EDITOR’S NOTE: Taxation is the mechanism for redistribution of wealth to combat inequality and for redirecting resources to build a society. But our current tax principles though largely hidden or not understood by ordinary people, lie at the root of all our current inequality and struggling economy. Struggling at least for ordinary people. This article shows our current tax principles are central to our economic problems. Understand and fix tax and we are on a path to greater economic security and wealth for all, a ‘citizens economy’.

Special Analysis by Stephen Minto.

In my article ‘Housing – We can’t build our way out of this housing affordability crisis.’ on 23 August 2021 I looked at the economic structure driving housing affordability and how to solve it.  I identified ‘the normal principles of taxation’ as a major factor driving excessive investor demand.

Those normal principles are helping create three of the main problems we are facing in our society:

• tax avoidance,
• inequality, generating poverty (including the housing affordability crisis),
• environmental damage, and the resulting multiple related crisis’s. (e.g climate).

These three problems show the current ‘normal principles of taxation’ are sending the wrong economic signals to the economy and distorting it away from its primary purpose, the supply of goods and services to meet our society’s wants and needs. But there is a simple reset of the principles that removes the structural drivers currently creating these problems. And a reset is essential to fix these problems as new taxes or laws will just be lipstick on a pig if we don’t fix the underlying structural drivers.

This relatively easy reset does not require any international agreement or loss of autonomy for New Zealand.

NOTE: For your convenience, we have structured this long-form report into five sections. Part A continues below. But you can download the full analysis via this PDF, without cost, which contains Part A, Part B, C, D, and E.

To summarise the five parts:

• In Part A we look at six ways the existing normal principles of taxation are damaging the long term economy and subsequently our society. They show the basic principles of economics are being undermined by the normal principles of taxation. I then identify the two main actions of a reset that will fix this damage.
• Part B in this series details the full range of required tax reset ideas (e.g. get rid of damaging GST) and goes through the impacts from the full reset and how many of those challenges actually put the economy on a more sustainable and stronger growth base, with more competition.
• Part C in this series covers aspects of the Pandora Papers and how it is the ownership structures of companies and trusts that are creating moral and economic problems just like the normal principles of taxation do. I raise some basic questions about how we should/could change the powers of, or scope, in which these entities are formed and operated. It is only in the structural permission about how they work that we can stop the economic problems we currently have.
• Part D in this series examines beneficial impacts and reasons why the capital revenue distinction must go. Including how it will operate and impact business.
• Part E in this series details impacts on various sectors of the New Zealand economy.

What are ‘the normal principles of taxation’?

At a very high level, income is identified by having three features:

• It comes in
• It is periodic (not one-offs)
• It has the character of income in the hand of the person who receives it.

From these base features principles arose. They have been adapted and interpreted through case law of a capital/revenue distinction. That can be defined as:

• Capital is not taxed but revenue is, so some businesses try to label items as capital to reduce their tax bill. A lot of the Pandora Papers covers this type of ‘legal’ activity.
• A sale of a farm, as a one off, is generally capital and not subject to tax. You would expect that to be reinvested somewhere rather than used to live off. But the sale of produce from the farm (periodic – used to live off) is taxable.
• Expenditure incurred to gain that ‘income’ should be deducted before tax is paid. Money spent to gain income is not really income that can be taxed.
• So you get gross income and net income.
• Expenditure incurred can’t be questioned.
• Costs to run a business can’t be questioned for taxation because it is up to the owners how to run the business regardless of the consequences or how sensible they are.

These are enough principles for my purposes; but inherent and inseparable in these principles are some values:

• tax is a cost, and
• it is legitimate and necessary for efficiency to minimise that cost. Like you would with any other cost.

But there is the catch in this, tax is not a normal cost.

Why are these ‘normal principles of taxation’ a problem?

Here are six points that explain why the principles send the wrong economic signals to the whole economy and undermine economic growth.

1. They undermine comparative advantage and encourage monopoly

(Small businesses with lower costs should have an advantage in price over big firms. But larger firms use costs to reduce their tax to give them an advantage.)

• Business is supposed to be efficient and reduce costs, to be competitive. The theory goes, by driving down costs you drive down price which is better for satisfying consumers wants and needs. This is more efficient and only business can do this as government is wasteful and costly.

• But this same efficiency driver on a micro business level sees tax as a cost that a business gets nothing for on a balance sheet.  So to avoid tax, a dead cost, the ‘normal principles of taxation’ allow them to grow other costs to not only prevent having to pay tax, but also to do things that drive up the price of their goods and services so they gain more profit.

• We all know and experience the marketing techniques that large business use to keep their profits high, or how they run anti-competitive practises to undermine competitors. e.g. run an airline along the routes of a competitor so they don’t grow and move into their high cost routes. And these techniques cost a lot. They rely on big data from loyalty cards, slick advertising, changing superficial designs with new releases, glamorous shops, etc. And they rely on access to debit financing. These are just ‘normal’ large business practises based on behavioural/marketing psychology and finance.

• So large businesses don’t mind incurring these costs because they will reduce the ‘dead cost’ taxation they have to pay. And it is a big saving, 28% on every dollar spent. So consumers/taxpayers in having a reduced tax are actually helping large companies pay for techniques to make us pay more money for their goods or services. So we pay twice for their supplied good or service – once on the high/‘discounted’ price and second through the tax subsidy.

• Small businesses simply can’t afford to run the same techniques or access debt finance in the way a large firm can. Their whole pricing structure is done differently; they reduce their costs and run a tight ship. These economic rules simply don’t apply to large business because the normal principles of taxation turn costs into an asset for them – a tool to drive out smaller competitors while driving up price.  Small firms can’t compete against these large firms no matter how good the quality or price they charge for their good or service.

• Another perverse result is large businesses become less concerned about quality and service in part because like any large bureaucracy they have to wear a few problems. But also in part because large businesses not only compete on price and quality, but compete through ‘cost accrual competition’. The ability to accumulate costs that work to their advantage over smaller competitors. And it is profitable and relatively easy and ‘legal’, but it shifts a large business’ focus away from innovation and building quality or low price, and into a focus on gimmicks and primal manipulations to trick us to buy. And it reduces competition as smaller firms can only compete by reducing costs and there is a limit to that.

• We can see this most easily in fast food and retail where there has been a slide into franchise. The Chemist Warehouse is one of the most recent. Costs on the floor are tight but the marketing, site location rental, management fees, executive salaries, advertising, debt financing are all high cost. In a generation the smaller owner run businesses taking pride in their business are largely gone from New Zealand.  So many small businesses struggle and fail because it’s hard to find niches to escape the larger firms relying on costs and turnover to drive their pricing. Cost efficiency is no longer a key economic driver for a large business; ‘cost accrual competition’ through saving tax is the easiest way to wealth.

• In addition larger businesses are more likely to spend on vanity expenses because it still reduces their tax bill so it gives them an advantages over smaller competitors.  e.g. take a lease on property in prestigious locations, purchase on finance or lease luxury cars, still get a 50% deduction for business ‘entertainment’ expenses – meals and lunches, tickets and who knows what else.
• ‘The normal principles of taxation’ remove the natural competitive advantage of a low cost business supplying the same goods and services. These smaller business are normally New Zealand owned and operated.  And to catch that advantage all businesses have to follow that high cost model, and treat tax as a cost to be minimised, leading to larger and larger businesses leading to monopoly capitalism. Cost accrual competition is a powerful economic tool and we the taxpayer are subsiding it to only some people’s advantage.

2. They undermine redistribution of wealth (tax) and the resulting economic stimulus

• Almost all businesses do not create wealth, they simply accumulate wealth.  And to accumulate they rely on the education and health systems to support access to employees and customers. They also rely on infrastructure, courts, police etc in which to do business. Tax minimisation, avoidance and evasion, undercuts the process of redistribution of wealth which pays for the supply of these services and therefore it undercuts the provision of the services the business needs to function with.

• Redistribution by taxation also supports demand across the economy which in turn supports business accumulation of wealth. The ‘tax is a cost to be minimised’ attitude comes from the normal principles of taxation, but tax helps promote the multiplier effect which benefits the entire economy. The principles need to change so that no business has an incentive, and mechanism provided by the principles, to minimise tax, as it works against the long term supply of goods and services, within the economy.

• Tax is like no other cost as it is not fixed. The principles calculate it as a relative cost based on what income is left over after costs. So on a micro economic level a business see’s an advantage to run up costs to minimise payment of tax. But on a macro economic level that minimisation is damaging the economy in which it functions. Tax minimisation is actually an act of self harm by a business in the long term. The normal principles of taxation are creating the problem.

3. They subsidise risk taking and provide no choice for taxpayers on doing that.

• By allowing business to deduct expenses to reduce their income that is liable for tax; it makes the New Zealand taxpayer subsidise the provision of that good or service through sacrificing tax collected. And as said before the saving is not always passed on, prices are held high and profit maximised so consumers are not getting the benefit of the subsidy. The normal principles of taxation allow no choice for society on making this subsidy. e.g. huge amounts of investment resources can be used to subsidise the business of taking rich people on tourism flights to space. Would people vote for that choice, over lifting more children out of poverty? But there is no vote, we have no choice, and it is tax revenue we could have.

