Tax Working Group Public Submissions Information Release

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September 2018

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Future of TaxEY’s submission to the TaxWorking Group

April 2018

A member firm of Ernst & Young Global Limited

Ernst & Young Limited2 Takutai SquareBritomartAuckland 1010 New ZealandPO Box 2146 Auckland 1140

Tel: +64 9 377 4790Fax: +64 9 309 8137ey.com/nz

Tax Working Group SecretariatPO Box 3724Wellington 6140New Zealand

Uploaded via online submission form

30 April 2018

The Future of Tax

Tēnā koe e te rangatira Sir Michael

EY welcomes the opportunity to submit to the Tax Working Group (“the Group”).

At EY, we are committed to building a better working world — with increased trust and confidence in business,sustainable growth and development of talent in all its forms. We have asked ourselves the question “How can thetax system contribute to a better working world beyond 2028?”

Our submission contains as many questions as answers. That’s deliberate. We’d like the opportunity to contributeto a national debate on tax – we don’t seek to dictate solutions.

Many of our recommendations are challenging. They will require further development both as to design and theirpotential costs and benefits.

The Group has a huge mandate. Your kaitiakitanga function as stewards and guardians of our tax system for futuregenerations is vital.

We look forward to continued engagement.

Matthew Hanley, New Zealand Tax Leader

Ernst & Young Limited

David Snell, Tax Policy Leader

Ernst & Young Limited

[1]

[1]

Future of TaxEY’s submission to the Tax Working Group EY ÷ i

Table of contentsExecutive summary ................................................................................................ 11. Framework for a good tax system ..................................................................... 52. The future of work ........................................................................................ 113. Taxes and productivity .................................................................................. 184. Opportunities for effective environmental taxation .......................................... 305. Capital taxation ............................................................................................ 436. GST is New Zealand’s most effective tax ......................................................... 627. Tax reform process improvements required .................................................... 668. Summary of our recommendations and their potential benefits ......................... 719. Glossary ....................................................................................................... 77

Future of TaxEY’s submission to the Tax Working Group EY ÷ 2

Executive summary

Future of TaxEY’s submission to the Tax Working Group EY ÷ 1

Whāia te iti kahurangi ki te tūohu koe me he maunga teitei

Seek the treasure you value most dearly: if you bow your head, letit be to a lofty mountain

This whakatauki is about aiming high or for what is truly valuable:the Future of Tax is a complex but critical discussion for ourcountry. However, the whakatauki’s real message is to bepersistent and not to let obstacles stop you from reaching yourgoal: we offer our submission as a supportive contribution to theGroup and this important kaupapa (cause).

We believe a more efficient and equitable taxsystem is necessary for inclusive growth. Thatsystem is achievable in the medium term. TheGovernment will need to make a substantialcommitment to tax reform if enduringimprovements are to be delivered.

New Zealand’s tax system isn’tbrokenA broad-based income tax with taxing pointsclosely matching cash-flows, a withholding taxbased approach, and a comprehensive GST hasmany benefits. Our tax system has served uswell for decades and retains the ability to raiseapproximately 30% of GDP from our currenteconomy. We do not want the strengths of theexisting system to be undermined.

See Chapter 1.

We do not see the current systemas sustainable beyond 2028The Group’s Terms of Reference require you toconsider the economic environment over thenext five to ten years. This time frame is tooshort. Reforms enacted after the 2020election will have little impact in this period.

Instead, our tax system – although able tocontinue to function well for the next decade –needs to adapt to reflect the changing worldover the next several decades:

► Technology is changing the nature ofbusiness, and of society, faster than at anytime in history.

► Workforces, workplaces and the nature ofwork are changing.

► Environmental issues, particularly climatechange, will shape our future.

► New Zealand society is aging andinequality is increasing.

These forces are challenging the broad-baselow-rate (“BBLR”) approach and how taxes arecollected. They seem to us to set out a likelydirection of travel for the tax system – moretargeted, greater use of behavioural taxes,flexible, transparent and making more use oftechnology. In more detail:

The future of workOn the future of work, technological changeand the gig economy are leading to more short-term roles and rising numbers of contractors.More automation is on the horizon. That’s bothempowering and threatening for workers.

For our tax system, we believe there’s a need tore-examine the current employee/contractordefinition and rules around the treatment ofallowances and work-related expenses. IRDcurrently estimates the self-employed under-report their income by around 20%. Thatcannot be allowed to continue. There’spotential for real simplification, and theopportunity to enforce the law by usingtechnology and smart withholding techniquesto ensure tax is right first time, every time.

See Chapter 2.

Taxes and productivityIn the long-run our living standards depend onproductivity. New Zealand’s productivitygrowth has lagged behind our competitors for

Executive summary

Future of TaxEY’s submission to the Tax Working Group EY ÷ 2

at least 60 years. BBLR takes no account ofproductivity enhancing behaviour.

There are no easy answers to New Zealand’sproductivity deficit, but we suggest targetedmeasures towards capital intensive investmentare worth investigating as a way of attractingand retaining investment capital. Weacknowledge any form of incentive has issuesbut the potential gains could be greater than,for example, a small cut in the headline rate ofcorporate tax. There could be merits in specialrules for infrastructure investment, drawing onthe Australian and Singaporean experiences.

Small and medium-sized enterprises (“SMEs”)in particular are often capital constrained.While there is some logic behind calls for aprogressive company tax, the UK experiencegives rise to pause on its design. We see SMEsas a prime candidate for an integrated taxsystem. A truly integrated tax system has thepotential to remove the significance of entityform for tax purposes and would be essential tothe success of any progressive company tax.

See Chapter 3.

Opportunities for effectiveenvironmental taxationNew Zealand’s taxes are poorly aligned with theenvironmental and climate costs of oureconomic footprint. At 1.3% of GDP, NewZealand’s revenue from environmentallyrelated taxes is among the lowest in the OECD.

It is time to assess the role which environmentaltaxes - on carbon, on energy, on transport – canplay in changing human behaviour.

See Chapter 4.

Capital taxationThe current level of wealth inequalitychallenges the concept of inclusive growth.New Zealand has a private savings shortfall, yetreturns from investment are arguablyovertaxed.

There is a case for tilting the balance of capitaltaxation from flows – such as interest anddividends – towards stocks – such as land andother stores of wealth. There seems a greaterneed for tax related tools to address inequality,potentially rebalancing our system towardstaxing wealth, real income and consumption,and away from taxing nominal incomes.

Taxation of capital gains needs to be seen as apart of the overall taxation of capital incomeand household wealth, not as an isolated issueto address concerns in the housing market.

We retain doubts about the worth of a separatecapital gains tax (“CGT”) given the family homeis to be excluded.

See Chapter 5.

GST is New Zealand’s mosteffective taxNo tax is perfect, but in our view GST comesclose in its efficiency as a revenue raiser.While its horizontal equity has been challenged,we see equity as best examined across the taxsystem as a whole, with changes to GST onthese grounds not justified.

See Chapter 6.

Time for a new tax reformprocess?When it comes to the process of tax reform,New Zealand has rightly prided ourselves onthe Generic Tax Policy Process (“GTPP”).GTPP has delivered tax law meeting theobjectives of the government of the day. Giventhe forces changing today’s world, it is now toonarrow and too slow. Has the time come forradical reform?

See Chapter 7.

Established criteria for tax reformretain meritNew Zealand is fortunate to have many choicesto strengthen our already successful taxsystem. In making those choices, we endorsethe value of established criteria for assessingtax reform. Fiscal adequacy, efficiency, equityand fairness, revenue integrity, compliance andadministrative costs and coherence remainimportant. While trade-offs and weightingsbetween these objectives vary, our suggestionstend to weight efficiency highly. We of courseaccept others will form different judgments.

Our interest in efficiency leads us to suggestthe current tax system takes too little accountof the impact of taxes on behaviour. OurBBLR tax system is designed to be neutralbetween activities. In effect, BBLR is a secondbest approach to taxation. At least in theory,taxes can be designed to alter behaviour in

Future of TaxEY’s submission to the Tax Working Group EY ÷ 3

efficient, productivity enhancing ways. Withever increasing ability to analyse sophisticateddata in real time, there could be opportunitiesto reform business taxation in productivityenhancing ways.

Given the long term focus of the Group, theintergenerational aspects of the LivingStandards Framework will also guide decision-makers. The changes we suggest will, in ourview, contribute positively to its Four Capitals.

See Chapter 8 for a summary of ourrecommendations.

Further analysis neededMany of the matters raised in our submissionneed further analysis and research before finalrecommendations can be made, which hasn’tbeen possible in the time available forsubmissions.

We will play our part in the nationalconversation.

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Chapter 1

Future of TaxEY’s submission to the Tax Working Group EY ÷ 5

“The original concept of taxation was a simple one; taxes were themeans of raising revenue for subsequent expenditure by the rulingauthority. In a modern society taxation continues to serve thispurpose and remains the primary source of the revenue requiredby the State to ensure the protection, social welfare, andprosperity of its citizens. But as the political and economicstructure of society has become more complex so have theresponsibilities of Government increased and, as a consequence,taxation now serves far wider purposes than the simple raising ofrevenue1.”

Snapshot

The New Zealand tax system outperforms those incomparable economies.

While sustainable over the next decade, in the mediumterm the current tax system will find it increasinglydifficult to finance spending at around 30% of GDP.

Recommendations

1. Endorse and use established criteria to assess whether the tax system is sustainable.

2. Draw on the Living Standards Framework as a pointer for future work, but not yet for policyrecommendations – it remains insufficiently developed.

3. Changes should first be assessed against whether they will damage our existing strongposition.

Fifty-one years ago, the Ross Committee - thisGroup’s predecessors - set out the centraldilemma for tax policymakers. A tax systemneeds to generate revenue, but that alone isnot sufficient. How should the Group thinkthrough the inevitable trade-offs andcomplexity?

1 The Ross Committee (1967) Report of the Taxation Review Committee.

EY sees five key principles forsustainable tax reform1. The tax system should be capable of

raising sufficient revenue to fund theoperations of government.

2. Taxes should be raised in a way that isleast detrimental to inclusive andsustainable growth.

1. Framework for a good tax system

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3. Changes to the tax framework must havebroad community support and buy-in,which in turn requires our tax system tobe clearly progressive.

4. The tax framework needs to be robust, yetadaptable, to changing social, economicand technological trends anddevelopments.

5. The tax system and reforms to it shouldbe consistent and coherent,administratively efficient andoperationally transparent.

These principles apply regardless of theefficiency of governments in determiningoperating costs.

