By Andrew Coleman*
New Zealand has one of the most unusual tax systems in the OECD. The main reason for this is its unusually large reliance on income taxes rather than expenditure taxes or other forms of taxation. Income taxes distort the pattern of saving and investment, which can lead to poor long term economic outcomes, particularly if the taxes are badly designed. In many countries, including New Zealand, poorly designed tax systems encourage too much investment in housing at the expense of other asset classes, and result in artificially inflated house prices.
New Zealand has a much larger reliance on income taxes than most countries. Last week, I discussed the single largest tax difference, which is the small amount of tax raised from the dedicated social security taxes. Social security taxes are much less distortionary on saving and investment patterns than income taxes and in most countries they are used to fund government pensions.
This week the topic is the way that specialized retirement income savings schemes such as KiwiSaver are taxed. New Zealand deliberately departed from the standard taxation method used internationally in 1989 and in doing so created one of the most distortionary taxation environments for retirement savings and housing in the OECD. Fortunately, New Zealand’s approaches to taxation are not written in stone. The tax system has been changed before, and it can be changed again.
The peculiarities of our tax system revolve around the differences between income taxes and expenditure taxes. (Expenditure taxes are sometimes called consumption taxes and are the same thing). Income taxes are paid in the year when income is first earned, and they are generally progressive. This means people on high incomes have a higher average tax rate than people who earn low incomes.
In contrast, expenditure taxes are paid when income is spent rather than when it is earned. This is the same thing if you spend everything as you earn it, but if you save some of your income the tax is delayed. One of the main benefits of expenditure taxes is that they help to compound the returns on your savings at a faster rate.
As we shall see below, the return from saving for retirement can easily increase by 75% if the earnings from savings are taxed on an expenditure basis rather than an income basis. More generally, expenditure taxes distort saving and investment decisions less than income taxes, which is why they are favoured by most OECD countries. They are much less affected by inflation, for instance.
There are several types of expenditure taxes, but the main one New Zealand uses is a value added tax, GST (Goods and Services tax). France was the first OECD country to adopt a value added tax, in 1958, and New Zealand eventually followed in 1986. (Yes, we can copy good ideas used elsewhere!)
It is applied to almost all goods and services, so whether you are buying umbrellas, utilities or uber rides you are paying tax when you spend your money. Because all items are taxed at the same rate, New Zealand’s GST is not progressive.
This is widely considered to be a disadvantage of value added taxes, which offsets their efficiency advantages. However, it is possible to design progressive expenditure taxes, and many countries have gone some way to transform their tax system so that it has a progressive expenditure tax basis. One way of doing this is to tax the difference between what people earn and what they save.
Retirement income taxes
Most countries tax the income earned in special retirement savings accounts such as KiwiSaver differently than the income earned from other assets. They do this by taxing retirement savings on an expenditure tax basis - income saved for retirement is not taxed when it is first earned, but when it is spent in retirement. The system they use is called an EET (Exempt, Exempt, Tax) system.
Under this scheme, when people put some of their labour income in a special retirement savings account, it is untaxed until the money is withdrawn. It is known as EET because:
⦁ Income put into a retirement fund is Exempt from tax when it is earned;
⦁ Interest and dividends and capital gains earned on this money are Exempt from tax as they accumulate; and
⦁ Tax is paid on all of the money once it is withdrawn.
This method of taxing retirement savings was first proposed in the 1930s by a famous Yale economist, Irving Fisher.
In contrast, most income in New Zealand including the earnings in KiwiSaver and other retirement income accounts is taxed on a “TTE” basis.
⦁ All income is Taxed as you earn it, with no exemptions for saving;
⦁ Interest and dividends are Taxed as they accrue; and
⦁ Savings and accumulated earnings are Exempt from further direct taxation when they are withdrawn or the investments are sold.
For example, suppose a person earns $60,000 a year, and saves $5000 in an ordinary bank account. Under the current TTE system an amount of $60,000 less tax is paid into their bank account as a regular paycheque. This is the first “T”. The person puts $5000 of the left-over money in a savings account. Any interest earned is taxed. This is the second “T”. When the money is withdrawn, no additional tax is paid to the government except for GST on items you purchase. The withdrawn funds are “E” for exempt from taxation.
An EET system is different. If a person put the $5000 savings in a special account like a KiwiSaver account, they would only pay tax on $55,000, not $60,000. This is the first “E”. The money in this account accumulates without any extra tax. This is the second “E”. When they withdraw the money in retirement, all of it is taxed as no tax has ever been paid on this money. This is the final “T”.