• The entrepreneur who has the knowledge to make these choices about what costs to incur should take the risk for those choices. Choices and risks should not be subsidised by taxpayers or government as that is not their role.

• If the people or the elected representatives decide to subsidise an activity that is okay. And that is very different from a blanket subsidy as happens currently under ‘the normal principles of taxation’.

4. They punish innovation or the efficient use of resources

If two businesses supply the same good or service but one does it at a higher cost than the other, why should the lower cost company pay more tax?   This is not good economic policy.

• The Lazy Inefficient company B has more expenses ($100)  so only pays $14 in tax but the efficient/innovative company A ($50 in expenses) pays $14 more tax at $28.

• The normal principles of taxation are sheltering poorly performing companies, and punishing well performing companies. And the taxpayers through having less tax collected are subsidising the inefficient poorly performing company.

• And the principles allow more investment income to be made available to this poorly performing company. i.e. wasting scare investment capital. (If B did not get the tax subsidy and had to also pay $28 in tax like efficient company A, then Lazy inefficient B would only get $8 to reinvest).

• To those who say the high cost of B could be due to the quality service they provide. Yes, and that will mark them out from their competitors, and that quality should sell them.  But there is no way for the blunt instrument of taxation to tell the difference of quality to wasteful spending; so it shouldn’t. If customers don’t want that business’s ‘quality’ then that is a market signal. There is no reason for the taxpayers to subsidise a business’s choices on quality as the entrepreneur might be right or wrong and there is no way to tell, except by the customer.

• More can be said on this example but it does not change the fundamental point that the wrong economic signals are being sent. e.g. Company A could have less customers and be price matching to Company B to maximise their profit rather than passing on the savings from innovation to their customers. Company B becomes a tool to make customers pay more as its existence takes up some demand, which slows the introduction of potential new competitors. This is another reason to have B out. This shows tax is only part of fixing the economy but a very very important part.

5. They subsidise environmental damage or resource waste by creating an externality

• Of course not all companies have high cost structures because they run anti-competitive practise, or have vanity expenses, or they are just seeking tax minimisation. Some businesses, are just very costly to undertake and there is nothing inefficient about that, e.g. mining.

• But should the costs to run those enterprises be subsidised by the taxpayers taking a reduced tax collection? The high costs of those business choices should be borne by the risk taking entrepreneur with the knowledge to take those risks.

• For example, if you do the Hump Ridge track you see some great wooden viaducts used to bring out the timber from a milling operation. The devastation of the local forest was complete but the business as reported never made a profit as its costs were so high and the sales income never fully came in. New Zealand got nothing of substance out of this destructive exploitation. Yes workers got wages and scrimped a life of remote hardship. The directors would have got income along the way. Yes there is now some tourism value but it’s probably not much more than if it was left. Overall, the value of the forest asset was wasted without profit. The ecological and cultural value lost can’t be quantified.

• The same destruction and waste occurred in the areas around the ‘Bridge to Nowhere’ in the inner Whanganui. All over New Zealand subsistence businesses were supported by ‘the normal principles of taxation’ for people to eke out an existence to the detriment of traditional Maori life and culture, the environment, and their own lives. The ‘normal principles of taxation’ were one of the systems within colonial exploitation that allowed profits to be stripped back overseas without as much redistributive effect from an effective taxation. The principles were a tool to strip value out of the new nation as the costs of exploitation were offset to the income.  It is a tool in a class system that strips income away from the redistribution/taxation process.

Colonial legacy justification and creation of an externality

• Yes, you can argue that this sort of tax subsidy for business was necessary to enable economic activity in new lands. And that is the colonial argument. From where we stand today we can see the waste and destruction of that legacy and thinking. Our climate and environment is imperilled because of it. But it’s still happening, that structure is still in existence within the normal principles of taxation, and it is helping drive environmental damage and climate change. The rules were made through judge law to favour the wealthy to help drive their, or their class’s, wealth. This reset will at least make the full cost fall on the risk takers and they will at least be more careful in future because the cost will fall on them fully.

Ongoing impact

• If income from a business  activity almost matches the cost of the activity, then very little tax is paid. So when the good is being sold the price does not reflect the cost of society’s human and physical infrastructure that was required to support that activity. Because tax was reduced this cost is not calculated into that sale price. i.e. a seller will work for the highest price but if the cost of production is subsidised, the threshold for the sale price is being subsidised and the true cost is not reflected in the price resulting in false economic signals being sent to producers. The normal principles of taxation are creating an externality of the cost of society.

• A business must fully contribute from its income back to society through paying tax or there is no point in society letting the business be in existence. Like the purchase of the viaducts, or the mill boilers, tax is just a cost that should be factored in and you can’t avoid it.

• Each business or activity needs to be viable in its own right so it has a cost that reflects if it is a high cost activity. Current loss offsetting hides a costly activity and dissuades companies funding research or looking for alternatives to get around high costs. Subsidising by tax undermines that drive for innovation.

• Environmentally damaging activities like mining are one such activity where if the cost of tax was not able to be avoided, a higher price would generate more focus on recycling, or innovation to find alternatives. See more comment under heading ‘Different sectors have different impacts’

• It is no longer appropriate for our business community to be molly coddled and subsidised by socialising their costs onto the New Zealand taxpayer, the government, and the environment.

6. The ‘normal principles of taxation’ are helping cause an international destabilisation problem.

• President Xi in China is crushing democracy in Hong Kong as he see’s it as a vehicle to undermine China. But he is fighting the wrong enemy. As a former colony of Great Britain Hong Kong follows the basic outline of ‘the normal principles of taxation’. And most of the tax principles were set through english case law by judges who arguably have acted in their own or their class’s economic interest when making decisions that set precedent. As a colony these tax principles facilitated economic value being stripped away from the colony and the lands near it to the benefit of the ‘mother country’. In the post colonial world we still see these tax principles being used to strip value out of countries with little tax paid, and then into tax havens for the use of the billionaire owners of Google, Amazon, Microsoft and others.

• China has become the factory of the world as large multinational companies moved manufacturing there for cheap resources and low regulation. President Xi wants the work and business to stay so it will give stability and economic strength to China. He was recently reported on CNN  Aug 18, 2021 by Laura He as pushing on China’s rich to redistribute wealth. So he can see problems in his nation but he is asking business people bound by a tax system to act outside that system. His quest for security by taking on democracy and the Uyghur people means he is no longer walking with his people as a leader, using the wisdom of the crowd to guide his nation but is leaning into an inherently unstable autocratic leadership model. And he is adding fuel to the cold war that leaders in the US, UK and Australia, seem willing to hype up in a new alliance. He has chosen the wrong enemy; it is the colonial based tax structure that is undermining China’s security, e.g Transfer Pricing and Thin Capitalisation are able to undermine revenue and the ability to grow domestic based businesses in a way that spreads wealth. That has to be dealt with by simple consistent rules as suggested here that do not favour multinationals, as the current normal principles of taxation do. Democracy needs to be decoupled from exploitive capitalism and a tax reset will help do that.

• And the ‘west’ is also struggling with conflict and polarisation in society, driven through culture war issues like immigration, climate change, vaccines, and abortion rights. In the ‘west’ the culture wars are facilitated through a dysfunctional 4th estate and poor quality democratic processes. These culture wars have some urgency for ordinary people, ‘taking our jobs, taking our opportunities’, but theses are just the scapegoats for the very real economic struggle many are experiencing. It’s about the economy getting polarised. Ultimately the western nations have the same enemy as China in the poor functioning of the tax system. The tax system is helping build monopolies, facilitating tax avoidance, and undermining local businesses. We are all poorer.

• The normal principles of taxation are well overdue for a complete overhaul so they build each nation’s economy and redistribute wealth, and that is the purpose of taxation, not to concentrate wealth and build tax havens.

• Note: The need for international trade by New Zealand will not be impacted by these changes but it may, or may not, modify it. And with the supply chain disruption brought by the Covid-19 Pandemic, it makes it an excellent time to bring in changes that will ameliorate the disruption we are already experiencing. It will help our nations build back on to a more sustainable path.

How shall we reset ‘the normal principles of taxation’?

• In the media and policy world the strongest reset theme for taxation is greater transparency and sharing of information from other jurisdictions (especially tax havens) so tax can be claimed. This is all essential work that needs to be done but transparency and sharing information does not remove the structural problems created by the principles. And the current principles have created a complex set of rules that are an administrative burden.

• And the creation of new taxes like wealth taxes will not deal with the structural drivers of wealth concentration.  As the Pandora papers show the normal principles of taxation are a major driver of wealth concentration and tax avoidance.

• I propose a structural reset that uses existing economic understandings which therefore won’t destabilise the economy, and it works alongside the existing market forces, sending appropriate signals to the economy.

