Bernard Hickey: Political bomb could level tax landscape

A bomb is about to go off in the political and economic landscape. As you read this, visit open homes and go Christmas shopping, we are shifting towards a debate about the structure of our tax system and economy that could prove politically explosive.

These changes could wipe $100 billion off wealth tied up in the property market, and add $26 a week to the average rent.

The Government-commissioned Tax Working Group is now writing its final recommendations to John Key and Bill English. They will have plenty to chew on with their ham and trifle.

The Government will be challenged to deliver tax reform that is not radical enough to break election promises, but it will cause enormous angst for National's support base.

The group of officials, business leaders, academics and bureaucrats cannot be ignored in the same way Don Brash's 2025 Taskforce was. Its proposals will be robust, realistic and largely a consensus of the "sensible" types across Government and business.

It is likely the group will recommend an equalisation of tax rates. Currently, individuals are hiding wealth in the loopholes between the top income tax rate of 38 per cent, the family trust rate of 33 per cent and the corporate tax rate of 30 per cent.

Most wealthy New Zealanders avoid paying the 38 per cent rate by investing in property, even if it means they make losses. They can offset them against personal incomes.

The Inland Revenue Department has estimated rental property investments worth $200 billion generated losses of around $500 million last year and reduced tax payments by more than $150 million.

The group is also likely to recommend a 0.5 per cent land tax and possibly a tax on equity invested in rental property.

These seem like moves that will not break election promises, but when the property-owning classes behind National work out what it means there will be a cacophony of protest.

Westpac has forecast that an equalisation of the tax rates at 30-30-30, along with a 0.5 per cent land tax would reduce median property prices by 16.9 per cent and increase rents by 8.4 per cent as landlords scramble to stop making losses on their property and lift yields.

This will be a true test of Key's ambitions for economic reform. Will he surprise everyone by taking on his support base the way he did with the anti-smacking bill?

Will he listen to his best advisers, who will tell him these are the first measured steps to reform? Will he put the interests of National party supporters ahead of those of Generations X and Y, who may opt for better real wages in Australia?

If Key and English choose to make these reforms in the 2010 Budget, the bomb will go off. If they take the easy option they can defuse the coming backlash. That would be a pity, and show they are politicians rather than reformers.