This small difference in taxation can have large effects on accumulated savings. Suppose the interest rate is 5% and a person pays tax on interest at 33%. If they place $1000 after-tax income in a saving account at the start of every year from age 25 to age 65, and then withdraw it slowly in equal instalments until it is all spent by the time they are 90, they would have 75% more to spend every year in retirement under an EET system than a TTE system.
Under TTE, the person accumulates $84,410 by age 65. This will allow withdrawals of $4,875 every year until they are 90, after tax. Under EET the person can place $1,492 into the account every year, and still have the same after-tax income. This accumulates to $189,310 by age 65. This allows annual withdrawals of $12,792, but since the full amount of the withdrawal is taxed, $8570 remains after tax.
EET taxes also have a second benefit: they significantly reduce the tax advantage enjoyed by owner-occupied housing. In fact, an EET system for retirement savings reduces the tax on saving to a similar although not identical level to the tax on owner occupied housing. This reduces the incentives for people to bid property prices to artificially high levels and it does without increasing taxes on housing.
Why is this? In most countries, including New Zealand, housing income is taxed on a “TEE” basis. You can probably guess what this means:
⦁ Houses are purchased and/or paid off from income that has already been Taxed when it was earned;
⦁ Imputed rent is tax exempt (see below); and
⦁ The value of the house including any capital gains that accrue when it is sold are also exempt from tax.
It turns out that there is not that much difference between TEE (housing) and EET (retirement saving) because the returns (housing services, or interest and dividends) are not taxed each year but are only taxed at the beginning or the end. You do not pay an extra tax penalty every year on your retirement savings if they are taxed on an EET basis, so they compound at a much higher rate.
This result was first demonstrated by a famous University of Cambridge economist, Lord Kaldor, in the 1950s.
However, when housing is taxed on a TEE basis and income is taxed on a TTE basis, there is a big difference, as retirement savings are more heavily taxed than housing (the “middle letter” tax). This difference creates incentives to build larger houses and pay more for owner-occupied property. Who in New Zealand doesn’t know that the best way to save for retirement in the last 30 years has been to buy the most expensive house you can afford and wait for it to appreciate? When everyone has these artificial tax incentives, the result is artificially high land prices.
Since New Zealand started taxing retirement savings on an TTE basis rather than an EET basis tax in 1989, new houses have become much larger and land prices have gone up significantly – in fact, between 1990 and 2020 New Zealand has had a faster increase in house prices than any other OECD country. Tax is not the only reason for both of these changes, and in fact it is impossible to know how important the tax changes were because so many other things have gone on in the economy since then. Nonetheless, the way housing and retirement savings are taxed in New Zealand mean we are likely to have one of the most distortionary housing-related tax policies for owner-occupiers in the OECD.
EET taxes have many desirable properties, so it is reasonable to ask why all capital income is not taxed in this manner. One reason is that EET requires people to pay tax to the government when they spend their savings. Governments suspect people may “forget” to pay their taxes when they spend their savings, so they restrict EET taxes to easily monitored accounts. Retirement savings accounts are easily monitored, and in most countries they are peoples’ biggest asset after their house. If a country taxes these assets on an EET basis, it covers a big fraction of savings. But some countries also extend EET to other assets. For example, in the United Kingdom money banked directly from a person’s income into special bank accounts is taxed on EET basis. The money is taxed on withdrawal whether it has been in the account for 20 weeks or 20 years, and that way the person gets the advantage of lower taxes on their interest earnings.
New Zealand did not always tax retirement savings on an TTE basis. The Government changed the way retirement savings were taxed in 1989. This was done for two reasons. First, the government wanted to tax retirement savings in the same way as other investments, but rather than reduce distortionary taxes on other investments they chose to increase them on retirement savings. This not only made the tax on saving more distortionary, but it also increased the tax advantage enjoyed by owner-occupied housing over other asset classes. (If you read the original documents, the government didn’t even consider the effects on house prices, even though housing is the biggest asset class in New Zealand).
This was an ill-wind that served property-owning baby-boomers very well, for it artificially inflated house prices. Secondly, the government wished to collect taxes earlier, as tax is paid much later under an EET system than a TTE system. This helped reduced the government deficit and the government debt in the medium term. To some extent, however, this reduction is offset by a corresponding increase in private debt as private agents exchanged later tax obligations for earlier tax payments.
The good news going forward is that it is possible to reintroduce EET taxation on the KiwiSaver accounts of younger New Zealanders. This can be done without changing the tax rules for older New Zealanders, as the one thing you can’t change in your life is your birthdate. Younger New Zealanders should consider adopting the international standard approach, not just because it raises the return from their KiwiSaver accounts, but also because it should reduce the extent that house prices are artificially inflated by the tax system. As any young person will attest, reducing factors that artificially inflate house prices is likely to have a very big effect on their welfare.
