Mark Keating: Low-tax threshold fairest option for all

Property investing will become tax-disadvantageous. Photo / Supplied

Changes to the tax system recommended by the Tax Working Group will create winners and losers.

The group was instructed that any changes had to be tax neutral overall. So any reduction in tax in one area had to be compensated by an increase in another.

In practice this meant changes will benefit some taxpayers at the expense of others. So the new taxes will "rob Peter to pay Paul".

Most of the public responses by individuals or groups have reflected whether they will gain or lose under the proposals. Obviously the biggest losers will be private investors in domestic rental properties.

The current tax regime that incentivised rational taxpayers to invest in the property market (full deductibility of all expenses, the ability to offset any annual loss against other sources of income, and the non-taxability of eventual capital gains) are likely to be removed or reduced.

While a full capital gains tax will not be introduced, the "associated persons" provisions were already widened last year to extend the range of taxpayers liable for existing income taxes on the sale of property.

The introduction of a new property tax will only compound the amount of increased tax payable by such investors.

Property investing will become tax-disadvantageous, which will presumably drive many landlords from the sector and, over time, reduce the cost of housing.

The Government is hoping investment will be redirected to other areas.

It is clear the Government is comfortable about increasing taxes on the property sector. Such taxpayers can only hope the increased taxes payable under the proposed changes are offset by the corresponding introduction of lower personal tax rates - provided they earn sufficient other income to enjoy these reduced rates of tax.

It is high-income employees who will be the biggest winners under the proposals with reduction in personal tax rates on incomes over $70,000.

By contrast with its treatment of landlords, the Government seems less hard-nosed about the proposal to increase the rate of GST from 12.5 per cent to 15 per cent, which will affect everyone, particularly low-income taxpayers.

Our rate of GST is low by comparison with rates imposed in most countries.

An increase to 15 per cent would still leave New Zealand's GST below almost all OECD countries, which range from 5 per cent in Japan up to 25 per cent in Scandinavian countries. Even with GST at 15 per cent only three countries, including Australia with a rate of 10 per cent, would still have lower rates.

Taxpayers who spends their entire net income of $40,000 on goods and services in New Zealand pay $5000 GST. If the rate is increased, that same taxpayer would pay $6000 GST.

The National Government has been quick to reassure low-income taxpayers they will be compensated for any increase in GST. For taxpayers on the average benefit of around $15,000 net a year, GST would go up from $1875 to $2250 - an increase of less than $10 a week.

Interestingly, when GST was introduced at the rate of 10 per cent by the Labour Government in 1996, significant compensation for low-income taxpayers was provided.

Yet when GST was increased to 12.5 per cent by the same Government in 1999 no meaningful compensation was given on the grounds the increase of only 2.5 per cent was too small to warrant additional widespread assistance.

Under an increase in GST up to 15 per cent, low-income taxpayers and beneficiaries would pay a small increase, while the average taxpayer on $40,000 a year would pay about $1000 more.

The cost of calculating and distributing the amounts necessary to compensate each of those taxpayers is likely to exceed that small amount of additional GST payable.

One answer to this problem, which surprisingly was not considered by the Tax Working Group, is to provide a low-tax threshold below which income is exempt. New Zealand is virtually alone in imposing tax on the first dollar taxpayers earn.

Most countries provide either a nil rate of tax on the lowest level of income or provide rebates and allowances that shelter such small amounts. For instance, Australia imposes no tax on the first $6000 of income earned. Canada provides a rebate for the first $1500 of income.

Only in New Zealand are all taxpayers, including children working part-time jobs, immediately brought into the tax net.

Surely the additional bureaucracy cannot be worth the small amounts of tax collected?

Introducing a small exempt-income threshold or low-income rebate in New Zealand would immediately compensate taxpayers for the small increase in GST proposed.

For instance, making the first $2000 of income exempt would provide an additional $270 to all low-income taxpayers and $420 for taxpayers on the average wage.

This is the most efficient way to ensure vulnerable taxpayers are not the losers under the tax reform proposals.

* Mark Keating is senior lecturer in tax law at the University of Auckland Business School.