Frank Newman: Taxation review just one piece of the puzzle

The big news of the week is the release of the report by the government’s Taxation reform Group. The six main recommendations of the Group are:

1. To broaden the tax base beyond income tax and GST the Group recommended the introduction of a land tax of 0.5% of the unimproved land value of a property.
2. Increasing GST from 12.5% to either 15% or 17.5%.   
3. Reducing the 38% and 33% personal tax rates. The Group says it would like to see lower personal tax rates across-the-board to offset any increase in GST.
   
4. Aligning the company, top personal and trust tax rates [to avoid income transferring to minimise tax], and the company tax rate with other countries company tax rates, particularly Australia. [At present international companies shift NZ income offshore to lower taxed countries.]
5. To address what it calls the “under-taxing” of rental property the Group recommends taxing capital invested in residential rental properties on the basis of a deemed notional return calculated using a risk-free rate. It also recommends disallowing depreciation on buildings as a tax deductible expense.
6. Review welfare policy to reduce the disincentive to work due to high effective marginal tax rates. [Created in particular when the previous government introduced the Working for Families tax benefits.]
   

The report has been roundly criticised by various interest groups, including Federated Farmers and the Maori Party who have hit out at the land tax, and the NZ Property Investor’s Association. Andrew King from the Federation described the recommendations as "an orchestrated attack on residential landlords".

I agree. Residential property investors have been singled out and falsely accused as tax villains. The recommendations would have a negative impact on property prices should they pass into legislation. Highly geared property investors in particular (being most first-time property investors in the last five years) will be seriously affected as they are likely to have negative cash flow and little or no equity in their property.

I suspect the recommendations may have an immediate impact as would-be property investors sit on the sidelines to see how things develop. It would be a courageous investor who bets on a market when the rules of the game are about to change.

There is of course no certainty that the Taxation Review Group recommendations will be implemented. That decision is a political one, based on political and economic realities. Does National really want to face the wrath of farmers and landlords who have traditionally supported it and leave the door wide open to others like ACT or NZ First to take up the protest vote at the 2011 election?

In my view tax reform is a minor part of what should be a much bigger puzzle. Bureaucracies by their very nature grow and consume the wealth created through the enterprise and initiative on individuals. In this respect they are parasitic – they live off their host.

The fact is government spending accelerated exponentially in the recent years - the current tax system is not able to cope, so new ways to tax are now being devised. By the end of next year government spending (local and central) will account for about 46% of the total economic output (GDP). In other words $46 out of every $100 spent in our economy is spent by government. That $46 must be either gathered as taxes or borrowed by government (which is in reality deferred taxation).

That shows how far our bureaucrats have raided the economic pantry. In comparison, Hong Kong, which is regarded as one of the most free market economies in the world, has a convention which caps government spending to no more than 20% of the economy.

Regrettably the focus on the tax debate has been on how to gather more, instead of coming to an agreement on the size of government as Hong Kong has done, and how we can grow the economy to the benefit of all.

Frank Newman is the author of numerous books on investment matters, and has worked as a sharebroker, investment adviser and university lecturer. He was a member of the Whangarei District Coucnil for six years, and has business and investment interests. Frank's NZ Investment Game was judged best new game of 2009!