Brian Fallow: Being wealthy isn't too taxing, finds Inland Revenue study

The average wealth of those in the IRD study was about $270 million. Photo / 123RF

How much tax do the rich pay and to what extent is their wealth merely the accumulated store of tax-paid income?

A report written by Inland Revenue officials two years ago — and now to be found among the officials' advice to the tax working group chaired by Sir Michael Cullen — sheds light on these questions, even though it is heavily redacted.

It looks at a group of 212 people the tax department classified as HWIs (high wealth individuals) worth at least $50 million and on average some $270m. So we are talking about the seriously wealthy, not the merely well-to-do.

The research was commissioned to critically examine the contention, espoused at a conference of accountants, that when it comes to taxing wealth, income tax already does the heavy lifting.

Spoiler alert: it does not.

Or, in the careful language of the IRD report, "we do not feel we have found evidence that wealth is simply a store of tax-paid income." That conclusion is based on IRD's review of data for the HWI "population" as a whole and on 18 detailed and, they reckon, representative case studies we are not allowed to see.

"While in absolute terms a large amount of wealth is taxed as it accrues, such as business profits or passive income, our data shows that the majority of tax (83 per cent) is paid by a minority of the [HWI] population (25 per cent) with the great majority of the wealth being generated by realised and unrealised gains on capital assets."

In 2014, the 212 high wealth individuals, including companies and trusts they controlled, paid $658 million in income tax. Not a trifling sum.

But this is a group whose estimated wealth was $58 billion. The estimate comes from the National Business Review Rich List. The IRD does not have precise data on taxpayers' wealth.

It does, on the other hand, have the data from tax returns and audits, stretching back years. So it is in a position to say how much of their reported income was taxable.

And 17 years' worth of information on income flows should give it a reasonable idea of the stock of wealth at the end of it.

It found that the tax paid by HWIs in 2014 was highly concentrated. More than a third of it was paid by just 10 of the 212 HWIs, and 83 per cent of it was paid by a quarter of the HWI population.

We don't know from the publicly available information whether they were the richest of the rich, or those who were less concerned or less able to minimise tax.

But taking the estimated average wealth of the HWI population, the tax paid by three-quarters of them would have amounted to less than three-tenths of 1 per cent of their wealth. "Onerous" is not the word that comes to mind.

The review found that more than a third of the core wealth controlled by the HWI population is untaxed, having been derived from one of these sources:
• Establishment of a new business subsequently sold, or its value crystallised in a public listing
• The acquisition and sale of an existing business or businesses
• Long-term property investments
• Long-term investment in other passive investments such as shares

Leverage plays an important part, with interest costs deductible and possibly contributing to tax losses carried forward. Leverage also amplifies the untaxed capital gain if the business flourishes and is subsequently sold or listed.

In close to all cases the [wealthy group] got its initial capital base from the non-taxable sale of a business or capital asset.

IRD report

"From our observations and discussions with the HWI team, in close to all cases the HWI population got its initial capital base from the non-taxable sale of a business or capital asset," the report says.

Untaxed realised capital gains in 2014 for the HWI population were $461m. Their combined taxable income was $2.4b.

Collectively they were also able to claim $3.7b in tax losses to carry forward. "As this population built up its wealth over many decades it is not clear to us the basis of these losses," the report says.

The report was written for IRD's internal purposes in 2016, before the change of Government and the commissioning of the Cullen tax review. But it is highly relevant to its task.

The broader context is that New Zealand is notable for government's heavy reliance on personal income tax. At 12.6 per cent of gross domestic product, it is the fifth highest in the OECD, where the average is 8.4 per cent.

It is not as if the income tax scale is all that progressive. The top marginal rate of 33 cents in the dollar is the seventh lowest in the OECD and there have been eight long years of fiscal drag since thresholds were last adjusted.

And we are exceptional for exempting from income tax most capital gains, even though they fall within a standard economists' definition of income.

We live in times when economies are becoming more capital-intensive and less labour-intensive, compressing the labour share of national income. If that is less evident in New Zealand, it is because our businesses are notoriously capital-shallow, and productivity the lower for it.

To the extent that capital income is under-taxed, this trend exacerbates inequality of income and wealth.

New Zealand is in the middle of the OECD pack in terms of the standard measure of inequality of market incomes, the Gini coefficient.

But it ranks ninth lowest among the OECD's 37 members for the extent to which tax and transfer settings are redistributive, that is, reduce the difference between inequality of market incomes and the inequality of disposable incomes. We rank as ninth worst in the OECD for disposable income inequality.