Terry Baucher on rising tax rates, the taxation of capital, environmental taxes, a rising corporate tax take & increasing power and reach of tax authorities

This week’s Top 5 comes from Terry Baucher, director of tax advisory business Baucher Consulting.  

As always, we welcome your additions in the comments below or via email to david.chaston@interest.co.nz.

And if you're interested in contributing the occasional Top 5 yourself, contact gareth.vaughan@interest.co.nz.

“There are decades when nothing happens and there are weeks when decades happen” Lenin is said to have remarked possibly sometime in 1918 during the early stages of the Russian Revolution.  

And certainly, there were days, let alone weeks, last month when decades seemed to happen.  We still don’t know the full extent of the economic damage the COVID-19 pandemic has inflicted, but there is no doubt it will have a massive impact for years, if not decades to come.  

This Top Five looks at the possible short-term and longer-term impacts on the tax system as a result of coronavirus. 

1) In the short-term tax rates will rise. 

The initial shock to government balance sheets is enormous. To compound the problem, many governments are still recovering from the effect of the Global Financial Crisis in 2008. Here in New Zealand, the Government's books were in good order coming into this crisis. But with projections of a potential doubling of net government debt in a matter of months the Government’s finances will undoubtedly come under strain. 

In case you missed it, not only will there be a huge hole in the government's books as a result of this pandemic, but the inexorably rising cost of New Zealand superannuation remains. As is the not so small matter of responding to climate change. Remember, it was barely three months ago that smoke from Australia was affecting our atmosphere here. 

The tax system was going to have to change to adapt to those two issues, and those changes will accelerate in the wake of the COVID-19 pandemic. The first sign of how those issues will be addressed will be in next month’s Budget. 

My guess is that next month’s Budget was going to include an adjustment of the tax thresholds probably targeted, as the Tax Working Group recommended, at low to middle income earners. I think that will still happen because putting money in people's pockets in a recession would be a reasonable measure at this stage. It will, however, be the last such adjustment for quite some time. 

Medium-term, maybe within a couple of years, personal income tax rates are likely to rise, at least for high earners. It's worth keeping in mind that the top individual tax rates are several percentage points higher than New Zealand in those countries we compare ourselves with. In Australia and the United Kingdom, it’s 45%, the United States top rate is 37% and across the EU-28 it averages 39.4% with Sweden and Denmark the highest at 55%.  A move higher seems inevitable, if not back to the 39% rate which prevailed between 2000 and 2009. 

During the 1970s and early 1980s the Robert Muldoon led National Government responded to a series of economic shocks with several ad-hoc measures.  These were increasingly ineffective and were swept away during the reforms of the 1984-1993 period. However, desperate times call for desperate measures and Grant Robertson or his successor might be tempted to follow the overseas examples of special levies. 

For example, in 2011 the United Kingdom introduced an annual charge on certain balance sheet liabilities and equity of banks. In 2017 Australia introduced a similar levy essentially only applicable to the four largest trading banks.

Australia also had a Budget Repair Levy of 2% on incomes over A$180,000 between 1 July 2014 and 30 June 2017. It was replaced by a permanent increase in the Medicare Levy to 2.5% for those with income over A$180,000.

Separate from special levies, the ugly combination of the inexorably rising cost of New Zealand Superannuation, a significantly damaged economy and weaker government finances, means the continued universality of New Zealand Superannuation will be increasingly debated. 

Options might include means testing, or a reintroduction of the deeply unpopular New Zealand Superannuation Surcharge, which applied in the 1990s.  An alternative to these might be the proposal made by Susan St. John, for a special tax to apply to recipients of New Zealand superannuation who are earning above a certain threshold. This proposal at least has the merit of fitting in with the principles of a progressive tax system as it targets those whose income indicates that they are not really in ‘need’ of New Zealand Superannuation. 

One other possibility might be to increase the GST rate, and barely three weeks ago Simon Bridges did not completely discount the option of doing so. 

However, the TWG noted that GST is seen as a regressive tax for low-income earners. It’s also worth noting that increasing the rate of tax for a consumption tax such as GST could slow down spending, which is contrary to what’s going to be required in order to help restart the economy.  

Instead what may happen over the medium-term is that GST may be extended to apply to financial services, something the TWG recommended be investigated.  This could happen in the wake of overseas changes in this area. Globally I expect to see a fierce debate emerge on the matter of expanding the ambit of GST, with countries looking to withdraw or tighten current exemptions around food and financial services.  

2. The taxation of capital.

Aside from short-term measures a longer-term implication will be increasing the tax on capital. This will also be a global issue. 

