to ensure that higher earners were "paying their fair share". That is also open to debate. For example, Inland Revenue statistics show that in the 2011-12 tax year, just over 87 per cent of taxpayers had taxable income at or under the current top tax bracket level of $70,000. They accounted for around 48 per cent of the tax assessed in that year. That means around 13 per cent of taxpayers paid over half of the personal income tax assessed in 2012 - leading to a view that high earners are already paying their fair share.

The Labour position on increasing the trustee rate is stated as being to "avoid trusts being used as tax avoidance vehicles". Increasing the trustee rate will have no effect on tax avoidance, as the current rate is already the same as the current top personal tax rate. It won't prevent the ability to distribute income to lower-income beneficiaries. A change to the trustee rate is only required if the top personal rate changes. Further, a number of other measures implemented over recent years have already made trusts less effective as tools for reducing tax.

The Government's response to Labour's announcement was predictably sardonic. However, it also contained comments that don't quite stack up. Amongst these was a claim that increasing the personal and trust rates would see an increased use of companies to divert income. The company tax rate is currently 28 per cent. There are a number of problems with that argument.

Firstly, there is already a 5 per cent differential between the company rate and the top personal and trustee rates. Presumably that's already enough to create an incentive to try to divert income to a company.

Secondly, wage and salary employees can't effectively redirect their income to a through company. Between the "personal attribution" rule and the Penny & Hooper decision, personally derived income gets taxed in the hands of the individual.

Thirdly, income earned by a company has to come out if the owners are to make personal use of it. That tends to be in the form of salaries or dividends, both of which are taxed at the shareholder's rate. In that sense, company tax is generally only ever an "interim" tax when it comes to New Zealand resident shareholders. A shareholder making personal use of assets left in a company also has tax consequences.

A return to surpluses on one side, and a desire to spend more on the other, creates an environment where there will be ongoing debate on what to do with tax rates. We'll soon find out which side wins.

The Press