It is hard to know where to start after reading 67 pages + 7 pages of footnotes of simplistic repetitive fence sitting. So I went for a swim. A 1.5 kilometre swim in a heated pool then I sat in the outdoor jacuzzi for half an hour.
I know why Speedo Weldon swims for recreation. As I swam mindless stroke after stroke I was reminded just how dull and uninspiring my time was at Pricewaterhouse Coopers, like swimming lengths in a pool going nowhere yet the process of suffering and going through it was utterly necessary for the rest of my life. The biggest lesson learned was to leave.
The biggest mission in writing a critique of the report I have just read is to make it vaguely interesting and with it readable.
The TWGThe Tax "Working" Group (TWG) consisted of 13 members. Three (Buckle, Prebble and White) were Victoria University Academics, 5 were heads of the final four accounting firms (Dunne, McLeod, Shaw, Shewan and Nightingale - PwC so important they needed two representatives), 1 was a tax lawyer (Plunket). That is 9 by definition were from dull "head-nodding" professions captured by the principle that to get that far they have had to remove any pretext that they have vision and strategic thought, especially when placed with other like-minds. The final four competing of course for lucratic government contract work - so hopelessly compromised by requiring to serve to the government of the day the lines they want.
Of the rest one was an erratic yet clever, outspoken fund manager (Morgan), one the head of the NZX on a performance bonus scheme incentivised to get more investors away from property into the stockmarket who praises Kiwisaver every morning before shaving (Speedo Weldon), an investment banker (Cameron) and finally Arthur Grimes from a fence sitting public policy institute.
Gareth Morgan already jumped the gun with a radical plan and spat the dummy when he didn't get what he wanted. To me he emerges with credibility for having an idea and some balls to back it up. Albeit an idea I didn't necessarily agree with.
Of note were missing representatives of New Zealand's leading export earner - farming. Also there was no representative for the $200 billion property sector. There was also no female representative but let us forget that as Rob McLeod represents Maori so therefore minority interests. I don't care about welfare groups and Unions not being represented as welfare beneficiaries don't pay net tax and Unions hinder businesses so do not increase the tax take.
BiasRather than making the tax system more simple, with 9 tax accountants, academics or lawyers on the committee of 13 this was never going to happen. All are self-interested enough to dismiss the
Morgan Plan for example as mutterings of an extremist. Most of the options as read require ironically more compliance cost and complexity in the tax system.
Right up front it is clear that this Group was heavily weighted against property. In all shapes and forms. At PwC, John Shewan's bias against rental property was reasonably legendary. Brought about more I guess from stories of senior staff making more money buying and selling rental property in the boom times than they did from working for him.
From press releases to initial working papers all concerned seem to have little time for property. They also had bias in favour of a need for change. They also decided that the report had to be "fiscally neutral". This fence sitting concept that any change decreasing tax in one area had to pay for itself not in spending cuts but in increasing tax elsewhere.
This is the flaw in the report from the outset. Government does not work like this, there must be spending cuts and controls else spending gets out of control and you never collect enough tax to cover a public sector used to wasting money. In terms of the report it is clear that it was written as a "package" of reform. Therefore unable to be cherry picked in isolation.
Page 5 stating "
The Group has not focused on any single aspect of the tax system, or single option for change, but has looked at the system as a whole and a number of options for reform".
Who honestly believes John Key and Bill English will follow this proposal as it is intended? As a package of reforms and not a piecemeal addition to a system already apparently flawed.
The "Housing is Evil" ShamLand apparently has a fixed supply and is inelastic. Who would have thought? Not PC covered
the issue extensively the key to freeing up more of this land and the costs currently incurred in housing that deem to be "tax" under your Mother's Maiden name.
New Zealanders seem to be stuck in a pre-historic myth that rental housing stock owners are evil and not only distort housing prices for the "good guys" (ie. themselves) but involve tax avoidance. Those stuck there all have one thing in common. Envy. Most either do not own property or only have an owner-occupied home, usually terminally geared to ensure they live a miserable existence for the rest of their lives. The rest derive their income from the workings of funds and the stockmarket.
The prime reason for the alleged fascination with property in New Zealand is detailed in the report in the irony of wishing to apply the RFRM (risk free rate of return method). On page 53 this is outlined. Why is housing deemed appropriate to be taxed at a risk-free rate? Well it is based on this silly New Zealand phenomenon that house prices will keep increasing.