Inevitably, here in New Zealand that will mean the reignition of the debate over whether New Zealand should introduce a comprehensive capital gains tax. That’s already begun with former Prime Minister Bill English raising the possibility in a briefing to private investors. 

In the short term I suggest the answer will still be “no” for the simple reason it would do enormous damage to the Prime Minister’s reputation (and re-election hopes) for her to repudiate what she said little under a year ago that there would be no CGT while she was leader of the Labour Party.  

Putting that aside, we can expect Inland Revenue to ramp up its enforcement of property disposals. It’s even possible New Zealand First might be persuaded to abandon its opposition to making all residential property investment subject to a CGT.  

One of the key drawbacks to CGT is that it is a transactional tax – the tax only arises on disposal. If people aren't buying and selling, no tax rises and there's always been great concern about what they call the ‘lock in’ effect of a CGT. That is, people will not sell because they do not wish to trigger a tax liability. This means CGT revenues can be either a feast or a famine for governments who prefer more regular tax streams such as PAYE and GST.  

Given the politics around CGT other alternatives may be considered. Globally, the idea of a wealth tax has been gathering momentum since Thomas Piketty raised the idea in his monumental work Capital in the 21st Century.  A wealth tax is part of Senator Bernie Sanders’ platform. Here in New Zealand, the TWG dismissed a wealth tax as “a complex form of taxation that is likely to reduce the integrity of the tax system.”  

Re-examining the role of a wealth tax in the wake of the COVID-19 pandemic seems likely. The 5% fair dividend rate applying as part of the foreign investment fund regime is a de-facto wealth tax which could be adapted for this purpose (although at a much lower percentage, maybe a maximum of 2% as Piketty suggests). The fair dividend rate had its origins in the suggestion of the MacLeod Tax Working Group in 2001 of a applying risk-free rate of return methodology to the taxation of investment property. 

The TWG also rejected the idea of a land tax, noting Maori concerns and its terms of reference. But maybe a land tax could be introduced for non-resident landowners only. This would be in line with a trend I see repeatedly in overseas jurisdictions of either taxing non-residents more heavily than locals or restricting the available exemptions. For example, in Australia non-residents do not qualify for the 50% discount for assets held for more than 12 months. Together with higher income tax rates the result is the tax rate on property disposals can be as much as 45%. Similarly, in the United Kingdom and the United States estate taxes of up to 40% apply to assets situated there. Expect to see these issues debated both here and abroad over the coming decade. 

3. Environmental taxes will be more important.

Like the cost of New Zealand Superannuation, addressing the cost of climate change will soon push its way back up the tax agenda once the immediate COVID-19 pandemic crisis is past.  

As part of this, the importance of environmental taxes to the tax base will rise. The TWG final report noted that according to the OECD, New Zealand ranked 30th out of 33 OECD countries for environmental tax revenue as a share of total tax revenue in 2013.

The TWG’s reference to the growing importance of environmental taxes was something that got drowned out last year with the debate over CGT.  In his briefing at the launch of the TWG’s final report, Michael Cullen stressed the need to initially recycle revenues to help those farmers most affected transition to a greener economy.  

What we will see emerge is a range of short-term tactical actions with immediate application allied to longer-term measures all intended to encourage a switch to a greener economy.  

Tackling emissions in the transport sector could involve the use of congestion charging, putting more money into public transport including rapid electrification of trains and buses. Charging vehicle emissions could be part of this perhaps allied with subsidies to get older cars off the road, replacing them with newer, more fuel efficient cars as an interim measure. This could achieve three benefits: it lowers emissions, reduces costs for families who are dependent on cars to move around and finally improves road safety because newer cars are safer. It would be a better use of funds than subsidising the purchase of electric cars.  

The TWG recommended increasing the Waste Disposal Levy, currently $10 per tonne at landfills that accept household waste. The TWG noted the effect of increases in the equivalent levy in the United Kingdom as illustrated by the following graph: 

Landfill tax rates and waste volumes in the United Kingdom

Other initial measures which would also raise revenues and simultaneously encouraging behavioural change would be to remove fringe benefit tax on the use of public transport and, as in the United Kingdom, tie FBT to the level of emissions of the vehicle.  (The coming clampdown on the non-compliance around FBT on twin-cab utes might have the indirect effect of taking these high emission vehicles off the road).  

Longer term measures could include widening the scope of the emissions trading scheme although I would like to see that introduced alongside John Lohrentz’s proposal for a progressive tax on biological methane emissions.  

4. The corporate tax take will rise. 

Tax is power. And maybe once matters have settled down, one of the most significant effects will be a shift in the power of taxation back towards the state and democracies. This will reverse the trend of the past 30 years ago or so, where lobbyists for corporates and special interests have been able to drive down corporate tax rates. This trend has been most noticeable overseas but as the CGT debate last year revealed New Zealand is not immune to the same influences.  

