Institute of Chartered Accountants of New Zealand
Thank you for inviting me to address your conference today.
The big tax news this week has obviously been the Tax Review's final report to the government. Because of the importance of the review, I shall devote a good part of this speech to it, before updating you on other tax policy matters.
I note that the Chair of the Review, Rob McLeod, is to speak after
me, followed by one of his colleagues, David Patterson.
I will leave it to them to discuss the contents of their report and why they came to the conclusions they have.
I want to do three main things today:
- outline why the government established the review - what was the context and what did we expect it to cover.
- discuss the key messages that the government and I take from the review's work.
- and talk about what happens next - what the government is going to do with the review's recommendations.
But before doing that, I want to thank Rob, David and the other members, Shirley Jones, Srikanta Chatterjee and Edward Sieper, for the work they have done.
They were charged with looking at the broad architecture of our tax system and assessing whether it is adequate for today's needs. The inquiry was to be independent and wide-ranging. It has been both.
The result is a report which would clearly not come from the Labour Party Policy Council but that was never the intention. We would not need a review if that was what we wanted.
What we have instead is a resource which I hope all political parties will draw from as they prepare their manifestos for the 2002 election campaign.
The last comprehensive structural tax review was the McCaw Report of 1982. It was established on the recommendation of the Planning Council which wrote, and I quote, "Our tax system is in pressing need of reform. It may have served us well in the past, but it has been distorted by the effects of high inflation.
"Other anomalies and inequities have emerged as a result of concessions and incentives introduced piecemeal by governments for particular purposes, and because of loopholes in the law, which allow large-scale legal tax avoidance."
The marginal tax rate of someone earning the average wage was nearly 50 cents in the dollar. For someone in the highest income bracket it was 60 percent, effectively 66 percent with the surcharge added.
The tax burden on middle income wage and salary earners had increased significantly relative to the tax paid by companies and the self-employed. People on similar incomes and in similar circumstances could pay very different amounts of tax.
The task force proposed radical structural change including lowering personal tax rates, introducing a less progressive scale of rates, taxing fringe benefits, and reviewing wholesale sales tax with a view to introducing a value-added tax.
The task force also recommended removing or reducing concessions and incentives, and making various business tax reforms, including changes that resulted in today's imputation regime.
Many of these recommendations have since been implemented with the result that we now have a broadly based tax system with much lower tax rates and a much more even taxation of different sources of income than in the early eighties.
But the McCaw Report predated such significant developments as the deregulation of the financial sector, New Zealand's increasing exposure to the global economy, and the development of electronic commerce.
It was again time to ask the fundamental question: does our tax system meet our needs, both now and into the future? The 2001 Tax Review was appointed last October with a brief to examine the structure and effects of the present framework and to make recommendations for improving it.
They were to do this within a context of fiscal neutrality. They were not to recommend cuts in expenditure, but were required to support the government's spending targets.
For our part, we committed ourselves to considering the review's report, indicating our views on the principles that should guide tax policy and developing concrete policy proposals for announcement before the end of this parliamentary term.
We were always careful to signal that we did not expect to pick up all the review's recommendations. We were also careful to state that we would not implement any significant new taxes without first seeking a mandate from the electorate through the 2002 general elections.
We will hold firm to that promise.
The review's report is radical politically in the sense that, if fully implemented, it would have a radical impact on the net incomes of thousands of New Zealand households and individuals.
However it is conservative in its assessment that the tax system is fundamentally sound and that major changes are not needed.
It is also conservative in its judgement that the reforms of the last twenty years have been right and should not be reversed.
It rejects new taxes, like a cash-flow tax; a financial transactions tax; wealth taxes or [with one exception] national eco-taxes.
But it can also be bold. It proposes to:
- tax savings and investment vehicles [which comprise a large proportion of the corporate tax base] and portfolio investment offshore using the "Risk Free Return Method"
- replace the current four-step personal tax scale with a two-step scale
- consider a widely-held/ closely-held regime for entities
- cap personal tax liability at one million dollars
- reduce taxes on new non-resident investment to 18 percent
- consider an active/passive regime for taxing offshore investment
- repeal the grey list for listed Foreign Investment Funds
- consider a carbon charge to meet our Kyoto commitments.
