Reform of the Tax System
The overall objectives of Budget 2010 tax reform are to:
- lift economic growth by improving incentives to work, save and invest,
- improve the fairness, coherence and integrity of the tax system by reducing opportunities to avoid tax (and/or unduly gain access to social assistance), and
- have a tax system that supports New Zealand's competitiveness globally in a sustainable manner.
A fair and efficient tax system is one of the Government's six key drivers of economic growth. The Government agrees with the Tax Working Group that shifting the tax burden to less mobile and less growth-damaging bases, reducing income tax rates and removing tax preferences is necessary to create a fairer, more sustainable tax system that is less damaging to growth.
Taxes are pervasive and they affect a myriad of business and personal decisions. New Zealand needs a tax system that helps us shift away from borrowing and consumption towards saving and productive investment.
Personal taxes affect incentives to work and to up-skill. They also affect people's decisions to stay and work in New Zealand or to work abroad, and the incentives for skilled foreigners to come to New Zealand. Around 17% of skilled New Zealanders now live abroad, the third highest percentage in the OECD. Given our highly mobile and skilled labour force, reducing personal tax rates is important for growth. A more competitive tax structure will help New Zealand to maintain its tax base; enhance our skills, knowledge bases and productivity potential; and so improve our living standards.
The cornerstone of the tax reform package is a $4.5 billion per annum reduction in income tax rates, funded by an increase in GST and income tax base-broadening and integrity measures. This is expected to increase the growth potential of the New Zealand economy by improving the overall efficiency of the tax system.
From 1 October 2010, all personal income tax rates will decrease. The new tax rates will be:
- 10.5% on income to $14,000 (down from 12.5%)
- 17.5% on income between $14,001 and $48,000 (down from 21%)
- 30% on income between $48,001 and $70,000 (down from 33%), and
- 33% on income over $70,000 (down from 38%).
The rate of GST will rise to 15% at the same time.
The Government has made it clear that it would not increase the rate of GST unless it would benefit the New Zealand economy in the long term and unless it saw the vast bulk of New Zealanders better off. The reductions in income tax rates more than compensate earners at all levels of taxable income for the increase in GST. For 250,000 workers earning around or just below the average income, namely between $40,000 and $48,000, their top income tax rate will have almost halved in 18 months, dropping from 33% down to 17.5%.
The tax reform package also contains measures to compensate vulnerable individuals for the increase in the rate of GST. Recipients of New Zealand Superannuation, Veterans Pensions, main working age benefits, Student Allowances, some Working for Families tax credits (WFF), some Government Superannuation and National Provident Fund payments, and some of the main supplementary benefits, will receive additional financial support.
The tax changes will affect different people in different ways, depending on their source of income, how much they earn and how they spend their money. Some examples are included below:A married couple both work. They jointly earn around the average household wage of $76,000 - one earning $50,000 a year and the other earning $26,000. They have two children under the age of 13 and also receive Working for Families. The family pays $300 a week in mortgage repayments which do not incur GST. Under Budget 2010 changes, they get a household tax cut of $45.85 a week and pay an extra $21.14 in GST to buy the same goods and services as before. Overall they are $24.71 a week, or $1,284.92 a year, better off.
A retired couple receive New Zealand Superannuation. They own their own home. Under Budget 2010 changes, they get a tax cut of $11.52 a week, plus an additional $10.12 increase in their NZ Super and pay $10.87 extra in GST to buy the same goods and services as before. Overall they are $10.77 a week, or $560.04 a year, better off.
A single person earns $50,000 a year - about the average full-time wage. He pays $120 a week rent towards the flat he lives in and is saving $50 a week towards a deposit on his first home. Under Budget 2010 changes, he gets a tax cut of $29.42 and pays $13.51 more in GST to buy the same goods and services as before. Overall he is $15.91 a week, or $827.32 a year, better off.
A high-income couple each earn $150,000 a year and have investment properties. They now own ten properties with a combined market value of about $6.5 million. Rents of these properties provide a return of $769.23 a week over and above interest and maintenance costs. They do not currently pay any tax on this additional income, as they are able to claim the same amount in depreciation. Under Budget 2010 changes, they get a combined personal tax cut of $235.76 a week. But because they can no longer claim depreciation on their houses, their tax increases by $253.84 a week. In addition they pay $89.39 more each week in GST if they continue to spend all of their after-tax income. Overall they are $107.47 a week, or $5,588.44 a year worse off.
Full details of the tax package can be found at www.taxguide.govt.nz
Examples assume that income after tax, housing costs and savings are spent on goods and services that attract GST, and that retailers increase prices for the full GST rise.
Economies are increasingly open, taxes influence global investment decisions and statutory company tax rates have been declining globally. Therefore the company tax rate will be reduced from 30% to 28% from the 2011/12 income year. A reduced company tax rate will make it more attractive for businesses to locate and invest in New Zealand and reduce incentives for multinational firms to stream profits away from New Zealand.
The tax rate for a number of other savings vehicles, including the top tax rate for portfolio investment entities (PIEs), superannuation funds, unit trusts, group investment funds and life insurance policyholder income, is currently aligned with the company tax rate. That approach will continue with the tax rate for affected savings vehicles also reducing to 28%. This will further increase incentives to save.
The tax rate for trustee income is unchanged, so as to align with the new top tax rate of 33%. This improves coherence and integrity. In particular, non-aligned rates provide opportunities for high income earners to shelter their income in trusts.
There are also widespread concerns about some households structuring their affairs to increase their eligibility for social assistance programmes (such as WFF). This is unfair. As an initial step, from 1 April 2011 investment losses will be added back to taxable income for the purpose of determining eligibility for Working for Families assistance. Further changes, covering areas such as distributions from trusts and income from cash PIEs, will follow after the Budget. Officials will release a paper setting out the issues and proposed solutions later this year for implementation from 1 April 2011.
The current tax system is not neutral with respect to investment decisions. The Budget introduces a range of measures that broaden existing tax bases and make effective tax rates more uniform across sectors. The existing 20% depreciation loading is explicitly designed to skew depreciation tax rates away from economic rates. This will be revoked for new assets. It is also clear that not all buildings actually depreciate. Depreciation rates for buildings with expected lives of 50 years or more will be set to zero to reflect this.
The thin capitalisation “safe harbour” threshold for inward investment will reduce to 60%. This is to buttress the internationally recognised principle that income should be taxed in the jurisdiction where it is generated (in this case New Zealand).