Terry Baucher talks to PwC's Geof Nightingale about what the public tax inquiries actually accomplished, land tax, environmental taxes, capital gains taxes, and taxing multinational companies and digital revenues

Terry Baucher:

This week, I'm joined by Geof Nightingale, tax partner at PWC and also a member of the last two working groups. Morena, Geof. Welcome to the podcast.

I'll begin by asking, you've been on two tax working groups. What was the difference between this tax working group  and the group chaired by Bob Buckle, which reported back in January 2010?

Geof Nightingale:
Well, they were very different, actually, Terry. The 2009 working group was hosted by the Victoria University, so it was independent of government, although it was supported by a significant number of officials provided by Treasury and Inland Revenue. The 2018 tax review was a formal, full government review, so that was one big difference. But the other big difference was the diversity of the groups.

So, in 2009 we were really a bunch of middle-aged males who all knew something about tax, and so we had a common language and a common structure and framework to have our discussions. It was all very efficient, but not very diverse. It was criticized at the time for being not diverse and inclusive, and with hindsight, that's absolutely right.

The 2018 working group, was, by design, diverse. Diverse politically, diverse in gender terms, diverse in experience. And so, we had about half men, half women. About five of us, were tax people and about five were from other disciplines such as economics, environmental, representatives of Māori and things.

So, it was a much more diverse group and it represented New Zealand in a much better way and I think we got a better outcome because of that. But it also means that it took longer, that there was a transaction cost. We had to develop a shared language and a shared understanding about how we were going to go about our job.

TB:
Yes, that's true, but your terms of reference, notwithstanding some very prescriptive areas, were probably broader and your approach was much, much broader than the 2010 group.

Geof Nightingale:
Yes, it was. The 2010 group, we set our own terms of reference. When we got together, we decided what we would do. In the 2018 group, the terms of reference were a political commitment and they were negotiated through a coalition government before they were issued. But in the end, they were very broad...apart from four very specific areas, not taxing the family home and the land underneath it, being the main one, inheritance being another one. But apart from those, they allowed us to do what was really a root and branch review of the tax system and lift our eyes above the horizon and look globally at other types of tax systems and taxes.

TB:
Yes. The timeframe over the past few years, [since] we work in this space, where maybe sometimes things happen without us really realizing that the ground's shifted. What was, for you, the biggest surprise this time around, and what's changed or is changing?

Geof Nightingale:
I think, surprise, or more like new learning and realisation. The first thing was the use of environmental taxes around the world, and New Zealand virtually has no environmental taxes. I mean, what we would call and disclose as environmental taxes are transport levies and fuel taxes and they're really about revenue, not the environment. We didn't really think about environmental taxes, we scoped them out in the last tax working groups, so that was a new area. When we looked globally at how integrated environmental taxes are to other Western economies, not just as a behavioural sort of response, but also as a revenue raising tool, that was a new area. And it was interesting, really interesting, and I think it will be a part of New Zealand in the future.

The second thing that I think really came home to me this time was our deep reliance on the labour income tax base to drive our tax system and to drive our government, really. In the broader sense, I think the economists will tell us that that GST, while you and I call it a consumption tax, that's a tax on labour, because we tax the labour earnings when they're made, and we tax the labour earnings when they're spent. So, we're having to rely more and more on that labour income base because we've got reasonably light touch on capital. I worry more now than I did 10 years ago about the sustainability of that as we go into the future, both from a sheer revenue perspective, but also from an equity perspective.

TB:
So, the equity and sustainability. In other words, the sort of issues that were sort of talked about around our relatively low level of capital taxation. Those aren't going to go away, because sustainability of the tax system is going to become more of an issue in the near or longer term.

Geof Nightingale:
Yes, that's right. Look, one thing the working group did find was the current tax system now and into the medium term ... and I'd describe the medium term as maybe three to five and out to 10 years even ... is working really well. It raises enough revenue for either government's set of policies and it does so in a fairly non-distortionary way, apart from one of these gaff, and it's got largely was a voluntary compliance and acceptance. You can see that it's worked well if you look at the surplus that was delivered a few days ago for 2019. But if you go out 10 to 20 years, then I start to worry about the sustainability because of the changing demographics. You know, more of us retiring. You and I will be retired and we're going to live a long time, and healthcare, national super, all of that sort of stuff. So, I do think that in the longterm we will need to reshift the burden of taxation more into capital.

TB:
Well, that's going to be very popular, that stage. What was the biggest disappointment in this from this tax working group?

