Opinion: What the Tax Working Group is most likely to recommend and what the government may actually do in 2010

By Bernard Hickey Here's the quick version: Out of the Tax Working Group's recommendations due later this month, I think the government will look at equalising the top income tax rate with the corporate and trust rates at 30% in the 2010 budget. The NZ$1.6 billion cost of this could be paid for by one or two smallish taxes on rental property investors such as the denying depreciation on buildings, making depreciable buildings taxable on sale, denying the offsetting of rental losses against other income or imposing a Risk Free Return Method for taxing the inflation-adjusted equity in rental properties. I'd like the government to equalise the income tax rates at 27%, increase GST to 15%, replace Working for Families with a NZ$2,000 per child semi-universal payment and impose a land tax, but that's politically too hard before the 2011 election. I'd like the government to campaign before the 2011 election for a 25% equalised income tax rate, a 0.5% land tax with a NZ$50,000 per hectare threshold and an inflation adjusted, universal Guaranteed Minimum Income to replace all benefits, including New Zealand Superannuation. Here's the long version: This week's public conference hosted by the semi-official Tax Working Group produced plenty of insight into the thinking of the group as it prepares to make its recommendations to the government later this month. These recommendations will be much harder for the government to let through to the keeper than the 2025 Taskforce, which was simply written off as an ACT party manifesto in drag that could be ignored as too radical.

For a start, the Tax Working Group's recommendations have been tempered by months of submissions from all sides of the political debate, an open debate involving business leaders, consultants and bureaucrats, and plenty of public debate. The process initiated by Bill English and taken up with gusto by Bob Buckle from Victoria University and its Centre for Accounting, Governance and Taxation Research has been an interesting exercise in 'open source' policymaking. This will help it 'stick' more than Don Brash's 2025 Taskforce and be much harder to ignore. Unlike his dismissal of the Brash group's proposals, Finance Minister Bill English told the Tax Working Group he will consider their recommendations as part of the 2010 budget. Over the next week the group will meet one more time before delivering their report to English over the Christmas/New Year period. It's not clear yet whether it will make a single recommendation or present a series of options from which the government can cherry-pick their favourites. Having spoken to several of the Tax Working Group members, I reckon it's more likely to be a series of options rather than a single consensus package. Here are the various options that could be put forward, broadly grouped in four packages of escalating 'radicalness'. I've linked to more expansive papers prepared for the Tax Working Group and our own articles for deeper explanations of the various measures, including the hotch potch of ideas for taxing residential property investment and a land tax. 'The No Cojones option' Keeping the current status quo is the easiest option. The government could just decide to leave the current unbalanced tax system that heaps the tax burden on PAYE earners without children or who haven't got loss-making rental properties. The system is unwieldy, complicated and riddled with unfairness and loopholes, particularly for rental property investors and high net worth individuals. Its interaction with Working For Families has created a poverty trap behind massively high marginal tax rates. It is biased against productive sector and unsustainable. But then again, it is by far the easiest option politically. 'The Little Kahuna option' The government could decide to cut the 33% and 38% top income tax rates and the 33% trust rate to match the corporate rate at 30%. This is the so-called 30-30-30 equalisation option that the government has said it wants to get to. This could be partly paid for by an increase GST to 15% with compensation for those on low incomes. This could be accompanied by the taxation of income from residential property investment in limited ways. These include:

• taxing equity with an inflation adjusted 'Risk Free Return Method' (which includes banning deductions for interest, depreciation and repairs) of say 6%,
• banning the offsetting of rental property losses against personal income. Currently NZ$200 billion of rental property generates NZ$500 million of losses and reduces tax revenues by over NZ$150 million.
• denying depreciation on buildings, or,
• making depreciable buildings taxable on sale.

