On Thursday 19th May 2022 Finance Minister Grant Robertson presented the Labour Government’s 2022 Budget. As is the custom over the last few Governments, there very few surprises with most good news stories announced in the weeks leading up to the Budget itself. The cynic might say this is to ensure each minister gets their share of the cash spend glory and don’t have to share the limelight. On Budget day, announcements tend to be adding everything up and saying “what a good boy [girl] am I”. Budgets are also an opportunity to spend money and the Government gets to call the shots on where that money is spent.
This year is no different, and there will be plenty of middle New Zealander’s (the “hard working New Zealander” we often hear about) in fact an estimated 2.1 million people that will be pleasantly surprised to receive $350 each from the Government in a few months to help them through this cost of living crisis (except we don’t think it is a temporary crisis), a mere steal at only $814 million. There is no application process, the Inland Revenue will assess a persons eligibility and pay it directly to their bank account over a three month period. [That’s scary for many reasons we don’t have space to go into] While the SME sector is getting an injection of $100 million for a Business Growth Fund. “A new fund to improve access to finance for small and medium businesses is included in a package of Budget 2022 initiatives to drive economic security, innovation, and low-emissions growth. … It is intended the Fund will help fill a gap in the capital market for SMEs that require growth capital not available through current market providers. The Fund is an investment model already established in the UK, Ireland, Canada, and Australia.” Charles Beckford of Radio NZ noted dryly that “$100 million goes nowhere” . So, on that cheerful note we will go slightly off topic and look at something else, but not completely outside the Budget square.
We were strolling along the Oamaru harbour in early May 2022 and took the photo for this blog. It seems to us that somethings like this photo are not quite what they first appear. Can you spot them? [Here’s a hint there is at least 6 things that are not what you first think. And since Shellock has just celebrated 7 years in business, maybe an eagle eyed reader will find a 7th].
Governments are very similar to life; what you first see is not what you get. Blending in or seeing different things in the same photo, facts, or perspective is to be expected. Take for example the idea of an Inheritance Tax – currently being discussed in various media outlets. It’s a “kind of” wealth tax, but arguably doesn’t really hurt anyone because the person who has accumulated it no longer needs their wealth and the person they leave it too didn’t work for it (earn it) so if they lose a bit around the edges (tax) before they get the cash then no one is harmed. Right? Tell that to someone who has had to sell off an inheritance to pay the tax bill. Consider where that wealth come from in the first place? Usually, someone earned the money and mostly paid income tax at the time, which post tax they invested. So, in effect an Inheritance Tax is a second tax if you didn’t spend it as you earned it.
Back in the day, New Zealand had a thing called “Estate Duty”, and “Gift Duty” and there were awful lots of tiny nasty rules to make sure ’rich people’ didn’t escape these duties. When Estate Duty was reduced to zero, it became obvious that Gift Duty would shortly follow. This was for two reasons. Gift Duty principally existed to prevent people divesting themselves of wealth before they died (and thus avoiding Estate Duty) and because it was relatively simple to avoid Gift Duty itself (for those in the know). When Gift Duty was repealed the Revenue saved a lot of money, because it cost more to administer than the duty it received. Yes, some other countries have Inheritance Taxes or Duties, and almost always coupled with some form of Gift taxes. Both are attractive in many ways (to some) on the basis that no one really gets hurt and the tax is only paid when the asset is realised. Unfortunately, that is not the case at all. Why one wonders are there so many large stately homes in the United Kingdom and Europe falling into ruins or gifted to a National Conservation Trust? Why do very (financially) successful people live in countries they were not born in, were not raised in and do not make their income in? Because of tax and duties. Most of these countries also have a land or asset transfer tax (yip, New Zealand got rid of “stamp duty” years ago too).
In the early 1980’s there were significant other taxes and rules and things that successive Governments used to control the economy and inflation. Now days these are called ‘levers’. A person paying their “fair share” of tax was also a common theme (often because the Government was spending big and needed more money). What is a “fair share” is much debated, and who is “wealthy” as well as who falls into the “squeezed middle” cannot be easily defined. Most people would say they are not wealthy, but it is all based on one’s perspective (literally and figuratively). Does wealthy mean that you own two properties (with or without debt), perhaps only one? Does it include those who earn more than $70,000 (as this budget clearly considers those earning under this amount are in need of temporary financial support), $100,000 (or $180,000 as the present Government believes based on the 39% tax bracket), $500,000 or more? Or does it mean that you have a debt free house and a “choices” retirement, which the Retirement Commissioner urges us to aim for. Should it matter that you took financial risks and had sleepless nights, that you “worked your way up to the top”, that you saved or inherited, or it fell into you lap?
Why were these historic taxes and duties removed in New Zealand? Why was it that the personal level of income tax rates were lowered and levelled significantly, and the “Super tax” for working annuitants repealed? Why? Because in our opinion these all caused basic inequity between taxpayers and they suppressed genuine capital investment, which had as a goal a decent return on your risk. Once the tax rates were more closely aligned to each other, the tax avoidance gravy train dried up and the New Zealand economy focused on growth not protection. We (as a country) had to live within our means. Protectionism was removed both within New Zealand and overseas and we had to play in the big wide world. That was a difficult time for New Zealand, and some businesses collapsed, and some lost jobs. Yet we were not the only country to go through that pain, but possibly one of the first.