The two main reset actions are:

1. Remove deductibility for all expenses except for domestic salary and wage payments.

2. No capital revenue distinction for non-individuals.

This is supported by:

• A very broad legislative definition of ‘income’ to ensure everything that comes in is taxed regardless of traditional capital revenue distinctions. Even to include related party loans (with an exception for 3rd party loans – perhaps a strict list of who can be a 3rd party). The Pandora papers show this is essential regardless of even this reset. Because the current normal principles of taxation allow a company to make income but then through a series of entities turn it into a loan to be made back to the company or another related party and a ‘loan’ is not taxable. Part C, in this series, gives an example.
• No grouping of companies for tax purposes. Companies are separate legal entities and will be treated that way for tax.
  • The original intention of grouping was to prevent tax avoidance but it has now been twisted to be a major tax minimisation technique. i.e. Company tax rates in the past had a progressive structure. To avoid paying the higher rates a company created lots of sub companies and spread the income out so each paid an amount just below the high tax rate. This was then stopped by the requirement to group the companies so they did pay the higher rates of tax. But then for anti-competitive purposes parent companies began to run subsidiary companies – not to make a profit but to make a loss (the exact opposite of what companies should be set up for in an economy). Using ‘cost accrual techniques’ and low income. e.g. run a small airline at a loss to compete with a budget airline to preserve their other profitable routes. Grouping then allowed their losses to be offset against the income of their profitable routes so less tax was paid. If a situation arose where the loss company was no longer needed the losses could be retained but limited liability remained as a protection for the parent company. A long time ago the progressive tax rates on companies were removed and company tax was made a flat tax rate but nobody got rid of this ability to group companies. The companies wanted it kept. It is overdue to get rid of grouping.
  • Without a capital revenue distinction and strict application of entity status, shifting assets between separate legal entities will generate taxable income because their status as a separate legal entity now becomes important for tax purposes. With less advantage in having separate legal entities, companies will become bigger which will improve transparency and reduce the ability to avoid tax or scrutiny.  This reset will work with international trends to improve transparency. With more potential exposure to risk, behaviour and focus will change.
• A company to trade in New Zealand must be required to have a company registered and based in New Zealand through which all its activities are subject to tax that are ‘sourced’ from New Zealand. And they must have a New Zealand bank account. An asset in New Zealand can’t be owned by a foreign based organisation in a tax haven as the risk of tax avoidance is too high. If there is not a base in New Zealand, e.g internet sales, then work must be done with banks on how sales can be caught for tax or punishments if not.  This is already a tax issue and not created by this reset.
• In ‘Part D (of this series) – Beneficial impacts for all with no capital/revenue distinction and less tax minimisation’ I go through more discussion of these points. In particular how taxing disposals of cash accumulations is not double tax but sends a beneficial push into quality and price for goods and services.

Economic policy and tax principles alignment

This reset does four main actions:

1. It removes the structural drivers for all the six economic problems listed above. Obviously other actions need to be taken in addition to tax for issues like international relations. This reset does not restrict actions but better supports them.

2. It stops almost all tax avoidance techniques based on currently ‘legal’ processes. Nobody is telling business how to run their business or control what they do. The choices are all still with the business, it is just the consequences and risks that will be fully carried by the chooser.

3. It removes any incentive to waste or damage the environment, or any assets, as all costs will be fully carried by the producer. Because things will cost more, the throw away culture will not be structurally supported by the tax system. Note – things are costing more now but with no quality improvement. Quality has the chance to come back.

4. It redirects investment capital to producing goods and services to meet the needs of society. With interest no longer deductible for tax there will less demand to debt finance. Finance will therefore be freed up for investment in actually producing goods and services. Yes some capital will be taken up to hold assets like land but that is a good investment at the moment. The purpose of debt financing is largely cost accrual competition. Part B of this series has more on the potential positive changes in how investment may occur.

But is this economically viable? We must look at the numbers.

Financial impact of reset

From the Statistics New Zealand website we have the ‘Annual enterprise survey: 2017 financial year (provisional)’.

It states for businesses/enterprises the:

• total income for New Zealand is $644.2b (billion) and total expenditure is $560.7b.

• Surplus potentially subject to tax = $83.5b   (If the current tax of 28% was applied, this = $23.38b)

• 2017 Inland Revenue Annual report, says corporates actually paid $14.2b.

For contrast from the Inland Revenue website 2017 annual report –

• Total tax in 2017 was $69.2b and Individuals paid 48% ($33.2b) plus GST 26% ($17.9b) = 74% of total tax was paid by you and me.

Taxation under a reset calculation – A soft transition calculation

The existing tax rate of 28% could be used or a lower rate of 15%. But if we aim to increase taxation because it is sorely needed for social purposes, and to pay down debt, and we don’t want to cause too much business disruption, then the following is an option.

• Businesses claimed they had $83.5b income over expenses for the 2017 year.

• If we initially taxed all companies at 10% of total income, no deductions for costs (except domestic salary and wages). And indexed to go up in future years. This will give a massive boost to small business.

• • $644.2b x 10% = $64.42b tax.

• As business had $83.5b over costs it means there is income available to pay the $64.42b tax. They would have to shift profit expectations and likely no dividends.  Impacts will depend on the individual business. If we add in the Individuals tax, and ‘other’ ($37.1b) tax paid that year (I leave out GST as it must be dropped – as it damages the economy) we would have: a total tax for 2017 of $101.2b

• The amount of 10% should be indexed to go up 1% every one, or two or so years, until it reaches 15% or 20% or whatever the government of the time decides. The 10% rate is too low for the urgent needs of climate change and human need. (The cost is higher now because actions were not taken earlier, and business in aggregate has not supported taking action sooner, in fact they hindered action).

Other taxes?

• This increase in tax collected is without any new wealth tax or capital gains tax, and with a reduction of the headline tax rate. But there may be other reasons to do new taxes. In times of war. Or environmental crisis. Or a housing crisis. Tax is so low at the moment and the social needs so pressing, plus the debt must be paid down, that the amount of tax to be paid must go up.

Easier compliance

• Another reset benefit is it could be possible/investigated to require all money deposits to a non-individual to go through one bank account with an instant deduction for 10% tax. A credit can come back once a salary or wage payment is made in the Inland Revenue employer account. This means no provisional tax or due dates to worry about. A great compliance saver for small business. Obviously all bank accounts would have to be linked to an IR number to prevent avoidance but if all non-individuals bank accounts were automatically subject to tax, then that removes some temptation to avoid tax liability.

The economy context

• This reset is still only income that is being taxed; something that has ‘come in’. So money is there. Any realised capital gains would also be taxed because they would have ‘come in’. But as there are avoidance techniques for companies to delay gains coming in I am not expecting much to be collected under this category, initially. But a rising tax rate might persuade them to come forward earlier. But we could use the ‘risk free rate of return method’ to calculate this ‘income’. But that would be at least 15%. Other options to capture unrealised gains are being discussed in the wider media.

• If large businesses say they will go out of business, then that shows just how dependent they are on the tax subsidy.  So are they truly viable?  The slow introduction of a lower but more effective rate would give them time to adapt to moving away from debt financing, and high cost structures. But there are many more effective ways to achieve this change. I don’t expect them to move away from their marketing techniques but they would pay that cost without being subsidised by taxpayers. Issues with marketing and consumer protection can be dealt with separately but those actions will be undermined by the current tax system. Actions will be more effective with a tax reset.

• To stick to the concept of government spending being less than 30% of GDP reduces our ability to create wealth through the multiplier effect.  A demand driven economy will bring better economic growth that actually satisfies people’s needs. The only risk to a demand driven economy is how to control pricing and inflation, (I propose an article on this at a later time). We tried supply side economics and we have poverty, housing shortages, housing inflation, a struggling health sector, and an education system beholden to overseas students.

Perfect timing

• The recent talk about inflation and stagflation in part due to supply chain disruption make it the perfect time for the reset to happen as it will reduce business sector demand. All large businesses will be strongly focused on reducing their high cost business structure which will reduce demand and take pressure off inflation. Recall that a lot of business sector demand is micro business churn to drive price and demand up for their product or service. It is not growing the economy except in an incidental sense.  Innovation, exports or savings are not being driven in the macro sense by that spending. By contrast small businesses with the lower tax rate will be opening up, increasing competition. I talk about inflation in Part B of this series but will require a further analysis.

Summary – we must reset ‘the normal principles of taxation’

• This reset is not about political sides or ideas. It is about making the economy work as it is supposed to, meeting people’s wants and needs.
• If we believe in markets with businesses competing on price and quality then this tax reset must be done because the current tax system undermines that, or
• If we see the economic system is failing and people are falling through the cracks then this tells us one of the main reasons why and how to fix it.

The current tax system is breaking the economy and society. We are a frog in a pot that’s been on the stove for a while.

• Further evidence the tax system is broken is seen in the US which has the same basic principles of our system and many of their largest companies aren’t paying much tax, e.g.  Amazon, Honeywell, Halliburton, IBM, Fedex, Nike, US steel, Chevron, Delta. These companies are even managing through globalisation to avoid capital gain taxes. So we can’t just rely on new taxes to solve the existing problems. The foundation, ’Income tax’ must be fixed and this reset is how to do it so the big companies pay their fair share.

• Minimising tax is big business for every large firm. For the cost of a small team of accountants they can structure finances to avoid billions or hundreds of millions of dollars in tax. The purpose of tax is to redistribute wealth but ‘the normal principles of taxation’ are discouraging redistribution so economies and societies are struggling, with small businesses disadvantaged and people’s wants and needs not being met.

