John Armstrong: Does Govt have the guts for change?

Lesser mortals would have been nowhere near as relaxed and unperturbed as Don Brash seemed to be after the Prime Minister put the kybosh on the radical recommendations of his 2025 Taskforce.

John Key made it patently clear what he thought of the report on closing the income gap with Australia produced by the Brash-chaired panel by commenting on its contents before its official release last Monday afternoon.

This tactic ensured neither Key nor Finance Minister Bill English would be ambushed by a report which the Prime Minister found politically toxic in the extreme.

Key's manoeuvre was designed to put Brash on the defensive. But there was no sign of that in Brash's reaction.

The man who relinquished the leadership of the National Party to Key greeted the putdowns with his usual unfailing politeness. Brash's genteel demeanour, however, only masked his steely determination if not to get his way, then at least to hold the moral high ground.

He repeatedly asked how Key hoped to attain his goal of income parity without implementing the sweeping right-wing reform agenda advocated by the taskforce.

However, it was Brash's assertion that Key and National are rating so high in the polls that they can afford to expend political capital on such a reform drive which will have struck a raw nerve in the Beehive.

While Key might rubbish the taskforce's recommendations, it is more difficult for him to dismiss the underlying question Brash was really posing his successor.

Has the Key Government got the guts to do what's needed to get its desired "step-change" in the New Zealand economy? Or is it going to play safe and just tinker between now and the next election?

Those questions were partly answered the following day at the conference at Victoria University organised by another Government advisory panel, the Tax Working Group, whose report is scheduled to be English's hands early in the new year.

While various scenarios on show offered some insight on where the group is heading, the proceedings were notable for the increasing pressure for a marked cut in company tax.

This is deemed necessary to keep New Zealand on a par with other economies, given its rate is now above the OECD average.

Lurking in the background is a similar tax review in Australia which is due to report to the Rudd Government this month.

That is expected to recommend Australia's company rate be slashed from 30 per cent - as currently applies in New Zealand - to a level as low as 25 per cent.

If adopted, such a rate would force the Government here to respond likewise or risk more capital flight across the Tasman.

If they really believe lower company tax rates generate economic growth, then English and Key should already be contemplating such a cut, if not something even more radical.

The tax working group has examined and ruled out the dual tax system operating in Scandinavian countries which taxes personal capital income at low rates while income from labour continues to be taxed at high and progressive rates.

It has looked more favourably - but with some reservations - at the even more radical example of Ireland where corporation tax has been set at 12.5 per cent since 2003, much to the chagrin of other European Community nations seeking greater tax harmony between them.

Alternatively, the Government might consider Singapore which has zero company tax for new local companies on the first $100,000 in profits for the first three years, a rate of 9 per cent for all companies for profits up to $300,000 and an overall rate of 18 per cent.

However, a substantial cut in company tax here would put paid to the New Zealand Government's "medium-term objective" of reducing the top personal tax rate and aligning it with the company rate and the trust rate for reasons of administrative simplicity and to stop people using companies as tax shelters.

Staring down the barrel of a possible decade of Budget deficits, English has imposed the condition on the tax working group that its recommendations are fiscally neutral. In other words, cuts in some taxes will have to be compensated by rises in others or by new taxes.

Raising GST could fund a big cut in the company rate. However, English and Key say they will need a lot of persuading to increase that tax, mainly because there would have to be associated cuts in personal tax rates for low-income earners for equity reasons.

Key has already ruled out a capital gains tax on the basis such taxes do not work very well and do not raise a huge amount of revenue. Privately, National concedes it would have a huge problem selling the idea, particularly to its own members and supporters.

Slightly more attractive is a land tax. That would be low in compliance costs and could raise large sums of cash.

However, a land tax has a major drawback. It would prompt an immediate drop in land values, with some estimates of as much as 17 per cent. That would hurt current landowners to the benefit of future ones. It would hit heavily mortgaged households in particular, potentially leaving them with negative equity.

It would also disadvantage those whose wealth is held in land as against other investments which now seem likely to escape the grasp of a capital gains tax.

English has not ruled out a land tax. It has the added advantage of a one-off cooling of the housing market. And one way to soften the impact would be to bring it in gradually.

However, like capital gains and property taxes, land taxes are difficult to sell politically, not least because the tax would probably be paid once a year in a lump sum. At a rate of 0.5 per cent, that would mean a $1500 bill for someone owning a house with a land value of $300,000.

In that vein, English told the Tax Working Group's conference that tax changes that are widely understood and which are supported by taxpayers make the most difference to economic performance and tend to stick. Those without public backing do not last.

Despite that reservation, property investment seems to be English's likely target, with limits on losses claimed against other income or a change in depreciation rules.

But if English wants to do something major, the logic points towards a land tax as a means of broadening the tax base. Such a tax would bring in $2 billion at a rate of 0.5 per cent.

Finding another $400 million on top of that would enable English to cut the top personal tax rate from 38 to 30 per cent and the company rate to 25 per cent.

Such a scenario was presented at the tax conference. It is probably at the boundary of English's comfort zone.

We may have to await next year's Budget to find out.

But the permutation of tax rates English settles on will indicate whether he and Key are men or mice when it comes to doing something bold to lift New Zealand's flagging economic game.