Editorial: Tax proposals set tough test for Govt mettle

Investors in rental property have been singled out, but only because that sector is, in the words of the tax working-group report, 'systemically under-taxed'. Photo / Janna Dixon

Predictably, a group representing landlords has reacted with hostility to the recommendations of the Government-appointed tax working group. They were "an orchestrated attack on residential landlords", said Andrew King, of the Property Investors Federation.

To a degree, he is right. Investors in rental property have been singled out, but only because that sector is, in the words of the report, "systemically under-taxed".

The working group's report is realistic, rather than radical, rejecting the likes of a capital gains tax. It could have been far worse for Mr King's federation.

The failure to reach consensus has drawn some of the working group's teeth. Nonetheless, its prescription is one the Government cannot ignore if it wants a fairer, more coherent tax structure.

The group's starting point is that the tax system was broken long before the recession created a $2.5 billion hole in Government revenue. New Zealand relies too heavily on the taxes most harmful to growth, especially corporate and personal income taxes. Savings, investment and productivity are hampered, and emigration is encouraged.

Sensibly, the group wants the top personal, company and trust tax rates aligned, probably at 30 per cent, and the corporate rate competitive with that of Australia.

To offset those cuts, the group identifies the property market as "a major hole in the tax base". Perhaps the most salient figures in the report are those that illustrate how much the tax system favours investing in rental property.

In 2008, the $200 billion investment in rental housing generated net rental losses of $500 million, thereby reducing tax income by about $150 million.

The working group suggests several ways to address this. The first is the setting of an assumed rate of return on rental properties that would stop investors claiming big losses.

Another is a low-rate land tax. The third is the removal of the ability to claim tax depreciation on buildings - something that has always appeared odd, as buildings usually rise in value, dramatically so when the market becomes overheated.

The working group has reservations about an assumed rate of return on rental properties. It points to "integrity issues" and says further work is required to understand the full implications.

That will lessen its attractiveness to the Government, which may be more inclined to the relative simplicity and bigger tax haul of an annual tax liability on landowners. Yet that will not address rental tax advantages.

Even with building depreciation ruled out, these would remain numerous, perhaps enough so for rental property to remain attractive.

The most controversial recommendation is probably that of raising GST from 12.5 to 15 per cent to further help offset tax cuts. The working group says this would reduce the tax bias against saving and investment.

Any increase, however, would require compensation to those on lower incomes. That points to a political fight.

It is one for which the Government is well equipped, given that any reining in of property investment would involve mainly its own supporters. Those identified by the Revenue Minister as using highly geared rental properties to reduce taxable income and so qualify for Working for Families assistance are also unlikely to vote Labour.

The Government says it will assess the report for "the best and most practical ideas". It will be easy for it to implement the popular options, especially tax cuts.

But this is about more than politics. It is about creating a tax framework that plays a pivotal role in creating sound public finances and economic prosperity. That will involve hard choices in this year's Budget, which will be a measure of the mettle of the Key Government.