These are not marginal changes!
I do not intend to respond in full today to the review's recommendations only two days after the release of its report. That is for the second stage of the inquiry, in the coming months. I shall, however, make a few general remarks on some of the highlights of the report.
As you are no doubt aware, the government will not be introducing a tax on owner-occupied housing. In the end, the review did not recommend one, acknowledging that public resistance to the idea was too strong for it to work.
Neither does the government agree with the review's recommendation to remove excises on alcohol, tobacco, petrol and gaming, and then to make up the lost revenue with an increase to GST.
Rather, as we look at issues like a carbon tax to meet our international commitments on global warming, we will see if there are opportunities to remove some of the anomalies in the current regime.
The other big issue dealt with by the review is the structure of personal tax rates.
It has suggested a two-rate scale of 18 percent on income up to $29,500, and 33 percent thereafter. This would have the effect of taxing middle-income earners more to deliver tax cuts to people earning over $72,500 per year.
The logic here is the reverse of the Rob Muldoon logic of the 1970s. He used to argue that, because the bulk of taxpayers were in the middle income ranges, tax cuts were seldom feasible. The amounts of revenue lost would be substantial but the amount of gain to the individual would be inconsequential.
As I read the review, it seems to be saying that tax increases in the middle income ranges are feasible because the extra amount payable by each individual would be very small.
That seems like a general justification for indulging the better off: we can do it because there are not so many of them so it does not cost very much. Philosophically, it is not a rationale which sits comfortably with the parties which make up the government.
Labour cannot support a two-step scale as we favour a more progressive tax system than this model allows.
It is interesting to note that the review does not recommend the introduction of a general capital gains tax. The thinking is that it would increase the complexity and cost of the tax system. The government agrees with this analysis.
The recommendations in the review of greatest practical interest to the government are in the areas of international tax and entities and savings taxation as they have the potential to stimulate economic growth.
I will ask officials to incorporate consideration of them into our tax policy programme, although there are some design details and implementation issues to be worked through before any final decisions can be taken.
International taxation is especially pertinent, given the increased mobility of capital, individuals and businesses. Although tax is not the main driver of decisions on where to locate investment, it can exert some influence at the margin.
We need to keep our foreign investment laws under constant review as other jurisdictions are using tax rates to attract investment. For example, much of Asia offers a lower tax environment for non-residents than the 18 percent rate recommended by the review.
That said, I agree with the review's comments that governments need to be cautious before they depart from the broad base, low rate approach to taxes, even when pursuing increases in international competitiveness.
The review has recommended reducing the tax burden on foreign investment into New Zealand, especially direct investment. It has also looked at ways of targeting new foreign investment.
I find this an interesting contrast to those who call for a wholesale cut in the company tax rate. As the review notes, the company tax rate can impact quite differently on residents and non-residents.
For residents who invest in New Zealand companies, reducing the company tax rate can have a limited effect, due to our imputation system: the reduction in company tax is simply offset by increased taxes at the personal level.
For non-residents, the impact can be much more immediate and far-reaching, since lower taxes on non-residents can lead to a lower cost of capital for all New Zealand firms.
It also has an obvious attraction to me as Finance Minister as cutting the tax for non-residents is far less expensive to the revenue than cutting the rate to everyone.
Both the review and the government recognise that their proposals give rise to a number of issues that will require further work. For example, how could we ensure that a lower tax rate would apply only to new activities?
In the outbound investment area, the review has captured the conundrum perfectly.
I quote: "On the one hand, New Zealand does not want to induce our most mobile taxpayers to consider moving from New Zealand. On the other hand, New Zealand does not wish to adopt a built in tax incentive that causes people who remain in New Zealand to see a tax advantage in investing off shore rather than in New Zealand.
"But it is precisely this type of system that produces a tax incentive to invest off shore that is the international standard."
The review's preferred solution is that investment in listed shares and securities be taxed at a standard risk-free rate of return, no matter the country of investment.
I am interested in this idea because it has the potential to make the relevant tax rules simpler, fairer and more effective.
If I was very optimistic, I might even venture that the review's recommendation to impose the RFRM method across a range of domestic and offshore investments has the potential to put to bed the controversy that has surrounded this area for over a decade.