• The reset here retains largely the same tax system with all business treated the same. But the reset strips the rules down so there is nowhere to hide or shift the money. Because it is in the rules where the loopholes are found. And the rules/legislation are written with the normal principles of taxation firmly in mind, and with considerable input from those accountants who are deeply embedded in tax orthodoxy. The business sector has had a significant input into developing tax law and the business sector likes lots of red tape rules as it offers lots of loopholes.

• In this reset you can’t shift money between income (subject to tax) to capital (not subject to tax). A person can’t reduce their tax by claiming expenses real or imagined. There are no losses or capital losses. I suspect the reason why we don’t have a capital gains tax in New Zealand is the fear of capital losses undermining future government revenue along with complexity of the law – but this reset shuts down those fears.
• With this reset the tax system becomes much simpler and more transparent. This is why stripping the rules back, as is proposed in this reset, is actually the only way to get a truly broad based low rate income tax system.

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EDITOR’S NOTE: For the full analysis, please download the PDF which includes: Part A, Part B, Part C, Part D, Part E of this long-form report.

About the author: Stephen Minto lives in Wellington with his two children. He worked for New Zealand Inland Revenue Department for approximately 33 years and is now enjoying no longer being bound by public service etiquette of being non-political.

Perhaps the public has looked at the Tax Working Group proposals for a capital gains tax and come back with a “no”. Certainly, the opinion poll published last night about the tax proposals looked quite definitive – the headline for Tova O’Brien’s Newshub scoop was: Large majority of New Zealanders don’t want capital gains tax – poll.

According to Newshub, a poll by Reid-Research – the polling company contracted to TV3 – “shows an overwhelming majority of voters – 65 percent – don’t think a CGT should be a priority for the Government. The poll found that just 22.8 percent think it should be a priority.”

More importantly, nearly 50 per cent opposed a capital gains tax on housing (with the family home exempt), against 39 per cent in favour. On the issue of businesses and farms being included, 54 per cent disagreed and 32 per cent agreed. And 69 per cent disagreed with a tax on shares, and 90 per cent disagreed with another tax on KiwiSaver.

Based on this poll, Newstalk ZB’s Mike Hosking has come out this morning to say the Government will ignore this poll at its peril: “If these numbers don’t wake them up, it might well be the break National have so badly been waiting for” – see: Numbers don’t lie, time for the Government to wake up over CGT.

In particular, Hosking says, it’s New Zealand First who will be most concerned: “these numbers, I would have thought, are about the final nail in the coffin for New Zealand First, who most see as the moderator of any excess that comes out of the Cullen report. If they weren’t hesitant to sign up before, surely the polling we’ve seen now is about as rock solid by way of proof as you could ever possibly want.”

Business NZ’s questionable data

However, Newshub’s Reid-Research poll wasn’t actually commissioned by them, but was instead paid for and set-up by Business New Zealand, a lobby group which is strongly opposed to the introduction of the full capital gains tax proposals. And, as always, the polling questions help determine the type of data produced.

So not only did Newshub report the survey in a questionable way, but the actual survey questions are rather unusual. For example, the headline figure is based on whether New Zealanders see the capital gains tax proposals as a priority. It is a useful question, with useful results, but it’s far from indicative of whether New Zealanders oppose the proposals.

Likewise, questions about whether the issue has harmed the government – 48 per cent say it has, against 33 per cent who say it hasn’t – are interesting, but not entirely useful. Similarly, it’s difficult to interpret the fact that 25 per cent of respondents say the issue would change how they vote, against 58 per cent who say it wouldn’t.

In general, when looking at the poll results, keep firmly in mind that the source is a lobby group with an interest in slanting the results a certain way. Similarly, the business group recently released research to show “estimates the ‘economic drag’ over the first five years of the proposed CGT regime at between $2.75 billion and $6.81b” – see Liam Dann’s Capital Gains Tax could cost NZ economy billions – Business NZ.

The head of Business NZ, Kirk Hope, explained that these concerning figures had been independently assessed by economists, and that the assumptions and estimates were actually “conservative” – i.e. the real figures are likely to be worse. However, this is all strongly challenged by Tom Pullar-Strecker in his article, What’s behind BusinessNZ’s claim CGT would cost $5 billion?

It turns out that many of Business NZ’s claims are less than rigorous. In fact, one of the economists, Chris Evans, who is cited as emphasising the likely high compliance costs of the new tax has been quoted out of context. Evans actually said “that the compliance costs would not be excessive”, and Pullar-Strecker reports his belief that the proposed CGT “would compare favourably with those in other countries, including Australia”.

Pullar-Strecker concludes his investigation into the lobby group’s report stating “BusinessNZ says it wants to start a debate, accepting its numbers aren’t perfect. But its figures may be better viewed as politicking dressed up as a study.”

This doesn’t mean that Business NZ are the only ones who might be accused of massaging the figures and evidence to suit their own arguments. Even the Tax Working Group and Treasury are being criticised for their questionable use of wealth inequality data to make their arguments in favour of change – see Troy Bowker’s Why argument of Capital Gains Tax fairness is based on unreliable data.

According to Bowker, the CGT report was based on wealth statistics gathered by Statistics New Zealand, which were used to show that few New Zealanders would be subject to the new taxes. However, “By the Department of Statistics own admission, it contains data that is so unreliable they cautioned against its use.”

Other capital gains tax surveys

There has been some other public polling about the tax proposals that provide additional and alternative information. The most recent was published just over a week ago, by the Horizon Research company, and this is best covered by Liam Dann in his article, More Kiwis support capital gains tax than oppose in new poll. Most notably, this survey showed much stronger support for the tax proposals: “44 per cent of New Zealand adults supported introducing a capital gains tax and 35 per cent opposed it. A further 16 per cent are neutral on the new tax, while 6 per cent did not know.”

This poll was particularly interesting and useful, because it also indicated how different voters and asset-owners felt about the proposals. Here’s the different political party supporters in favour and against: Labour (60 per cent support; 14 per cent oppose), National (23 support; 62 oppose), Greens (75 support; 14 oppose), and NZ First (30 support; 55 oppose).

In terms of asset owners: those with shares (56 per cent oppose), with rental properties without a mortgage (66 oppose); with rental properties with a mortgage (74 oppose); and those with farms or large lifestyle blocks (90 oppose).

Some farmers are actually showing increased support today for a capital gains tax on farms, particularly when the asset is brought and sold in a short space of time. Newshub reports today that “Federated Farmers vice president Andrew Hoggard told Newshub people’s gains from quickly selling on farms need to be targeted first” – see: Farm flippers should be taxed – Federated Farmers.

It’s also interesting to look at a survey of business owners, which was carried out by the MYOB company, and showed that opposition from this sector wasn’t as clear as might be assumed: “Most business owners are against a capital gains tax but a survey found fewer than half were strongly opposed and a fifth were supportive” – see Tom Pullar-Strecker’s Capital gains tax compromise inevitable, accounting body believes.

This article shows that “Backing for a CGT was strongest among ‘Gen Y and Z’ business owners – with more than a quarter of them happy to stomach the tax – and from business owners in Wellington, while ‘baby boomers’ were more likely to be opposed.” In addition, research in New Zealand from the Certified Accountants Australia found that “there was a minority of business owners who did not like a CGT but who felt it would be necessary to meet the country’s future social and economic challenges”.

New public debate on CGT

A new campaign was launched yesterday to provide a pro-CGT perspective in the current debate. The Tax Justice Aotearoa launch at Parliament is best covered by Tom Pullar-Strecker, who points out that “Much of the lobbying over a CGT to date has come from groups opposed to the tax, which include the Taxpayers Union”, and the new campaign is meant to even up the disparity – see: CGT supporters and Taxpayers Union take tax wrangle to Parliament.

The article reports concerns about the political independence of the new campaign, as well as whether taxpayer funds are being used to assist it, especially because of the involvement of the Public Health Association, which receives funding from the Ministry of Health. The article reports: “PHA chief executive Prudence Stone clarified it had not provided any cash or resources for Tax Justice Aotearoa to date but did not rule out doing so in future.”

The campaign has established a petition: Tell Jacinda we want a capital gains tax. It’s time to join the modern world, which currently has 1,200 signatures.

Although Tax Justice Aotearoa’s petition appears to implicitly support the Government’s Tax Working Group proposals for a capital gains tax, including the exemption of a family home and the package being fiscally-neutral, two of the campaign’s organisers explain in more detail their advocacy of tax reform, which involves going further than what is currently proposed – see Paul Barber and Louise Delany’s Why we’re shouting about a capital gains tax.

In line with some of these messages, it’s also worth reading today’s opinion piece by Alison Pavlovich who emphases some of the selling points she believes are missing from the debate on the current proposals, such as the importance of equity in the tax system, and pairing of tax cuts with the CGT – see: The point being missed in the capital gains tax debate.

Finally, for humour on the tax proposals, see my updated blog post, Cartoons about the proposed capital gains tax.

by Dr Bryce Edwards

The capital gains tax debate is a huge political issue, and a great deal rides on the outcome – especially the chances of the Labour-led Government being re-elected next year. So far, it’s not looking great for the Government. At this stage it appears very unlikely that they will be able to implement the full capital gains tax that Labour and the Greens clearly want. Instead, at best, a watered-down capital gains tax (CGT) compromise seems likely.