Benchmarking New Zealand’s taxsystemThe New Zealand tax system is not currentlybroken. In our judgment, it outperformssystems in comparable economies such asAustralia. Applying the established criteria fortax reform:2

Benchmarking approachThe scale (1 to 5 on the benchmarking chart) indicates how our tax system performs acrossestablished criteria – with a score of 5 representing absolute best practice and zero an absolutefailure across a particular dimension.

We do not expect all tax systems to target a score of 5 across all dimensions. There are trade-offs.

For example, a tax system with a high degree of revenue integrity is likely to face high compliancecosts and fall short of maximum efficiency due to complex anti-avoidance legislation. A systemwhich raises little revenue by design may well have a narrow tax base due and therefore be simpleto administer, but is unlikely to achieve horizontal equity.

2 At 19 of the Paper.

012345

Fiscal adequacy

Efficiency

Vertical equity

Horizontal equityRevenue integrity

Compliance andadministration…

Coherence

Benchmarking the New Zealand taxsystem

New Zealand Australia

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Factors behind our judgment are:

Direction oftravel

Importance Current state Short-termchange

Medium-term outlook

Fiscaladequacy

↔

The fundamentalpurpose of thetax system is toraise therevenue neededto fund theefficientprovision ofpublic servicesthat helpunderpin NewZealand’s socialfabric.

Tax revenues currentlymeet government’spublic finance objectivesand, in general, havedone so for many years.

None. The changing nature ofeconomies and a failureof the tax system toevolve will means itbecomes increasinglydifficult over time tofinance the level ofspending the communityexpects.

Efficiency

↗↘

After fiscaladequacy, thenext highestpriority is toconfigure the taxstructure topromote strong,sustainable andinclusive growth.

In a world where it isdifficult to measure andisolate taxpayerelasticities, the BBLRsystem is a good secondbest.

Boost frompending R&D taxincentive (if well-designed andadministered).

Challenges frompotential digitaleconomy taxes,pending BEPSreforms.

In a globalised worldthere is mobility ofeconomic activity – bothin capital and labour. Inthe medium term the taxsystem will have to bere-balanced in favour ofindirect taxes relative toincome taxes. Businesstaxation will need to bereassessed. The currentmodel of a source-basedapproach to taxingbusiness profits mayneed to be adapted toalternative approachesbetter able toincorporate digitalpresence factors.

Equity

↔↘

Reality andperceptionsabout equityboth essential tosustainablereform.

Capital taxes have notbeen fully integrated intoNew Zealand’s taxsystem, which cannot becategorised as taxingthose in similarcircumstances in anequal way. Whetherincome is earned via aPIE, company, trust orindividual affects taxliability; income fromemployment, self-employment, gifts,inheritances or capitalgains are all taxeddifferently.

Ambiguous effectsfrom potentialCGT.

Challenges fromgrowth interritorialtaxation.

The tax and transfersystems will remain thekey mechanism throughwhich governments willseek to influence desiredincome distributionoutcomes.

Revenueintegrity

↗↘

A well-designed system,supportive Courts andprofessionaladministration from IRDmean that opportunitiesto avoid or evade tax arefew.

Businesstransformation,transparencybetween revenueauthorities,pending BEPSreforms, potentialCGT, dataanalytics.

With the breakdown oftraditional employmentrelationships, the ‘blackeconomy’ may be agrowing issue. A rise inactivity and peer to peertransactions facilitatedthrough and recorded byon-line platformspotentially opens upopportunities for the tax

Future of TaxEY’s submission to the Tax Working Group EY ÷ 8

Direction oftravel

Importance Current state Short-termchange

Medium-term outlook

But R&D taxincentives hard toadminister.

base to capturepreviously ‘informal’transactions.

Complianceandadministrationcosts

↗↘

Comparative studies3

suggest our tax systemis, relatively speaking,easy to comply with andcheap to administer.

Businesstransformationsystems good.

But informationrequests, potentialCGT, pendingBEPS reforms,changing nature ofwork, breakdownof traditionalfamilies.

Open questionsregarding small businesstaxation. Technologycould both simplify andcomplicate aspects ofcompliance.

Coherence

↘

Components ofthe tax systemneed to sit wellwhen workingtogether.

A BBLR systemminimises boundaries,with different forms ofincome taxed similarly.Pressure points existaround thecapital/revenueboundary, notably forproperty transactions,differential treatment ofentities (such as PIEs andMāori authorities) andcross-border taxation.

Pending BEPSreforms, potentialCGT excludingfamily home.

Likely need to redesignbuilding blocks ofinternational tax to takeaccount of digital worldand changing balancebetween direct andindirect taxes.

Our changing worldAs the nature and structure of the economyand society changes over time, the tax systemmust adapt in parallel.

Just as GST was introduced as part of awholesale reform to a broken and outdated taxsystem, new challenges are unfolding for therevenue base as digital transformation reshapesmany aspects of economic activity. It ischanging the way people interact and is raisingimportant issues around jobs and skills, andprivacy and security, as well as opening up newopportunities for value creation and fosteringnew and transformed business models.

The Government could do well to stand stillwhen faced with these challenges though NewZealand cannot stand still for ever. However, atax system which fails to raise sufficientrevenue – whatever its other merits – is a failedtax system. Changes should first be assessed

3 Refer World Bank Doing Business Guide, OECD comparisons.4 On the subjective life satisfaction measure used by the OECD (the share of people who report a life satisfaction levelbelow 4 (on a 0/10 scale)), New Zealand outranks all other OECD countries.5 These statistics are taken from: OECD (November 2017) How’s Life in New Zealand, OECD Publishing, Paris, onwhich the Living Standards Framework draws with approval.

against whether they will damage our existingstrong position.

Using the Living StandardsFrameworkThe Living Standards Framework provides a toolfor policy makers, although it’s not in our viewsufficiently developed to act as a guide forspecific policy recommendation.

A well-designed tax system will have a positiveimpact on all four living standards quadrants -natural, human, social and financial/physical.

Taking a Living Standards approach, on averagewe’re well-satisfied with life4. Even so, humanand social capital problems which should beexamined include5:

► Jobs - labour market insecurity remainsrelatively high compared to 2005, and theincidence of job strain has risen by almost

Future of TaxEY’s submission to the Tax Working Group EY ÷ 9

7 percentage points. Working hours arelong and time off limited. Whatimplications do the current workingenvironment and the future of work havefor our tax system?

► Earnings – real earnings growth ismoderate and earnings remain low byOECD standards. Ultimately, earnings aredriven by productivity. Can the tax systemhelp us become more productive?

► Housing affordability – a longstandingproblem, which has worsened in the pastdecade, with the proportion of incomespent on housing costs increasing from25.8% in 2005 to 26.2% in 2014. Is this atax problem?

We have overlaid the Four Capitals within theLiving Standards Framework as a directionaltool when assessing the impact of our variousrecommendations in Chapter 8.

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Chapter 2

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“A tsunami of change is coming, and we need to prepare now so thatno one is left out or left behind.”6

Snapshot

The gig economy is seeing more short-term roles andrising numbers of contractors.

That’s leading both to empowered workers benefittingfrom flexibility and to an increasingly insecureworkforce.

The next step is likely to be a greater use ofautomation, but the speed of transition in New Zealandshould not be overstated.

Recommendations1. Tax reforms should allow for flexibility in working arrangements.

2. One option would be to create a class of “dependent contractors”; those who have acontractor relationship, but are effectively under a high degree of control.

3. Simplify the tax obligations for dependent contractors, potentially by way of restrictingdeductions.

4. Develop smart withholding techniques to replicate income tax for dependent contractors(and potentially contractors in general).

5. Apply “dependent contractor” status in a standardised way across all employment laws.

6. Use technology, such as Blockchain, to strengthen integrity of tax administration forindividuals.

Our working world is undergoing significantshifts. The future of work provides a nuancedchallenge to our tax system. Quiet concerns ofthe recent past will come increasingly to thefore.

Contractors and the gig economyContractors are becoming a significant

6 Andrew Little, The Future of Work, New Zealand Labour Party (2016).7 EY (2016) Is the gig economy a fleeting fad, or an enduring legacy? Ernst & Young, Oceania.

proportion of the workforce. Forty percent oforganisations expect to increase their use ofcontingent workers by 2021, with 25%expecting to have 30% or more of theirworkforce made up of them7. Labour’s Futureof Work Commission reports the insecureworkforce in New Zealand to be as high as 30%

2. The future of work

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as of 20158.

Traditional approaches to employment tax willnot in the long-term assist with driving inclusivegrowth in a modern economy. Nor will theycollect tax as easily as in the past.

Why is the gig economy growing?The model of part-time contractors who holdmore than one job is not new. Seasonalagriculture, oil and gas, and other primaryindustries have been employing similar modelsfor decades9. We are seeing more of this trendbecause there is a significantly increaseddemand for that type of work. Both employeesand employers are increasingly attracted to acontingent workstyle.

Lifestyle is one of the key drivers of demand forgig work. Working in the contingent workforcebrings an increased degree of freedom overworking days. People increasingly dislike the“nine to five” way of working. From EY reports,we know that 80% of contingent workers seeflexibility as the top benefit10. Clearly there isan increasing attraction for individuals to shifttowards this style of work.

Employers see the benefits of gig workers in theworkforce as well. Industries that haveemployed the model for much longer, such as inagriculture, have done so in response to boomsand busts in seasonal demand. While manybusinesses do not run to the season of crops,there are still seasonal elements. Demand forinformation technology professionals will peakwhen new systems need to be rolled out, but inbetween these updates these skills are surplusto employers. Forty-two percent of businessessurveyed reported they were using contingentworkers to meet these needs11.

There is also increasing demand for specificskills for specific projects. More freelanceexperts are being demanded by companies tosatisfy a need for expertise not otherwiseavailable in-house. Our reports indicate that56% of businesses use contingent workers forthis purpose12. Digital recruitment tools arealso making it much easier to fill these gaps.

8 The Future of Work, New Zealand Labour Party.9 Is the gig economy a fleeting fad, or an enduringlegacy? At 610 Is the gig economy a fleeting fad, or an enduringlegacy? At 1211 At 9

EY operates a platform called GigNow – a globalproject based employment portal foropportunities with us. This style of recruitmentis becoming more common.

What external forces will influencethis change?During the economic downturn of 2008businesses became attracted to theminimisation of cost that contractual workprovides. EY reports show among the S&P 500organisations, the growth of employment offulltime workers slowed by nearly a third (2.7%growth, down from 3.9% prior to the recession)13. For those affected by this, contract workoffered an attractive option. Discovering thebenefits of contract work, many have stayed oneven after economic recovery.