The COVID-19 pandemic has almost certainly put paid to any idea of corporate income tax cuts. But the TWG noted that there was little justification for lowering corporate tax rates and a background paper prepared for it noted: 

“…the two recent reductions in the company tax rate in New Zealand (from 33% to 30% on 1 April 2008 and from 30% to 28% on 1 April 2011) did not cause a surge of FDI into New Zealand. Nor did it show up in New Zealand’s level of FDI increasing relative to Australia’s.”

How the backlash against corporates will initially manifest itself will be in the adoption of the OECD’s international tax initiatives such as Base Erosion and Profit Shifting, or BEPS, and the recently launched Global Anti-Base Erosion Proposal (“GloBE”) - Pillar Two. The OECD estimates aggressive tax planning by multinationals costs US$240 billion annually.  

Late last year, prior to the outbreak of coronavirus, these initiatives looked in danger of stalling after the United States indicated it might not adopt the measures.  This appeared to be the result of lobbying by American multinationals. However, the US Government’s finances like those of every other country have been devastated by the Pandemic.  

So, for a brief moment, I can see the OECD and the US government's intentions aligning, resulting in a relatively quick agreement on the changes to multinational taxation.  

In any case, the digital giants such as Google, Facebook, Apple and Amazon might well drop their opposition to the OECD’s proposals as the price of stopping the widespread introduction of digital services taxes. (The UK government has pushed ahead with its 2% DST effective as of 1st April).

Notwithstanding the OECD measures, social media tech companies might find themselves hit with advertising levies as a means of supporting local media. India raised 939 crores (about $207 million) for the year ended 31st March 2019 from a digital advertising levy. Expect to see other countries follow suit (it could be one way of supporting New Zealand journalism and media which is in crisis as the collapse of Bauer Media shows). 

This may now be the time to implement a global financial transactions tax. However, in order for an FTT to be effective, it must be universal. The European Union outlined a possible FTT back in 2013 but has been unable to reach agreement on its introduction. Without that universal agreement, an FTT is effectively inoperable because it is too easily avoided. Adopting the principle of never wasting a crisis, it will be interesting to see if the objections to an FTT are overcome by governments’ need for new sources of revenue. 

5. The power and reach of tax authorities will increase.

The final trend that will accelerate is one which has been happening very quietly over the past 10 years since the GFC. That is the swapping of data between tax authorities through initiatives such as FATCA and the OECD’s Common Reporting Standards or the Automatic Exchange of Information. 

According to Inland Revenue, since the CRS exchanges started in 2018 it has “received more than 1.5 million records on New Zealand tax residents from 74 jurisdictions.” These records relate to approximately 80,000 New Zealanders. Inland Revenue apparently intends to contact all those for whom it has received information and confirm they have met their obligations. 

Separately Inland Revenue has used information sharing agreements with Australia to collect $46 million of overdue child support for the year ended 30th June 2019. In the same year it sent the Australian Tax Office details of 149,031 student loan debtors for matching and obtained contact information for 81,875. 

The scale of this information sharing is unprecedented and has happened with very little public debate on the matter. Furthermore, exchanges under CRS are separate to specific information sharing which can happen as part of a double tax agreement between New Zealand and another jurisdiction. No specific data on those information exchanges is made public but anecdotally it is significant. 

A little-known feature of the multilateral agreement under CRS is that all signatories agree to undertake to assist in the collection of unpaid tax. Prior to CRS such agreements were negotiated individually as part of a double tax agreement. Under CRS Inland Revenue can now assist any of the other 68 jurisdictions with which it has activated the CRS Multilateral Competent Authority Agreement.

As Inland Revenue’s Business Transformation upgrade continues its data analytic capabilities will increase. My understanding is that the latest upgrade will now enable it to automatically assimilate information it receives under CRS and automatically connect it with taxpayers. This information will only be available to Inland Revenue who can then monitor the taxpayer’s compliance against the data it holds. A question then arises as to the extent Inland Revenue is using artificial intelligence and how that use is being monitored.  

Information sharing and the growing use of AI by Inland Revenue and other tax authorities will be a trend about which we should see increasing discussion over the next 10 years. For the moment, citizens appear to be paying little attention to what is happening.  How much longer will that inattention will continue? And what are the implications for privacy and democracy? Or is it a case of the ends of higher tax collections justify the means?  

Writing about the Easter 1916 Uprising a couple of years before Lenin’s alleged aphorism, Irish poet, W.B. Yates wrote “All changed, changed utterly.”  It is indeed all changed, changed utterly and the extent and impact of those changes to the tax landscape will only become clearer over the coming years.