Tax Report

New Zealand Income Tax: Unfair and favours the rich

Gareth MorganEconomics, Tax and Welfare16 Comments

This report continues the work on closing tax loopholes that we started in the Big Kahuna. The two main loopholes explored in this report are not taxing the full benefits received by the owners of assets (this is particularly significant in the property market) and the advantages enjoyed by foreign firms competing in the New Zealand domestic market.

These loopholes favour those with wealth, they also favour businesses that are slothful (i.e. don’t even earn a taxable income that is comparable to a bank deposit). The loopholes also encourage people to speculate on the housing market and as a result it has become very difficult for new entrants to get into that market – either as owners or tenants. This is increasing inequality, which is unhealthy for society.

This problem is easily fixed, but some will scream that it’ll kill off their wealth creation. That’s wrong – a profit is a profit, taxing it properly doesn’t eliminate it. In fact, closing tax loopholes will encourage greater investment in productive assets, benefiting the economy.

The report sets out in detail how to close these tax loopholes. In essence we assume that all assets generate a minimum 5% return, and tax on that basis. For international companies Australia and the UK have a deemed tax (45% and 25%) on diverted profits – NZ can do similar simply by requiring foreign firms to justify deductible costs. These changes would ensure any person or company that is currently paying a fair amount of tax wouldn’t pay any more. 

Closing the loopholes in our tax system would:

  1. make the tax system fairer, 
  2. improve the economy by ensuring that investments go where the return is best, not where the tax breaks are highest, and
  3. generate income for the government, which can be used for additional spending or to reduce tax rates overall.
Download the report

Preface

If we close the worst of the loopholes in our income tax system we’ll not have to collect as much tax from salary and wage earners. Taxation will become more fair and capital will become more productive.

Rising inequality in New Zealand is most evident when measured by net worth, rather than income. Although there is a paucity of data about net worth, what information there is suggests some of New Zealand’s most wealthy people, persistently and consistently, have relatively modest taxable incomes. So it’s wealth (net worth) we should be watching.

A rise in inequality (however measured) is not necessarily a bad thing. It may simply reflect the dynamics of a modern economy where those who innovate get exceptional rewards for exceptional effort. Think Steve Jobs or Peter Jackson. In theory anyway, the exceptional rewards aren’t necessarily long-lasting – the innovator might have been a one-hit wonder who has a much lower income in the future. But as long as there is a continual stream of innovation delivering exceptional incomes to someone, we can always expect income inequality in a modern market economy. That’s one possible explanation for the rising inequality evident in New Zealand. But there are other, more likely, explanations for rising inequality too – and these are more sinister.

Inequality occurs when some groups in society have enough political clout to secure important economic privileges such as being exempted from tax or receiving substantial amounts of public money or regulatory protection for their earning activities. This type of inequality reflects entrenched power divisions in society and so is more likely to persist from one generation to the next. Such privilege reveals itself as an increasing concentration of net worth.

This paper is concerned about two of the glaring gaps – deliberate loopholes – in New Zealand’s income tax regime. These loopholes have persisted for many decades and have contributed to a rising concentration of wealth, particularly but not exclusively, held in the form of property assets. These loopholes have distorted investment and income, and ultimately undermined the growth potential of the economy. Not surprisingly, these loopholes are of increasing public concern as well.

The proposal here is reform of the income taxation regime. The reform I suggest is not incremental, it is fundamental. I propose that New Zealand moves from a tax regime that confers privilege and amplifies inequality, to one that supports equality of opportunity, freedom of choice, and higher living standards. Such a radical change will, of course, have to be introduced carefully as there will be important transition issues.

This paper is based on work initiated in the 2011 publication of the book, “The Big Kahuna”, and updates and refines one side of the tax and welfare reforms proposed in that work. It is part of a project that looks at the need for even wider taxation reform and considers options for reform of social welfare. The intention is to produce a sequel to The Big Kahuna, late in 2016.