Recessions are often said to occur, on average,every ten years. With New Zealand’s lastrecession being in 2008/09, it is possible wecould see an economic slowdown with a degreeof financial hardship within the next decade.We are highly likely to see another frontier pushby the gig economy in such an event. It iscrucial that the Group recognises the impactthis movement is having, and will have, in thework force.

Automation, low wage workersand the near-futureThe future of work is increasingly challenged bya global trend towards automation. With labourcosts for companies growing in many areas, andautomated systems becoming cheaper andmore reliable, automation is becoming anincreasingly attractive way to shrink costs.

Why has there been comparativelylittle automation?Low-skill workers are still comparativelycheaper than machines in many processes. Thecost of an employee in New Zealand on theminimum wage is $660 per 40 hour workweek.14 Attaching variable costs such astraining and fringe benefits the employee is

12 At 913 At 614 Employment New Zealand, Current Minimum WageRates, sourced at 20 April 2017:https://www.employment.govt.nz/hours-and-wages/pay/minimum-wage/minimum-wage-rates/

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often still more competitive than the costs ofimplementing and maintaining an automatedsystem.

Indirect costs also pose significant barriers toentry for mass automation. For example, self-service checkouts in supermarkets have been acommon sight for years, yet most checkouts arestill operated by low wage employees. Self-service checkouts are responsible for asignificant increase in theft, with a lack ofhuman oversight emboldening shoppers.15 Thecost of this is significant when tallied, withnearly one in three shoppers reporting somedegree of theft.16 Similar unforeseen costs andinefficiencies are common across all industries,and significantly decrease the attractiveness ofautomation.

However, at the point where the costsassociated with training and maintainingemployees outstrips the cost of automation,businesses are highly likely to automate thosepositions. Further, as the rate of innovationincreases, the rate at which companies canminimise the indirect costs of automation willincrease as well, incentivising automation.

New Zealand as a target forautomation testingNew Zealand is an attractive testing ground fornew processes. New Zealanders are (on aglobal scale) highly educated, have highincomes and speak English. We share a strongsimilarity with consumers of key markets suchas the US and the UK.

Our relative distance from those key markets isimportant too. The poor reception of aparticular new process or product influencesthe opinion of consumers in California less thanthe same reception coming from customers inanother state of America. Because of this NewZealand is often the first consideration as a testenvironment for tech companies. Facebook andMicrosoft are increasingly testing more featuresand apps in our market first and makingchanges to their models from our reactions.17

15 Emmeline Taylor (2016) Supermarket self-checkouts and retail theft: The curious case of theSWIPERS, British Society of Criminology. 3.16 At 417The Economist (2015), Kiwis as Guinea Pigs,sourced 19 April 2017 at:

Wages increasing the speed ofautomationNew Zealand has recently announced it willincrease its minimum wage to $20 by 2021.With a 27% increase in the cost of minimumwages the cost of each employee will shrinksignificantly compared to automated systems.In a global environment conscious of the costsaving potential of automated systems, NewZealand will present a timely test environmentfor these systems.

We are likely to see a unique degree of labourdisplacement in the coming years. More andmore New Zealanders in low-wage employmentwill change the nature of their work, and inturn, change the nature of the working worldaround them. What form that work is likely totake is a broad and difficult question, but it willcertainly increase the population of thoseparticipating in a more mobile and digitally-dependent workforce.

Growing difficulty with the taxprocessFor those participating in this kind of work thereis a growing difficulty in reporting tax properly.Many individuals transitioning into thecontingent work force have never beenresponsible for their own reporting – relying onPAYE to manage their obligations where suchreliance can be misplaced. Recent research byIRD and Victoria University highlights this issue,estimating the average underreporting of self-employed and contractual workers at 20% onaverage.18

As emphasised in that report however, this doesnot necessarily mean that is wholly the result ofintentional underreporting. The same researchindicates 90% of New Zealand’s workforce feelsthat properly paying tax is the right thing to do.The figures indicate there is a significantproportion of this population of taxpayers thatare simply making mistakes. IRD hasrecognised the need to simplify the tax process,especially for the contingent workforce.

https://www.economist.com/news/business/21651858-small-technophile-country-great-place-test-digital-products-kiwis-guinea-pigs18 Victoria University (2018), Estimating self-employment income-gaps from register and surveydata:Evidence for New Zealand, Victoria University Press.

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The future of workplace taxThe greatest challenge we face is ensuring wedon’t throttle innovation in the working worldwith a taxation structure that is too inflexible.New Zealand is often praised as a world leaderin its taxation structure – we should endeavourto maintain this reputation.

A blurred line – who is an employee and who isa contractor?

The current legal scheme for determining whois a contractor and who is an employee is tooambiguous. With the scheme dependent oninterpreting case law rather than legislationbusinesses and contractors are often confused.If the trend towards increased gig workcontinues we need to clarify who a contractor isfor tax reporting purposes.

What solutions might exist?

In the case of contingent workers, there can bereal confusion as to who is ultimatelyresponsible for withholding and reporting tax.Legislative intervention to create newclassifications of workers would be highlyhelpful. There is a compelling case from arecent UK report to create a classification of“dependent contractor”; those who have acontractor relationship as per the currentscheme, but with a higher emphasis on thedegree of control.19 A new class such as thiswould allow for the proper classification ofcontingent workers, and attach to thoseindividuals specific reporting requirements.20

As the contingent workforce grows the numberof individuals with personal reportingobligations will grow. Importantly, this willmean the population of contractors will becomprised increasingly of individuals whohistorically had their tax obligations handled bytheir employer. The risk of these individualsgetting their tax obligations wrong is likely tobe high. IRD will be faced with an increasinglylarge task of investigation if this is not resolved.In the interests of an equitable and efficienttaxation system, we would stress theimportance of a change.

19 Mathew Taylor (2017), Good Work: The TaylorReview of Modern Working Practices, Royal Society ofArts. 35.20 At 35

One possibility could be to replicate the positionof employees – no tax deductions for costsassociated with delivering services as adependent contractor. If this is seen as a steptoo far, deductions could be simplified andstandardised.

Innovations in tax collection

With many of the more ambiguous gig economyroles facilitated by the digital economy there isscope for experimenting with methods ofwithholding tax at the point income is earnt.Russia has recently implemented a Value AddedTax (VAT) that specifically targets the provisionof digital services.21 Where a digital service isprovided to a Russian resident, regardless ofthe country of residency of the digital serviceprovider, the value of the service is taxed at15.25%.22 The tax is deducted at the point ofthe sale, but rather than the tax being withheldby the service provider, it is immediatelydebited to the Russian Government.23 Thissystem has allowed the Russian Government toeffectively create an income tax withholdingsystem for gig workers.

This system has the potential to significantlyminimise the revenue lost from reportingerrors. It also provides a valuable asset in real-time data of earnings of contractors, allowingsmarter policy to be formed into the future.New Zealand could greatly smooth thereporting obligations of those who are confusedby their reporting obligations by exploring asimilar model.

The changing demands of employment rights

One of the core benefits an employee has overa contractor is access to statutory employerrequirements. An employer must pay at timeand a half over holidays, to provide a minimumnumber of days off in a given year, and toprovide KiwiSaver contributions to anemployee’s scheme. Contingent workers areincreasingly reporting that while they enjoy the

21 EY (2018), Russia revises VAT rules for electronicservices provided by foreign companies, Ernst &Young Russia. 2.22 At 2.23 At 3.

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relative freedom gig work offers, the loss ofthese benefits is a significant concern.24

There have been many challenges to the legalstatus of gig workers during the past four years,and different jurisdictions with similar legalframeworks have come to very differentanswers.25 As a result, there are seriousconcerns for businesses with large populationsof gig workers. By clarifying the rights of gigworkers with tighter employment relationshipsthan status-quo contractors we would ensurethat disputes about proper classification areminimised.

There is a distinction between who is acontractor for tax purposes and who is acontractor for employment rights purposes, butthis is often misunderstood. In the interests ofboth equity and efficiency it is our view therewould be significant value in aligning thedefinitions. Should there be a review of theclassifications for tax purposes, this should bereplicated for employment rights as well.

Blockchain as a solution

One of the biggest vulnerabilities of the taxsystem to the growth of the contingentworkforce comes from the wide spread of taxinformation. Information needed to properlycomplete a return is required from manysources, and the more people responsible forproviding information the more likely you are tosee errors or double ups in data. Where thereare errors, people (intentionally orunintentionally) will under report taxableincome by going with the most favourable set ofinformation. An interesting solution to thisproblem is Blockchain. The diagram overleafdemonstrates how this system might work.

24 Is the gig economy a fleeting fad, or an enduringlegacy? At 13.

How might Blockchain be utilised?

As the diagram shows, the most significantbenefit of Blockchain in tax reporting is that itrequires everyone to update just one source ofinformation. Blockchain also allows you tospecify who is and isn’t allowed to alterinformation, ensuring self-interested or carelessindividuals cannot interfere with properreporting. By doing both of these thingsreporting can be made much easier foreveryone involved, while also minimisingotherwise significant administrative costs.Further IRD would have access to a much tidierpool of information, making its role of verifyingreporting much less burdensome, and makinginvestigating fraud or errors much easier

The Future of Government Assistance

Given the trend of automation, in the long runthere is likely to be a rise the number inmarginalised workers. Demographic trendsdictate there will be many older NewZealanders, with more complex needs andrequiring a higher standard of care.

We predict higher demands will be placed ongovernment assistance in future decades andfewer employees in the traditional sense. Asthis trend grows, income sourced exclusivelyfrom employment is going to becomeincreasingly scarce.

We don’t have a ready solution without makingradical changes to the tax and transfer systemgoing beyond the Group’s mandate.

25 University of Oxford (2017), The Employmentstatus of Uber Drivers, University of Oxford, Oxford.13-95.

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Chapter 3

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“Productivity isn’t everything, but in the long run it is almosteverything. A country’s ability to improve its standard of livingover time depends almost entirely on its ability to raise its outputper worker26.”

Snapshot

New Zealand’s productivity growth has lagged ourcompetitors for at least 60 years. That feeds throughto the living standards of us all.

Ensuring the tax system doesn’t inhibit productivity andinnovation can play a part in inclusive growth over thenext decades.

Our current BBLR system takes no account ofproductivity enhancing behaviour.

Recommendations

1. Consider reforms to the corporate tax system to enhance productivity.

2. To that end, further investigation of:

a. Targeted measures which may have a more significant impact on business investment,

b. Bespoke rules for SMEs based on the integration principle, and

c. Whether design challenges associated with progressive corporate tax rates for SMEs canbe overcome.