Writing on the RNZ website today, outgoing Morning Report co-host Guyon Espiner – who will be replaced on the show by Corin Dann – has expressed his disappointment at what is shaping up to be a less than satisfactory new tax, saying a compromise might help the governments re-election chances but “it’s not the transformational government we were promised” – see: Politics punches holes in the tax net.

According to Espiner, “already Jacinda Ardern is buckling” on the issue, and appears to be positioning the public for a likely back down on how comprehensive any new capital gains tax will be. Reporting on the Prime Minister’s Monday press conference, he says “her main goal was to soften the ground for exemptions” to the tax, with farmers and businesspeople likely to be allowed to continue without paying such a tax. He says “It sounds as though after all the pet constituencies are protected we may end up with a CGT on residential investment properties only.”

Espiner makes the case that providing lots of exemptions to such a tax weakens it, to the point where it may end up almost meaningless: “we can run into real trouble by granting concessions in the tax system in order to please constituencies. Fairness and kindness are subjective concepts so tax systems have to have strong and consistent principles underpinning them. That’s why GST works. No exceptions. Even drug dealers pay GST, as David Lange famously observed… We are heading into that territory now with the CGT where you puncture the IRD’s net with such large holes that it becomes useless.”

Other commentators are also critical of providing too many exemptions to the CGT. For example, Newstalk ZB’s Mike Hosking: “Do remember the more they cut out of this, the more people they exempt, the less sensible a CGT is. If you’re taking farms and businesses out, you open the Pandora’s Box of the fast burgeoning industry that is tax avoidance. Not to mention the fact the more you exempt, the less you actually raise. And the less you raise, the more questions are asked about the cost of compliance and chasing the returns” – see: Capital Gains Tax a train wreck driven by a naive Government.

Hosking suggests the Tax Working Group process simply didn’t work out, and now the Government is in disarray over the whole project: “The working group was specifically tasked with finding a way to make a CGT work, they couldn’t. They told the Government they couldn’t, they were then told to go away and try harder. All the while the Government stalled, pretending they hadn’t made up their mind. They’re still stalling, pretending they haven’t made up their mind and in that is the naivety, they’re taking their issue, and making a complete and utter hash of it.”

Newstalk ZB’s political editor Barry Soper argues that Ardern has miscalculated the whole CGT strategy, and only now is she “wide awake to the political damage it’s doing to Labour” – see: Prime Minister Jacinda Ardern in state of shock at reaction to Capital Gains Tax plan.

Certainly, there will be plenty of disappointment if Ardern and her government backs down on the CGT. For example, Anna Connell says that a back down on the CGT would indicate that this government isn’t really going to deliver: “I hope the CGT stays if only to signal that Labour isn’t crippled by short-termism and that working groups can effect change. Because we have a lot of them and while I applaud rigorous thinking in decision making, at some point we’re going to need to see some transformation from this government. They have already spooned out a lot of transformative rhetoric and backed working groups to do a lot of the heavy lifting for them” – see: Capital gains tax – should we care?

A back down would be reminiscent of Ardern’s earlier CGT retreat during the 2017 election campaign when she first promised the new tax would be implemented and then changed her mind and promised no such tax would come in during the next parliamentary term.

According to RNZ’s Tim Watkin, back in 2017, “Having made the hard political decision, she choked”, and he can see her doing this yet again – see: Capital Gains Tax – now it’s a numbers game.

Here’s his main point: “This is a weakness for Ardern; the sense that she can talk the talk, but is timid when it comes to the walk. She has consistently talked about a CGT as a “fairness” issue, implying that the current regime is not fair. Will she balk again? If she does, there is a serious risk that a narrative of timidity will begin to form around her. I’m not sure she can afford to do the all groundwork – again – and then not ride into champion the fairness she has indicated she wants.  The kindness doctrine she aspires to comes with a cost – political and fiscal. At some point she needs to stop just humming the tune and start paying the piper.”

Such a back down on CGT by Ardern and her finance minister is simply not tenable according to John Armstrong: “They have made it their mission to address inequality. The means of doing so has now been laid out in detail in front of them. For Ardern in particular, the implementation of a capital gains tax is the ultimate test of her willingness not just to talk about doing the right thing, but to actually do the right thing” – see: Failure to deliver capital gains tax would see Ardern reduced to a laughing stock.

Armstrong says that “having declared 2019 to be the year in which Labour will deliver, the failure to deliver a capital gains tax would see Ardern reduced to laughing stock.” He thinks this is unlikely though, and that there “will have to be tempest-level tumult from all parts of the electorate… for Labour to abandon the working group’s key recommendation…The reality is that even if their nerves get the better of them, Ardern and Robertson no longer have the option of engaging reverse gear.”

Perhaps, however, Ardern and Labour never had any intention of introducing a full capital gains tax, and the whole exercise has been a face-saving one in which the party manages to signal its virtue to its supporters without actually intending to burn up any political capital. This is the argument from Heather du Plessis-Allan, who says the exercise is “all talk. There’s no chance it’s going to happen” and she says Labour is actually relying on New Zealand First to veto anything substantial – see: Big tax shake-up or big PR job?

She explains why the Government has gone through the motions with the CGT exercise: “A CGT was a Labour election promise. It’s all about making the tax system fairer. It’s a Government looking after the poorest Kiwis. Robertson and Ardern have both spent too much time repeating that message to now walk away from their one chance to fix the system.”

And then Peters and his party can be relied on as “Labour’s get-out-of-jail card”, because Labour can “happily drop a CGT and blame it on him. They could trot out the old you-win-some-you-lose-some argument. They’ve used it before.”

Clearly the government parties will risk losing votes if they implement any sort of CGT. And Bernard Hickey has a useful column outlining how the electoral maths is against a CGT being implemented. He says that many citizens who are most inclined to vote have a strong financial interest in preventing such a tax being implemented: “The dirty little secret of the whole debate is that property-owning voters are almost completely dependent for their retirement security and their small business survival on over $500 billion of untaxed and leveraged capital gains from their land over the last 15 years” – see: Capital gains debate’s dirty little secrets.

Hickey says that “voting rate imbalance is especially wide between older Pākehā property owners and young renters that are Māori, Pacifika or new migrants”, but Labour “will be hoping the electoral mathematics of the low voting rate of young urban renters can be changed just enough to swing the balance.”

Chris Trotter is even less optimistic, and argues that polling data and any study of New Zealand political culture shows that introducing a CGT would simply lead to the current government being defeated at the next election, and therefore cheerleaders for the change are suffering from “a peculiar kind of political tone-deafness” – see: Dying in a ditch for a capital gains tax that half the country doesn’t want. Trotter also suggests that the CGT on offer is far from radical, and progressives have more important issues that “are worth dying in a ditch for”.

There are definitely some big questions about principle versus pragmatism over the issue, and for Magic Talk radio’s Ryan Bridge, Jacinda Ardern “must decide what’s more important for her politically, principle (we all know Labour believes a CGT is what’s right), or electability” – see: Jacinda has poked an angry tiger.

Bridge reports from talkback-land that “you’d be forgiven for thinking a bomb went off given the amount and heat of the reaction to a comprehensive CGT. I’ve not seen anything quite like it in my time hosting drive-time radio. Jacinda Ardern has well and truly poked the tiger.” But on the other hand, “then the left won’t be happy” if the Government only implements a watered-down CGT: “It’d be like going to a strip show where the main attraction keeps her pants on the whole time.”

However, the Herald’s political editor Audrey Young argues that “even a limited version would be an extraordinary political achievement for Ardern and Robertson” – see: Michael Cullen has given the Government exactly the kind of report it needed. She points out that “It is already quite an achievement politically that a Labour Party that could not sell a 15 per cent capital gains tax at the 2011 and 2014 elections now stands a reasonable chance of imposing an even bigger one at 33 per cent on residential investment property”.

Young has focused on the elephant in the CGT room: New Zealand First. In her column, A limited capital gains tax may not be such bad news for NZ First, she reports on statements last week that Winston Peters made on The Country radio show, in which he ruled out farmers being affected by any CGT.

This is a sensible position, Young suggests, because “New Zealand First would be dicing with death if it supported a comprehensive CGT on small businesses, including farms.” She also argues that Peters can benefit electorally through pushing for such major exemptions: “If New Zealand First can stop the Labour-Greens this term to have a CGT apply to farms and business, it will have a strong case to argue it would similarly be needed next term.”

For more on NZ First’s likely role in watering-down the CGT, see veteran press gallery journalist Peter Wilson’s Capital gains tax: Winston Peters holds all the cards on changes. Here’s his main point: “The party’s leader, Winston Peters, is on record as a strong opponent of a CGT. He has said it doesn’t work in other countries and won’t work here. In recent days, some of his MPs have been saying the same thing privately. Mr Peters doesn’t swallow dead rats. There’s no way he’s going to change his mind to the extent necessary for the government to get this through in the form presented by the Tax Working Group.”

Wilson is worth quoting further: “Peters will play this for all it’s worth. He’ll want concessions, and his demands will be focused on NZ First’s voter base in the regions and among older people. He’ll almost certainly insist that farmers are exempt, and perhaps small businesses as well. We’ve seen it before with the changes Labour had promised to employment law, which NZ First watered down to a level that greatly reduced their impact. If Mr Peters goes through a similar exercise with a CGT he’ll be a hero to those he has saved from it and his party could reap the rewards at the ballot box. It will also test Prime Minister Jacinda Ardern’s leadership.”

