Bernard Hickey: Key sidesteps tough tax reform decision

Prime Minister John Key promised in his speech this week to deliver reforms to our tax system that would deliver a "step change in the New Zealand economy".

Instead, he executed a giant sidestep that avoided the tough political decisions needed to ensure our kids and grandkids grow up here rather than somewhere east or north.

Key rightly identified the core problem: New Zealand has over-invested in property and under-invested in the productive sector, particularly the export sector.

Without that productive investment, we are starved of the productivity juice needed to grow real wages fast enough to keep emigration at bay.

It's no accident that while baby-boomers partied through a property boom, no new jobs were added to our export sector. Almost one in four New Zealand-born graduates now live overseas, the highest rate in the OECD.

Here's why Key's decision to tax property only lightly and exchange a higher GST for slightly lower personal income taxes is just a sidestep:

1. Residential property worth $600 billion remains virtually untaxed.

Key suggested after the speech that depreciation on buildings as a taxable expense was likely to be removed. But the Tax Working Group estimated that could only bring in $1.3 billion if it was applied to all buildings.

KPMG has since pointed out that 70 per cent of that cost would be borne by commercial property owners, many of whom are owner-operated businesses. That means residential property investors face a maximum tax hit of $390 million on assets worth $213 billion (0.18 per cent).

Most tax experts believe that $1.3 billion is a maximum figure and many property investors will be able to prove actual depreciation and avoid being hit.

2. The GST hike fixes nothing. The proposed hike in the GST rate to 15 from 12.5 per cent would nominally raise more than $2 billion, but the Tax Working Group pointed out that compensation to poorer taxpayers would mean the net benefits would be closer to $200 million.

Key suggested after his speech that the compensation would come in the form of reductions in the lower 12.5 and 21 per cent income tax rates, plus increases in benefits.

That would be better than Working for Family-style tax rebates suggested by the Tax Working Group. But it still raises the question: why bother employing a whole bunch of bureaucrats to administer the compensation when the net benefit is so small?

It leaves little fiscal headroom for a significant reduction of the top income tax rate of 38 per cent or the corporate tax rate at 30 per cent, which may be necessary if Australia cuts its rate from 30 to 27 per cent (or even 25 per cent).

It will be very difficult to equalise the top personal tax rate, the family trust rate and the corporate tax rate with such a small increase in new revenue. That is what is needed to stop the property tax avoiders.

3. There isn't enough money to make a difference.

Without a land tax or a capital gains tax, the net revenue raised from denying depreciation on buildings and a couple of other changes would raise around $2 billion net.

Key said after the speech the "across the board" income tax cuts would cost $3 billion to $4 billion.

4. The GST hike could prove politically difficult.

Key pledged before the election that he would not need to raise GST if he was a half-decent manager of the economy. This doesn't look good.

It also reduces the likelihood of any sort of politically sustainable "grand coalition" with Labour to shepherd a wide-ranging tax reform programme through Parliament.

5. The new tax system would not be broad enough.

A land tax or a capital gains tax would have captured that part of the economy that is effectively untaxed at the moment.

A land tax that included a tax-free threshold of say $50,000 and the ability to defer payment until the property is sold would have hurdled the political problems of grumpy grannies in Remuera and shirty farmers.

Instead, the tax system will be focused on extracting more income from those PAYE taxpayers who are unable, unwilling or ignorant enough not to have bought rental investment properties.

It will have failed the Tax Working Group's drive for a fairer, broader and flatter tax system to cope with an impending increase in government spending needed to pay the health care and baby boomer pension costs.

Little will have changed. We will continue to leak our best and brightest, leaving in their wake a hollowed out economy filled with retiree landlords, beneficiaries and immigrants.

bernard.hickey@interest.co.nz