Worse is that the RFRM in the example on page 53 encourages excessive leveraging as it calculates based on equity. I can think right now of a fabulous tax structuring product you could sell to strip equity out of these homes. It's just a bad, bad, bad incentive for loading debt that people cannot afford to have currently, let alone in the future.
Contrast this with Hong Kong where cyclical booms and busts are allowed by a non-interventionalist government. This means that housing is not risk free, it is actually a reasonably risky asset with massive booms and busts. The attitude towards New Zealanders pouring savings into housing is historically in the last generation it has been risk-free. Banks keep lending, governments keep encouraging people to own their own home. And property investing is easier and in New Zealand indeed safer than investing in the dog that is the NZ stockmarket.
In Hong Kong the stockmarket is the prime gambling centre for poor people to collect enough money to invest in property. Middle aged ladies carry real time beepers for their day-trading. It is volatile, up and down. HSBC stocks here are suitable christmas presents to grandchildren. There is stamp duty on transactions as there is on housing sales. Thing is the boom and busts in the stockmarket make it like housing - plenty of opportunities for gains and those who lose take it on the chin as part of the game. They don't whinge to government and other taxpayers to bail them out.
New Zealand has no such massive "up" in the cycle in the stockmarket, or the volume of trades as here. It has even less of a property cycle.
So what do you do with your money?You can do these things with money that I can think of -
give it away,
spend it,
put it in the bank,
put it in business,
buy shares or
put it in housing.
If you spend it then the government taxes it on GST. If you save it in a bank the government taxes it with RWT on interest. If you put it in business the government can take it in company tax (net of deductions) or RWT on dividends. If you put it in the stockmarket then you are only taxed if you are trading, and on dividends. That leaves putting it in housing which has the same capital gains rules as the stockmarket presently and rental income is taxed net of tax deductions.
The difference with property is that you can gear it, claim an interest deduction for it and pay very little tax for the first few years you own it until the property makes a book profit.
But you can do the same for shares. Set yourself up as a business and you can borrow money to buy shares, claim deductions and losses and return gains.
Thing is New Zealanders do not do this because - they don't trust the stockmarket, and historically with good reason. The banks will generally not lend for share trading.
FarmingAt page 9 of the report it states "
There is a major hole in the tax base concerning the taxation of capital which is manifest in high investment and low returns in the property market".
This is an erroneous base to work from if judging the property market as such.
Does the "nation's darling industry" farming provide better returns for the land it uses? When externalities are added in such as pollution costs and charged per farm, just what is the return on that land?
Most farmers are in essence milking to pay interest and principal on their mortgage so one day they can sell at a capital gain. They are allowed a deduction for interest and farm and business expenses that in many years means farmers actually pay little tax. Many are farming to pay for capital gain which funds their retirement. Is this any different contribution to the economy than a worker who works in say an export business to pay for their capital gain on a property investment? And in doing so employs a whole raft of people in maintaining that property. Not to mention adding to private rental stocks.
After all, the government cannot provide all rental housing. Someone has to own it to rent to people who cannot afford to or choose not to, buy their own home?
PoliticsWith so many of the TWG reliant on government for their income, it is interesting to note for example on page 10, references to the system needing be "
robust against interest group pressure and political tempatition to change the critical elements of a coherent system".
How do you do this? I would say by introducing no new taxes at all. New taxes are like a beer to an alcoholic for the political left. National introduces a new tax, not only will we laugh at them for breaking election promises, we will also scratch them for giving Labour the ultimate in pay-back if elected - Labour can increase the silly new tax.
Capital Gains TaxThis was discussed and rejected. I imagine because those involved realised they would have to treat shares the same way as rental property. On page 48 the TWG admitted New Zealand already had a CGT system, they then go on to discuss the accrual method of accounting for it. Which would be horrid. What the "accrual method" means is that at 31 March each year (or your balance date) you would have to value the asset under a method and then pay tax on any gain even if you had no income or cashed out money in your bank account for that asset.
In Australia it is interesting to read on that page that CGT accounts for just 3.9% of Federal annual revenue. On page 14, you can see that 3.9% wouldn't even qualify CGT as a sundry excise tax in New Zealand.
Speedo Weldon would have jumped up and down if accruals methods were applied to shares and his influence would have popped out the second last paragraph dismissing it. Imagine if you had to value all your stocks at a date and pay unrealised capital gains on them before you even had the revenue from the sale? It could not happen in a low wage country such as New Zealand.
