Bernard Hickey: Tangle created by top tax rate

Some describe the past decade as the "naughty noughties" because of the amount of debt accumulated through the Western world that triggered the global financial crisis.

It was also a naughty time for New Zealanders, particularly after the Labour government introduced the 39 per cent tax rate for those earning more than $60,000 a year.

Inland Revenue data shows how hard Kiwis worked to avoid paying that rate.

Firstly, the number of taxpayers declaring relatively high incomes plunged.

In the five years from 1994 to 1999, the number of taxpayers who declared more than $1 million in income grew more than 35 per cent, but that figure hardly grew from 1999 to 2008.

Yet the period from 2002 to 2008 was the most prosperous in New Zealand's history, creating thousands of new millionaires.

However, this new wealth was structured in family trusts and LAQCs (loss attributing qualifying companies) to ensure it was taxed at a maximum of 33 per cent rather than 39 per cent rate.

Income declared by trustees rose from $2 billion in 2000 to almost $10 billion in 2008. Losses generated by LAQCs rose from around $750 million in 2003 to around $2.25 billion in 2008.

Westpac economists estimate much of this tax avoidance focused on buying investment properties put into family trusts and LAQCs to reduce taxable incomes.

This helped drive up property prices.

It was the unintended consequence of Labour's high tax rate, generating a property boom and a boom in the tax avoidance industry.

This in turn fuelled demand for extra income from middle-class families stung by higher property prices.

This led to Working for Families, which in turn created monstrously high marginal tax rates.

Our tax system is now an unfair, unworkable mess needing reform.

Let's hope the Government that inherited the mess doesn't feel too beholden to those rorting the system now and fixes it.

A land tax and an equalisation of the income, corporate and trust rates would capture those currently sheltering more than $12 billion of income.

New Zealand faces decades of higher pension and health care costs that will be unsustainable without a broader, fairer tax system.