Savings infertile without gains tax

By Brian Fallow

Between the lines


Even if the hideous current account deficit forecast by the Treasury proves to be on the gloomy side it is a salutary reminder, ahead of the election, that we are not paying our way in the world.

As for the individual, so for the country: we can live beyond our means so long as we are in a position to run up debts and sell off assets to fund the shortfall.

But in the process we are progressively reducing ourselves to being tenants in our own country.

The current account deficit can be seen as a measure of the extent to which savings in New Zealand fall short of funding investment in New Zealand.

The key to reducing that reliance on the savings of foreigners, everyone agrees, is to get household savings rates up. But how?

Treasurer Bill English, asked yesterday what the Government was doing to alter our spendthrift culture, cited tax cuts.

In theory, tax cuts boost disposable incomes out of which savings are made, and increase the incentive to save by raising after-tax returns.

In practice, the incentive is blunted by anomalies in the tax system.

The Investment Savings and Insurance Association has raised concerns about differences between actively managed and passive funds in terms of the taxation of capital gains.

There is also the unresolved problem that the income generated by peoples savings is often taxed at a much higher rate (12c in the dollar more) than their other income is.

But the biggest anomaly of all is that investment in some forms of financial assets, like managed funds, attracts capital gains tax while other forms of investment, notably in bricks and mortar, do not. In addition the interest cost of money borrowed to buy investment properties is deductible.

There is a theoretical argument, Mr English said, that the absence of a capital gains tax on investment properties is a distortion. "But trying to resolve that is impossible in practice and we are looking for practical schemes."

In other words a capital gains tax on residential properties is politically radioactive.

That is unsurprising given that households have about 70 per cent of their assets, or a bit over $200 billion, in housing (offset by $54 billion in mortgage debt), compared with $42 billion in the bank, $26 billion in superannuation funds and $28 billion in other financial assets.

Even with 73 per cent of homes owner-occupied, that leaves 27 per cent of dwellings that are rentals a substantial amount of investment to be tax-privileged.

New Zealand is unusual among developed countries in not having a capital gains tax regime. Maybe we need to debate the proposition that the absence of one not only puts more pressure on other kinds of taxation but channels savings into economically infertile forms.