COMMENT: Good politics, but will it fix a 'broken' tax system?:

Tuesday 9th February 2010

Prime Minister John Key is obsessed with two things about the New Zealand economy. One is the fact that productive industry has been shrinking as proportion of the economy for more than five years.

The other is the price of houses - an issue that Reserve Bank governors and other politicians have identified for years and done nothing about.

Key's outline today of the tax and economic policy agenda for 2010 hints at fixes for the first of those two issues. And on the second, it deals as decisively as a cautious Prime Minister who knows the value of the public's trust dares to go.

By ruling out a land tax, Key has killed potentially unsurvivable grizzling from homeowners, the elderly, and the farming community - three groups that cover an awful lot of National voters - and Maori, whom he needs on-side.

By ruling out the risk-free return method (RFRM) for calculating rents on residential investment properties, he has softened the blow for residential property investors, many of whom also vote National and whose various lobbyists had already reached shrill heights of rhetoric ahead of today's speech.

On the other hand, by leaving open the prospect of axing depreciation deductions on investment properties, Key is finally doing something to put a spanner in the ludicrously favourable tax treatment of residential property investment relative to other forms of investment.

This is an important point. Yes, investing in rental property has been a rational decision for New Zealand investors, but not only because other investments - finance companies, shares, and new businesses - were riskier, but because the tax system was making them even riskier by favouring housing.

That will, to some extent, come to an end when, as seems inevitable, depreciation allowances currently denying the government about $1.3 billion a year in tax revenue are closed in the Budget on May 20. In the end, no sane government can let a sector with $200 billion of assets go on claiming $150 million a year in tax losses.

Whether the government will go the next step and try to "ring-fence" losses on rental properties to prevent write-offs against other income remains to be seen. As accountants know, for every ring-fence, there is always a loophole.

Key is also giving plenty of notice to prepare for a GST increase, and he has staked his trustworthiness on doing so only if the "vast bulk of New Zealanders" - i.e., those not rorting the tax system - are better off.

From the political perspective of a government that would like two or three terms in office, this all looks relatively deft. But from the perspective of a government seeking a step-change in economic performance, it is minor stuff.

New science and innovation tax breaks seem likely, and a fall in company and top personal tax rates will be important to maintain international competitiveness and remove some of the arbitrage opportunities that the current mish-mash of tax rates allows for high earners.

But one thing today's announcements don't do is the one the thing the Tax Working Group said was most important - fixing a tax system that shows no sign of being able to sustain the very large growth in government debt and spending forecast over the next decade.

Without a land tax or some other major new base-broadening measure, the bedrock of any future government's fiscal intentions remains as fragile as it ever was. And if a low rate of land tax was too hard to stomach, it's a fair bet this government won't be making up the difference by cutting spending instead.

Businesswire.co.nz

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