3. Consider rebalancing taxes towards immobile factors such as land.

4. Where possible, tax at the corporate level should be fully integrated with tax at the ownershiplevel:

a. For smaller businesses, seek to achieve full integration.

b. For larger businesses, imputation remains the best approximation of integration.

c. Extend Māori authority regime to include wholly owned subsidiaries.

5. New Zealand should respond to tax challenges caused by digitalisation of the economy:

a. Investigate nexus, profit allocation rules and place of consumption for digital businesses.

26 Paul Krugman (1994), The Age of Diminishing Expectations, MIT Press, New York.

3. Taxes and productivity

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b. Monitor digital services tax developments, for example, current EU proposals.

6. Radical reform to New Zealand’s corporate tax base or taxation of SMEs is not currentlyrequired.

Note these recommendations are finely balanced, as:

1. Economic literature provides sufficiently strong advice on a general direction of reform, butnot on the size or enduring growth effect.

2. Studies are not based on New Zealand data so take little or no account of imputation.

3. Other policy priorities, such as coherence or ease of administration may outweigh theproductivity benefits of corporate tax reform.

4. Both economic theory and country practice will develop in the next decade. Other countriesmay overcome the practical and theoretical challenges of radical reform. In that case, NewZealand should consider becoming a fast follower of other productivity enhancing reforms.

New Zealand’s current tax structure aims to becoherent. In general, it:

► taxes a broad base of income at low rates,

► makes extensive use of withholding taxesat times close to the associated cash flows,

► attempts a neutral treatment betweendifferent assets and entities, and

► historically sought to align the tax rate ofentities with the top personal tax rate.

BBLR is a second-best approachto taxationThere is much to be said for this simple neutraltreatment.

But it is not perfect. “In principle, the mostefficient taxes are not broad-based and low-ratetaxes but taxes whose rates are higher the lesssensitive are activities to tax (or, in economists’jargon, the less elastic are activities).”27

New Zealand has backed away from seeking totax more efficiently in favour of using a broad-based, low-rate approach because governmentsover several decades have doubted their abilityto make distinctions based on elasticities or onvalue judgments around fairness.

But is that selling New Zealand productivitypotential short? New Zealand depends on

27 Victoria University (October 2009), Company tax issues facing New Zealand: Background paper for Session 4 ofthe Victoria University of Wellington Tax Working Group, Victoria University Press, Wellington.28 For New Zealand, FDI is the main form of inbound equity investment. As at December 2015 the stock of foreigndirect equity investment was $66.4 billion and the stock of FPI equity investment was $33.5 billion.

inbound investment28 for which there is noobvious best means of taxation. Manycommentators have concerns about the highlevels of capital taxation and some economicmodels suggest it is optimal for a Small-OpenEconomy (SOE) such as New Zealand to levy notax on inbound capital.

We are not suggesting zero taxation on inboundinvestment or that economics gives a strongcase for substantially lower capital taxation.We are, though, suggesting the time is right toreassess whether our system of corporatetaxation could do more to enhance productivity.In particular:

► Does our relatively high corporate tax ratereduce productivity?

► Is there a case for targeted investmentincentives given the potential importanceof keeping the corporate tax rate high?

► Is there a case for differential taxation ofsmall, domestically owned businesses,based on the integration principle?

► Should our tax base be rebalanced towardsimmobile factors of production such asland?

Existing policy choicesNew Zealand has already chosen to depart fromneutral, broad based, low rate taxation for

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fairness, efficiency or coherence reasons incertain areas:

► The top personal tax rate has not beenaligned with the corporate tax rate sincethe 1999/2000 income year29.

► The PIE rules set a maximum tax rate forinvestment vehicles of 28%.

► The income of a Māori authority is taxed at17.5%.

► Charities are not taxed on trading income.

► R&D activities will shortly be in receipt of a12.5% tax incentive.

► Certain capital gains are not taxed, with -in the case of the family home – an all-party agreement not to tax them.

We therefore have form when it comes toadapting BBLR as evidence emerges that suchchanges are necessary.

Importance of productivity

New Zealand’s productivity has been in a periodof relative decline for at least the Past 60years, during which time we have graduallydrifted down the OECD productivity ladder(we’re now 21st).30

While our national income can be divided indifferent ways, and there are real questionsabout inequality, without growth in thatnational income, living standards – howevermeasured – will remain below those in richercountries. Any moves towards greater fairnessdepend ultimately on increasing productivity.

“Generally speaking, the higher the productivityof a country, the higher the living standardsthat it can afford and the more options it has tochoose from to improve wellbeing. Wellbeingcan be increased by things like qualityhealthcare and education; excellent roads andother infrastructure; safer communities;stronger support for people who need it; andimproved environmental standards.”31

29 The period of non-alignment – 18 years andcounting – now exceeds that of alignment (11 years).30 OECD Productivity Indicators (2017).31 Productivity Commission (2017) Why isproductivity important?, accessed 9 April 2018 from:https://www.productivity.govt.nz/about-us/why-is-productivity-important

Lifting productivity is a priority for the currentGovernment. There is no single way to achievethis, and we would not argue tax settings arecentral to productivity. Even so, factors includean attractive business environment, investmentand smart technology. Tax can influence thesefactors.

Corporate tax rate can impact on economicgrowth

The economic literature around corporate taxesand growth has limitations. Nevertheless, itpaints a suggestive picture.

Generally speaking, several propositionsemerge:

► Tax increases appear to reduce growth.

► Tax increases appear to reduce investmentmore than consumption as components ofGDP (although both fall).

► The effect is heterogeneous in that smallerfirms are more impacted in theirinvestment decisions than larger firms,possibly supporting aprogressive/differentiated corporate tax.

► The tax rates of a country negatively affectdecisions to direct investment in thatcountry.

We accept these studies do not directly accountfor imputation systems, that high corporatetaxes may be required to keep New Zealand’stax system coherent, and that location-specificeconomic rents and sunk investment costsprovide reasons to keep New Zealand’scorporate tax rate high.

Probably the leading macroeconomic study inthis area (Romer and Romer)32 demonstratesthe negative effect an increase in tax levels hason growth. Investment appears to be moresensitive to tax levels than consumption asnoted above.

Arnold et al33 draw similar conclusions in amore policy-based paper. This paper sets out to

32 Romer, Christina D. and Romer, David H (2010),The Macroeconomic Effects of Tax Changes:Estimates Based on a New Measure of Fiscal Shocks,American Economic Review 100. 763–80133 Jens Matthias Arnold, Bert Brys, ChristopherHeady, A˚sa Johansson, Cyrille Schwellnus and LauraVartia (February 2011), tax policy for economic

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consider the implication of tax structures onlong-run growth. It uses a panel of 21 OECDcountries over 34 years to estimate the effectof tax structure on growth in the short andmedium run. It also takes a look at micromechanisms by using data at industry and firmlevel to estimate the effect of tax structure oninvestment and productivity growth, which theresearchers consider to be the two main driversof economic growth. Findings:

► Empirically, economic growth can beincreased by gradually moving the tax basetowards consumption and immovableproperty.

► Ranking of tax instruments for growth(from least to most harmful):

► Recurrent taxes on immovableproperty.

► Consumption taxes and otherproperty taxes.

► Personal income taxes.

► Corporate income taxes.

While such studies appear robust at anaggregate level it is fair to note there isscepticism about the ability to place strongreliance on them through the need to controlfor outside factors such as the economic cycle,or changes in the quantum and incidence of taxthrough planning.

It is also unclear whether the growth impactwould endure beyond the short-run (say five toten years).

Corporate tax impact oninvestment location choicesAnecdotally, we already see US tax reforminfluencing investment location decisionsamong our clients. This is backed up by theOxford University Centre for Business Taxation.Taxes and the Location of Targets34. Thisdemonstrates how the corporate tax rates of ahost country and the tax system of theacquirer’s country (territorial or worldwide)affects the merger and acquisition target

recovery and growth, The Economic Journal, 121F59–F80,

choices of domestic and multinationalenterprises. Findings include:

► Host country tax rates have a negativeeffect on the probability of an acquisitionin that country.

► But where the corporate rate of the targetis lower than the acquirer’s country, andwhen the acquirer’s country operates aworldwide tax system that allows a creditfor foreign tax paid, the corporate tax ofthe target country plays a much lesssignificant role, or no role at all.

While the study does not take account ofimputation, imputation credits are of little useto overseas investors, therefore its conclusionsremain broadly valid. We understand the strongreasons for continuing to charge high levels ofcorporate tax on foreign investment, includinglocation-specific economic rents, sunk costs ofexisting investment, coherence of our taxsystem, and perceived equity issues.

No immediate cut to corporatetaxesThe various reservations are sufficiently strongand the economic case insufficiently compellingfor us to recommend an immediate cut incorporate taxes.

One reason is that our existing, well-functioning, imputation rules mean much of theof a corporate tax rate benefit might flowoffshore. Also, the revenue and growth fromnew investment would take time to emerge.

The issue is one to keep under medium-termreview.

Tax incentivesIs there a case, alternatively, to targetinterventions towards capital intensiveinvestment? Historically, most tax incentiveshave failed but there may now be grounds torevise that viewpoint:

► Globally, interest in incentives isincreasing, there are valid grounds for thatinterest, and proper targeting and design isessential to the success of an incentive.

34 Arulampalam, W, Devereux, M, and Liberini F(2017), Taxes and the Location of Targets WP 17/04,Oxford University Centre for Business Taxation.

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► The strongest case for incentives appearsto be as a form of tax competition in aconstrained world, as a way of attractingand retaining investment capital.Targeting reduced taxes at the mostmobile forms of capital may be a rationalposition.

► The test for the beneficial impact oninvestment by firms benefiting from taxincentives should be analysed in light ofthe effect of aggregate investment.

► Availability of sophisticated data, analysedin real time, gives a better chance ofdesigning and administering a smart,targeted incentive than ever before. Thisis a new factor, giving advocacy of taxincentives to alter behaviour greaterweight than before.

This is a subtle argument – it’s not as clear-cutas “tax incentives = good for business”. Weacknowledge tax incentives are fraught withrisks, including their use by immobile localfirms, distortions of capital allocation,increased complexity, administrative difficultyand reduced transparency around effective taxrates. These drawbacks will need to be tradedoff against the potential economic advantagesof being able to combine raising high capitalincome taxes while remaining competitive formobile activity.

Incentive designAny incentives should be transparent,predictable and stable over time if they are toinfluence investment decisions. That tends tosupport investment allowances and tax creditsrather than tax holidays, financing incentives,special economic zones or tariff/trade taxexemptions. Generous depreciation schemes orcapital allowances/tax credits tend to work wellfor marginally profitable capital intensiveprojects, which could be relevant given NewZealand’s infrastructure shortfall.