Finally, for humour on the political backlash against the capital gains tax proposal, see Andrew Gunn’s Hysteria and hubris: the CGT files.

by Dr Bryce Edwards

Are the purported benefits of the Tax Working Group’s proposed capital gains tax an illusion? So far, questions about the potential effectiveness of the tax are the biggest challenge to the proposal, as there are strong doubts about whether the new tax would really achieve its desired aims. 

The best arguments in favour of introducing a capital gains tax centre around the need to fix problems of economic inequality in New Zealand. I outlined these yesterday in my column, The arguments in favour of a Capital Gains Tax.

But would the proposed CGT actually achieve much in this regard? At what cost? And are there better ways of dealing with some of the problems of economic inequality? They’re some of the questions being asked by commentators across the political spectrum at the moment.

The biggest challenge to the Tax Working Group’s proposal is whether it’s “too little, too late”. In the context of the huge problems of inequality, especially in terms of housing, the solutions do seem comparatively weak.

This has been best expressed by Anna Connell in her Newsroom column yesterday, in which she says she has been underwhelmed by the proposal’s lack of vision or ambition: “The recommendations just don’t seem that radical or go far enough to address some of the enormous challenges we have looming on the horizon. There’s a limit to what tax policy can achieve but when it’s the main source of revenue for the entity in charge of which direction we travel and where we spend our money, it’s pretty high up the list of things I’d like to see properly future-proofed” – see: Capital gains tax – should we care?

Connell thinks that both the strong pro- and anti-CGT factions fail to appreciate the extent of the problems the tax is seeking to tackle, and have an exaggerated idea of how much impact the proposed tax would have: “when you live in a world where the odds seem increasingly staked in favour of the overtly wealthy, where tech companies pay little or no tax and the gap between rich and poor seems beyond closing, I don’t necessarily view a CGT as any kind of real leveller. I just can’t get that het up about it – as a blow for fairness or an assault on the individual’s right to reward for hard work. I reserve most of my apathy for the politics of it all. Because I think it’s past it’s use-by date as a political lightening rod”.

Economist and TOP leader Geoff Simmons believes something similar, lamenting that inequality problems will be barely touched by this proposal: “Our tax system should be the central tool in fixing these problems. Sadly the best we can hope for following the Tax Working Group’s recommendations is that these problems will continue to get worse; only a bit more slowly” – see: The Tax Tweaking Group.

Simmons says that at the heart of worsening inequality lies housing, particularly with home ownership and renting becoming unaffordable: “The Tax Working Group was supposed to make our tax system fair. Sadly the Government tied their hands at the outset, ruling out the biggest tax loophole we have – the ‘family home’.”

What’s more, according to Simmons, the effect of the CGT will be to drive more investment in family homes: “it reduces the incentive to invest in businesses (which produce jobs and incomes) rather than sticking all our money into housing. As a result, under a CGT Kiwis will probably end up sticking even more of their money into housing than ever before, particularly the family home. This is known in Aussie as ‘the Mansion Effect’.”

Simmons and Connell aren’t the only ones wondering if the CGT will actually have any impact on inequality. An Otago Daily Times’ editorial has a long list of good questions that need to be addressed when assessing if the tax is worth supporting – see: Jury must deliberate on tax reform.

The ODT’s questions boil down to: Will it really fix inequality? Is there a better solution to inequality? Will the tax really be fiscally neutral? Will all the compliance and efficiency costs be worth it? Will there be too many exemptions and therefore possible loopholes? Will it reduce investment and rental housing?

Even a lot of CGT supporters are expressing reservations about the likely effectiveness of the proposal. For example, inequality researcher Max Rashbrooke says that it’s a mistake to make the scheme revenue-neutral, given that the Government urgently needs to spend money to implement its kindness policies. He also says that greater egalitarianism would be achieved from a more radical inheritance tax: “Fairer still would be a tax on gifts received – to compensate those not fortunate enough to inherit wealth – and a more thorough wealth tax that acknowledged the benefits people derive from their assets every year, not just at sale” – see: Capital gains tax: A test of our national myths and Labour’s mettle.

Similarly, many on the left and right continue to question why the “family home” is being exempt from the CGT, suggesting that this creates all sorts of problems with the scheme as well as reducing its potential to fix inequality and unaffordable housing.

For example, at the pro-Government blogsite The Standard, Matthew Whitehead writes In defense of taxing the family home. Here’s his main point: “National is right about one thing. The exemptions proposed by the Tax Working Group leave ridiculous holes. We should close them. It’s wrong that a $5 million dollar home, whether it belongs to an accountant, a union-busting director, a politician, or a business owner, somehow doesn’t get taxed because it’s a family home. Let’s tax it, and use that money to discount other taxes, or to nationalize the ambulance sector, or to partially fund NZ Super, or a million other things that will be worth the tradeoff. They’re right that it’s ridiculous that selling an art collection would be free from a capital gains tax. Let’s tax it. Hell, let’s set a reasonable threshold, and tax the real realized gain on every asset over it.”

Others have criticised the political decision to exclude the “family home” from the CGT, including economist Cameron Bagrie who was reported yesterday as believing “a CGT should be implemented, but it should be across the board and include the family home” – see Jason Walls’ Economist Cameron Bagrie is not convinced a CGT would do much to improve living standards.

According to Bagrie, “the impact of the CGT would be more negative than positive. This was mainly down to the way small businesses would be hit by the tax.”

There is plenty of concern that economic investment will be discouraged by the CGT. This was one of the main problems raised by the three dissenting members of the Tax Working Group. And for a high quality and in-depth discussion of such concerns it’s worth listening to Kathryn Ryan’s 33-minute interview with former Inland Revenue deputy commissioner Robin Oliver: Could capital gains tax proposals encourage dis-investment?

Similarly, Brian Gaynor argues that under the CGT there will be much more incentive for New Zealanders to invest overseas, because of inconsistencies in taxation rates – see: Tax plan likely to go the way of the Titanic. He points out that the new tax could also negatively impact on the non-wealthy in another area: “There is a widely held belief that capital gains tax only impacts the wealthy, but this is incorrect if we include the 2,926,821 KiwiSaver members. All KiwiSaver funds holding New Zealand and Australian equities, either listed or non-listed, will have lower investment returns if the proposed CGT is introduced.”

For other arguments about who else will be negatively or inequitably impacted by the tax it’s worth reading David Farrar’s Who will be affected by the proposed CGT?  and Liam Hehir’s How the capital gains tax affects the average New Zealander.

Will house prices go up or down as a result of the CGT? There is no consensus on this question, but certainly there’s no strong suggestion that the CGT will be any elixir for the problem. Likewise, with rental properties, it’s hard to see that the tax will result in cheaper rent.

It is clear that there will be some headaches caused by the tax in terms of compliance costs, especially in terms of valuing the price of assets when the CGT is first introduced. For the best discussion of this, see Ben Leahy’s Automated mass valuations could be used to value Kiwi properties ahead of a capital gains tax. As this article – and others – make clear, there will certainly be a bonanza for tax consultants and accountants, who will be advising the wealthy on how to structure their assets to avoid the CGT.

There will be many complicated situations that arise from the CGT and often there will be inequities as a result. This is dealt with well in David Snell’s Implementing capital gains tax will be ‘incredibly difficult’.

Finally, for humour on the tax proposals, see my blog post, Cartoons about the proposed capital gains tax.

by Dr Bryce Edwards

During the last decade, there has been an explosion of concern around the world about economic inequality. Here in New Zealand there has been a growing debate about how to deal with this, and virtually all parts of the political spectrum now pay attention to this problem. It is in this context that the Tax Working Group’s proposal for a relatively comprehensive capital gains tax (CGT) has been produced – as an attempt to help rebalance inequalities in New Zealand, and improve our society.

The best arguments in favour of introducing a comprehensive CGT revolve around inequality, and Michael Cullen, who chaired the Tax Working Group (TWG), has been clear in his defence of their proposals that they are fundamentally about fairness.

He’s pointed to the great economic inequality that exists in New Zealand and suggested that a CGT would help ameliorate that, because it would result in the rich paying more tax based on their wealth and income. He has argued that it is wrong that wage-earners are taxed on their full income while the wealthy “can earn income from gains on assets and not be taxed at all”.

The proposed CGT would have a 33 per cent tax applied to rental properties, baches, company shares, farms and other businesses. Cullen has argued that the additional $8bn that might be raised from the new tax over the first five years would allow tax cuts for the poorest New Zealanders.

Straight after the release of the report on Thursday, leftwing blogger No Right Turn elaborated on this: “At the moment we have a situation where ordinary New Zealanders are taxed on every dollar they earn, while the rich are not. And that is simply wrong. Income should be treated equally and taxed no matter what the source – and that means taxing capital income. If it has the side effect of removing distortions in our economy – the housing bubble, or farmers farming for capital gains – then that is a bonus, but fundamentally it is about fairness and making the leeches pay their fair share for once” – see: For a capital gains tax.