The more bizarre rationale for excluding CGT came at page 49 - "
a capital gains tax on share sales would in some circumstances result in double taxation of corporate profits". Isn't this the whole point? I am assuming they mean when a corporate owned shares in another corporate and sold them for profit they will be taxed.
It is like on page 35 where it states "
People earning their income by salary and wage...should be able to expect that they will be treated in a similar way to someone who earns the same level of income from property investment". Why? Property should be a riskier investment than pulling a wage so the return higher. In any instance property is purchased and financed from after-tax PAYE.
The salary on which the PAYE is paid has been derived from working for others who pay company tax with deductions available to the business owner, so why not the owner of a rental property?
Why is there no such bother in taxing natural persons twice, once through PAYE and once again when they own a rental property and use those post-tax profits to finance the purchase? They've already paid tax on the funds used to buy the property and now the TWG are looking at taxing them again through either CGT, RFRM or land tax, on top of the tax they have to pay on net rental income presently?
After much ado the TWG decide it's all too hard.
Land TaxI am not necessarily opposed vehemently to land tax when residents of the country have first world wages to pay the tax every year (ie. Hong Kong) however the TWG makes such a hash of discussing it at page 50 that it will not be politically expedient and if introduced will see pandemonium in the market and with it National's approval rating. The TWG states rents will increase - therefore those intended to wear the burden will pass it on. The TWG then blubs out and suggests cashflow issues with low income people, retirees and provides a threshold for which land tax would not be payable.
The report states "
a land tax constitutes a lump-sum tax on those who own land at the date of its introduction" - nice.
Anyone want to vote for that in a centre-right constituency?
So in essence this is a land tax possibly without Maori land, farming, forestry (just those three there - huge stocks) and low income people included. Ridiculous as the burden left will be on low to middle income people who are renting. Landlords will simply hike rents or make tenants pay the tax as part of their rent.
Once again it can be argued that it is farming and forestry and not rental property that receive unequal shares of government privilege and assistance. Farming as I have discussed can be a cash-poor, asset rich process. Likewise forestry with its delay in income generation.
DepreciationMuch has been made of building depreciation. Those who still think this is a starter should read up on the IRD website
about "depreciation recovered" . It is erroneous to say that the current system doesn't already have a clawback on sale where depreciation has been overclaimed. As it does for other fixed assets depreciated in business as well.
ImputationThis is discussed in the report and applies generally for income from dividends when the tax has already been paid by the company. It is based on the principle that the income has already been taxed.
Analogous to this of course is that when people put their savings in the bank and receive interest do they receive a credit for tax already paid for by the post-tax deposit? While it seems okay to impute dividends to gain an equitable result, why can't the same be extended to double taxation where revenue is being derived and that revenue has already been clipped?
Welfare for FamiliesIronically while outside the scope of the report, the best submissions are at page 17, 32 and then at 55 where the TWG discuss the distortions created by welfare for families. A crazy system where the top 10% of earners pay 44% of the personal tax and when WFF is included the top 10% of taxpayers pay a whopping 76% of net tax.
On page 32 there are listed some structures families are implementing to gain WFF, all entirely legal, however the depth and breadth of this avoidance behaviour may very well be more than any distortions in the system currently gained by the humble rental property.
GSTThe Labour opposition should focus on page 46 in the last paragraph. There you will find some twisted reasoning as to justify GST.
"
Because people spend income over time, actual spending may be a better measure of lifetime income. For this reason, GST as a proportion of expenditure is roughly proportional across all income levels over time. This reflects the fact that people tend to base their current spending decisions on, not simply their current income but also their expected lifetime income."
Say what? If you are low-incomed and a beneficiary of course you will spend most of your income and therefore pay more as a proportion in a consumption tax. Unless you can climb into a higher income bracket you will be stuck with this scenario.
The TWG suggest as part of a "revenue neutral" approach that beneficiaries should be compensated for any increase in GST? How? Because a main feature, in fact THE feature of the report is arguing that credits such s WFF create very large marginal tax distortions.
Again taxing GST on "financial services" misses an appointment with the firing squad. On page 48 however the reason given for rent continuing to be excluded from GST basically because it is passed on to the tenant in any case.
Another case therefore of - tenant will be paying so we won't tax it. Why then consider land tax, RFRM and CGT?
