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Friday 22nd January 2010

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Here's a story you probably won't read anywhere else about the findings of the Tax Working Group.  

The working "rich" are paying three-quarters of all the personal income tax being collected.

Close to half the tax the government depends on collecting annually comes from personal income tax.

So it's not trivial that so much of it is coming from so few income earners, especially when to be rich in New Zealand means to earn six figures if you're lucky. In America, or Australia for that matter, that's not particularly rich.

The problem is all the greater when the evidence is that these few kiwi "high-rollers" are making ever increasing use of a panoply of loopholes that have mushroomed over the past 15 or 20 years of dumb tax policy to avoid as much tax at the top personal tax rate as possible.

In other words, the rich are both the bedrock of the tax system and the bad guys. As usual, being the bad guys plays better in a standard news narrative. And some of the current rorts are really pretty bad.

Inexplicably, income from trusts, exploitation of the fringe benefit tax and tax treatments on rental property investments that produce income through tax losses are not counted when people using these devices apply for benefits under the state-funded Working for Families package.

Hence a plunge in the growth of people declaring million dollar-plus incomes and a decidedly suspicious clustering of people declaring taxable incomes of $60,000 a year. If they have children, that income entitles them to WfF payments.

Meanwhile, wage-earning working families that qualify for WfF look over the fence and see a very unfair system, given how they have to pay tax rates close to 60% if they start earning more, leading to cuts in their WfF entitlements that almost making working more the wrong decision.

While the TWG thinks this is a mess, Finance Minister Bill English says the government is OK with WfF, but is interested in closing down the flagrant rorts.

It is almost inconceivable that those loopholes won't be closed in the Budget, in May.

Meanwhile, look out for a lot of nervous accountants who don't know anymore what constitutes tax avoidance, as opposed to previously legitimate tax minimisation.

The $2.2 billion win for the taxpayer in the bank tax avoidance cases, announced for minimum publicity on Christmas Eve, is also a massive can of worms for the taxpayer. 

For big corporates, it means a sharp intake of breath, a review of current tax arrangements, and potentially less focus on the opportunities suddenly emerging for New Zealand as a food and fibre-maker with strong access to the developing world on our doorstep. 

For small taxpayers, answers on that question will be provided shortly.

There will almost certainly be no more claiming depreciation on buildings, which routinely rise in value, along with the land they are sited on. That might raise $600 million a year, with a big chunk coming from rental residential property. 

Today, the residential rental sector reports $500 million in tax losses a year, despite holding $200 billion of assets. No sane government can let that continue.

It also serves many longer-term economic desires - more productive investment, more growth-oriented savings, improved productivity and competitive capital market arrangements - to put a very real spoke in the wheel of the national obsession with owning houses.

However, this week's proposals would not just end the depreciation write-down anomaly. They would also tax rental property using an imputed risk free rate of return model (RFRM), irrespective of whether that was actually the income from the property or not. It would become infinitely more difficult to stack up tax losses in the way that some taxpayers do now.

Accordingly, the combination of sudden corporate caution and a sudden stall in rental property sentiment could also put a spoke in the sudden surge of economic optimism observable as house prices return to levels not far from 2007. More than anything, the government needs the recovery.

Given the likely large number of National-Party voters who also own rental properties and run the complicated, tax-efficient structures that self-employment and entrepreneurship allow, this is tricky territory for a National Party government.

Ending the depreciation allowance might yield a handy $600 million and send the signal the economy needs. But is RFRM too hard?

And if RFRM is too hard, how to broaden the tax base?

The other big options are raising GST to 15% and imposing a land tax.

Signs from the Beehive are that GST is not as easy as it looks, so that leaves a land tax.

Farmers will hate it, and Federated Farmers certainly knows how to play the victim, so that's politicallytroublesome. The TWG helpfully suggests an exemption for land under a certain value per hectare, but also points out that every time you exempt something, you are storing up tomorrow's tax dodge.

Put your money on a low rate land tax that doesn't punish farmers or the elderly. That will broaden the tax base better than any other option.

That’s important because there’s one big difference today from when the tax system was last properly reformed. Globalisation has happened in the last 20 years. Labour and capital flee to where they can make the most, and borders are not a problem.

As well as having the broad base and low rate of GST, New Zealand needs a tax system that rewards work and productive risk-taking, encourages clever people to stay here, invest their money, and help collect the tax for all those bed-pans we're going to need in the next 20 years.

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