For a more in-depth discussion of the inequality driving the CGT agenda, see Max Rashbrooke’s Capital gains tax: A test of our national myths and Labour’s mettle. In this he says: “most of all the proposed tax is a test of the stories we New Zealanders like to tell about ourselves. Fairness and egalitarianism are supposedly our touchstones. Yet we have allowed inequality in income – our salaries and wages – to soar to such a point that we are among the developed world’s most unequal. When it comes to wealth – the assets we own – our wealthiest tenth have 60 percent of all assets while the poorest half of adults have just 4 percent. At the moment, that vaunted egalitarianism looks a lot like a myth. But a capital gains tax could make it something more real.”

Reinforcing that the CGT is all about dealing with inequality, John Armstrong also argues that the case for such a tax has been well made by the Government and the TWG: “They have made it their mission to address inequality. The means of doing so has now been laid out in detail in front of them. For Ardern in particular, the implementation of a capital gains tax is the ultimate test of her willingness not just to talk about doing the right thing, but to actually do the right thing. And without question, it is the right thing to do. Taking into account the current inconsistencies and anomalies in the way assets are treated, the logic for the introduction of a capital gains tax is compelling. The economic logic in terms of removing distortionary factors impeding investment decisions is similarly persuasive” – see: Failure to deliver capital gains tax would see Ardern reduced to a laughing stock.

Similarly, according to The Press newspaper, the debate “is about fairness. Is our tax system as fair as it could be? If your definition of ‘fairness’ boils down to the reduction of income inequality, then the answer is no… But we have heard little about fairness since the report was released on Thursday” – see: The pains and gains of tax reform.

The editorial condemns opponents for “political hyperbole” that has become “absurd”, especially the suggestion that “ordinary New Zealanders” are going to be worse off under the proposed new tax: “The reality is somewhat different. Rather than the ordinary Kiwi battler, it’s the wealthiest 10 per cent who would overwhelmingly be affected by the proposed capital gains tax. It is bizarre to hear hokey lines about the mythical Kiwi way of life trotted out by politicians who own as many as eight properties.”

Another newspaper editorial, in the Whanganui Chronicle, says that the CGT is an appropriate response to the growing divide in society between renters and landlords, and can help “correct an economic imbalance that threatens to tear our society apart” – see Simon Waters’ editorial: Why shouldn’t you pay tax, the rest of us do?

The editorial argues that the CGT should be implemented despite pushback from those negatively impacted by it: “We have become a nation of landlords. And tenants… Half the country is now crying like children who’ve had their candy fix taken away by mum. The other half, the tenants and the ones who can’t get on the property ladder because the investment frenzy has driven house prices too high to afford, wait. They wait to see if the Government has the gumption to turn those recommendations into reality. Will it cost Labour votes? Most likely. Would it be a politically savvy thing to do? Nope. Is it the right thing to do? Absolutely.”

For TVNZ’s Jack Tame, the deciding question is whether we “value fairness” in society. He supports a CGT and points out that perhaps it’s not in his interests to do so: “I work hard. I don’t sleep much. I work six days a week. I have sacrificed a lot in my life to get ahead. And I earn a lot of money. Most accountants would agree, a capital gains tax is absolutely not in my personal interest. But I do think it’s fair” – see: Why I think a capital gains tax is ‘fair’.

Tame says it’s all about consistency: “why if we value fairness, do we have an economy where every form of income is taxed tax, except one? Where, if someone buys a property, rents it out for a decade to cover the mortgage, then sells it for $400,000 more than they bought it for… that person gets to keep every single cent of that profit, while you working down the street and slogging away in a job, lose as much as 33 cents on the dollar.”

Even bank economists seem to agree that the CGT proposal is a positive step in dealing with inequality. For example, Jarrod Kerr and Jeremy Couchman of Kiwibank told The Spinoff on Thursday that “This is at a time when the concentration of wealth is shifting to a declining share of the population, and if nothing changes, wage and salary earners will likely have to pick up an increasing share of the country’s tax bill” – see: Five commentators weigh in on the Tax Working Group’s recommendations.

Similarly, Salvation Army social policy analyst Alan Johnson explained: “The taxation of wealth is past due in New Zealand if we’re to address the inequity that income from labour – and especially the labour of wage and salary earners – is taxed comprehensively, while the taxation of income from capital is taxed lightly”.

Another important part of the argument for introducing a CGT is the simple fact that most other similar nations have them. For a discussion of the various international tax rates and configurations, see Zane Small’s Capital gains tax proposal: How it compares to the rest of the world.

Cullen has been keen to push this line, and appeared on The AM show on Friday to say: “Everybody else has [a capital gains tax]. The United States, the United Kingdom – these rabid ‘socialist’ countries like the United States have a capital gains tax… France, Germany, the Nordics – they all take it for granted. Many of them have higher productivity than we do. The world doesn’t collapse with the introduction with a capital gains tax” – see Dan Satherley’s Judith Collins says capital gains tax will ‘make Simon Bridges the Prime Minister’.

On the question of whether it is fair to include cribs or baches in the CGT, Cullen also said: “Let’s be real about this – most families in New Zealand don’t own holiday homes. We never did – most families never did. We certainly don’t now. Holiday homes now are often bigger than the houses most people live in, in the cities. And if they’re not taxed, then it’s unfair to tax the ma and pa investors in rentals.”

Finally, so far National’s major attack-line against the proposed CGT was Simon Bridges response that the recommendations “are an attack on the Kiwi way of life”. For responses to this, see Megan Harvey’s Kiwis roast Simon Bridges on social media for his ‘Kiwi way of life’, and Hayden Donnell’s Once more unto the beach house: Simon Bridges and the Kiwi way of life.

What do some bankers and fund managers, a few senior government officials, a dozen top taxpayers, and a handful of companies located in the Philippines have in common?

They are among some 200 Filipinos, Philippine residents, and corporations that own or are linked to offshore accounts in tax havens across the world, according to the “Paradise Papers” cache of 13.4 million confidential electronic documents that had been leaked and exposed this month.

READ MORE: PCIJ’s Malou Mangahas to speak at Pacific Media Centre’s 10 years On event in Auckland

While having offshore accounts is not a wrongdoing per se, in some cases, these may be used to avoid or evade tax payments in their host countries, hide unexplained wealth, or move illicit and fraudulent financial flows across borders.

The latest expose by “Paradise Papers,” which has led to stories by media outfits such as the BBC and the UK newspaper The Guardian, covers offshore investments made by the law firm Appleby and corporate service providers Estera and Asiaciti Trust in 19 tax jurisdictions in the world.

About 120,000 people and companies are enrolled in “Paradise Papers,” including Philippine citizens, residents, and business entities.

Leaked papers
The “Paradise Papers” data files were leaked to the German newspaper Süddeutsche Zeitung, which shared these with the International Consortium of Investigative Journalists (ICIJ) based in Washington, DC, and its global reporting network of over 380 journalists from 100 news organisations, including PCIJ.

PCIJ reviewed the list with special attention to apparent transparency and accountability issues. PCIJ thus sent inquiry letters to about a dozen individuals who had served as senior state officials, donated to candidates for president, own or run major corporate entities, or are tied to contracts with government.

Not all the Philippine accounts are active as of the current year. Most accounts are listed to be operational still while some turned out to have been dissolved already, according to those PCIJ reached for comment.

PARADISE PAPERS: For the full list of persons and companies, check out ICIJ’s Paradise Papers database

This is the second round of PCIJ reporting on offshore accounts with ICIJ. In 2013, PCIJ wrote about the offshore ties of then re-electionist Ilocos Norte Gov. Maria Imelda “Imee” Marcos, then senator Manuel “Manny” B. Villar Jr., and then senatorial candidate Jose Victor ‘JV’ Ejercito. They all failed to disclose their interests offshore in their Statements of Assets, Liabilities, and Net Worth.

Five of those PCIJ sought for comment, as well as replies from the law and accountancy firms that had assisted them, invariably disowned or denied any wrongdoing had been committed in regard to their offshore accounts.

But Filipino and Philippine-based offshore account holders may have nothing to worry about for now. At present, the Philippines has neither law nor rules, nor any effective regulatory framework for monitoring or even recovering taxes possibly due from monies in these accounts.

Split opinion
Also, between former and current finance officials, there is a split opinion on what the Philippine government should do to regulate such accounts and to run after their owners.

Interviewed recently by PCIJ, former Internal Revenue Commissioner Kim Jacinto-Henares said that in her view, when someone or some entity opens an offshore account, that should raise concern at once among government officials.

In contrast, Finance Secretary Carlos G. Dominguez — who admits his connection to an offshore account himself until 2001 – told PCIJ that “there is nothing illegal per se about these accounts… and we are not about to declare them illegal”.

“Actually,” Henares said, “nobody can stop you from incorporating anywhere in the world.” But, she said, “the question is if that company has an asset that matches (its) net worth.”

She pointed out, “The important thing to ask is if the tax for that had been paid, and second, did it come from questionable deals. Kasi ‘yung galing sa masama rin, hindi mo rin binabayaran ‘yung buwis (Because if it came from something illegal, you wouldn’t pay the tax due).”

Why hide monies?

Henares continued: “Ibig sabihin, hindi mo siya maipasok mainly sa pangalan mo kasi hindi mo ma-explain saan nanggaling ‘yung income, saan galing ‘yung pera. ‘Yun lang naman ‘yung tinatanong d’yan, pero itself, wala namang problema (In other words, you couldn’t place it under your name because you won’t be able to explain where the income was sourced, where the money came from. That’s really the only question there, but itself, there’s no problem).”