EET taxation of retirement income is not, of course, the only way New Zealand’s tax system affects housing. The overall way tax distorts housing is a much bigger topic, to be explored next week.
*This series and an accompanying paper are based on work I started in 2020 with Jeanne-Marie Bonnet while we were both at the University of Otago. I am very grateful for her assistance and insights. All errors remain my own.
(This article is part 9 in the series. You can find all other articles in the series to date here).
**Andrew Coleman is a visiting professor at the Asia School of Business. This article is his personal view of retirement policy in New Zealand, based on academic study.
Coleman is on extended leave from the Reserve Bank of New Zealand, while working overseas. The views expressed in this article do not represent the RBNZ and are unrelated to work conducted at the Bank, which has no responsibility for retirement policy in New Zealand.
65 Comments
Any move that helps to make houses affordable homes rather than objects to pour money into would be welcome.
'It is possible to reintroduce EET taxation on the KiwiSaver accounts of younger New Zealanders. This can be done without changing the tax rules for older New Zealanders, as the one thing you can’t change in your life is your birthdate.'
KiwiSaver accounts are a subset of Portfolio Investment Entities, taxed the same way, and now compromised by being able to be tapped by first-home buyers and for emergency withdrawals.
Surely a new class of retirement saving vehicles will need to be established by Parliament using EET, available to anyone of any age, but quite distinct from KiwiSaver.
Perhaps the new EET savings vehicles might be required to be disbursed after retirement or at age 65 as annuities, rather than being available as a lump sum.
The existing NZ Superannuation must remain the basic pension, universally available to everyone at 65. Yet, as Super is a basic pension, those who sign up for it ought to be on a separate income-tax regime that charges a surtax on all other income, and that surtax must apply to the taxable payouts from the EET pension-saving schemes that Andrew Coleman proposes.
New Zealand needs to introduce capital gains tax, inheritance tax and gift tax to provide much greater investment in the NZ Superannuation Fund to fund future Super payouts. And Andrew Coleman's discussion of EET should draw attention to the absurdity of the NZSF being required to pay tax on its investment returns.
I think you will be correct that retirement savings will have to be converted to an annuity rather than taken as a lump sum. This will be to stop people avoiding the inevitable means testing of government superannuation.
Remember, it's not the money you put into retirement savings accounts that counts, it's the value you get out.
Not necessarily an annuity, but if you look at US 401(k)s which are also EET, they have somewhat complicated rules around required minimum distributions (RMDs) once you reach a certain age, otherwise you face penalties. Let's not take our relatively simple Kiwisaver and make it more complicated.
No, my pension should be in addition to my savings. That's the social contract I've already spent half my working life under, revoking it now is an unconscionable bargain. With the costs that soon-to-be-middle-aged Kiwis have paid for basics like owning a house or starting a family, there isn't enough runway left to pivot to a system where they can accumulate enough to make up the difference if the pension disappears from under them.
These kinds of changes need to flagged decades in advance and introduced as people enter the workforce, not imposed on those who have spent the bulk of their lives working under a certain social contract.
Agree, any form of means testing should be done on income earned not asset tested.
If you are above retirement age and still working than yes you don't require the full super.
If you are earning huge amounts on investments that is still earning income, can take some off that as well.
I'm nearly 40 and not far off middle age, I see people only a few years younger than I who swear Super wont exist in their time.
IMO any political party with intention to cancel is doomed. I certainly wont vote for it and doubt many older than I would.
I guess they will be voting it off themselves!
No they don't, and that's the way it should stay. They may have won lotto, made a lot of money in their 60's or made millions for decades...who cares...they're entitled to it.
You're suggesting those worth money shouldn't get super...the green-eyed monster syndrome.
We have asset and income tests on other benefits, why aren't you out protesting that? Those people refused help because they have too much in the bank, or the partner earns money, might have paid a bunch of tax in there time
I think we should be consistent and only offer welfare when it is actually needed.
Those that have got to 65 will have paid ample amounts of tax in most cases, and it's catered for in future budgets. Citizens who have made an effort to cater for their retirement would be unfairly punished.
Secondly, any asset testing is easily rigged, the money could be hidden in trusts or sent offshore.
I just can't figure out why there's so many socialists here wanting to wring funds from the 'wealthy', whoever they are.
Because it's the generally accepted retirement age. I retired at 64.8 so it was exactly on target for me.
The last Labour Govt. squandered billions, on the most absurd, eccentric projects it's possible to imagine, but you're concerned about savers who get to 65 and have made adequate provision for themselves. You want to penalise them....NO!