InfrastructureInfrastructure is an area of particular interest.The costs of delay are substantial.

Adequate infrastructure is a key element ofenhanced productivity, which augmentspopulation and participation to build economicgrowth35. Transport infrastructure to enhancethe logistics of transporting goods, and peoplelocated in cities, is as important ascommunications and other social infrastructure.

If enabling infrastructure development duringthe last ten years was characterised as being aquestion of financing (“how should theinvestment be structured?”), then the nextdecade is likely to be about funding (“who hasthe desire to cover the cost?”) Manyinfrastructure projects are too big to be fundedwithin New Zealand: an internationalcomponent is essential.

Currently, infrastructure funding tends to occurthrough special purpose vehicles. Would amore nuanced tax system help to speedinfrastructure development? Is it worth givingup some tax revenue now in exchange for theeconomic advantages of faster infrastructuredevelopment in the future?

Many potential international infrastructurefunders are tax exempt. Any New Zealand taximpost on sovereign wealth funds or pensionfunds is likely to be irrecoverable and to act as adisincentive to New Zealand investment.

The case for special treatment of inboundinfrastructure investors is strong. As a counterargument, allowing international investorsaccess to special treatment can be seen asproblematic. Various countries have sought toreconcile the need for foreign direct investmentinto infrastructure with appropriate domestictax collections. The recent Australianexperience shows both sides of the equation.

35 The Australian Treasury uses the 3Ps ofpopulation, productivity and participant as keyfactors in driving economic growth: see the forexample Where is the Growth Going to Come From?

Reserve Bank Assistant Governor (Economic) – 15November 2017, athttps://www.rba.gov.au/speeches/2017/sp-ag-2017-11-15.html

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Example: Productivity and theinfrastructure investmentpipeline in AustraliaInnovative financing approaches are havinga greater role in Australian infrastructuredevelopment and the PPP model,encouraging private sector investment andoutcomes for state and local governments.Australian governments have used multiplefunding mechanisms to financeinfrastructure development including assetsales, debt, PPPs, federal grants, valuecapture and concessional loans. PPPinvestment opportunities attract Australiansuperannuation funds (pension funds) andinternational investors.

When combined with existing concessionsused by foreign pension funds and sovereignwealth funds, some foreign investors canpay tax rates of 15% or less (in some cases,almost tax-free), rather than 30% onAustralian business income.36

There has been concern about the overallincome tax framework as, over recent years,a growing number of taxpayers have soughtto re-characterise trading income into morefavourably taxed passive income.37 The useof stapled structures to access reducedManaged Investment Trust (“MIT”)withholding tax has been the subject ofAustralian Taxation Office and Governmentscrutiny.38

This led to the release of a revisedAustralian Taxation Office infrastructureinvestment framework on 31 January 2017and recent announcement of integritymeasures to apply from 1 July 2019 to limitaccess to the lower MIT rate, with

36 Levelling the playing field for Australian investors:Taxation of Stapled Structureshttp://sjm.ministers.treasury.gov.au/media-release/024-2018/37

https://www.ato.gov.au/law/view/document?DocID=TPA/TA20171/NAT/ATO/0000138 The MIT regime was aimed at increasing theattractiveness of Australia’s fund managementindustry (especially commercial and retail propertyfunds) to mobile foreign investment. It did this bylowering the withholding taxes on certaindistributions of passive income to foreign investors,particularly rental income. In recent years, the

transitional rules for certain existingprojects. 39

Example: Singapore tax basedincentives to help fundinfrastructure developmentSingapore sees infrastructure financingincentives as important.

It has a package of discretionary taxincentive schemes for project andinfrastructure finance which are targeted topromote the attractiveness of non-bankinfrastructure financing for investors seekingalternatives for long-term investments ininfrastructure-related projects in Asia.

The incentives include:

► Exemption of qualifying income fromqualifying project debt securities

► Exemption of qualifying income fromqualifying infrastructure projects orassets received by approved entitieslisted on the Singapore Exchange (SGX),and

► A 10% concessionary tax rate onqualifying income derived by anapproved infrastructure trusteemanager or fund management companyfrom managing qualifying SGX-listedbusiness trusts or infrastructure fundsin relation to qualifying infrastructureprojects or assets.

withholding tax rate has generally been 15 per cent.It followed that foreign investors in certain stapledbusiness structures could also access reducedwithholding rates on certain passive income (ratherthan be effectively subject to tax at the corporate taxrate) if the trust side of the staple was a qualifyingwithholding MIT. These stapled structures included abroad range of infrastructure projects including insocial infrastructure and privatisation of Governmentbusinesses.39 Tax treatment of stapled structureshttps://treasury.gov.au/publication/p2018-t273732/

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Integration and ImputationBusiness taxation can follow one of two broadapproaches – taxing the business in its ownright or attributing that tax base directly to itsowners – in substance, integrating the companywith its owners.

In principle, we prefer the latter approach, as itallows the individual circumstances of theowners to be taken into account.

Look-through treatment is not always possible,particularly where there are many owners. Andit may not always be desirable, for example,where New Zealand wishes to tax incomebeneficially owned by non-residents on awithholding basis.

Imputation provides an effective step towardsintegration for domestic residents and weendorse its retention. An imputation systemtherefore reduces the case for a corporate taxcut. One possible improvement would be toallow for refundability of surplus imputationcredits to New Zealand tax residents as fiscalconditions allow. This would be a step towardsintegration.

The default tax treatment for widely-heldentities should be the corporate treatment(including approximations of that treatment).

The default tax treatment for closely-heldentities should be the partnership treatment(including approximations of that treatment).

A particular benefit of full integration is thatentity form and tax rate become much lesssignificant. It supports progressivity as it stopsincome sheltering through entities. If taxliability will in some form be attributable to thebeneficial owner of an investment, then thetreatment of income in a widely-held company,trust, limited partnership, portfolio investmententity etc. becomes of much less significance.

Small business taxation –integration in practice?In a further productivity study,40 Gemmell et alfind higher rates of corporate taxation slow therate of convergence to the productivity frontierfor small firms (defined as twenty or feweremployees). One possible explanation for this isthat because smaller firms are more likely to becredit constrained, they are more reliant onretained profit for investment, which is reducedby corporate taxes.

Gemmell et al’s findings suggest there is a casefor investigating a separate regime for SMEs.

Conversely practical experience to datesuggests differential taxation for SMEs can bedistortionary and ineffective/inefficient atstimulating job growth or innovation.

Example: UK Experience with corporate tax reformThe UK sought to encourage growing businesses by reducing corporate taxes for SMEs.

Over the period 2001/02 to 2006/07 (at which point the incentive was abolished):

► Corporate tax rate was reduced to 10% (0% from 2002/03 to 2006/07) for profits between £0and £10,000.

► A lower small-profits rate applied up to £300,000

► Tapering marginal relief applied for profits between £300,000 and £1,500,000

Amendments occurred during this period attempting to ensure the system worked as intended.

Devereux and Loretz examined the UK’s experience with marginal corporate tax rates in the 2000s.41

Findings included:

40 Gemmell, N, Kneller, K, McGowan, D, Sanz, I andSanz-Sanz, J (2018), Corporate Taxation andProductivity Catch-Up: Evidence from EuropeanFirms, Scand. J. of Economics 000(0). 1–28..

41 Michael P. Devereux and Simon Loretz (2011),Corporation tax in the United Kingdom, OxfordUniversity Centre for Business Taxation, Oxford.

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► A spike in new incorporations coinciding with the implementation of a 0% starting rate.

► Profit ‘bunching’ at kinks in the marginal corporate tax rate.

► Closely held companies changing the way the owners extracted income from the companies,switching between wages/self-employed income and dividends. (This is less of a problem with animputation system.)

► Distortions to investment patterns in situations where the value of “capital allowances”(depreciation) depended on marginal tax rates.

The chart below, taken from Devereux and Loretz shows the ‘bunching’ effect at the £10,000threshold.

Lessons learnt from this failed reform include:

► Size linked with legal form, as in a progressive corporate tax, is a poor design for special relief.

► Failed reform of this kind is expensive.

► Targeting specific activities or particular market failures has a greater prospect of success.

The UK experience suggests a conflict indeveloping a progressive corporate tax modelfor SMEs. Giving lower corporate tax rates forSMEs has productivity advantages (Gemmell etal) but integrity disadvantages (Devereux andLoretz).

Singapore will shortly expand its range ofincentives for SMEs.

Example: Singapore incentivesfor smaller firms

Currently, Singapore has in place two broad-based tax schemes to support smaller firmsand start-ups without eroding the premisethat every profitable company should paysome taxes. During its recent 2018 budget,there were further refinements starting inthe 2020 year of assessment 2020:

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► A Partial Tax Exemption scheme whichprovides for 75% exemption on the firstS$10,000 of normal chargeable income(NCI) and 50% exemption on the nextS$190,000 of NCI.

► A Start-Up Tax Exemption scheme forqualifying companies which provides for75% exemption on the first S$100,000of NCI and 50% exemption on the nextS$100,000 of NCI.

In addition, Singapore has also in place sometemporary targeted measures to tide firmsespecially the small and medium entitieswith near-term cost pressures.

We are not convinced it would yet be possiblefor New Zealand to overcome the problemsapparent in the UK. Given the theoreticalappeal of such rates as a productivity tool,further investigation on potential design wouldbe worthwhile. Full integration between smallcompanies on a progressive tax rate and theirowners would be an essential component ofreform. Otherwise it would be too easy for ahigh net worth individual to route fundsthrough a series of small companies.

We do, however, see differential treatmentabout integration as being justified. A trulyintegrated approach for all small businesseswould allow owners to take advantage ofprogressive personal tax rates more completelythan is currently the case.

Māori authorities – integration inpracticeOne example of semi-integrated taxation is thesystem of Māori authority taxation. Tax rulesspecific to Māori authorities follow on from theunique way Māori freehold land and other tribalassets are administered and owned, includingcommunal ownership and restrictions on theability to sell.

Māori authority taxation sits betweenimputation and full integration. A Māoriauthority pays tax at a low rate of 17.5% onretained earnings, and operates a creditattribution system, similar to the companyimputation model. A crucial difference is theMāori authority tax credit is refundable to theextent the members do not have a tax liabilityagainst which it can be offset.

This model in practice works well and weendorse its retention. Improvements neededare:

► Wholly owned and controlled subsidiariesof Māori authorities should also qualify forMāori authority status. We understand thiswas proposed by officials at theintroduction of the regime. The policymerits still hold, and this omission hascreated unnecessary tax and compliancecosts for Māori authorities.

