Bernard Hickey tells the story of an almighty tax furore, the backroom attempts to contain it – and the original sin that started us on this road more than 30 years ago.

This is an edited version of an article first published on Bernard Hickey’s newsletter The Kākā.

David Parker denied yesterday that the Labour government tried to “sneak through” a $225m tax increase by extending GST to Kiwisaver fund management fees – but the optics did look plenty sneaky.

The initial announcement from the revenue minister early on Tuesday afternoon didn’t even mention the GST change, despite the extra tax raised being five times that of the other main measure announced – and the FMA having warned it would reduce Kiwisaver and other savings by over $163b by 2070. Parker’s explanation yesterday was that the IRD had checked with a few fund managers, who didn’t seem that concerned. The implication seems to be that the government hoped the change would go through to the keeper, or bizarrely, that big and small fund managers would come out in support of it, and the opposition and media would either not notice or care that much. Whatever the thinking, it blew up in the government’s face spectacularly.

The detail about the extra taxes was on page 95 of the bill’s 225-page commentary and the detail about the potential loss of $163b in lost savings was on page 10 of the IRD’s 19-page Regulatory Impact Statement. The NZ Herald’s Thomas Coughlan and Stuff’s Rob Stock both reported those key details later on Tuesday afternoon. I found them around 4.30pm. The NZ Herald’s ‘Government quietly introduces $103b tax on KiwiSaver’ headline caused all sorts of ructions in the afternoon, including attempts to get it taken down or changed. The Herald doubled down with a banner ‘Tax Grab’ headline in the physical paper yesterday morning.

Parker defended the plan on RNZ’s Morning Report yesterday morning, shortly after National leader Christopher Luxon attacked it on the same show as a “retirement tax” and a “wealth tax” that he would repeal immediately.

Within an hour or two, Parker and finance minister Grant Robertson had clearly started considering a reverse ferret. In the end, it was a rapid and complete capitulation, as the announcement below sent at 1.16pm makes clear.

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I’m reproducing it here in full, if only because the explanation is the clearest about the problem the government wanted to solve, and its justification for first going ahead with it and then abandoning it within 24 hours.

Inland Revenue and Treasury advised this change be made to remove a loophole used by large financial companies, so they would have to align with how others in New Zealand pay GST.

The move would also have brought New Zealand fund managers more into line with the approach in Australia.

“Smaller fund management providers who were doing the right thing were at a competitive disadvantage compared to others, mostly larger providers, who were using the loophole,” David Parker said.

“Generally it’s bad to have these sorts of distortions in the tax system as bigger players can exploit them, but if the sector as a whole is happy to operate with the status quo then we will leave them in place.

“During extensive consultation views were mixed on the merits of the technical change. The large companies profiting from the current set-up were opposed to the change, while smaller providers were more supportive of the change. This was because these providers who did charge the full GST on their service fees faced unfair competition from the bigger players.

“However since the announcement it has become clear that smaller providers now oppose it too.

“It’s important to clear up some inaccurate representation of the proposal. New Zealanders’ KiwiSaver contributions and balances were not going to be taxed under this legislation. However it is clear from the reaction to this proposal that it has caused concern for Kiwis,” David Parker said.

“I am proud of Labour’s role in introducing KiwiSaver and its role in securing the future of New Zealanders. We will never do anything to undermine it.

“By contrast, National will not commit to keeping KiwiSaver in its current form, and cannot be trusted to support this important scheme. When last in Government National ditched the Kick-Start payment and introduced a tax on employer contributions,” David Parker said.

“Because of the importance of public confidence in KiwiSaver and the need to ensure nothing unduly affects New Zealanders’ willingness to save, the Government will not to go ahead with the proposal contained in the Taxation (Annual Rates for 2022–23, Platform Economy, and Remedial Matters) Bill.”

The absence of this rationale from the original release is made all the more glaring by its inclusion in the about-face.

In theory, the GST decision all made perfect sense and is totally in line with Treasury and the IRD’s three-decade-plus quest to design the perfect tax system, one which is broad-based, low rate and free of unfair exceptions and loopholes. That’s the basis for our current income tax and GST systems, which are among the world’s least-exception-ridden tax codes in the world.

This government’s embarrassing and politically damaging backflip was an epic fail from all angles, but it was only a short-term one. The real tax failure highlighted by yesterday’s drama was a much longer-term and more damaging one for our economy and society. It was the failure of the fourth Labour government in 1989 to complete its redesign of the tax net to include capital gains or land wealth in any form.

It was then finance minister David Caygill’s inability to complete the “pure” trifecta of a simple exception-free income tax, a comprehensive value added tax and a capital gains tax, that led to this week’s contortion, which is just the latest of many to try to rectify that failure in a politically acceptable way.

Failing to complete the capital gains leg of that trifecta has changed Aotearoa in a fundamental and negative way. And now that failure is piling on the political pressure to further pollute the purity and effectiveness of the other two legs.

It is the biggest “if only” in our political history. If only Caygill’s proposal from December 19, 1989 had been implemented, we would be living in a different place now. Its failure created the conditions for our brutally expensive housing market which now dominates our political landscape, is a major factor in our child poverty, health and education crises, and is holding back our attempts to get to carbon zero.