The fact remains that NZ Super is a social welfare benefit like all the others. Its only requirement is to have lived in New Zealand for a number of years (formerly 10, but rising to 20). There is no reason not to asset-and-income-test it like any other social welfare benefit, except that you're the one who wants to collect it, so you want to be exempt.
Superannuation is not a Social welfare benefit. People paid their taxes into it. The Politicians used those taxes as a slush fund. Now that they have again blown the budget want to change the system. All the other social welfare benefits are short term and mean to be a hand up not a hand out. Alternately let people claim their Kiwi saver contributions as a tax deductions. No way the Polies would lose control over the people heaven forbid
Super is paid by current taxpayers. It matters not what you have paid in over your lifetime as that money has already been spend and the taxation is simply cancelling out some government spending. It is not a piggybank you draw back from. It is a benefit to ensure a basic standard of living for those at and over the NZS qualifying age, whatever it may be at any given time, and should always be treated as such. If we care about our elders, we should focus on ensuring they have a basic standard of living, can afford heating, some disposable income and a roof over their heads. If one is wealthy at 65 they have set themselves up well to be comfortable, however due to many unforeseen circumstances many end up hard up in retirement. Houses can burn down, spouses can pass or require significant and costly medical treatment, insurance can decline to pay out, etc etc. I'd rather my future pension paid to someone in genuine need if I have sufficient wealth at 65, not someone who is earning $100k+/yr via work, investment returns, rent from IP's etc.
Things change when necessary. The superannuation surcharge was introduced in 1985 with the agreement of all parties ... except Winston Peters, who persuaded Bolger under National to abolish the surcharge from 1998 as a condition for becoming the Government, as I recall.
The surcharge was introduced because without it the pension, a social welfare benefit, was recklessly going to those who don't need it. That is still the case.
I disagree with Andrew.
Tax is a zero sum game. EET gives a higher after tax balance at 65 because the interest isn't taxed each year, and that tax saving compounds. But simultaneously the government is missing out on these tax payments so has to borrow more (assuming they don't just increase taxes elsewhere) and borrow earlier so that compounds too..
The result is higher balances in retirement savings accounts and higher levels of government debt. Both of these higher numbers are good for the ticket clipping finance industry, but it's still a zero sum game for the government/taxpayers.
On the other hand, Andrew Coleman points to an EET savings regime as a way of providing competition for houses, now everyone's principal vehicle for tax-avoiding wealth accumulation. It is important for New Zealand's social cohesion that future rises in countrywide property values be no greater than general inflation. I look forward to Coleman's next instalment: 'The overall way tax distorts housing is a much bigger topic, to be explored next week.'
This isn't correct. There are two issues here. One is the type of taxes you have. It is widely agreed in tax circles that if you tax income when it is first earned you have a more distortionary tax system than if tax income when it is spent. This is why many countries have a preference for EET rather than TTE taxation of income, where practical. The second issue is the rates that you tax income and expenditure. You can have high rates or low rates. In practice many European countries choose to have EET and high tax rates. The US and Canada have EET with lower tax rates. You can make an EET system more redistributive by having high tax rates, as the Europeans do, or less redistributive by having low rates. NZ could choose EET and keep the same overall redistributive aspects of the tax system by changing the tax rates. This is what other countries do.
There are several arguments for and against either approach.
The accumulation of capital that can be invested productively in NZ and the multiplier effect being one for EET.
I've frequently heard gst being referred to as a regressive tax, because low income earners spend all their income, where as higher income earners save/invest. But GST is a perfect example of the expenditure/consumption tax being touted.
"The accumulation of capital that can be invested productively in NZ and the multiplier effect being one for EET."
Not really. Personal retirement savings accounts are mostly invested offshore. The government invests *cough* within NZ. So EET is worse for local investment.
Even if they are mostly offshore, that's far better than non existent, and the offshore investments will hopefully generate a return that's does eventually come back to NZ. Whereas if the govt taxes it will not invest, it will spend in the current period, and voters will vote for whoever will lower/not raise taxes. Just look at where we are now, how many times has actually prefunding super been voted down to keep taxes low. At least three times in my life.
Hello Beanie
You are correct that it would be a zero sum game if people only invested their retirement savings in government bonds, for the return on the additional private savings would be equal to the additional government debt. But they don't. The additional investments are made in a wide range of assets that typically return a much higher return than government bonds. This allow the country as a whole and the government to be better off. The government issues a low yielding bond and in return has a claim on a diverse portfolio of high yielding investments. This of course assumes there is a higher return on private investments than government bonds. This has been true for a very long time and is the subject of a very large economics literature called the "Equity premium puzzle" - in essence a literature trying to understand why the returns to government bonds are so much lower than the returns to private investments, much lower than can be accounted by usual risk considerations. A shift to EET should change the overall portfolio of investments that people hold.