Geof Nightingale:
Well, I think it's the obvious, that we did a quite a bit of work on a capital gains tax and we did ... by a majority, not full consensus ... we did, by a majority, recommend one, and it failed politically, basically. I think that's probably the biggest disappointment, because I thought that it would have been useful. You know, I was realistic about whether or not this capital gains tax would get voted in or even be put in front of an electorate. We know what New Zealand is. We New Zealanders have a particular aversion to capital gains tax. But I thought that the design debate could have gone on longer so that we could have ironed out some of the undoubted problems satisfactorily, so that some time again in the future when it's revisited, we would have had something closer to a consensus on what it would look like.

TB:
Yes. I think two things got compressed. The timing, the having to make a decision and design it all for discussion to go to and basically then be put to an electorate next year just simply left very little time for really nutting out quite a few of the issues.

Geof Nightingale:
Absolutely, and one of the things that we were clear on as a working group was that if the government had proceeded, the timetable they were aiming for was too ambitious and they needed to give themselves another year or two. There were some very complicated areas left undone in the bones of our design.

TB:
Actually, it's well-known that the group split at 8-3 on the question of comprehensive approach, but you were all unanimous in saying we need to increase the rate of taxation or the level of property that is within the net. Sorry, that may have come out slightly wrong. That was actually, everyone I've spoken to who was on the group is quite firm on that view, that it's an undertaxed area.

Geof Nightingale:
Yeah. I mean, the way I frame it up is I think there was a consensus on the group that in theory and in principle capital gains should be taxed. I don't think anyone disagreed with that, that capital gains are just economic income. So, everyone agreed with that. Where the group parted company into the 8-3 was as you move along the spectrum of easy-to-tax capital assets to hard-to-tax capital assets, as you move along each step of that spectrum, you've got to weigh up the benefit of taxing the capital assets, equity and efficiency, versus the distortionary cost caused by the by the rules to try and do it.

At the easy end, taxing land really is pretty straightforward. There was a consensus around that. But as you moved into classes of assets, business assets, shares, managed funds and everything, it got harder and harder, and the minority judged that once you got out of the land assets, the trade-off wasn't worth it. Whereas, the majority felt that you could explore at least some solutions in that. So, it wasn't a split as such, it was just how far each of us was prepared to go.

TB:
Just on land, one of the interesting differences to me from the 2010 Bob Buckle Victoria University group is that that group made a recommendation for a land tax, but this time around you walked away from that. What prompted that change of approach?

Geof Nightingale:
Yeah, that's a great question, and the blunt answer is politics. Land taxes are quite efficient and easy to collect, and they've got a lot of good things about them, but in our terms of reference, we were unable to consider taxing the family home and the land that sat underneath it. Residential land is the most valuable by value land class in New Zealand. So, as soon as you take that out of the land tax base, the benefits of the land tax evaporate. It's no longer fair. Why is it fair to tax a farmer, not my house in Parnell? And it's no longer efficient, because it will distort land use decisions. So, the minute that political constraint came on, land tax was no longer viable.

New Zealand's also got another unique feature and that is Māori land. It would be inequitable and economically wrong too, probably, to affix land tax onto certain classes of Māori land.

TB:
Yes. That was one of the other things in the reports. Going into exploring the Māori issues was a big difference from any previous tax working group. I think we've talked about this separately, is that that's an area where we're really only just starting to get into.

Geof Nightingale:
I thought that was a great piece of work that the working group started. It was picked up by the Māori academic and policy people, but trying to incorporate into our policy analysis frameworks not only traditional economic things plus the Treasury's living standards framework, but a uniquely New Zealand framework. He Ara Waiora

I think we called it or it became called. Picking up Māori values and frameworks for thinking about life. That work was used by us and it is ongoing, and I think it will start to form part of public policy development in New Zealand more broadly. So, I think that's a really interesting offshoot of the working group.

TB:
That's great to hear. You also mentioned it previously, the environmental issues. There was a lot of very good groundwork laid down by yourselves and the group. It's just a shame that all that just got drowned out by the noise around capital gains.

Geof Nightingale:
Yes. I mean, capital gains was a third of our work, but it was 90% of the media and politics, you know?

TB:
Yeah.

Geof Nightingale:
The other two thirds of our work is not wasted. I'm disappointed that we didn't explore, as a country, capital gains tax further. I acknowledge all of the risks and concerns. They were all valid. But the other two thirds of our work is being explored in various ways, and some of it's on the work policy program now. Some of it's on the long-term.

Many of the environmental taxes have been given to other government departments for review. So, there's a really good body of work there. The official papers and the commissioned papers and things is a tremendous body of work that will inform policy making for a good 10 years, I think, and so it's useful in that respect.

