Personal income taxes in particular are damaging
A number of recent studies (including OECD studies), have concluded that some taxes are more damaging to economic growth than others. In particular, they have found that income taxes are the most damaging while consumption and certain property taxes are least damaging. Further, personal income tax progressivity appears to adversely affect Gross Domestic Product (GDP) levels.
International and domestic evidence highlights three existing aspects of New Zealand's tax system which are particularly harmful for revenue integrity, economic efficiency and productivity growth:
- High Rates of Personal Income Tax;
- Large differentials between the top personal and corporate rates of tax; and
- Different tax rates applying to different sources of income and different forms of investment.
This evidence suggests a focus on the reduction of personal and corporate tax rates in order to maximise the growth gains from tax reductions. In determining where to most immediately focus tax cuts, a key consideration is the need to address differences in tax rates applicable to different sources of income and different business vehicles or investment forms - which provide tax arbitrage opportunities and cause investment and tax-planning responses to divert income towards tax-favoured forms. As a result of this tax-induced behaviour, investment may be diverted into investments producing high post-tax returns, despite higher pre-tax returns elsewhere. This reduces national welfare through lower overall returns to the economy. Such behaviour can also create serious and unsustainable tax system integrity risks for the government. In addition, these disparities also reduce equity between taxpayers, as an individual's tax liability is less a function of the quantum of income earned and more a function of the type of income and manner in which it is earned.
An example of rate disparities across certain forms of income and investment vehicles can be seen in the following tables:
| Taxable Income | Marginal tax rate if earned through PIE (high earner) | Marginal tax rate if held direct* (high earner) | Marginal tax rate if held by a trust* (& taxed at trustee level) |
|---|---|---|---|
| Interest | 30% | 39% | 33% |
| Dividends | 30% | 39% | 33% |
* Assuming the individual is not a trader and shares are not bought for purpose of resale. With respect to land, it is assumed that the individual is not a dealer, developer, subdivider, or builder and that the land was not purchased with the purposes or intention of resale.
| Investment vehicle | Marginal tax rate |
|---|---|
| Sole proprietor/individual | 0%-39% depending on total taxable income |
| Portfolio Investment Entity (PIE) | Typically 19.5% or 30% depending on prior year income of investor |
| New Zealand Company | 30%, then marginal rate of shareholder upon distribution |
| Trust | Trustee income: 33%; if beneficiary income: generally marginal rate of beneficiary |
| Qualifying company/LAQC | Income taxed at 30%. There may be claw back on payment of dividend to high marginal rate recipient but also potential to pass through capital gains through payment of tax-free dividend; losses may be passed through to LAQC shareholders for use at their marginal rate (e.g. 39%) |
| Partnerships | Ability to use exemption thresholds to escape tax on sale of underlying interest in assets (e.g. up to $50,000 depreciation recovery). Otherwise marginal tax rate of individual partner applies: 0%-39% |
In addition, horizontal inequity exists within the current tax system as individuals on the same income level face differing MTRs and ATRs depending on their personal circumstances. For example, an individual without children earning $35,000 per year derived entirely from salary/wages will pay around $146 more per week in net taxes than an identical individual who has one child (assuming no other household income). This is a result of the targeted WfF tax credits. Perceived inequity in the application of taxes can undermine the integrity of the system and result in reduced voluntary compliance.
Consequently, the negative effects on efficiency and equity, combined with the tax system integrity risks associated with these disparities, shows that a lowering of personal taxes and alignment of tax rates on different forms of income and investment are key matters to address. However, such changes cannot be undertaken in a vacuum and therefore must be considered in the overall context of fiscal and macroeconomic constraints. For example, the current fiscal and macroeconomic situation requires prudence concerning the extent of changes that can be made in the short to medium term.