The governments of many countries have very large tax claims on the EET-taxed retirement savings accounts of private citizens, which will be paid a t a future date. These claims are not usually measured when governments calculate their debt, because they are contingent on the future value of these assets, but they are real. This is one of the reasons why NZ has a lower government debt than many other countries. The NZ government collected its tax early, and doesn't have such large claims on the retirement saving accounts of private citizens. The fiscal position of some of these other governments is not nearly as bad as it looks, since they have a claim on the large retirement income accounts of babyboomers. Note that this doesn't mean that retirement accounts are over taxed in other countries relative to New Zealand - it is the other way around, since the NZ government lowers the compound returns from high yielding assets. In the example I gave, EET could raise private returns by 75% relative to the NZ TTE system.
Thanks for your reply. I am sticking to my guns about tax being a zero sum game between the taxpayer and the government. Your reason put forward why it isn't is that taxpayers can earn a better return than the government so there is effectively free money just waiting to be picked up. But of course the government could similarly invest the money from the first two T's as it already does with the NZ Superannuation Fund.
If the Equity Premium Puzzle (that makes all this free money possible) keeps puzzling, then the government could also borrow to invest and pick up that free money. Betting the farm on something that has been defying financial logic for a long time is not something I would do though.
If we were to move to an EET system for Kiwisaver, it becomes a means of tax reduction for the wealthy who could afford to put more of their wealth in there. Perhaps we would need to put a per year cap on contributions like the US dors for 401ks.
What is not mentioned here is the government contribution of $512/year, assuming you put in $1024. That's equivalent to having no tax on the first $36k assuming 5% returns and 28% tax rate (top PIR).
While a EET system sounds nice it adds a lot of complexity as it makes Kiwisaver different from non-Kiwisaver investments which would remain TTE. There would be additional complexity around early withdrawals, for example US 401ks have a 10% early withdrawal penalty to account for this.
If we want to give savers a tax reduction, perhaps increasing the gov match to something higher, such as dollar for dollar up to 5k. Unlike EET that helps those on lower/normal incomes more than the wealthy, and amounts to making balances up to $350k tax free. For lower balances the subsidy would be more than the tax they would pay so their balance would build up more in the early years.
The net cost to the government between moving to an EET system and increasing the match should be compared, and modelling over who would benefit the most.
"There is no excuse for the state using the taxes I pay to subsidise someone else's savings." - maybe the tax on their savings is paying for it.
Probably half the country would have no savings at all if it weren't for Kiwisaver and the government contributions. Those people would not be paying tax on their savings as they wouldn't have any savings.
The EET system described in the article is also the taxpayer subsidising peoples savings, by giving them preferential tax treatment over other investments. There are two questions at hand: (1) should the government be subsidising peoples savings, whether that's in the form of the gov match we have now, EET, something else, or some combination, and then (2) if we decide that we want a subsidy, what should it look like.
If we plan to keep NZ super at it's current level (relative to wages) forever, then I don't think that there's a need to subsidise retirement savings, as there is a reasonable fall back scheme which in general is higher than the other benefits. However if the plan is to abolish or limit NZ super, I think there's a solid case to be made for encouraging retirement savings by some form of subsidy. I think the government match is easier to grasp than the potential benefits of EET, it also strongly encourages contributions over your entire working life as it's a take it or leave it style system, and lastly it caps the subsidy on a per person basis so the wealthy don't get a lot more than those on lower incomes.
Hello Morepork
Your statement assumes that it is appropriate to tax income when it is first earned (an income tax system) rather than when it is spent (and expenditure tax system). In other words you are assuming there is a subsidy to savers if they are not taxed when income is first earned, but taxed later on. However, there are no good grounds for believing it is best to tax income when it is first earned rather than it is spent. Indeed there are a large number of thinkers, going back at least to John Stuart Mill, that argues on philosophical grounds that people should be taxed on what they take out from society (the goods and services they consume) not what they put into society (the goods and services they produce for others). There are very good grounds for believing income taxes are more distortionary than expenditure taxes. So your statement that EET is a subsidy for retirement savings is really a statement that income should be taxed when it is earned not when it is spent, even though we know this distorts the economy.
