A hotly anticipated IRD report arrives next week which could herald a generational change in New Zealand’s tax system.
“While I have believed in a CGT, it’s clear many New Zealanders do not. That is why I am also ruling out a capital gains tax under my leadership in the future.” With those two sentences, almost exactly four years ago, then-prime minister Jacinda Ardern broke the hearts of progressive tax reformers. Labour had campaigned for a decade in favour of a structural reform to our tax system which might expand its scope to include capital. Ardern’s pledge seemed to mark the end of that possibility for a generation.
Yet with Ardern’s resignation, so went her vow. And while new PM Chris Hipkins has been assiduously torching many of the policies touted by Ardern, less thought has been given to those she ruled out. Behind the scenes, a bold new IRD report has been working its way towards a conclusion. It looked into a very invidious group – 400 of the wealthiest families and individuals in New Zealand, who collectively hold enormous quantities of assets and investments. It’s accompanied by a related piece of analysis from the Treasury, and together these reports are expected to give the most detailed view yet of the financial world of the richest New Zealanders, and just how much tax that wealth generates.
“This report will estimate the effective tax rate of the wealthiest families in New Zealand when taking into account their full economic income, rather than just their taxable income,” a spokesperson for the IRD told The Spinoff. “At the same time, the Treasury will release its research into the effective tax rate of New Zealanders across the income and wealth distributions.”
The studies were commissioned by revenue minister David Parker, a noted fan of Thomas Piketty, the French economist whose Capital in the 21st Century has become a totem of leftist economic thinking. The IRD and Treasury reports’ function is, essentially, to form the research base for any change to New Zealand’s tax regime. After the bonfire of the policies, Labour is about to start announcing some new ones. And that for the old guard like Parker and finance minister Grant Robertson, the price of agreeing to jettison so many beloved ideas might just be the revival of one of the most sacred – a capital gains tax.
A very contentious report
Somewhat predictably, this idea has some in the tax community freaking out. Pattrick Smellie, BusinessDesk’s founder and editor, broke the news of a mammoth new report from Sapere, commissioned by tax consultancy OliverShaw. The report claims, somewhat improbably, that New Zealand’s tax system is actually operating fairly, and that the more wealthy you are, the higher the effective tax rate you pay – even on capital gains.
“One of the questions asked is whether the very wealthy pay taxes at the same or higher rate than middle income earners,” says OliverShaw Principal, Robin Oliver. “This research shows clearly that, whether you consider taxable income or other measures, such as economic income, the answer is: ‘Yes, they do’.”
This is, to put it mildly, a controversial statement. The OECD is a club of wealthy nations with 38 members. New Zealand is the only one in which capital gains – profit on the sale of investments – is not a significant part of our tax system. This is part of why this country is seen as such an outlier in the global tax circles. Because the income of the very wealthy is far more likely to come from investments than wages, it is logical that such income will generate little tax revenue – hence the head-scratching nature of Oliver’s conclusion that, somehow, the wealthiest pay a greater share of their income in tax than those who work for a living.
It’s the first salvo in what can be expected to become an extremely heated debate in the coming months, so I called up Craig Elliffe, one of the people best placed to comment on tax in Aotearoa. He has decades of experience on both sides of the tax system, spending years advising how to (legally) minimise tax payments at KPMG and Chapman Tripp, before flipping to academia at the University of Auckland, where he’s now a tax professor in the Faculty of Law. He has also been commissioned as an external reviewer for the forthcoming IRD study, and while he cannot speak to its contents, it makes him extremely well-qualified to verify its integrity and methodology – each of which are implicitly called into question by the OliverShaw report.
I asked Elliffe about the Sapere report, and he professed to being “extraordinarily confused” by its central contention. While he has not yet had the chance to absorb its full scale, he believed its central thesis to be entirely counterintuitive. “It just defies common sense. As economic income increases, especially with capital gains not subject to tax, the effective rate of tax must decline … If that’s the primary conclusion, then, then that just defies common sense.”
What does New Zealand’s tax system really look like?
It’s worth stepping back and assessing New Zealand’s tax system as a whole. “We’re very dependent on two major tax bases,” says Elliffe. One of those is GST, a tax which applies to almost all goods and services sold. Elliffe says it’s “at a comparatively lowish rate, but it’s very comprehensive”. GST generates around a third of all revenue raised through taxation by the government. Other countries will have higher rates of GST, but often a labyrinth of exceptions, which can lead to semi-farcical outcomes – in Australia a glazed bun is GST-free, but one with icing is taxable.