RepetitionIn the report there are 40 references in 67 pages to Australia. 11 references to the phrase "integrity and fairness", 30 for "fairness", 9 pages of discussion referring to Working for Families. Reading the report you get a sense of the authors insistence on nice phrases and systemic hammering of the issues without saying an awful lot that is coherently ordered and definitive as a plan from getting us from A to B without diverting through C.
Recommendations
Of the 13 recommendations there may not be a lot to disagree with as they are not recommendations as such given the premise that they must be implemented as a package. Sir Roger Douglas tried this in his
Unfinished Business manifesto, and failed to sell a package reform. In any instance I completely disagree with a few.
1. Alignment of rates - unnecessary as people set up trust structures for more reasons than tax avoidance. Asset protection, matrimonial property, potential estate duty in the future and business continuity being just a few. Alignment of tax rates isn't something that other countries necessarily worry about and the TWG seemed focused on this discussion when in reality getting rates as low and as flat as possible should be the outcome. If New Zealand law develops as it should, plenty of people who set up trusts will soon be regretting it as few understand precisely what it means in terms of control and fiduciary duty. Not to mention the poor drafting of many of these trusts will keep litigators and trust specialists in the legal profession in business for many years to come.
I can't see many people lining up to switch from being taxed at personal rates from company rates even if they are equal. The company rate of course offers the advantage of it being net of a whole host of deductions that people will still be able to take for their business purposes. The company rate offers this and the personal rate does not. It is not about the tax rate per se it is about the taxable income that you are paying the rate on. Lower that and the rate becomes less of an issue.
2. Competitive company rate - yep, so what? And why obsess with Australia? Aim lower. Lower rate that is.
3. Imputation Regime - follow Australia. Uninspiring.
4. Reduce top tax rates. Same as 1. Half of the wealthiest New Zealanders don't pay the top tax rate apparently. Easily explained away that their wealth is locked up in company structures as they have in the past or currently are entrepreneurs, risk takers and responsible for employing thousands or tens of thousands of New Zealanders. Who cares if they don't pay the top tax rate given their contribution to the economy - providing jobs for people who do. They have already paid their fair share of company or even trust taxes in the past and probably still continue to do. You cannot expect a multi-millionaire to pay 38 cents in the dollar on his income in a country such as New Zealand, he has enough money and will just get on a jetplane and leave. While I question the mobility of the average New Zealander, money gives you one fabulous thing that makes it all worthwhile - complete geographical freedom.
5. Base broadening. Hong Kong is always discussing this. Hong Kong seems not to care and chucked GST to the pavement.
6. No CGT - too hard.
7. Pick on rental properties as apparently the area is under-taxed (whatever that means) and apply for example RFRM - discussed above.
8. Land tax supported - but it will increase rents as landlords seek to recoup costs as well as punishing those who own land right now. Politically unsaleable and problematic with exemptions such as farming, forests, Maori Land, elderly etc..
9. Depreciation - over-reaction as "depreciation recovered" concept.
10. GST should continue to apply broadly. There should be no exemptions - in the same breath however they have discussed at page 48 why financial services and rents etc. should remain exempt and foreign visitors should keep having to pay it.
11. GST should be increased. TWG then states in same breath low income earners should be compensated, this after proving that in fact the top 10% of earners pay 76% of the tax. And complaining of high marginal rates when you apply WFF credits to low income earners.
12. Review welfare policy. Sure, but that's not part of the report brief, even though it was focused on and remains the highlight and most crucial part of the report. To roll back the Cullen/Labour reforms creating this distortion where 10% of earners pay 76% of tax - creating middle class beneficiaries.
13. "
Government should introduce institutional arrangements to ensure there is a stronger focus on achieving and sustaining efficiency, fairness, coherence and integrity of the tax system when tax changes are proposed".
Reads - employ more bureaucrats and consultants perhaps even those on the TWG to advise on tax changes when a more practical approach is to cut government spending to increase efficiency, fairness, coherence and integrity of the taxpayer.
The Perfect Tax SystemForget references to Australia - the report references 16 times to "global" or "globalisation", 6 times to "international competition or competitiveness". So why are we stuck on "A" for Australia?
The perfect tax system is found in Hong Kong and it explains why I live here. Copy it and guaranteed is a path to prosperity. Low flat tax, low land tax, source income concepts, stamp duty for land and stock transactions, free property market, no capital gains tax, no RWT, low company tax. To achieve this there is minimal government, less intervention and streamlined welfare provisioning.
* Disclosure - Do not have New Zealand based real property or shares.
