Terry Baucher unstitches the 'surprises' in the Labour Party's CGT decision, to see how many of the 99 recommendations will in fact actually make it into law. A third are certain, another 11 high priority. The rest?

This week in tax, we’re going to be talking about the government’s response to the Tax Working Group’s proposals. In short, a big surprise.

No doubt, the political fallout will be filling acres of newsprint and hours of TV and radio, and mainly around the fact that not even as I rather too confidently predicted on the morning of the announcement that the residential investment property would become taxable.

Even that was taken off the table, and followed by the equally big announcement that, so long as Jacinda Ardern is the leader of the Labour Party, she will not be campaigning on the capital gains tax. Basically, her argument is the Labour Party has tried and basically failed three times to get this through, so it’s not going to happen, and they should accept that and move on.

There’ll be plenty of talk around the politics of all that.

On the tax side, that was a big surprise, obviously, but there were also other surprises in the report – beginning with the lack of movement on environmental taxes.

At the time of the report’s launch in February, Sir Michael Cullen made much of using environmental taxes and recycling these through to help farmers transition to a low-carbon economy. The government’s response has been to downgrade that urgency and, in fact, take all those possible water taxes, et cetera, off the table for this term of this Parliament.

The Tax Working Group’s recommendation to develop a framework for “externalities” in this area – environmental externalities, i.e. pollution – has also been downgraded and taken off the table. That probably adds insult to injury for the Green Party, but it is also concerning that, at a time when pressures seem to be mounting around climate change and taking action, several useful tools are at the moment not available for use.

Those are the two big surprises in the government’s recommendations. There’s a lot of detail to work through on this and there’ll be plenty of commentary flying about on it. But, overall, there were 99 different recommendations. Of those, 30 were probably what you’d call accepted and brought into practice, with another 11 treated as high priority for a progression in the current 2019 to 2020 tax policy work programme.

Quick to pause to consider what does that mean has been pushed up the table for high priority?

Well, that means that Inland Revenue’s policy and strategy division will now be expected to work through the technical issues involved in those 11 recommendations and prepare firstly a discussion paper or issues paper setting out what are the issues involved, what are the tax answers, what’s required to address those in terms of tax legislation. That’s the first stage of it. It won’t actually translate into legislation in the near short-term but would in a couple of years.

The process is Inland Revenue prepares the issues paper, sends them out for consultation, back comes consultation, and then legislation is prepared, or the matter is dropped because it’s deemed too difficult or it’s no longer a priority. That’s what’s going to happen with the 11 recommendations.

There are some interesting ones in there. Probably the two that are drawing the most attention would be to do with land banking, i.e. vacant land which is being held by speculators; and, also, just general taxation of land transactions by “speculators”.

There’s not much detail which accompanied the release of the government’s responses to those two main proposals. What we do know is that the Productivity Commission which is looking at local government funding and taxation has been directed to look specifically at this matter of how vacant land should be taxed.

I think the government is correct in thinking in their response. This was also the review of the Tax Working Group – that the best response would be at the local government level rather than at the central government level.

As for taxing speculators, well, we’ll see probably more on the funding given to the Inland Revenue’s property compliance programme which will be looking carefully at all those people who aren’t already caught within the Brightline test but appear to be engaging in property speculation in other words they are transacting or attempting to transact without being caught under either the Brightline test or any of the other various taxing provisions.

That’s basically a continuation of existing policies. If I was a little cynical – which, to be frank, is handy in my game – you would look at the overall recommendations that had been adopted by the government for want of a better phrase and are on the Inland Revenue’s tax policy work programme and think, “That’s not terribly different from what Inland Revenue would normally be doing.”

Maybe one or two items have higher priority but, on the whole, there’s nothing that grabs our attention to say, “Oh, my god, that’s a very, very major issue which requires urgent attention!” and that’s perhaps a good criticism of the end result. There’s no big hairy goal being set out we are going to tackle on a tax front, so it’s steady as she goes.

It’s partly that which prompted me to say in the two articles I’ve written so far on the matter that we will be back litigating the debate on capital taxation very soon – maybe not at this next election, but soon after that – because the stresses that led to the point where a Tax Working Group felt that a capital gains tax was a valid measure to be introduced will still remain. That is certain asset classes are tax-preferred, mainly property, but business goodwill, other matters like that, and business assets – some New Zealand and Australian shares. They remain essentially slightly tax-preferred.

And then, you have the issue that a significant proportion of income is not being taxed or rather income in this case should be classified as what we call the economic return, i.e. tax capital gains on asset classes which aren’t being taxed but which, in a different asset class, would be taxed – the Brightline test picks up that; overseas shares are caught under the foreign investment fund regime; bonds; overseas currency accounts are caught by the financial arrangements regime.

The inconsistencies within the tax system remain. And so, people like myself and others will be saying, “Well, hang on, what are we going to do about this?” because it’s a distortion in the tax system and it also drives investment. It potentially drives investment into the wrong place.

The other pressure that may continue to build will be if the wealth inequality gap continues to rise. The 80-20 rule came into play that a significant proportion of the wealth derived via capital gains accrues to the wealthier individuals, i.e. the people that make money make more money. That can and will lead to social pressures for change. We’ll have to wait and see on how those play out but, as I said earlier, my view remains that we will be back litigating this issue again.

The government’s response in that context can be regarded as a bit disappointing. There’s no change on savings, for example, although the work on the suggested changes to KiwiSaver is continuing. It’s just at a lower priority.