Apart from GST, almost all the rest of the government’s tax revenue comes from taxes on income. The biggest share comes from taxes on individuals’ incomes, which makes up almost half of all tax revenue collected. Corporate tax is huge too, though, contributing almost 20% of government tax revenues in 2022. Elliffe says this is “quite a high proportion” compared to the OECD more broadly.
There is a lot to like about New Zealand’s tax system. It’s commonly known as a “broad base, low rate” system, which means that almost everyone pays almost all relevant taxes, so the rates imposed can be relatively low. In other countries, tax rates can be very high, but there are rafts of exemptions. It leads to situations where companies and individuals spend half their time lobbying for an exemption to a tax, and the rest of their time filling out mammoth tax returns. Whereas in New Zealand, as Elliffe notes, many of us barely think about tax at all.
So what is the case for some form of CGT?
The glaring hole in that simple, two stream system is a capital gains tax. Arguments have been made for a tax on the sale of assets like property and shares for generations, yet as Ardern noted, there is a powerful lobby implacably opposed to such a tax, largely because they would have to pay it. Those who would have to pay are individuals and families who have through work or inheritance gained portfolios of assets, like shares and property, which can be traded and generate significant income, but only rarely is tax payable on that income.
This is all perfectly legal, incidentally. The suggestion, widely held in some circles, that New Zealand’s wealthy are evading tax is erroneous, according to Elliffe. Yet behind the legal status of tax is a moral calculus, dating back to centuries to Adam Smith’s four general principles of taxation. The first principle Smith identified is known as the ability-to-pay – that people should “contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities”. Proponents of a capital gains tax suggest that by leaning so heavily on the income of individuals and companies, and barely touching established wealth, we violate this principle.
To Elliffe though, it’s not just about fairness. It’s also a pragmatic response to the changing makeup of New Zealand’s population. Demographer Paul Spoonley calls New Zealand a “hyper-ageing” society. The population aged over 65 will soon exceed those aged under 15, and continue to rise from there. This is a massive change – as recently as the 90s there were twice as many young people as superannuitants. There are three factors which distinguish the fast-growing population of over-65s:
- They are the wealthiest group of New Zealanders, by far
- They are almost all eligible to receive a relatively generous superannuation payment, which is not means-tested
- They are the largest users of the healthcare system
It’s worth underlining that these are true of the cohort, though clearly not true of all over-65s. Still, the aggregate data does not lie. Add to that the fact the working age population is projected to markedly shrink over time, just as we see growth in the proportion of beneficiaries (including those on pensions), and you have an unsustainable situation. “You can almost see it on a yearly basis,” says Elliffe. “The forecast is for there to be a significant decline in the income producers [to create] labour income, versus the recipient of benefits. Then on the expenditure side, there will be a doubling of superannuation contributions relative to GDP in 20 to 30 years. And the same is true for health care costs.”
(An aside: It’s not strictly true that New Zealand has no capital gains tax. There are a number of limited situations where it does apply, most notably the “bright line” rule when applied to property sold within 10 years of being purchased, with some exceptions. But as a proportion of income created and revenue raised, its contribution to the tax base is negligible).
All eyes on April 26
Next Wednesday, revenue minister David Parker will make a speech to accompany those reports from Treasury and the IRD, which will give the most powerful insight we’ve ever had into the real economic incomes (as opposed to taxable incomes) of the wealthiest New Zealanders. If, as seems likely, they reveal enormous incomes which attract a relatively small tax contribution, that sets the stage for a policy response – potentially a reversal of Ardern’s position on capital gains tax.
The history of tax in New Zealand says that arguments around tax are awfully difficult to win, and Labour has learned to be wary of the political backlash to the spectre of new taxes. But National claims to be the party of business, and the current system has a looming income and expenditure mismatch which cannot be solved without some form of drastic change to the government’s revenue model.
There is also a relatively recent political memory of a right-wing approach to tax changes which Parker has studied. That was Bill English’s “tax switch”, when he raised GST to 15% while lowering the amounts paid across all income tax brackets. Parker has studied that move, and in a speech a year ago spoke admiringly of how it was carried out. “While I did not agree with the proportion of that ‘tax switch’ that went to higher-income earners, the way he carried that debate was a masterclass in the politics of changing the tax mix.”
If the introduction of a CGT was accompanied by a meaningful reduction in income tax, it would be an opportunity for Parker to implement a tax switch of his own, and potentially leave a legacy of having meaningfully changed to tax system, not only to make it fairer, but to make it function at all in years to come. After a few months of shredding sacred policies, getting this one epochal change across the line might be enough succour for the old guard of Labour to feel like something profound came out of their term in absolute power.