TB:
That is actually always a great by-product of a tax working group, this sort of peripheral information that suddenly comes out and is available. It's an absolute treasure trove for nerds like me to dive into and have a good poke around. You know, plenty of material. You mentioned earlier that the government now is running at a surplus, and I suppose there's probably plenty of speculation about how it might utilize that surplus. What recommendations within the tax working group would you like to see it adopt for the budget?

Geof Nightingale:
Yeah. Look, my thinking's changed on this even since the working group, but the working group had a number of revenue negative recommendations, which we thought were good policy. Things like restoring depreciation on buildings, and some tweaks to KiwiSaver and tax rates and things like that. All of those cost revenue and you could do that with the surplus.

But my thinking's moved on, and in this I've been influenced heavily by Robin Oliver's thinking, one of the fellow working group members. He really worries, and I worry now, about the 30% tax rate, which kicks in at $48,000. That's a very high tax rate at a relatively low income. It's 90% of our top marginal rate and it kicks in at a relatively low income, $48,000.

TB:
It's below average wage. In fact, I think it's now below median wage. It might just be above that, but it is a very low threshold. I totally agree.

Geof Nightingale:
Yeah. And so at the moment, as we stand today, and particularly as we look at the economy, the rate of growth's slowing a bit. There are major uncertainties in the global politics that could affect the global economies. You know, our monetary policy lever is just about exhausted. It's not going to change behaviour much more if interest rates go to zero or close to there, too. So, that leaves you thinking that fiscal stimulus might be a thing in the near term, and one way of doing that would be to do something around that 30% rate, spend a couple of billion dollars lifting that threshold, lowering that rate, combination of that. That would have the added benefit, both of, I think, equity increasing the progressivity of the system, but also put some money back into the economy.

TB:
Yes. I totally agree. The thresholds issue, we don't change thresholds. That particular threshold, 48,000, hasn't been adjusted in 10 years. The $70,000 threshold hasn't been adjusted in 11 years. And so bracket creep, as we call it is, is a real problem. That would be one of my priorities to be addressed.

Moving on to international tax, the group got quite a lot of public feedback on the taxation of multinationals, most of which was pretty derogatory over them. Well, not derogatory, but was critical. You floated the idea of maybe in certain circumstances the government running with a digital services tax. Could you explain how such a tax might work and what's its risks for the wider business community? I think the commentators were probably overlooking the downside.

Geof Nightingale:
Yeah. We got a lot of submissions on the taxation of multinationals and the overwhelming theme of them was that somehow multinationals are not paying their fair share of tax in New Zealand and tax is leaking out of New Zealand, billions of dollars a year. The working group had a pretty solid look at.

The answer to that is that in the traditional multinational goods and services, after three waves of international tax reforms, we don't think that there is a big problem. We think traditional multinationals are now paying equivalent levels of taxation on the same activity to domestic businesses, and we don't think there's a big problem to solve anymore. On the other hand, we did identify that with the sort of weightless revenues, the digital economy, ex, there is no tax or low levels of tax being paid.

It's a problem right around the world, not just New Zealand. The current international texts rules don't cope very well with it, because they focus on physical location and the ownership of a tangible property. They just don't work for digital revenues. But we said the government should think about this, because for both tax revenue, for economic efficiency, and for equity reasons, we should attempt to tax the value being derived from New Zealand by those digital services.

Our first recommendation was to be part of the multilateral OECD process. And then we said, if that doesn't look like succeeding or taking too long, then you might consider unilateral action, a digital services tax.

But the working group put two big caveats on it. First, we said a majority of our trading partners would have to do that as well, so that we're in good company, because we're a small, trade-exposed nation. And secondly, we'd have to be confident that it wouldn't cause any retaliatory action or damage to our export-led industry. I mean, in June the government came out with its digital services tax paper.

I don't think they have yet met the threshold test that we set for them in the working group with China, US, Australia, not doing the unilateral taxes.

Yes, they're becoming more common in Europe, but I don't think there's enough of a critical mass of countries moving that way. And secondly, I think there's real evidence that you can provoke retaliatory trade actions. President Trump threatening France with wine tariffs because of their digital services tax is a classic example.

TB:
Yes. So, the multilateral approach, the OECD approach, specialists will have looked very closely at what happened in the last week when the OECD released what I referred to as potentially the biggest shakeup to international tax since the 1920s. Its formal title is a Unified Approach Under Pillar One, but what's it all about?

Geof Nightingale:
Yes. Yeah. Look, it's a very complex and theoretically pure idea to tax and share the tax on digital revenues amongst different countries. Basically, what it does is introduce a third pillar. At the moment, the international tax regime looks at where your physical activity takes place and it looks at where you own your intellectual property. The location of those two things drives where most of the tax is levied.