► Post-settlement governance entities(PSGEs) for Treaty of Waitangi settlementsshould be permitted to be established afterthe settlement process is complete (e.g.,within a 12 month period from thesettlement date). The current legislationand policy requires PSGEs to beestablished before receipt of settlementredress and contemplated in the deed ofsettlement. This limits flexibility needed forinnovative settlements or under-resourcedclaimant groups.

► The default RWT rate for Māori authoritydistributions when the recipient does notprovide an IRD number (currently 33%)should be the Māori authority tax rate. Asignificant proportion of distributionrecipients are unknown (particularly inlong-established Māori land entities)meaning there is likely a significant excessof RWT being withheld by IRD for thesedistributions.

Tax challenges caused bydigitisation of the economyDigitisation is a leading example oftechnological change. The digital tax landscapeis altering and will alter the future of businessin unpredictable ways.

Put simply, digitisation now underpins business,and allows businesses to operate globally withmuch less friction, in a more mobile manner.

This digitisation was a key driver of the OECD’swork program to counter base erosion andprofit shifting. However the analysis of taxpolicy directions for the digital economy, Action1 of the BEPS project, was held over pendingthe other actions.

So the OECD’s valuable BEPS recommendationshave in effect patched up existing internationaltax law but not yet set out a compelling vision

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for the future. We – and the G20 – await itsfinal recommendations to be developed incoming months for delivery by 2020.

The digital economy will be the nextbattleground for fundamental tax reform.Three areas provide particular challenges fortaxing authorities:

► Businesses can supply digital serviceswhere they are not physically established –“scale without mass”,

► The development of specific software suchas social platforms allowing userinteraction – “reliance on IntellectualProperty assets (IP)”, and

► The value from the business perspectivecomes from the participation of the usersin the digital activities that they offer –“user value creation.”

In response we recommend the Group looksfurther into nexus, profit allocation and place ofconsumption.

A watching brief on digital services tax in NewZealand

There is significant global political support foran interim digital services tax, led by theEuropean Commission. The OECD rightly notes:“There is no consensus on the need for, ormerits of, interim measures, with a number ofcountries opposed to such measures on the

42 OECD Secretary-General Report to G20 FinanceMinisters and Central Bank Governors (March 2018).

basis that they will give rise to risks and adverseconsequences.”42

For New Zealand, we do not feel the time isright to follow the European Commission pushfor a 3% digital services tax. Interim taxes suchas a digital services tax tend not to betemporary. Other challenges include:

► advertising revenue splits betweencountries,

► potential economic incidence of taxationon business — loss making businesses,

► difficulties in achieving compliance (use ofalgorithms, etc.),

► location of users,

► insufficient rewards to developer of IP,

► double or over taxation, and

► barter services.

While these challenges are as relevant for NewZealand as for other economies, we have astrong corporate taxpaying culture and noimmediate pressing revenue problem. We areconcerned that if New Zealand moves quickly totax the digital economy, that may actuallyencourage unilateral moves and foster furtherinstability in international tax systems.

Instead, we recommend taking a watching briefon digital tax developments. We would not ruleout following experiences in other countries asa part of wholesale corporate tax reform in themedium term. Reducing corporate taxes couldbe a reasonable trade-off for entering into adigital services tax in the future.

Radical company tax reformsA substantial body of literature, dating back toMeade43, has put forward the case for radicalcorporate tax reform under a range ofeconomic models.

Many of these reforms have strong theoreticalappeal, in that they target an alternativecorporate tax base with potential gains to theoverall efficiency of revenue raising.

43 J.E. Meade (1978), The Structure and Reform ofDirect Taxation: Report of a Committee chaired byProfessor J.E. Meade, Institute for Fiscal Studies.

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In particular, both the Allowance for CorporateEquity (ACE) and the Comprehensive BusinessIncome Tax (CBIT) target an arguablesystematic bias in favour of debt over equity instandard corporate taxes. The ACE does this byallowing a notional deduction for the cost ofequity, the CBIT by way of denying a deductionfor interest costs.

The different tax bases targeted by ACE andCBIT are shown below.

They have been implemented rarely in practice,making it difficult to assess their likely impact.The Victoria University of Wellington TaxWorking Group put this dilemma well, in itsdiscussion of one such alternative – a dualincome tax combined with an ACE:

“While the TWG thought this approach wasinnovative and may be worth considering atsome time in the future, a system like it isuntested (it has never been implemented) and italso raises significant transitional andimplementation issues.”44

While ACE in particular has seen a degree ofuptake,45 this comment remains valid in ourview and radical company tax reforms are notdiscussed further in our submission.

44Victoria University (January 2010) A Tax Systemfor New Zealand’s Future,Victoria University Press,Wellington.. 43.

45 Variants of ACE systems have been introduced inBelgium, Cyprus, Italy, and Turkey but this is not yeta sufficient sample to assess the system’s long-termsustainability.

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Chapter 4

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“We stand now where two roads diverge. But unlike the roads inRobert Frost's familiar poem, they are not equally fair. The road wehave long been traveling is deceptively easy, a smoothsuperhighway on which we progress with great speed, but at itsend lies disaster. The other fork of the road — the one less traveledby — offers our last, our only chance to reach a destination thatassures the preservation of the earth.”46

Snapshot

The Government has committed to action on climatechange.

Our taxes are poorly aligned with the environmental andclimate costs of our economic footprint. At 1.3% of GDPNew Zealand’s revenue from environmentally relatedtaxes is among the lowest in the OECD.

Recommendations

1. Tax should be part of the Government’s toolkit for dealing with environmental issues.

2. The Group should agree good principles for environmental taxation including:

a. An initial presumption against the introduction of selective taxes tempered by theunderstanding that the Government’s international commitment to take transformativeaction on climate change is compelling.

b. Environmental tax bases should be targeted to the pollutant or polluting behaviour.

c. The scope of an environmental tax should match the scope of the environmental damage.

d. The tax rate should be commensurate with the environmental damage.

e. The tax must be credible and its rate predictable.

f. Distributional concerns should be addressed through other policy instruments.

3. There is a prima facie case for further investigation of:

46 Rachel Carson (1962)., Silent Spring, Houghtin Mifflin, New York.

4. Opportunities for effectiveenvironmental taxation

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a. Including agriculture within the NZ ETS or any future carbon tax. We believe there is acase for bringing agriculture within the NZ ETS sooner rather than later.

b. Pricing roading taxes taking into account environmental factors as well as transportneeds.

c. Broadening roading taxes from ad valorem to include an element of congestion charging.

d. A resource rent tax or royalty on the exploitation of natural resources that are notcurrently subject to royalties, such as water.

e. Considering how the Group’s preferred principles for environmental taxation apply towater quality and usage.

The time to act is nowThe mass of scientific evidence shows ourclimate is changing, with carbon emissions thesingle biggest cause.

The Government has committed to a target of anet zero emissions economy by 2050 under aZero Carbon Act, a Green Investment Fund, aProvincial Growth Fund and an independentClimate Change Commission. Should taxreform complement these initiatives?

New Zealand’s environmentalissues“In this summer of 2017-18 there can surely belittle argument that the effects of globalwarming are already with us. To think otherwiseis probably to belong to a small, but not select,group of people who believe Elvis is alive andwell and has changed his name to DonaldTrump.47”

As stated in the Paper, New Zealand’s economyand the wellbeing of New Zealanders areheavily dependent on protecting our naturalcapital base. However, this natural capital baseis under pressure48. While trading on our“100% Pure New Zealand” image, New Zealand

47 Hon Sir Michael Cullen, Chair Tax Working GroupPurpose, principles, and possibilities: The TaxWorking Group, Speech to the New ZealandInternational Fiscal Association (IFA) Conference,Queenstown, 2 March 2018.48 Tax Working Group (March 2018), Future of Tax:Submissions Background Paper. New ZealandParliamentary Press, Wellington 40.49 OECD (2018), Taxing Energy Use 2018:Companion to the Taxing Energy Use Database, OECDpublishing, Parishttp://dx.doi.org/10.1787/9789264289635-en (asat 19 April 2018).

faces numerous environmental challenges,including but by no means limited to:

► Greenhouse gas emissions, particularlyfrom agriculture.

► Our roading-based transport system, withan aging emissions-heavy vehicle fleet.

► Freshwater pollution and over-allocation ofwater.

► Plastic pollution.

► Pressures on land use, housing andinfrastructure from population growth.

New Zealand currently adopts a light touchwhen it comes to environmental taxation. Likemany other OECD countries, our taxes continueto be poorly aligned with the costs of oureconomic footprint on the environment andclimate49.

We don’t think environmental taxes should berelied on as major revenue raisers50. Bydefinition, if they succeed in changingbehaviour, the direct revenue raised will besmall. Nevertheless, at 1.3% of GDP NewZealand’s revenue from environmentally relatedtaxes is among the lowest in the OECD51.

50 Supported by Dimensions of Tax Design, Vol. 1 ofthe Mirrlees Review (September 2010), OxfordUniversity Press: Ch. 5 Environmental Taxes by DonFullerton, Andrew Leicester, and Stephen Smith,https://www.ifs.org.uk/publications/mirrleesreview/(as at 19 April 2018).51 OECD Environmental Statistics Database (OECDaverage is 1.6%). See https://www.oecd-ilibrary.org/environment/data/oecd-environment-statistics/environmental-policy-instruments_data-00696-en?parentId=http%3A%2F%2Finstance.metastore.ing

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Environmental taxes should bepart of the responseEnvironmental issues generally requirecollective action, usually led by government.There is no market incentive for consumers andbusiness to take into account environmentaldamage, since its impact is spread across manypeople with little or no direct cost to thepolluter52.

Environmental taxes are by no means the onlyway for government to respond toenvironmental issues, nor should they be theonly response. However, we believeenvironmental taxes are an essential part of theGovernment’s toolkit and can play a key role indelivering positive environmental and ecologicaloutcomes in both the medium and long term.

The Government will no doubt develop a clearset of environmental outcomes it wants topursue both socially and environmentally.Establishing desired outcomes will enable aclear path to investigate whether taxmechanisms are the best option to achievethose outcomes. In some instances a straightelimination of a social-ill could be moreappropriate than placing a tax on it.

The OECD has recommended New Zealandexpands the use of environmentally relatedtaxes, charges and prices, possibly within theframework of an overall reform of the taxstructure with a view to encouraging moreefficient use of energy and resources53.

