KEY POINTS:
New Zealanders do not save enough. So why is the Government taxing the interest they earn on savings? This does little to encourage savings and misses an opportunity that should be grasped in the current financial crisis.
One of the many causes of the crisis can be found in steadily decreasing levels of personal and company savings, and in the over-reliance on credit, which has come to pervade the spectrum of financial market activity.
In the current stressed economic conditions, one key issue is the availability of cash within banking systems.
Thus, any measure that would favour increased cash flow within banks may limit the effects of the current financial crisis, and avoid similar serious malfunctions in the future.
Furthermore, any measure that encourages individuals and companies to save limits the effects of downturns and financial crises.
For these reasons, promoting savings would benefit both the financial sector and individuals and companies whose operations depend upon the efficient and secure functioning of economies.
Additionally, while savings do not generate the kind of economic growth and consumer spending that credit can, the steady accumulation of funds available for reinvestment is able to provide economic solidity.
Traditionally, the three main reasons people save are:
* To be able to face future uncertainties.
* To be able to pay for education and/or retirement.
* To be able to pay for holidays and/or deposits on major items such as a car or house.
The interest rate paid on savings in banking institutions does not constitute a payment for services, and cannot be usefully regarded as an instrument to enrich those who save.
Rather, the goal of such interest payments is to provide a counterweight to inflationary pressures, so that money saved today has more or less the same purchasing value tomorrow.
In this situation, bank interest paid on savings acts as little more than a purchasing-power guarantee.
In New Zealand, the Government taxes interest on savings at the regular income tax rate. This can reach 39 per cent a year. The same rate of tax is imposed whatever the interest rate offered, and is withheld by the banks.
If you deposited $1000 last year and the average interest on that was 4 per cent, you would be left at the end of the year with $1040 before tax.
However, this will be taxed. If your average income tax rate is 20 per cent, instead of $1040 you will in fact be left with $1032. Consider the effect of this over time when the inflation rate increases.
The imposition of any tax on interest earned on money in a bank account, regardless of rates of inflation, will lead to that money losing value over time. In that sense, taxation of interest on savings works as a double taxation on income by discouraging savings over time. Its effect could also be seen as a disguised capital gains tax.
In the previous example, if inflation is at 4 per cent, you would need $1040 at the end of the year to buy the same things that you could have bought the previous year with your initial $1000.
A year later you can't. Ten or 20 years later, when it is time to pay for your children's university education, you have to tell them that they'll need a loan.
If the absolute value of savings decreases over time as a result of taxation, the immediate impact is that income earners are deterred from saving, and overall savings levels will drop.
New Zealand provides a perfect example of this process at work. Indeed, New Zealand's household savings performance is among the worst in the OECD. Despite strong economic growth over the past decade, household savings rates in this country have consistently declined, and they compare poorly with those in Australia, the UK, the US and Canada.
Any measure that, in effect, leads to the taxing of interest on savings constitutes a deterrent to savings. In adhering to such fiscal policy, the Government delivers an unmistakable message to savers, and potential savers, that they will be penalised for accumulating reserves in the bank.
The taxation of interest on savings is unfair because it punishes people who save money by limiting or reducing their future purchasing power.
This form of taxation is generally perceived as unjust because it decreases the value of money which has already been taxed once at source.
As a savings deterrent, it has significant negative effects on the soundness of the economy and exposes it further to credit crisis issues.
The recent deposit guarantee scheme that was proposed may help promote savings over other types of investments - but will, in fact, do nothing to improve savings generally over credit. One measure that would be well-received by the public and contribute to limiting the consequences of the current financial crisis over the long term would consist of taxing only that portion of interest on savings that exceeds the level of inflation.
* Jean Albert is a specialist in international law and consultant on taxation, trade and competition.