I have previously said that the government will be examining the Foreign Investment Fund regime. The review's recommendations are wider reaching than what I have commissioned, so it looks like next year will see some major work again on these issues.
The taxation of entities is another important area for further consideration.
Companies, trusts and partnerships are the most common form of taxable entities, and they all have different tax rules applying to them. The review favours reducing the number of different tax treatments, thus reducing the influence of tax in the choice of investment entity.
Decisions over the choice of entity should be based on what best suits the business, rather than tax.
I note that the review is not suggesting wholesale change now but that future tax reform should be guided by the distinction between closely held and widely held entities.
Related to this is the taxation of savings and investment - an area in which, as you know, I am particularly interested. At present, different savings vehicles attract different tax treatments which can distort savings decisions.
The review has recommended that savings and investment entities be taxed in the same way, applying the standard risk-free rate of return recommended for foreign investment funds.
The advantage I see in this approach is that it would introduce some much-needed fairness and neutrality into what is now a highly uneven playing field. Ideally, New Zealanders' savings decisions should be driven by the return on investment rather than tax considerations.
The taxation of savings vehicles is, of course, quite distinct from the issue of tax incentives as a way of stimulating greater levels of saving, or of converting savings from short to longer term forms.
Suffice it to say that just as I remain unconvinced by officials' view on this, I am not convinced by the review's pronouncements on it either. Further work is needed.
I shall now touch briefly on other current tax policy issues.
As you will no doubt know, we have recently enacted legislation simplifying and clarifying the tax rules on interest deductibility for most company borrowing, a measure that has been welcomed by business. The changes apply with effect from 1997.
The other part of the package involves strengthening the related thin capitalisation rules. These rules are designed to prevent companies controlled by non-residents from allocating too much of their worldwide interest expense to New Zealand.
The government had considered reducing the "thin cap" threshold from 75 percent to 66 percent, which was considered to be more commercially realistic. However, given that the Australians have brought in a 75 percent threshold, we considered it unwise to be moving in a different direction.
But the issue of foreign equities within the thin cap calculations remains. Pressure of other commitments in the work programme has meant that progress has been slower than I anticipated earlier this year.
Our plans now are for an issues paper on the matter to be released in the first half of next year. Any resulting changes are tentatively planned for introduction in 2003, instead of this year, as we had hoped.
To turn to the tax side of trans-Tasman investment, over the last few months we have been preparing a joint Australia-New Zealand discussion document on a proposed solution to the "triangular taxation" problem. I was able to discuss the matter with Peter Costello at the APEC meeting in China in September.
Unfortunately, the calling of an election in Australia next month has stalled the release of the discussion document, which cannot proceed under the Australian caretaker conventions. I hope we will be able to resume work on this early in the new year, although that will depend on the priorities of the next federal government.
We welcomed the submissions made on the recent discussion document on GST and imported services. Over the next few weeks we will consult further with the financial services sector on the proposed reverse charge mechanism and the GST impact.
We plan to introduce legislation resulting from this part of the review in May.
By now you will have seen the three-volume exposure draft of rewritten parts of the Income Tax Act. I understand some tax professionals are concerned they are going to have to re-learn the Act by which they make their living.
It has been over 80 years since the Act was rewritten, so it is inevitable that a rewrite will create problems for existing users in the short term. Over the longer term, however, legislation that is easier to use will save time and money for tax professionals and their clients.
I hope the tax community will take advantage of the opportunity to express their views on this first draft of the rewritten legislation.
The government will be introducing the second taxation bill of the year in December. It will include two sets of measures arising from the review of the compliance and penalty legislation. One amends the debt and hardship provisions in the Tax Administration Act, and the other carries out further work on provisions relating to overpaid tax.
The bill will also include a set of amendments arising from the "tax and charities" review. They will clarify that charities and non-profit bodies can claim GST refunds for all their activities except exempt supplies.
To conclude, I recognise that it has been a busy year for tax people. I want to say here that the Government is very appreciative of the effort your Institute and other professional bodies and individuals have put into consulting on proposals and legislation this year. That contribution is significant and is vital to the tax policy process.
I wish you all the best for your conference.