New Zealand Income Tax: Unfair and favours the rich was last modified: June 14th, 2016 by Gareth Morgan
About the Author

Gareth Morgan

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Gareth Morgan is a New Zealand economist and commentator on public policy who in previous lives has been in business as an economic consultant, funds manager, and professional company director. He is also a motorcycle adventurer and philanthropist. Gareth and his wife Joanne have a charitable foundation, the Morgan Foundation, which has three main stands of philanthropic endeavour – public interest research, conservation and social investment.

16 Comments on “New Zealand Income Tax: Unfair and favours the rich”

  1. “In essence we assume that all assets generate a minimum 5% return, and tax on that basis.” How does this represent the closing of a tax loophole? Many people have assets that don’t generate a return, i.e. the family home.

      1. That doesn’t answer my question. I asked how it represented the closing of a tax loophole, as opposed to a horrifying and unprincipled expansion of the tax base.

        1. I believe the proposition is to expand the tax base, to recognise the benefits home ownership provides. Presumably tax would be reduced in other areas. This proposal would be against my interest, as a recently retired person with a freehold home and a low income. However it would have some good effects on the housing crisis.

        2. I read some comment from Geoff Simmons that the imputed value of assets such as a house should be the same as what you can earn from bank deposit. In which case 5% is around 2% too high.

      2. Sue – how does one pay a tax with *accommodation*? A tax can only be paid in cash; the revenue don’t accept furniture or free nights. If someone has no income or low or fixed income how can you tax their “accommodation” and what are they supposed to pay it with?! This is WHY income taxes are fundamentally fair and property taxes are fundamentally unfair; taxes that bear no relationship to *ability to pay* are bad and wrong.

        1. I believe the concept is that if instead of buying a house for $500,000 I put the money in the bank and earn interest on it, I will be taxed on the interest as income. But if I spend the money on a house, the return on my investment is that I can live there rent free – so the saving on rent is a tax free benefit to me. Gareth Morgan says that to equalise the position of the two investments, and lessen our appalling property speculation, the benefit of free accommodation in the family home should be recognised as income. I tend to agree with him, though it is against my personal interest.

          1. Oh I get the principle Sue – although it seems hard to apply in practice; try telling someone with an old leaky house that needs a lot of maintenance that it’s “assumed” to be generating a return and you’re likely to get a punch on the nose and an invitation to test your DIY skills!

            Still doesn’t deal with the fundamental issue; the approach outlined treats this as a notional ‘income’ and taxes it **even if there’s no actual monetary income – or insufficient income – with which to pay the tax**! That’s the point that you can never get past as far as I can see.

    1. so, take the family home out of the equation and then look at the wider system again. Lot’s of speculative house/land/share/other asset buying/selling/holding etc goes on all over the place by folk who don’t have (or declare an appropriate level of) PAYE income. We need to design a system that brings those folk into the net to reduce the disproportionate burden on the salaried class

      1. I absolutely agree on that point. There is a lot of scope for making the tax system fairer that is unfortunately not being used because of entrenched interests (i.e. a capital gains tax). However I think in this case the net is cast too wide. Putting my own feelings aside, my original question was how it represents the closing of a tax loophole? The NZ tax system is in no way designed to tax non-productive (financially) assets, and this would represent a quite dramatic expansion of the tax base.

    1. Income taxes are generally pretty fair because they take good account of ability to pay. Consumption taxes are less fair because the relationship to ability to pay is indirect; you rely on poor people consuming less things and cheaper things than rich people.

      If by ‘assets’ you mean peoples houses or land – well that’s fundamentally UNfair because such taxes bear NO relationship to ability to pay. I know high income single people who rent relatively small cheap flats; I know people who own big houses on big sections who are on small fixed incomes. Bad and wrong; taxing assets is always evil because of the inevitable gross injustice to people who are asset-rich but cash-poor. You can only pay tax with cash. No cash? No tax.

      1. Income taxes a fair if all the income is taxed, and that is the point, we are not taxing all income. I think my tax rate is less than 12% of my effective income. Does this seem fair? Have a read of the report again.

  2. Arent you a hypocrite Gareth!!! You say you own investment property with no tenants.WTF? Youre doing this and not paying your fair share of tax which you are so vehemently critical of. If you believe in what youre saying sell your dam property and invest it in the productive sector. Youre part of the problem not the solution lol.

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