Living Standards FrameworkThe Paper states that “the ultimate purpose ofpublic policy is to improve the wellbeing andliving standards of New Zealanders”54.Treasury’s Living Standards Frameworkidentifies four capital stocks as being crucial tointergenerational wellbeing: natural capital,

enta.com%2Fcontent%2Fthematicgrouping%2Fd77d7b93-en (as at 19 April 2018).52 OECD (2010) Environmental Taxation – A Guide forPolicy Makers (September 2011), based on theOECD’s book Taxation, Innovation and theEnvironment (October 2010).53 OECD Environmental Performance Reviews: NewZealand 2017. Seehttp://www.oecd.org/newzealand/oecd-environmental-performance-reviews-new-zealand-2017-9789264268203-en.htm (as at 19 April2018).

social capital, human capital andfinancial/physical capital55.

In our view, environmental taxation cancontribute to each of the various capitals –notably natural, but also human (theenvironment plays a part in the physical andmental health of New Zealanders) and, in themedium term, social and financial (provided theenvironmental taxes are efficiently designed).

Burden of proofIn 2001, the McLeod review noted:

“Our view is that the appropriate burden ofproof on those advocating eco-taxes should beidentical to the burden placed on those seekingconcessionary tax treatment for particularactivities or sectors. We consider the initialpresumption should always be against theintroduction of selective taxes.”56

While we agree with the logic of this test,climate change and environmental issues arenow more prominent and urgent and we believethere is a stronger case for examiningenvironmental taxes than in 2001.

Environmental taxation faces challenges

Recently, Hon Sir Michael Cullen committed, inhis own words, the “ultimate heresy” in puttingforward the notion that a particular tax beingdistortionary might be a good, not a bad,thing57.

The case for using taxes to help achieveenvironmental goals rests on efficiency. Cantax reform achieve a given level ofenvironmental protection at lower cost thannon-tax alternatives such as trading schemes orregulation? Will the tax change behaviour forthe public good?

54 Tax Working Group (2018), Future of Tax:Submissions Background Paper.17.55 Treasury (2018), Living Standards New Zealand,sourced at 17 April 2018 from:https://treasury.govt.nz/information-and-services/nz-economy/living-standards-0 (56 Treasury (2001), Issues Paper – Tax Review 2001New Zealand Treasury, Wellington.57 Hon Sir Michael Cullen, Chair Tax Working GroupPurpose, principles, and possibilities: The TaxWorking Group, Speech to the New ZealandInternational Fiscal Association (IFA) Conference,Queenstown, 2 March 2018.

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Environmental taxes have difficulties. They canfoster inefficient avoidance activities, such asincreasing emissions to purchase fuel at a lowercost outside the Auckland area. They can oftenbe equivalent to consumption taxes withregressive consequences, requiringcompensation for vulnerable groups.

Environmental taxes also raise challengingquestions and intergenerational issues, such aswhether current polluters should incur the costof any future financial loss being caused bytheir activity, and whether they should also payfor a possible loss in New Zealanders futurequality of life.

They tend to work well when wide-rangingchanges in behaviour are needed across a largenumber of businesses and individuals58.

Given the global nature of climate change, andthe insignificant impact that could be made byunilateral action, coordinated internationalaction will be important59.

The design of environmental taxes is one of thecrucial determinants of their overall success60.We set out some suggested design elementsbelow.

Benefits of a well-designedenvironmental taxAs recognised by the OECD61, taxes can directlyaddress the failure of markets to takeenvironmental impacts into account byincorporating environmental impacts intoprices. Changing prices in this way providesconsumers and business with flexibility todetermine how best to reduce theirenvironmental “footprint”. This flexibility62:

► Enables lowest-cost solutions –consumers and business decide how tochange their behaviour, with market forces

58 Supported by Dimensions of Tax Design, Vol. 1 ofthe Mirrlees Review (September 2010), OxfordUniversity Press: Ch. 5 Environmental Taxes by DonFullerton, Andrew Leicester, and Stephen Smith,https://www.ifs.org.uk/publications/mirrleesreview/(as at 19 April 2018).59 See Dimensions of Tax Design, Vol. 1 of theMirrlees Review (September 2010), OxfordUniversity Press: Ch. 5 Environmental Taxes by DonFullerton, Andrew Leicester, and Stephen Smith,https://www.ifs.org.uk/publications/mirrleesreview/(as at 19 April 2018).

determining the lowest-cost way to reduceenvironmental damage.

► Encourages innovation – the cost to apolluter of generating pollution isincreased, which incentivises business todevelop new innovations and adaptexisting ones.

► Reduces the need for the Government to“pick winners”.

► Provides an ongoing incentive to abate atall levels of emissions, unlike a target ortechnology-based regulation whichprovides no incentive to abate once thetarget or standard is met.

► Improves competitiveness of low-emission alternatives, for example publictransport and cycling in the case of vehiclefuel taxes.

What makes a successfulenvironmental tax?To lead to improved outcomes, anenvironmental tax must:

► Change the price of the affected item toreflect the cost of the environmental harmthat it imposes on others63, and

► Lead to a change in behaviour – eitherlesser consumption of environmental"bads”, such as fuel, or greaterconsumption of environmental “goods”,such as reforestation.

For the tax to be truly effective, there needs tobe64:

► A comparable degree of environmentaldamage from the consumption of eachtaxed item across the tax base,

60 OECD Environmental Taxation – A Guide for PolicyMakers (September 2011), based on the OECD’s bookTaxation, Innovation and the Environment (October2010).61 Ibid.62 Ibid.63 Ibid.64 These three principals are supported by theMcLeod review – see Treasury, Issues Paper – TaxReview 2001 (June 2001).

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► The ability to measure consumption –either directly or by proxy, and

► An assessment of the marginal damagecaused by consumption.

Designing environmental taxesThe OECD suggests the following designelements65:

► Environmental tax bases should betargeted to the pollutant or pollutingbehaviour, with few (if any) exceptions.

► The scope of an environmental tax shouldideally be as broad as the scope of theenvironmental damage.

► For example, greenhouse gasemissions from one locationcontribute to climate change on aglobal basis – greenhouse gasemissions would therefore ideally beaddressed by a global tax.

► The tax rate should be commensurate withthe environmental damage.

► The rate should generally be set toreflect society’s value of theenvironmental damage, othernegative spill-over effects of theactivity, and the need to raise publicrevenue.

► The tax must be credible and its ratepredictable in order to motivateenvironmental improvements.

► Well-designed taxes are highlytransparent – it is generally clearwhat is taxed, who is being taxed,and what the cost to polluters will beper unit of pollution generated.

► Environmental tax revenues can assistfiscal consolidation or help to reduce othertaxes.

► We place little weight on thiscomment because, as previouslynoted, if environmental taxes

65 OECD (2011) Environmental Taxation – A Guide forPolicy Makers, (September 2011), based on theOECD’s book Taxation, Innovation and theEnvironment (October 2010).

succeed in changing behaviour, directrevenue raised will be small.

► Distributional concerns, for example thepossibility of certain taxes having asignificant impact on low-incomehouseholds, should generally be addressedoutside the tax through other policyinstruments to preserve the incentiveeffect of the tax.

► Competitiveness concerns need to becarefully assessed. Ideally taxes shouldnot be adapted for competitivenessreasons as other more suitableinstruments are available for providingcompensation without compromisingeffectiveness66. Responses could include:

► International co-ordination to reducegains from relocation.

► A transitional period to allowaffected firms to undertakemitigation measures.

► Recycling revenues to affected firms(on a basis different from thecollection).

► Clear communication is critical to publicacceptance.

► The utilisation of independent greentax reform commissions can help toensure the policy prescriptions areperceived as credible and not aspolitically driven.

► Environmental taxes may need to becombined with other policy instruments toaddress certain issues.

Having outlined some design elements for theGroup’s consideration, we now turn to somespecific considerations relating to what weconsider to be two of the largest environmentalissues in New Zealand: greenhouse gas andagricultural emissions, and issues aroundroading and transport. We also discuss thepossibility of a resource rent tax or royalties oncertain natural resources (water in particular),followed by some other options the Group maywish to consider.

66 OECD (2018), Taxing Energy Use 2018:Companion to the Taxing Energy Use Database, OECDpublishing, Paris

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Greenhouse gas emissionsAccording to the OECD, New Zealand’sgreenhouse gas gross emissions increased by6% from 2000 - 2014, while decreasing by 5%in the OECD as a whole.67 Emissions per capitaand per unit of gross domestic product (GDP)are among the top five in the OECD.

New Zealand’s Emissions Trading Scheme (“NZETS”) is the Government’s principal policyresponse to climate change. Theobjective of the NZ ETS is to support andencourage global efforts to reducegreenhouse gas emissions by68:

► Assisting New Zealand to meet itsinternational obligations, and

► Reducing New Zealand’s netemissions below business as usuallevels.

While we believe the NZ ETS is the rightinstrument for addressing emissions issues, theemissions issue is of such magnitude that theGroup should consider tax reform as part of thetoolkit for New Zealand’s response.

Greenhouse gas emissions are different to morelocalised issues such as water use, as emissionsfrom one location contribute to climate changeon a global basis. Given the relatively small sizeof New Zealand, action taken to reducegreenhouse gas emissions in New Zealandalone is very unlikely to have a significantimpact on the level of global emissions.

The emissions issue would therefore ideally beaddressed by global cooperation. However,despite New Zealand’s limited ability to impactglobal emissions levels, New Zealand shouldtake action as early as possible to lead byexample and encourage other countries to dothe same. There is a question whether the NZ

67 OECD Environmental Performance Reviews: NewZealand 2017. Seehttp://www.oecd.org/newzealand/oecd-environmental-performance-reviews-new-zealand-2017-9789264268203-en.htm (as at 19 April2018).68 Ministry for the Environment (2018), reducinggreenhouse gas emissions, sourced at 19 April 2018from: http://www.mfe.govt.nz/climate-change/reducing-greenhouse-gas-emissions/about-nz-emissions-trading-scheme69 Tax Working Group (March 2018),, Future of Tax:Submissions Background Paper, New ZealandParliamentary Press, Wellington. 14.

ETS should return to allowing the use ofinternational emissions credits, which may beof dubious provenance.

Agriculture greenhouse gasemissionsThe composition of New Zealand’s greenhousegas emissions is unusual, with agriculturalemissions dominant:

New Zealand has committed to reducing netemissions by 30% below 2005 levels by 2030under the Paris Climate Change Agreement(“Paris Agreement”), and the Government hasannounced it will develop a new emissionstarget of net zero emissions for 205069.

