Economy could be winner in rebalanced taxation system
In his opening address to Parliament early last month, Prime Minister John Key provided some signals on the direction future tax reforms may take, following on from the recent recommendations of the Victoria University of Wellington's Tax Working Group.
A comprehensive capital gains tax, a land tax and a risk- free return method for taxing residential investment properties have all been ruled out by the Government. However, the Government believes there is a gap in the current tax system in relation to property investment. It now seems clear that residential rental property investments will be subject to increased tax in some form. What is less clear is whether the changes will extend to commercial and industrial property investments.
The Tax Working Group's report released in January identified that $200 billion is invested in New Zealand residential rental property - almost four times the market capitalisation of the New Zealand Stock Exchange. This investment is producing no tax revenue at all. In fact, in 2008, it generated net tax refunds to investors of $150 million.
Mr Key has now given a clear message that the Government will look at ways to close this gap in the upcoming Budget, due to be presented on May 20. Although the Government has ruled out a "comprehensive" capital gains tax, a narrower form of tax on residential rental properties may be considered. Some capital gains in New Zealand are already taxed.
A number of options are available to the Government to close the current gap in the taxation of property investment. One alternative, which has been debated recently, would be to deny deductions for depreciation of buildings. Another option could be to implement some sort of "bright line" test in respect of property sales - for example, this could involve taxing gains on the sale of property held for less than two years.
Mr Key has also signalled that the Government is giving serious consideration to an increase in the GST rate from 12.5 per cent up to a maximum of 15 per cent. This potential increase has caused much public debate as an increase in GST alone will have an adverse impact on low-income New Zealanders. Why? Because those on lower incomes will spend a higher portion of their total income on consumption.
However, an increase in GST will be part of a broader package of reforms. The Tax Working Group noted that New Zealand's tax system relies excessively on taxes from businesses and wage and salary earners. Mr Key's speech on February 9 suggests the Government agrees with this observation. These taxes are seen as the most harmful to New Zealand's growth as they act as a disincentive to work and investment. Another major problem is that the income from these two sources is highly mobile - businesses and wage and salary earners can shift overseas to benefit from lower tax rates.
The Tax Working Group recommended a shift in New Zealand's tax base from income to consumption based taxes. To achieve this redistribution, an increase in GST could be implemented in conjunction with a reduction in personal and corporate income tax rates and closer alignment of the income tax rates applied to various entities. Interestingly, even at a rate of 15 per cent, New Zealand would still have one of the lowest rates of GST among OECD countries.
Redistributing taxes in this way will be good for the New Zealand economy. It will leave people with more in the hand from their work efforts, and they can choose whether they want to spend it or invest it. Further, it is much more difficult for taxpayers to restructure their affairs to avoid a tax on consumption, like GST.
Under the current system, taxpayers are often able to limit their tax rates to 30 per cent (in companies) or 33 per cent (in trusts), while salary and wage earners are subject to a top tax rate of 38 per cent.
Shifting the focus of the tax system will bring positive benefits to the economy. This will, in turn, create more revenue, more spending, and a higher tax take for the Government.
Effectively, we get a "growth dividend" - a shift of the current tax burden will, in the long run, mean greater income for New Zealanders and, as a result, higher tax revenue for the Government (or more optimistically, an opportunity for the Government to reduce tax rates, while maintaining a constant revenue).
The exact details of the tax reforms will not be known until the Budget in May. Yet, the Government is working towards a fiscally neutral package - meaning that the total tax take will remain the same.
According to the Tax Working Group's report, an increase in the GST rate to 15 per cent will generate about $1.9b of tax revenue. Removing depreciation on buildings would generate up to $1.3b. This would give the Government just over $3b for income tax rate reductions.
These figures are static estimates, based on the current tax mix. A redistribution of taxes would probably bring flow- on benefits to the economy, meaning the actual costs may be less. In any case, the final package would involve a careful balancing act to ensure that all taxpayers would benefit.
Whatever the final package, it seems certain that taxpayers will see some big changes to the tax mix in the near future.
Taranaki Daily News