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Home / Business / Personal Finance / Tax

<i>Brian Fallow:</i> Why there's no saving grace to mortgage levy

Brian Fallow
By Brian Fallow,
Columnist·
14 Feb, 2007 04:00 PM6 mins to read

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Brian Fallow
Opinion by Brian Fallow
Brian Fallow is a former economics editor of The New Zealand Herald
Learn more

KEY POINTS:

The idea of a mortgage rate levy is about as dead as a duck can be. We have the Prime Minister's word for that.

But the problem that engendered the proposal is alive and well.

And it is too serious a problem for any potential way of addressing
it to be rejected with barely a nanosecond's reflection.

A hostile reaction to any proposal, however tentative, that puts "house" and "tax" in the same sentence was inevitable.

Remember the McLeod tax review?

It called for substantially lower income tax rates, but also for a broadening of the tax base by introducing a wealth tax. At plausible values for bond yields and inflation it would have amounted to a little more than 1 per cent a year of the value of people's assets including - horror! - their houses.

The reaction to the second part of the proposal - the first was instantly overlooked - was an upwelling of lava from the netherworld of talkback radio that killed the idea within hours.

So six years later we still have the problem of a dangerously narrow tax base, with nearly half of the tax revenue coming from taxing company profits and the incomes of the lamentably small minority of taxpayers who earn more than $60,000 a year.

The result is company and marginal personal tax rates that are increasingly uncompetitive in a world where capital is mobile and so are people who are, or can realistically aspire to be, in the top income bracket.

The knee-jerk rejection to the McLeod committee's proposal - the product of many months' research, reflection and consultation - has not served us well.

Tax is also fundamental to the issue that the Reserve Bank and Treasury are grappling with: How can monetary policy "get at" the household sector?

How can you slow the economy down to curb inflation except in the most destructive way, by driving up the exchange rate and clobbering the export sector?

The issue is not the switch from floating to fixed mortgage rates, not really.

The real problem is the way the fixed-rate loans are funded. It is our abject reliance on imported savings.

Other countries like the United States have long had fixed-rate mortgages, and fixed for much longer terms than two or three years, but no one suggests the Federal Reserve is impotent.

If it means official cash rate rises take longer to bite on the mortgage belt, then it means the Reserve Bank has to scan a more distant horizon in setting policy, be more aggressive when it does decide to tighten and be more patient while it waits for the tightening to work.

No doubt that makes monetary policy harder to do. It is understandable if the bank gets wistful and nostalgic for the days when most mortgage debt was at floating rates.

From that standpoint a variable levy that would in effect turn fixed rate loans into floating ones - giving monetary policy more traction - is only a return to the good old days. Is that so bad?

But there are some obvious problems.

Who would decide what the levy should be? Delegating the power to raise and lower a tax to an unelected official, the Governor of the Reserve Bank, would take us into uncharted constitutional waters.

If Parliament were to give him that power, it would be hedged with conditions and accountability that might undermine the bank's operational independence.

If the power was instead given to the Minister of Finance, we could have two people trying to do monetary policy at the same time. Not a good idea.

Home buyers have opted for fixed-rate loans not only because they have been cheaper for some time but because of the certainty they give.

Erect a wall between them and what they want to do and they will quickly find ways around it, ways to burrow under it or pole vault over it.

The most striking thing about the proposal is that it sought to put a wider wedge between the interest rates borrowers pay and the rates the savers funding their loans receive.

Isn't the point of raising interest rates when you want to slow the economy not only to discourage borrowing but to encourage saving?

The fact that policymakers would contemplate a regime that weakened the second half of the interest rate effect looks like a white flag of surrender on the prospects of encouraging a savings culture in New Zealand households.

It only makes sense because about a third of the banking system's funding comes from savers in Japan and other foreign lands. And the term of that funding neatly matches the terms of fixed-rate home loans.

More than $50 billion worth of uridashi and eurokiwi bonds are on issue.

It is a tsunami of cash that has flowed into the New Zealand banking system, for the most part over the past three years when the Reserve Bank has been trying to tighten monetary policy.

And all of it represents yen, euros and so on that had to be swapped for New Zealand dollars, driving up the exchange rate.

The real question, then, is why New Zealand households are so keen on borrowing and buying houses and so uninterested in saving.

The answer is that they are responding to the clear and consistent message that the tax system has given them for the past 20 years.

It is not just that the tax laws are especially benign to investors in property.

It is that the regime Roger Douglas introduced in the 1980s for the tax treatment of retirement savings is a brutally penal one.

It is called TTE: after-tax money that goes into managed funds or other financial instruments. The income it generates is taxed. And savers have to take it on trust that it will be exempt when eventually they get it back.

Few developed countries, if any, have as discouraging a regime. In opposition Michael Cullen called it a gigantic exercise in intergenerational theft.

In office, while he has made other changes to encourage saving, he has not overturned the toxic Douglas legacy of TTE.

No doubt the fiscal cost would be high.

But he can hardly complain if people have got the message coming so loud and clear from the tax laws: Save through financial instruments and you will be taxed until your eyes water; leverage up and buy an investment property and you will be able to deduct just about every expense and face no capital gains tax when you sell.

People also regard the roof over their own heads as a form of saving, oddly confident that they will be able and willing to trade down when they retire, though if they are babyboomers there will be lots of their contemporaries trying to do the same thing at the same time.

It is not, ultimately, the monetary policy framework that is making life tough for exporters and firms which compete with imports.

It is people's entirely rational response to massive distortions in the tax laws.

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