I have noted a lot of New Zealanders have gotten used to the idea that because we largely tax income when it is earned not when it is spent, we SHOULD do this and any attempt to tax income when it is spent rater than when it is earned is a subsidy. Yet you could equally say income SHOULD be taxed when it is spent and any attempt to tax it when it is earned is an exercise in applying particularly distortionary taxes. Most other countries don't see EET as a subsidy because they don't believe that there is a compelling case to tax income when it is earned rather than spent, and several good reasons to tax it when it is spent not earned. New Zealand seems to have fallen in love with income taxes for reasons that I don't really understand. As I keep pointing out, it is possible to move towards a consumption tax base and have a redistributive economy without having such distortionary taxes and many countries do it. For the last 35 years NZ has turned its back on one of the ways to do this, which is to tax retirement savings on an EET basis. This effectively delays the tax that is paid on the portion of income that people earn that they save for retirement, and thus moves the whole tax system towards a consumption rather than income basis.
AC
"So your statement that EET is a subsidy for retirement savings is really a statement that income should be taxed when it is earned not when it is spent"
Not necessarily. If we want to tax expenditure we should move to a GST only system and remove income tax altogether. Not move to a special tax arrangement for Kiwisaver that will mostly benefit rich people smart enough to take advantage of it.
You could move to a GST system to raise all taxes. If it is a normal GST system, it will not be progressive. The attraction of an EET system is that it converts a progressive income tax into a progressive consumption tax. You can have both, which you cannot have with a NZ style GST system.
Perhaps you don't like progressive tax systems. That is your choice. People in most countries around the world do like progressive tax systems and tax systems with fewer distortions, which is why they use EET systems with a progressive tax scale. High income people who consume most of their income at some point in their lives still end up paying tax at higher average rates than low income people under the EET system used in most countries in the world. NZ turned its back on this in 1989. Moreover you can make it as progressive as you like my changing the tax scales.
AC
People in most countries around the world do like progressive tax systems and tax systems with fewer distortions
Well in that case doesn't it make more sense to be talking about the elephant in the room of untaxed capital gains from property instead of labouring over TTE vs EET?
Hi Murray
I will talk about this week. But unless you plan to tax the capital gains on all homes, including the family home, no, it does not make more sense to avoid talking about EET and TTE. Only about one third of houses are rented, and these only account for a quarter of the value of the housing stock. Even if you apply a capital gains tax to these houses, you are avoiding the tax distortions that apply to three quarters of the housing stock. These can be at least partially addressed by adopting an EET approach to retirement saving. They are not addressed by fixing capital gains taxes, either on rented property or all property.
Fortunately the rest of the world figured out how to partially address both problems. It is to adopt TEE for owner-occupied housing (the current system in NZ and in most countries) , and a CGT on other assets. NZ has not done either.
AC
Hi Murray
I will talk about this week. But unless you plan to tax the capital gains on all homes, including the family home, no, it does not make more sense to avoid talking about EET and TTE. Only about one third of houses are rented, and these only account for a quarter of the value of the housing stock. Even if you apply a capital gains tax to these houses, you are avoiding the tax distortions that apply to three quarters of the housing stock. These can be at least partially addressed by adopting an EET approach to retirement saving. They are not addressed by fixing capital gains taxes, either on rented property or all property.
Fortunately the rest of the world figured out how to partially address both problems. It is to adopt TEE for owner-occupied housing (the current system in NZ and in most countries) , and a CGT on other assets. NZ has not done either.
AC
People can argue all day about income vs consumption taxes, but for the majority of the world TTE is the predominant philosophy, with the exception of some retirement savings schemes in some jurisdictions.
I only have good knowledge of Kiwisaver and the US 401(k) as they're the only countries I've worked in and the only schemes that I have. From what I know from my own 401(k) and from friends that have other tax advantaged schemes is that they can be a pain to deal with, as you essentially have two kinds of money, taxed and untaxed and there are a plethora of rules around the latter, especially for people moving to other tax jurisdictions.
Income is never immediately spent, it is always hours/days/months/years later, and it is impractical to move to a progressive consumption tax, so I don't see a good way past that two kinds of money divide. By treating the retirement savings scheme differently to every other form of investment (TDs, housing, shares, etc.) we are adding a further distortion to the market, and it is one that favours the wealthy.
Which is why the 401(k), which is widely talked about as tax advantaged (aka subsidised), has per year contribution caps. It also has required minimum withdrawals so isn't a pure consumption tax play either. Arguably both of these are to limit the tax advantage (subsidy) available to the wealthy.
I do think NZ has too much of a focus on income related taxes, but would go with an alternative approach such as a LVT, even if it would cause quite a lot of pain. If we were to move to an EET system for Kiwisaver there would be a multibillion dollar hole in the governments yearly budget, which would either be filled with increased borrowing, or an increase in our favourite taxes, income or GST. This may be temporary and be closed in the coming decades as more people withdraw their savings, but it isn't insignificant at the moment.