Totally off the table, of course, are the suggested changes to thresholds for the lower-income earners that was designed or intended to be designed as a trade-off to essentially make any additional tax revenue from a capital gains tax revenue neutral.  It was to be recycled in the form of tax cuts, tax adjustments. That’s all off the table.

That’s another area where pressure will build on the government because the tax thresholds that we currently have haven’t been adjusted since 2010. For example, the top marginal rate of 33 percent – the threshold at which the top marginal rate of 33 percent would kick in. It’s currently $70,000. It should be closer to $80,000 based on standard inflation using the Reserve Bank of New Zealand inflation tools. That’s the same all the way through all the other thresholds.

That pressure will still continue to mount so the government may decide as a sweetener to do something about it in this year’s budget but maybe not. It’ll probably be likely in next year’s budget which, being election year, is traditionally, and you can say yes very cynically, when these things tend to happen.

The other thing that I think would be disappointing that I’ve mentioned before, when I talked about the role of Te Ao Māori in the development of the report and the living standards framework that the report was prepared under. All the recommendations that were specifically targeting Māori have all been put basically on the backburner. That means they’re not off the table, but they’ve been put on the sort of low-priority list.

Again, that’s another matter of politics as to how that might play out. It cuts both ways because I have seen some commentary from people expressing outrage that Māori had been suggesting that, given the pitiful returns that we see in exchange as part of the Waitangi settlements. It was not unreasonable that Māori would be excluded from potential capital gains tax. It’s a highly politically sensitive matter. That’s another one the government has kicked down the road.

The other thing which has also popped up which is actually a little bit on the nit-picking side of things – things were actually, frankly, ridiculous – is that some have complained about the cost of the Tax Working Group which is roughly expected to be about $2m all up.

There was an enormous amount of work involved in being part of the Tax Working Group. The 11 members gave up substantial parts of their time – not just on the days in which they were meeting, but in preparation for the meetings. I know, for example, for one particular meeting, they had received something like 750 pages of reading material – all densely written tax stuff which may be food and drink to a tax nerd, but requires a substantial amount of input.

The government actually got a bargain. I’m not quite sure exactly what the daily rate was for the members of the Tax Working Group, but I can tell you that, for those tax lawyers and specialists involved, their hourly rate was probably comfortably an average of at least $500 an hour and they may, if they were lucky, be getting that on a daily rate. In other words, the government got an absolute bargain to get a whole group of highly qualified people to look at the tax system. That’s something I think we should remember.

Whether you agree or not with the outcome, the exercise of regularly reviewing the tax system is something that should happen. One of the submissions I made to the group was that, in effect, given there should be a permanent Tax Working Group. That’s actually not so original. Other submitters made the same point, and the Tax Working Group that was established in 2010 suggested that would be a good idea.

Australia has a Board of Taxation which effectively acts as a monitoring the Australian tax system on an ongoing basis. I still think that is something we should look at.

One of the disappointments in the government’s recommendations is not, at this stage, going to proceed with the idea of a tax advocacy service for smaller taxpayers in disputes with Inland Revenue. Inland Revenue, unsurprisingly, was not terribly keen on the idea. As I said a few minutes ago, when you look overall at what’s now in the work programme, it’s pretty much for Inland Revenue work as normal, carrying on. Nothing dramatic for them to deal with.

That also reflects possibly two things – one, I’m not entirely convinced Inland Revenue had all the resources it would have needed at the policy level to have been able to implement some fairly complicated legislation; secondly, Inland Revenue has, for the past two to three years, been very involved in its business transformation programme – arguably, a bit too self-involved.

It is a $1.5b transformation programme. Understandably, everyone involved in Inland Revenue wants to make sure that works, but I can’t help but feel that that has proved a distraction from the wider operational and strategic policy outlook it should have.

Just as an aside, the next stage of Inland Revenue’s transformation programme will start this afternoon when it will shut down totally. Online, and call centres, and offices will all go offline for the next week as it upgrades the computer system to get ready as part of what they call Release 3 – the next stage of this business transformation.

Inland Revenue will come back up online on Friday, 26th April, at which point it will start automatically processing the refunds and tax liabilities for over $2m PAYE taxpayers. This is the core of the Release 3 project. It’s going to be very interesting to see how that plays out.

To sum up, Tax Working Group did a lot of very good work. As always with these things, there’s a lot of interesting material to work through – not just in the report itself but also in the background papers. There’ll be a treasure trove of analysis going forward.

That said, ultimately, on what was key goals around a capital gains tax and environmental taxes which were talked about being part of a transformative government – both of which, at this point, the government has decided to pass and sit on that.

Now, in my view, that means that we will be seeing as a result of that, for the reasons I said earlier, we’re going to see pressure come back on these issues being re-litigated. They just simply aren’t going to go away.

Finally, over in the United States, the Congress has demanded that President Trump hand over his tax returns for examination. This prompted the White House Press Secretary Sarah Sanders to snipe back “Well, even if Congress did get it, they’re so complicated, it wouldn’t understand it.”

In turn, Congresswoman Katie Porter went on air and held up and told Sarah Sanders, “I’m very happy if you ask to send you a copy of this tax handbook I wrote.” It turns out she was, before she became a congresswoman, a professor of tax law. That’s what you call a real burn.

https://twitter.com/ManInTheHoody/status/1117501732584427521

This article is a transcript of the April 18 edition of The Week In Tax, a podcast by Terry Baucher. This transcript is here with permission. You can also listen here.