Minister David Parker (Revenue) in his speech at Victoria University on 26th April 2022 raised the idea of a Tax Principles Act. This may well have merits as it is time to reset the clock on what we as a country believe is appropriate for us. The way we do business, the way we work and the way we live is completely different to mid 20th Century New Zealand. While an oil crisis is upon us (again) but discussion and action on climate change and social contracts and constructs are no longer just academic discussions. A level of social fairness and equity has always been a part of our history (even if not perfectly executed) and will be part of our future. The idea that each political party agreeing to these core Tax Principles, and the public, is not as difficult as you might think. Since 1994 we have had legislation regarding Fiscal Responsibilities and the sky has not fallen in.
Minister Parker’s speech can be found here. It’s entitled “Shining a light on unfairness in our tax system”. He references the long running tax principles being already settled (from Adam Smith 1776 through to UK, Australia tax reviews, and our own tax reviews of 1982, 2001 and 2019). Minister Parker says the main settled principles are:
- Horizontal equity, so that those in equivalent economic positions should pay the same amount of tax
- Vertical equity, including some degree of overall progressivity in the rate of tax paid
- Administrative efficiency, for both taxpayers and Inland Revenue
- The minimisation of tax induced distortions to investment and the economy.
Whatever your view or your interpretation of these, our paper here is to raise the fact the latter two are currently being overwhelmed by political debate in identifying and securing the first two.
There is a well-known saying which goes something like this: ‘Those who do not remember the past are condemned to repeat it’.
Why is the present New Zealand Government investigating bringing back a number of old rules in a new wineskin? See for example the “Dividend integrity and personal services income attribution” discussion document released in March 2022, which proposes a two or three tranche review to stop top earners from circumventing the 39% tax rate. Here is an extract:
1.12 The Government considers that the current tax settings will lead to further integrity pressures. Evidence to support that expectation comes from the increased avoidance of the top personal tax rate that occurred in 2000 [sic] in response to the increase in the top personal rate to 39%.
1.13 Increased structuring may have unintended impacts on:
- Revenue: Tax collected is reduced by increased structuring activity. This is due to the direct impact of taxpayers being able to earn their income through lower-taxed entities, such as trusts and companies. It is also because an inconsistent rate structure makes it harder for courts to find tax avoidance when the different rates mean it is difficult to determine whether a structure undermines what Parliament contemplated.
- Social capital and the integrity of the tax system: Perceptions of arbitrary outcomes, such as when some taxpayers can structure to avoid the 39% rate, will erode public confidence in the integrity of the tax system and the perception that all taxpayers are treated fairly.
- Horizontal and vertical equity: In the absence of integrity measures, more income of high-wealth individuals and others with substantial capital income is likely to flow to lighter-taxed entities. This suggests that the impact of the 39% personal tax rate will disproportionately fall on less wealthy salary and wage earners.
Tranche one looks at addressing “dividend integrity and income attribution measures relating to the use of closely-held companies and trusts by high income individuals” [1.16]. Let us spell out what that means in real speak. Taxing the sale of shares by a controlling shareholder, to the extent the company has undistributed retained earnings. A form of Excess Retention Tax if a company does not pay out sufficient profit each year. Extending the Personal Attribution Rules to potentially affect nearly every small service provider in the SME field and most service provider start-ups? This by the way, could affect doctors and surgeons, dentists, physiotherapists, accountants, lawyers, engineers, plumbers, electricians, hairdressers, dog walkers, cleaners, taxi and courier drivers, financial advisors, midwifes and consultants to Government agencies – to name but a few. Even if individuals holding these occupations do not get caught in the tax net, they need to prove (at their cost) they do not. In essence anyone who ‘does’ stuff, rather than ‘sells’ stuff will be subject to a higher level of tax compliance. Why? Because, as reported in this document, the Government has ruled out a comprehensive Capital gains tax, has ruled out raising the company tax rate and has chosen to introduce a 39% personal tax rate thus creating an (up to) 11% difference between corporate and individual tax rates. And they have to do something about it! Perhaps someone should point out that if the Government are the cause of the problem by their own policies, maybe instead of digging a new hole (or building a new higher and stronger anti-avoidance wall) they should stop and reconsider why the 4th Labour Government (1994 – 1990) dismantled these very things they are considering recreating.
Tranche Two will look at “trust integrity” and “company income retention issues” [para 1.18], and a possible Tranche Three will look at investment income held via PIE’s (Portfolio Investment Entities) [para 1.20]. This last one will be extremely unpopular if the Government tinkers too much here, and it may affect everyone of us with a KiwiSaver account.
In our experience, if the Government ignores the social contract between it and taxpayers there will be a problem to the tax integrity of collection. If compliance costs too much to administer people will not comply. If the distortion between different levels of taxation is too great, the temptation to try to avoid the rules will be enticing. Let’s not go back to the 1980’s – lets move forward with different thinking that makes us all proud to call this country home and all be prepared to pay our “fair share” of tax fairly.
If you have got to the end of this paper and you still want to read a summary of each of the Budget announcements they can be found here. There is something for many, not enough for everyone, and some miss out. Minister Robertson has described this as a “Wellbeing Budget 2022 – A Secure Future [which] charts the course for economic security and a high wage, low emissions economy as the world emerges from the COVID-19 pandemic.” A shorter summary is also available on Radio NZ’s website through this link.
Overall, the social contract is we pay our taxes to bring us all on the wellbeing path. Few would object to the idea of a secure future, economic security, a high wage, low emissions economy (and support for those who need it the most). How we finance it, and Who finances it are legitimate questions. Has the budget provided the answers? Probably not, and to be fair, does any Government budget really say how it is to be funded? But when the Government looks to fund these aspirations, it needs to remember the social contract that we have signed up for (whether we knew it or not).
The views expressed in this paper are those of the Director of Shellock Consulting Ltd. If you wish to join in the debate please do so. Death and taxes affect us all.