This is a considerable oversimplication Morepork,
First, it is simply false to say that most of the worlds assets are taxed on a TTE basis. A very large fraction of he worlds assets are owner-occupied housing and these are taxed on a TEE basis. A large part of this article argues that a reason to adopt EET on retirement savings is so that you have two major asset classes taxed on an expenditure basis (owner-occupied housing and retirement savings in specialised accounts) rather than one (owner-occupied housing) precisely to avoid a situation where owner-occupied housing is taxed advantaged relative to all other classes of assets. This is the argument that Kaldor made in 1955 but which the designers of our policy missed in 1989 - they ignored housing altogether. The main point, however, is that the choice of taxation on other assets be they in retirement accounts or general assets needs to be taken into account alongside the taxation of housing assets, which is usually on a TEE basis. Only if you ignore housing is it possible to say that EET adds another distortion. If all assets were taxed the same, EET is less distortionary than TTE. If some assets (owner-occupied housing) are taxed on a TEE basis, then it is far from clear whether taxing all other assets by TTE creates fewer distortions than taxing retirment income assets on an EET basis and other assets on a TTE basis. Most countries say that it is best to tax retirement assets on an EET basis when housing is taxed on a TEE basis - NZ is one of a very small number of countries to adopt the contrary position, and the decision was not and has not been properly justified. You simply should not ignore housing when making these decisions.
It is also the case that in countries with EET retirement income accounts a large fraction of assets are held in these accounts. Globally they are large, even if this is not the case in NZ. There are at least two reasons for this. EET taxes adjust for inflation much better than TTE, which tends to substantially over-tax interest earnings. Secondly, EET compounds returns much better than TTE and this leads to a huge advantage in returns. So in many countries (but not NZ) EET is not considered a dead argument. Indeed the Mirrlees review of UK taxation practices (2010) recommended that countries pursue additional ways to tax on an EET basis, as did the much earlier (1978) Meade review. The world defaults to TTE when it can't do anything better, but it can do better with retirement income accounts and so it does.
I also have a 401k from my time working in the US. I found it perfectly easy to use. I do acknowledge there can be issues when moving from country to country but as far as I know these are not too difficult. (I am not old enough to be able to access my 401k funds yet.) All cross-country pension issues are problematic, which is one of the attractions of compulsory super schemes - they provide people with a more mobile claim on retirment income if they move countries. But that is a different issue.
If we moved to an EET system there would be a temporary multi-billion hole in the fiscal accounts, but eventually the tax is collected. You have a temporary increase in deficits and a permanent increase in public debt, offset by a decrease in private debt. If the government's claim on EET retirement accounts were included as an asset on the government's balance sheet (which it isn't) the increase in government debt would be offset by this asset. So the effect on debt and deficits is to some extent smoke and mirrors. The cost is a set of distortionary taxes. New Zealand seems to be very averse to public debt, even when it is sensible. For example, the Key government stopped contributions to the New Zealand Superannuation Fund, a decision that was expected to cost the government billions (ad did cost the government billions) to avoid government debt. Another example has been the decision to funding roading on a pay-as-you-go basis, which leads to under-construction of public infrastructure (and unsafe roads), rather than to borrow to fund additional roads. Like most people I am averse to wasteful government spending, but this is very very different from being averse to government borrowing and government debt when it is sensible.
There are many arguments in favour of Land value taxes, although finding a way to introduce them in a politically sustainable way can be problematic. I talk briefly about them next week, but wrote more extensively on them in 2009 in papers that are available on the Motu Economics website, if you are interested. They are not mutually exclusive with EET retirement income taxes.
AC
I mostly agree with that sentiment. Especially when you expand it to not wanting your tax to be used to subsidise somebody buying their first home when they raid their kiwisaver balance.
What are your thoughts on our tax being used to subsidise superannuation? That's essentially an inferred saving scheme for everyone who gets to 65 years.
My tax already gives money to people for free for turning a certain age and people who could work but choose not to.
If we want to get this granular about tax and who gets what out of it then you're going to run into the reality of a shrinking pool of workers and the fact that our tax system is extremely reliant on a very small cohort of the population - with most proposals in the name of 'fairness' only further looking to concentrate that.
Kiwisaver works well for PAYE types that are in large organisations, especially the more monopolistic ones which can have a mixture of either suppressing the wage increase a bit, or pushing the kiwisaver cost onto the customers.
Not so well for tradies, self employed etc. Or those on really low incomes who may have to forgo even giving up the minimum contribution from their wage to make ends meet. Winners and Losers everywhere I guess.
(A good read. Thanks.)
"..the government didn’t even consider the effects on house prices, even though housing is the biggest asset class in New Zealand"
And here we are. Ignorance is Bliss. Refusing to do anything concrete about the problem or the solutions. Want proof of that? Just look at the actions of our current and previous Governments of any colour. And here's what some unlucky future Government will use as a political electioneering slogan, "If only...."