It’s a question, according to her, of what would drive someone or some entity to open an offshore account. “Siyempre, medyo may tanong lang na ano bang objective mo (Of course, there’s a bit of a question there on what really your objective is),” Henares said. “Parang lahat ng tao feeling nila na kapag Pilipino ka, naiisahan mo ‘yung gobyerno mo. Bakit mo ginagawa ‘yan? (So everyone starts feeling like, if you’re a Filipino, you can easily put one over your government. Why do you do that?)”

‘No law, not illegal’
Dominguez takes the contrary view. Indeed, he said that there is no clear, cogent legal framework to regulate offshore accounts, but getting one “would require legislation by Congress.”

At the moment, he said, “we’re all focused on the tax reform bill until December.”

“But really,” Dominguez said, “there is nothing illegal per se about Filipinos or Philippine residents opening accounts overseas.” Still, he said that “when information like this comes out, then we look at it case by case.”

“In truth, there is nothing illegal about it,” Dominguez said. “It is legal, and we are not about to declare it illegal.” He then cited one instance when he was told that a friend of his staff had planned to open a dollar account in Hong Kong to buy bitcoins. Recalled Dominguez: “I told her, ‘Go ahead, that’s okay’.”

These comments by the Finance Secretary came on the fourth time that PCIJ had called him in the last month, to follow up on a request letter for an official opinion on offshore accounts from his department.

PCIJ mailed its letter to Dominguez last November 8, prompting a quick call from him; at the time, though, he was still in Vietnam for the Asia-Pacific Economic Cooperation Summit (APEC).

Working group promise
He promised then that he would organise a technical working group of his staff, as well as officials of the Bureau of Internal Revenue, and — if they would agree, he said — of the Bangko Sentral and the Anti-Money Laundering Council.

The ASEAN (Association of Southeast Asian Nations) Summit intervened and kept Dominguez busy for a week. He received PCIJ’s second and third calls during the week, however.

Last November 16, he said, “My staff will write you a letter. We discussed this yesterday. There is no law prohibiting anyone from opening offshore accounts. It’s allowed by law.” Offshore accounts “may be a tax leak for us,” Dominguez said, “but it is a small leak.”

He added that offshore accounts are a lesser problem than tax incentives that some companies and sectors have been enjoying for so long. “We have a list of tax incentives given, and you’d be surprised how big those amounts are,” Dominguez said. “Some have been receiving tax benefits for over 40 years.”

Tax leakage on account of incentives given to corporations is, in Dominguez’s view, “a more important issue than someone buying, registering a plane or cargo vessel — that is a one-off thing.”

In an offshore leaks database reported in 2013, Dominguez’s name had actually come up as an offshore account holder. The company listed in his name was called Radstock Corp.

Connection admitted
When PCIJ asked Dominguez about this, he promptly acknowledged his connection with Radstock.

“I saw that before,” he said. “I was involved with them a long time ago, 2001 ‘ata.” As he recalled it, his engagement as a director of Radstock was connected with a project of the Philippine National Construction Corporation.

Like Dominguez, many other finance experts say that offshore accounts are legal. They also note that these are rather common among multinational enterprises with global operations.

Yet when account holders turn to tax havens offshore to avoid or evade paying taxes, hide illicit wealth, and conduct illegitimate or abusive financial flows in secret, they cross over to forbidden territory in law.

Evade, avoid taxes
International companies, finance experts say, operate in tax havens to be able to transfer the taxable income to jurisdictions where tax rates are lower. Companies that make profits in the Philippines, for instance, can transfer these to other jurisdictions. This means that what should have been part of the tax base of the Philippines becomes instead part of that of another country.

Tax havens also use secrecy as a prime tool to hide identities. Individuals and entities can hold shares in offshore companies without being identified, unlike in the Philippines where incorporation and registration records are public.

Too, one can sell shares offshore without having to pay capital-gains tax.

Secrecy jurisdictions provide structures that enable people or entities to skirt or undermine laws of their home country or jurisdictions elsewhere. In the Philippines, the lack of a legal and regulatory regime over offshore accounts makes it difficult for government to run after tax evaders and money launderers.

According to the Tax Justice Network, between $21 trillion and $32 trillion of private financial wealth is located, untaxed or lightly taxed, in tax havens around the world. Illicit cross-border financial flows have also been pegged at $1 trillion to $1.6 trillion per year, a huge amount compared to the $142.6 billion in global foreign aid in 2016.

Founded in 2003, Tax Justice Network or TJN is a UK-based independent international network that conducts research, analysis, and advocacy on international tax, the international aspects of financial regulation, the impact of tax evasion, tax avoidance, tax “competition,” and tax havens. Not aligned with any political party, TJN has global and regional partners in Africa, Asia, Africa, Europe, Latin America, and North America.

TJN has a Financial Secrecy Index that ranks jurisdictions according to their secrecy and the scale of their offshore financial activities. The higher the rank, the more secretive financial activities are in the country.

The scoring is based on an assessment of 15 secrecy indicators that can be grouped around four broad dimensions of secrecy: knowledge of beneficial ownership, corporate transparency, efficiency of tax and financial regulation, and international standards and cooperation.

Of the 92 countries surveyed by TJN for its 2015 Index, Bermuda was ranked No. 34 and Isle of Man at No. 32. The Philippines was 46th. Switzerland, Hong Kong, and the United States are first, second, and third, respectively.

The Financial Secrecy Index reveals that the stereotypes of tax havens are misconceived. Said TJN: “The world’s most important providers of financial secrecy harbouring looted assets are mostly not small, palm-fringed islands as many suppose, but some of the world’s biggest and wealthiest.”

Wanted: Evidence
As of this posting, PCIJ has yet to receive a written reply from Dominguez himself, or even from the “technical working group” that he said he plans to convene to study the matter of offshore accounts.

He tossed PCIJ’s query letter to Finance Undersecretary Antonette C. Tionko, who recently replied to PCIJ. She said in part that they had “gone through the attached list which contains names of Filipinos and a few foreign corporations which appear to have Philippine ownership (although this is not clear considering that only the name of said corporations are provided).”

“Please note,” Tionko said in her letter dated November 22, “that under Philippine tax laws, income of Filipino citizens are subject to Philippine income tax regardless of where earned. On the other hand, only income of foreign corporations from Philippine sources is subject to Philippine income tax.

“Hence, if we assume that the listed corporations are all foreign corporations, evidence must be presented… that income is earned and not reported in the Philippines to constitute a violation of the Tax Code.”

She then asked for “further information” on the Filipinos on the Paradise Papers list. According to Tionko, information “such as purported types of investments, amounts of said investments, and the like will be relevant in determining whether or not there is a violation of Philippine laws.”

Global vs local firms
To Henares, meanwhile, big companies and top taxpayers who have offshore ties are not suspect. She is more concerned, she said, about those on the list who have no global business or reason to have offshore companies.

Asked Henares: “If you have no international corporation, then what are you doing there?”

Henares said that she welcomes having more information into offshore transactions primarily because without information and appropriate regulations, governments have no way of running after tax evaders who hide their wealth offshore.

The BIR, with Henares at the helm, had set to investigate Filipinos with offshore accounts following PCIJ’s 2013 report. But Henares said she could not recall updates on the planned investigation.

When contacted by PCIJ on the matter, BIR Assistant Commissioner Marissa Cabreros said that the Bureau cannot confirm or deny any information about it because its staff are bound by law to keep silent.

In any case, Henares said that the country’s strict bank secrecy law in a way already offers “a domestic haven” for people who may want to hide their cash assets. Tax havens offshore meanwhile offer options for people who may want to hide their ownership of properties.

“Let’s say,” she said, “without knowing how much they have in the bank, we already know they’re deficient by P1 million. What more if we have that bank figure? It would be much, much more ‘di ba? Then what more if we have the information about the international (accounts)? Then it could become much, much more din.”

Information exchange
The OECD Global Forum for Tax Transparency was specifically set up to address the risks to tax compliance posed by secrecy jurisdictions. Global Forum members, among them the Philippines, had agreed to implement transparency and exchange of information for tax purposes. This includes the Exchange of Information on Request (EOIR) and the Automatic Exchange of Financial Account Information (AEOI), which requires tax administrations to exchange taxpayers’ financial information.

Henares clarified, however, that the Philippines is involved only in the EOIR, which allows the BIR to exchange information only with a country that the Philippines has a tax treaty with.

The Philippines was reviewed as “largely compliant” in the first round of the EOIR review. But it currently has treaties with 41 countries only; it has no tax treaty with many of the popular tax havens.

The OECD and the Council of Europe also developed the Convention on Mutual Administrative Assistance in Tax Matters, which is said to be the “most comprehensive multilateral instrument available for all forms of tax co-operation to tackle tax evasion and avoidance.”

The convention not only provides for exchange of information, but also includes assistance in recovery, the service of documents, and facilitation of joint audits.

The Philippines signed onto the agreement in 2014 but has yet to ratify it.

The article was published by the Philippine Center for Investigative Journalism (PCIJ) and is republished here with permission.

Article by AsiaPacificReport.nz