Capital gains was the missing link that would have made our income tax and GST systems sustainable, and removed the tax advantages in leveraged residential land investment. Instead, its loss has screwed the scrum of our banking system, dramatically widened inequality and embedded over $1t in wealth into homeowners, whom centrist politicians must now attract in order to win or retain power.

We built a perfect tax system – except for the exceptions that turned us into a housing market with bits tacked on.

And there is Aotearoa’s political economy and predicament in one sentence.

Sadly, perfect was much more than the enemy of the good in this case. “Almost perfect” just plain wrecked the good.

The long-term epic fail

Roger Douglas, David Caygill, Geoffrey Palmer and Ruth Richardson were the driving political and legislative forces behind the tax reforms, resource management, public finance and labour law reforms that are now the bedrock of our economy. In many ways, their logic and intent was pure and good.

They reformed everything to get away from the all-encompassing morass of tax and industrial law that appeared to bog down the economy in a tangled mess of:

• wage and price freezes to fight endemic inflation;
• a fixed exchange rate that was bankrupting the nation;
• import and export tariffs, controls and subsidies designed to reward farmers and punish consumers to attain trade surpluses;
• nationally arbitrated and set wages and conditions to bolster the power of workers at the expense of industrial firms’ profits; and,
• a tax code designed to enhance the wealth of the connected and their accountants and advisers, rather than improve the health of the Crown’s finances.

They decided to rewrite the tax code in a “broad-based, low rate and neutral way” to:

• lower and simplify personal income taxes by cutting the top tax rate from 66% to first 48% in 1988 and then 33% in 1989 (with just two rates of 33% above $30,000 and 24% below that);
• create a value added tax (GST) of 10% in 1986 (subsequently lifted to 12.5% in 1989 and 15% in 2010);
• removing tax subsidies for savings into pension funds between 1987 and 1990; and,
• lowering the corporate income tax rate from 48% to 28% in 1988 (subsequently lifted back to 33% in 1989, cut to 30% in 2008 and then 28% in 2011);

But these were all ultimately reliant on introducing a capital gains tax to fill out the landscape completely, as Caygill pointed out in December 1989:

“As the Consultative document points out, investments which are not attractive in their own right can be attractive merely because the income they produce is untaxed.

“The tax exemption therefore encourages investment in areas offering low pre-tax returns.

“On that basis, and on the basis that the advantage of existing concessions is greatest for those with most wealth, it is both efficient and fair to include currently untaxed income in taxable income.”

The third leg was just left hanging

The rest is history. Labour lost the 1990 election and never got the chance to introduce a capital gains tax. National didn’t introduce one and both National and Labour have been trying to directly or tangentially fill the hole ever since. Meanwhile, home-owning voters, savers, investors, businesses and the whole economy more broadly has been sniffing out the hole and piling into it with a passion. Renters can only stare into the edges of the abyss as it recedes into the distance with their dreams of bringing up families in their own secure and healthy homes.

National won the 2011 and 2014 elections, at least partly, by campaigning against Labour’s plans for a CGT beyond the family home, but it was National which introduced the “bright line” test for taxable capital gains on property trading by landlords in 2015 to try to squeeze the hole a bit. Labour extended National’s two-year test to five years in 2018 and then 10 years in 2021 in what was a politically adept move to squeeze it a bit more.

The current Labour government has also tried to throw up barriers to home owners using their untaxed and leveraged home equity to buy ever more rental properties. It has done that by ring-fencing rental property losses from other income and removing interest as a deductible expense for tax purposes for residential landlords.

While these are all positive moves, these “fixes” are a long way from the pure and simple tax model laid out in the 1980s. They create confusion, break basic principles of taxation and create grey areas and boundary issues all over the place.

No wonder the tax geeks at IRD and Treasury jumped at the chance to do something “pure” this week by removing the confusion about whether funds management fees were eligible for GST or not. Some used to be. Most weren’t. Now, after the back flip, all aren’t. That’ll learn them.

Don’t forget Working For Families and the accommodation supplement

Meanwhile, the politics of imposing capital gains taxes got ever tougher as the leveraged and tax-free gains got larger and harder to give up. That led to increasingly expensive, difficult to build and unhealthy housing. This growth of housing as the preferred investment class has made it politically impossible to achieve a capital gains tax now.

So other ways to help those struggling with housing costs were dreamed up and delivered via the income tax and welfare systems. Working For Families (WFF) was created as a rebate scheme to help low-to-middle income earners with children cope with high housing costs and low wages, both of which were driven by low public and private investment in infrastructure and business technology (because any surpluses were being ploughed into land values).

Now WFF has created an income tax system pocked with the most awful ulcers of marginal tax rates nearing 100% at points. Meanwhile the costs of the accommodation supplement, along with emergency housing and emergency benefits, are now approaching $4b a year. That would be more than enough to service $100b of debt – enough to build half a million homes.

All because we couldn’t get a capital gains tax across the line 32 years ago. Now that was an epic and long-term tax fail.

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