Exactly. Who wants to sign up for paying tax at a rate to be determined a lifetime away when you have no time left to do much about it if you don't have as much as you thought.
Your point about inflation is spot on too, the figures quoted in the article assume a return of 5% and zero inflation. The difference between TTE and EET is not so much when you put more realistic figures into the model.
Which is more likely to make you seek a tax free capital gain in RE....TTE or EET?
Also as has been noted elsewhere there is advantage in knowing the tax liability (rate) when making the decision about where to place your money rather than trusting a future regime will treat you as well or better.
It is true that under an EET tax system, the future tax rates are not specified. This does not seem to have been a problem in the large number of countries that use these systems. The money that people withdraw in retirement is taxed at the usual tax rates prevailing in society at the time of withdrawal.
It should be noted that any money you save for retirement under a TTE system is also subject to uncertainty about future taxes - that is the "middle T" ie the tax you will be paying on the interest and dividends on the investments between now and when you withdraw the money.
In my example, I suggested that over the course of a lifetime an EET system provides perhaps a 75% advantage in returns over a TTE system. It seems unlikely that the uncertainty over future tax rates would substantially undermine this advantage. I should also note that EET is protected against the vagaries of inflation, whereas TTE is not. TTE exposes you to much more uncertainty on the effective tax rate you pay on interest.
It is correct that under EET tax is paid on the capital gain component of your investment returns - just like GST is paid when you spend any capital gains. This is one advantage of an EET system - it doesn't matter how you invest within your KiwiSaver account, all investments are taxed in precisely the same way. This is one of the reasons why EET taxation is less distortionary than TTE taxation in practice, because under TTE and the current tax rule book different investments can be taxed in very different ways.
AC
National Super cannot last. The creaking there is getting louder . But politicians have trouble facing that reality so the situation may well become ridiculous and it will break. Break suddenly and a disaster can occur.
Which is why the sooner we phase it out the better. Replacing it with a universal large contribution compulsory Kiwisaver.
A changeover progressive over say thirty years.
Then, why tax such a retirement scheme at all? EEE would be quite appropriate because it's not a standard investment. First and foremost it's a social protection scheme. A social instrument. And it's compulsory. So - no tax at all. At entry, during and exit. No tax.
Your first point: NZ Super is perfectly sustainable if (a) investment by the Government in the NZ Superannuation Fund is greatly increased by taxing the unearned wealth of capital gains, inheritances and gifts, and (b) applying a surtax to all other income of those who sign up to get NZ Super.
Your second point: 'Why tax such a retirement scheme at all? EEE would be quite appropriate because it's not a standard investment; it's a social protection scheme, a social instrument'. An excellent idea in a stateless, government-less anarchy. But you may have noticed lately that we do live in a state with a government that needs to get taxes from somewhere to run hospitals and schools, and build roads, and police gangs, and, and, and .....
Maybe any changes to the tax system of this nature need to be consensual across the political spectrum to give confidence, and be incrementally change-managed over decades to avoid exhausting the social licence that underpins collection.
Convincing the people that what's collected will be used responsibly to actually improve the majority's lives would help credibility.
It should be means tested, although I'm probably biased as a younger person because I know it will be means tested by the time I'm 65 because it's unsustainable. While I'm paying for it now, I know I won't benefit when I'm older and it will be another advantage accrued by older generations.
Interestingly, while super isn't means tested - the rest home subsidy is, and with dementia and other such diseases likely to become more prevalent over time as people live longer it will have an impact. My dad has been caught in this situation, and is now selling his house to cover the cost (they leave about $250,000 of assets). I was visiting him the other week, and I started talking to an older woman about how the expensive the rest homes are and how we're having to sell his house, which his one asset. Her response to me was "Oh, but why didn't you put it in a trust?" as if it was something obvious. I was like my parents don't know anything about trusts - it's something that wealthier people use. What bothers me is the thought that this policy is catching people who worked their whole lives with their house as the one asset to show, while the wealthy once again get a free ride. Pretty sad really.
April,
Sorry to hear about your fathers predicament. I struggle to understand how the wealthy get a free ride in comparison to your father. As a side note, I have been paying taxes at a reasonably high level in NZ since 2007, and I will not ever see a single dollar from superannuation due to the dual taxation agreement between NZ and the country that I moved from.
I will politely note that if you are over 60 and have only $250k in total assets, you have failed in financial planning for your future. It is a good thing in my opinion that trusts have become less beneficial in hiding financial assets in recent years. Then again, I support the concept of taxing capital gains without exception, including when selling ones abode. I am strongly against taxing capital assets, although strongly for taxing capital gains (when realized).
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