Labour's Grant Robertson has been left little room to move on tax.

Labour’s dead-end tax policy is straight out of last century

The tweak to the top tax rate was hardly a surprise given NZ voters’ continuing acceptance of a distortionary system that leaves capital gains largely exempt, writes Geof Nightingale.

Labour tax policy, announced last week, was pretty brief: a new 39% marginal tax rate on income over $180,000 to raise $550m of new tax revenue. Brief and predictable – but disappointing.

Labour backed itself into this dead-end last year when, on the back of New Zealand First’s decision to squash the capital gains tax recommended by the Tax Working Group, the prime minister ruled out any prospect of a capital gains tax under her watch. With any increase in GST affecting low income earners proportionately much harder than higher earners, this left Labour with only one politically viable option to try to raise more revenue to service the growing Covid-19 induced debt: a new top marginal rate.

For modest revenue gains of $550m a year, the 39% rate policy returns us to the tax settings of the end of last century, makes the existing equity and efficiency distortions in our tax system worse and will have no significant impact on income or wealth inequality.

A 39% top marginal tax rate on income over $60,000 was imposed by Helen Clark’s fifth Labour Government in 1999, fulfilling an election promise. In an unintentional nod to Dickens’ Ghost of Christmas Past, the legislation received royal assent on Christmas Eve 1999.

The 39% rate (by then a slightly reduced 38%) was removed by the National led government as part of its Budget 2010 tax reform package, based on the work of the 2009 Tax Working Group. The tax reform package reduced personal tax rates, reduced the company tax rate to 28% and increased social assistance, all funded by an increase in GST from 12.5% to 15%, the removal of tax depreciation on buildings and tighter tax rules for multinationals. The objective of the tax reforms was to change the tax mix to reduce the revenue from income tax and increase the revenue from GST. The shift was intended to improve incentives to save, increase growth, be more efficient and increase our global competitiveness.

By reinstating the 39% tax rate, Labour’s tax policy winds back part of that reform, returning us to 1999. But not all the way. By retaining GST at 15%, they aim to keep the GST rise that funded the 2010 personal tax reductions.

It is true that the 39% top marginal tax rate makes our tax system more progressive. That is the idea that as our income increases we should shoulder a higher proportionate share of the tax burden. And most New Zealanders (including this one) agree with a progressive tax system – although we may have differing views on what level of progressivity is “fair”.

But the trouble is that Labour’s 39% personal rate will only really be progressive on employment and personal services income – income earned from personal effort.

If you’re lucky enough to earn investment income, or income from a business, you will be able to earn that income quite legitimately in a company and pay tax at 28%, in a portfolio investment entity (PIE) and pay tax at 28%, or in a trust and pay tax at 33%. If you’re really lucky (or well organised) you can earn that income through capital gains and pay 0%. What you can’t do is divert your employment or personal services income exposed to tax at 39% into a company or trust to access those lower rates because there are tax avoidance rules to stop you doing that.

As a result, despite the proposed 39% top marginal tax rate, the actual marginal tax rate on more wealthy New Zealanders is likely to remain, quite legitimately, the 33% trust rate, the 28% company and PIE tax rate and 0% on capital gains. And, as the quantitative easing helping us through this Covid-19 induced economic crises fuels assets prices, these investment returns and capital gains are likely to increase.

Compare that for a moment to an employee on the median income of $52,000 a year who has a marginal tax rate of 30% on income over $48,000.

To be fair to Labour, this is a longstanding tax system design issue that existed at 33% but it’s made much worse at a top rate of 39%.

One solution is, of course, the realisation based capital gains tax proposed by the Tax Working Group last year. While tricky to design and complex to administer, such a capital gains tax could spread the tax burden more equitably across the economy, allow lower personal income tax rates, and still raise additional revenue into the future.

The tax reform package options presented by the Tax Working Group last year showed how revenue raised from a capital gains tax could be recycled into personal tax reductions, incentives to save and business friendly tax measures. Such packages not only increase the progressivity of the tax system but may have economic benefits from reducing the current distortion caused by investment decisions to pursue untaxed capital gains.

But a capital gains tax was not and will not be a solution because many New Zealanders –voters – unlike most of our OECD counterparts and for a reasons that are still not entirely clear to me, rise up against the thought of a capital gains tax and are happy to live with our distortionary system.

National have tapped strongly into that voter sentiment, sticking with opposition to capital gains tax and ruling out any tax increases in its first term. So far it has announced a package of sensible business tax compliance saving measures, largely based on the recommendations of the Tax Working Group. But there is also a proposed incentive designed to stimulate business capital investment through allowing immediate deductions for assets costing up to $150,000.

National has indicated a further tax policy release later this week. I suspect that they will go for that middle-income voter that Labour’s policy has ignored and reannounce Simon Bridges’ proposal to index the personal tax rate threshold to inflation. Of course, none of these measures raise revenue to assist with the debt crisis. It will be interesting to see if there is any mention on how these are to be funded.

So, here we are then. A government that wants a second term, faced with a major fiscal crisis but backed into the dead-end of a 20th century tax policy. Predictable, but disappointing.

Geof Nightingale is a tax partner at PwC and was a member of the 2009 and 2018 Tax Working Groups. The views in this article are his own and do not necessarily reflect the views of PwC.



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