These measures would broaden the tax base and reduce incentives for avoidance. They (may) increase rents, reduce property prices and the RFRM (may) lead some property investors to gear up with debt to reduce the tax on their equity. They may force (some) highly leveraged property investors over the edge. More detail on the RFRM is in Appendix A in this paper. National's property-owning support base would kick up a big stink. It also leaves open the risk that Australia cuts its corporate tax rate to 25%, triggering a flight of capital back across the Tasman. 'The Medium Kahuna option' The government could align the top income tax rate, the corporate rate and trust rate at 25% to remove distortions of differential rates and match an expected cut in the Australian corporate rate to 25%. It could then increase GST to 15% with compensation for lower income earners. It could then introduce a 0.5% land tax on the rateable value of land worth more than NZ$50,000 per hectare. It could also tax rental property income via the RFRM. This would encourage business investment and discourage rental property investment. The relatively high threshold for the land tax would leave farmers, lifestylers, horticulturalists and foresters lightly taxed, but would hit asset rich/income poor retirees hard. The Remuera blue-rinse brigade behind National would not be bringing a plate to the next fundraiser. 'The Big Kahuna option' This is Gareth Morgan's idea. He introduced himself at the conference as the 'token anarchist' on the Tax Working Group and he lived up to his billing, proposing something he called The 'Big Kahuna'. This would include the introduction of a flat income, corporate and trust tax rate at 25%, the introduction of a guaranteed minimum income of NZ$10,000 per person to replace all benefits, and the introduction of a 1.25% tax on all capital such as land, buildings and machinery. The current GST would stay. There's more detail in this opinion piece by Gareth Morgan. It would transform the incentives inside New Zealand's economy and its social welfare system. It would drag an entire group of high net worth individuals kicking and screaming into the tax system. It would force investment decisions to be based on generating ongoing cash profits rather than ongoing cash losses. It would be revenue neutral and therefore avoid any need for a massive slash and burn exercise within the government. It may frighten the living daylights out of some internationally mobile businesses and wealthy individuals, who could flee to friendlier climates in the Caribbean (or more likely Australia). It would alienate both the 'Blue-rinsers' and the 'Blue-Bloods' behind the National party. There would be no plates for the Remuera fundraisers, and no raising of funds. The missing Kahunas and a few leftovers Some options will not be recommended because it was clear from the discussion in the Tax Working Group they were considered unworkable, inefficient or just plain too hard politically. Any capital gains tax is off the agenda because it's difficult to administer and is obviously too politically painful for John Key and Bill English. A cut in the corporate, top income and trust rates below 30% is unlikely because of the cost, although it's not as expensive as some might think. Two wildcards in here are the ideas of a differential corporate tax rate (30% up to say NZ$10 million of revenue and 25% beyond that) and a semi-universal payment of say NZ$2,000 for children to replace Working For Families. The differential corporate tax rate would reduce the risk of being trumped by Australia and the Working for Families reform would reduce the ruinous marginal tax rates and rort-friendly means testing. What English and Key are most likely to go for Both Bill English and John Key have ruled out reforms in Budget 2010 that are too radical, 'purist' or politically unsustainable. Here's the money quote from Bill English at the conference:

"There is simply no point in embarking upon a tax reform programme that might be desirable from a purist perspective but which is socially inequitable, or administratively impractical"¦ [and] the Government is unlikely to accept solutions that go beyond what most New Zealanders would see as fair or reasonable."

But I do think they are interested in reform of some sort, particularly Bill English, who has been banging on all year about our unbalanced economy and unsustainable budget deficits. New Zealand needs a more robust productive sector and a less bubbly property sector. Most of all the government needs the faster growth that a cleaner and fairer tax system is likely to produce if it wants to make the budget sustainable. I think they may opt for an equalised 30-30-30 system for the income/corporate/trust rates to remove all this gaming of the system by top rate taxpayers. It would take some of the heat out of the residential investment sector as the tax avoiders relax a bit. They may also opt for a RFRM tax on equity in residential property and/or a ring-fencing of losses from rental property. They could also deny depreciation on buildings or make depreciable buildings taxable on sale. Either one of these would send a message and not cause too much pain.  That may be enough for one year. A change in the GST may be seen as something for after the 2011 election. The think there's a good chance of a differential corporate tax rate (25% above NZ$10 million revenue and 30% below that) to ensure the Australians don't get one up on us. The Henry review appears likely to recommend a cut in Australia's corporate tax rate to 25%. I wouldn't rule out a change in Working for Families to a semi-universal payment for children, which could be sold as a reshuffling of Working for Families that doesn't break an election promise....maybe. I think a land tax would be a step too far politically for Key and English. Even with a high threshold to avoid hitting the farmers, the grief from National's support base would be enormous, particularly from those asset rich retirees in the leafier suburbs. What I'd like Key and English to do I think there's a strong case for something more comprehensive that really tries to rebalance the economy without hurting those at the bottom end. An equalisation of the top income, corporate and trust tax rates at 27% would cost NZ$3.1 billion and reduce much of the crazy displacement investment in loss-making rental property. It may even encourage some investment in businesses. This could be paid for by a 0.5% land tax with a NZ$50,000 threshold, which would generate around NZ$1.5 billion a year and not hurt farmers too much. Taxing rental property investors using the RFRM at say 6% would raise NZ$700 million. Denying depreciation expenses on buildings and denying rental property loss offsets would raise up to a further NZ$1.5 billion. That would leave around NZ$700 million to play with, which could be used to help pay for a restructure of Working for Families towards a semi-universal NZ$2,000 per child payment rather than the current means tested tax rebates. What I'd like Key and English to campaign for in 2011 I'd love them to argue for a 25-25-25 equalised income tax rate and a 15% GST with compensation. I'd love them to move towards a Gareth Morgan-style Guaranteed Minimum Income (GMI) that included inflation adjusted (not average wage adjusted)  indexation. It would replace New Zealand Superannuation and make it sustainable with a retirement age indexed to life expectancy tables. I'd also like Key and English to work towards a broad capital and land tax along the lines of Gareth Morgan's Comprehensive Capital Tax, although the looming valuation disputes make my head hurt and may end up forcing a lot of tax advisers to retrain as valuation experts. I'd also like them to target core government spending at 30% of GDP, which is only where it was three years ago after 6 years of Labour government. It's now around 36%, although that's inflated somewhat by the recession spending and the the smaller size of the wider economy. That would require some tough decisions on spending, although a GMI-style welfare reform would go a long way to doing that. Much stronger economic growth powered by the tax reforms above would also reduce the likely pain involved. Your view? We welcome your comments and insights below