This approach introduces a third leg to that stool, which is to say, we will think about where you have customers located who are creating value for your business and that will be a third sort of pillar on which we might allocate taxing right. That conceptually makes sense. The issue will be is how you get all the sovereign nations cooperating to share those revenues fairly. New Zealand being a very small nation on the world stage, that's got more downside risks for us than upside, I think.

TB:
But the amazing thing is that this has actually moved quite a long way in a relatively short time. They're very ambitious. As I understand it, they hope to get this Pillar One proposal signed off by the G20 by end of this year and have the actual detailed technical stuff all sorted out next year, which is phenomenally quick. Is that realistically achievable?

Geof Nightingale:
Yeah, it is a very ambitious. You know, I think it's just possible that it is achievable. I was amazed. I was a big sceptic of the BEPS process. I just didn't think they'd get multilateral cooperation and get it done like they have. But that's been a remarkable success looking backwards from an OECD perspective. And so I guess my scepticism has reduced. They do seem to be able to move and move effectively.

One of the things I think that's driving it is there's an assumption that the US will be opposed to all of this because they are the main owner of all the digital companies.  But actually, what we forget, and was reminded to me the other day by a US tax official, is that the US is also one of the largest manufacturing export economies in the world. That whole segment of US industry is deeply invested in preserving the integrity of the current multilateral international tax rules, and therefore that acts as a counterbalance to just protecting the digital companies. So, I think there's a better chance than I would have thought that the OECD could pull this off by the end of next year.

TB:
That's great. The other thing is, even the American politicians under pressure from lobbyists, they're not immune to the fact that the digital giants pay substantially less tax. The European Commission had an impact assessment and it noted that cross-border digital businesses paid an average tax rate of just 9.5%, whereas their traditional-based enterprise, such as manufacturers, are 23%. As we know, the US is running a gigantic budget deficit, so it does need the tax. It has a huge military to pay for.

So, yeah, this is quite encouraging, and it has moved quickly. From my viewpoint, and I'm not as immersed in this field as you are, it is surprising how quickly it's moved. The next stage, so this Pillar Two, what's that? That seems even more ambitious.

Geof Nightingale:
Yeah. Pillar Two is the OECD's idea of a sort of a minimum tax. That multinational groups should face a minimum tax on their global enterprises and global profits, and then that minimum tax should be shared out in some fashion through certain rules. That's to address that gap, that tax gap between the 9.3 and the 27 or 23 that you just said before. In policy terms, it's to remove the incentive to migrate profits out of high tax jurisdictions and into low tax jurisdictions, or if that does occur, it's to at least recapture some of that. That does feel even more ambitious, perhaps, than a multilateral consensus on Pillar One on the unified approach.

TB:
It's almost like a step towards we're going to have a global corporate tax rate. Could that work? Could that actually cut across everything and we just simply say tax havens are verboten? That's it. Their privileges are withdrawn.

Geof Nightingale:
Yeah. I mean, in the perfect world you would agree a corporate tax rate consistent across the trading world and you would assess it on a consistent basis of a consolidated level, and then you'd parcel out the revenue raised using some allocation key across the countries. But I just can't ever see that happening. You know, it's too much sovereign rights for a country to give up their rate of tax, their design of tax.

I remember when we, in Recommendation 13, I think it was, of the previous working group, was that that tax policy come out of Parliament and go into an independent kind of body like the Reserve Bank, so that it wasn't subject to politics. The politicians just laughed and said, "We're never going to give that lever up. That's what gets us elected." The world's going more nationalistic and less globalized at the moment, so I don't think that would ever happen, Terry.

TB:
Yes. Ah, well, one can dream. I think that's about all we've got time for Geof, but what's next for you? Would you be up for a third tax working group?

Geof Nightingale:
I might be, but I'm not sure PWC would be that enthusiastic. These things are highly time intensive, and sensitive at times, too. I intend to stay keenly involved in tax policy through the firm. We work closely with Inland Revenue policy on developing tax policies, submitting and working with them, trying to iron out the problems and make sure that they work in practice. I'm part of a team here that does that, so that'll keep me involved. And I'd like to see through some of the things like the feasibility and loss continuity stuff that was announced in the last couple of weeks out of the working group. I'd like to see that through to fruition. That would be good. So, yeah, I'll keep involved.

TB:
Fantastic. Well, I'm sure you will be. Well, that's it for The Week In Tax. Thank you very much, Geof. It's been a privilege to have you on board for this episode. Ka kite āno!

This article is a transcript of the October 11, 2019 edition of The Week In Tax, a podcast by Terry Baucher. This transcript is here with permission and has been lightly edited for clarity.

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