Due to the amount of emissions coming fromthe agriculture sector, where emissions-reduction options are limited, New Zealand mayface higher costs than other countries to meetits emissions reduction targets70. It has beensuggested the cost to the economy of buyinginternational carbon units to offset our ownemissions will be $14.2 billion over 10 years71.Taking action to reduce climate pollution couldreduce the cost to the New Zealand economy ofmeeting Paris Agreement targets.

70 Hon David Parker, Minister for the Environment,Economic Growth within Environmental Limits,Address to the Resource Management LawAssociation Seminar, Auckland, 28 March 2018. Seehttps://www.beehive.govt.nz/speech/economic-growth-within-environmental-limits..71 Seehttp://www.newshub.co.nz/home/politics/2017/05/new-zealand-to-spend-14-billion-to-meet-paris-agreement-targets.html (as at 19 April 2018).

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Although agricultural emissions make uparound half of New Zealand’s greenhouse gasemissions, agricultural emissions are currentlyexcluded from the NZ ETS. The treatment ofagricultural emissions has been flagged asan initial area of focus for Government’srecently announced Climate ChangeCommission72, and the Government isassessing whether to phase agricultureinto the NZ ETS over a transition period73.

Westpac NZ reportA recent report commissioned by WestpacNZ74 analyses two modelled economicscenarios for New Zealand out to 2050:

1. A smooth “central scenario” whereNew Zealand takes early and plannedaction to reducing greenhouse gasemissions, and

2. A “shock scenario”, where New Zealanddelays action on climate change until2030, when it’s forced to take moreaggressive action to reduce emissions in ashorter timeframe.

The most significant difference between the twoscenarios is the timing of the agriculturesector’s inclusion in the NZ ETS. Agriculture’sfaster phase-in into the NZ ETS in 2030 is the“shock” in the “shock scenario”.

The report finds that earlier, planned action onclimate change under the “central scenario” ismodelled to save $30 billion in GDP growth by2050 compared with the “shock scenario” andresults in a 32% lower greenhouse gasemissions price by 2050.

Both scenarios would achieve net zerogreenhouse gas emissions in the second half ofthe century. However, the Government ispursuing a more ambitious target of net zeroemissions by 2050.75 The graph below shows

72 Future of Tax: Submissions Background Paper. At15.73 Westpac NZ (April 2018),Climate Change ImpactReport, based on research carried out by EY andVivid Economicshttps://www.westpac.co.nz/assets/Sustainability/Westpac-NZ-Climate-Change-Impact-Report.pdf (as at19 April 2018).74 Climate Change Impact.75 Hon David Parker, Minister for the Environment,Economic Growth within Environmental Limits,

the relative performance of the shock scenariocompared with the central scenario:

GDP in the central and shock scenarios and

the cumulative difference

The report also finds that agriculture faceschallenges under both scenarios but benefitsfrom an early and phased introduction into theNZ ETS, rather than a more rapid entry later onin 2030. Agricultural sectors are ultimatelybetter able to manage their economic impactsthrough a longer, better signalled transitionperiod within the central scenario.

What should be done?The OECD has previously stated that NewZealand needs to reassess its decision toindefinitely postpone the entry of biologicalemissions from agriculture into the NZ ETS76.Based on the evidence outlined above, webelieve there is a case for bringing agricultureinto the NZ ETS or any future carbon tax soonerrather than later.

The OECD has stated that if agriculture is notbrought into the NZ ETS, alternative pricing orregulatory measures should make agriculturecontribute to achieving climate mitigationobjectives77.

Address to the Resource Management LawAssociation Seminar, Auckland, 28 March 2018. Seehttps://www.beehive.govt.nz/speech/economic-growth-within-environmental-limits.76 OECD Environmental Performance Reviews: NewZealand 2017. Seehttp://www.oecd.org/newzealand/oecd-environmental-performance-reviews-new-zealand-2017-9789264268203-en.htm (as at 19 April2018).77 Ibid.

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Transport system – taxing ourvehicle fleet?While agriculture is New Zealand’s largestemissions sector, one of the largest increases inemissions since 1990 has been in road andtransport78. Seventeen percent of emissionsproduction in New Zealand is fromtransport79. We have one of the highest ratesof motor vehicle ownership in the OECD80. Thenumber of vehicles has increased by 65% since2000, with a rising share of diesel vehicles andan average fleet age touching 14 years81. Ourfleet is highly emission-intensive82.

New Zealand is the only OECD country to applyan excise duty only on petrol, with dieselvehicles subject to a distance based road usercharge instead83. Given its current roadingrather than environmental focus, merits of thecurrent road user charge include the exclusionof boats and other machinery which do notimpact on road use. Disadvantages of thisunique approach include84:

► Apart from a weight based component, theroad user charge doesn’t encouragebehaviours that would reduce fuel use85

and

► Diesel vehicles tend to be favoured by thedifferential charging system due to theirhigher fuel efficiency. Higher emissions of

78 Our Atmosphere and Climate 2017, Source:Ministry for the Environment, Stats NZ, and dataproviders, and licensed by the Ministry for theEnvironment and Stats NZ for re-use under theCreative Commons Attribution 3.0 New Zealandlicence. Seehttp://www.mfe.govt.nz/sites/default/files/media/media/our-atmosphere-and-climate-2017-final.pdf (asat 19 April 2018).79 OECD Environmental Statistics Database,https://www.oecd-ilibrary.org/environment/data/oecd-environment-statistics_env-data-en (as at 19 April 2018).80 OECD Environmental Performance Reviews: NewZealand 2017. Seehttp://www.oecd.org/newzealand/oecd-environmental-performance-reviews-new-zealand-2017-9789264268203-en.htm (as at 19 April2018).81 Ibid.82 Ibid.83 Ibid.84 Ibid.85 See also OECD (2018), Taxing Energy Use 2018:Companion to the Taxing Energy Use Database, OECD

local air pollutants from such vehicles arenot taken into account.

In addition, the tax and charge rates are basedon roading infrastructure needs rather than onenvironmental externalities86. For example, thelargest external cost of motoring comes fromcongestion, yet existing taxes are based on fuelpurchases87 and distance travelled. Significantgains could be made by a more preciselytargeted structure of economic instruments88.

While car users respond to increased fuel taxesby driving less, they also invest more in fueleconomy which does not reduce congestion – toallow for better congestion management andalso anticipating a possible eventualdecarbonisation of road transport, it might bebetter to argue for more sophisticatedcongestion pricing than for increasing fueltaxes to reflect average congestion89.

Developments in technology may affect thetraditional base of fuel excise duty as vehiclesbecome more fuel efficient90. Thisdevelopment further supports the need to re-consider New Zealand’s current approach totaxing our transport system.

The Group should explore the following optionsin further detail:

publishing, Parishttp://dx.doi.org/10.1787/9789264289635-en (asat 19 April 2018).86 OECD Environmental Performance Reviews: NewZealand 2017. Seehttp://www.oecd.org/newzealand/oecd-environmental-performance-reviews-new-zealand-2017-9789264268203-en.htm (as at 19 April2018).87 See Dimensions of Tax Design, Vol. 1 of theMirrlees Review (September 2010), OxfordUniversity Press: Ch. 5 Environmental Taxes by DonFullerton, Andrew Leicester, and Stephen Smith,https://www.ifs.org.uk/publications/mirrleesreview/(as at 19 April 2018).88 Ibid.89 OECD (2018), Taxing Energy Use 2018:Companion to the Taxing Energy Use Database, OECDpublishing, Parishttp://dx.doi.org/10.1787/9789264289635-en (asat 19 April 2018).90 Tax Working Group, Future of Tax: SubmissionsBackground Paper (March 2018), p12.

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► Should the Government introduce anexcise duty on diesel, as recommended bythe OECD91?

► Could the tax mix be changed to imposefleet taxes and/or registration taxes basedon factors such as greenhouse gasemissions, noise and congestion?

► Should a car’s weight, age or engine sizeaffect road charges?

► Should road pricing (tolls or congestioncharges) be introduced? The OECDbelieves road pricing would help improvetransport demand management in largeurban areas, especially Auckland92.

Resource rent taxes?New Zealand currently imposes royalties on theextraction of certain natural resources toensure the public gets a fair share of any profitsgenerated. The royalties usually try to capturethe profit generated by a miner over and abovea reasonable economic return (the “rent”) andare generally a percentage of either therevenue or profit generated by a miner. Analternative approach is a resource rent tax,which attempts to estimate the rent generatedby a miner and directly apply a tax to thatrent93.

The Government has banned new offshore oiland gas exploration but will allow 22 activeoffshore permits to run until their expiration,which is as far out as 2030.94 The exploitationof various natural resources, most notablywater, is currently not subject to royalties orany form of resource rent tax. Should royaltiesor a resource rent tax be imposed on theexploitation of these natural resources?

91 The OECD recommends New Zealand considersintroducing an excise duty on diesel: OECDEnvironmental Performance Reviews: New Zealand2017. See http://www.oecd.org/newzealand/oecd-environmental-performance-reviews-new-zealand-2017-9789264268203-en.htm (as at 19 April2018).92 OECD Environmental Performance Reviews: NewZealand 2017. Seehttp://www.oecd.org/newzealand/oecd-environmental-performance-reviews-new-zealand-2017-9789264268203-en.htm (as at19 April 2018).93Future of Tax: Submissions Background Paper.41.

In particular, New Zealand faces severalchallenges around freshwater pollution andover-allocation of water. Water contaminationfrom the cumulative effects of diffuseagricultural and urban storm water run-off is agrowing environmental and public healthconcern95. Water demand in some regions isexceeding what is available and sustainable96.

The options of a royalty or resource rent tax,water taxes / pollution charges or water qualitytrading should be considered in further detail.These options may have the potential tointernalise the environmental and opportunitycosts to diffuse pollution from rural and urbansources and promote innovation in pollutioncontrol97.

Other options for considerationIn addition to the points raised above, otherpossible environmental taxes the Group maywish to explore could include:

94 Rt Hon Jacinda Ardern, Planning for the future - nonew offshore oil and gas exploration permits (12 April2018). Seehttps://www.beehive.govt.nz/release/planning-future-no-new-offshore-oil-and-gas-exploration-permits.95 OECD Environmental Performance Reviews: NewZealand 2017. Seehttp://www.oecd.org/newzealand/oecd-environmental-performance-reviews-new-zealand-2017-9789264268203-en.htm (as at 19 April2018).96 Ibid.97 Ibid.

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Sustainability incentivesTax incentives can be used to promote activitiesaligning with environmental objectives.However, as recognised in the Paper, taxincentives can have disadvantages when

compared to an environmental tax – they caninvolve “picking winners” and can be fiscallycostly102.

Nevertheless, the Group may wish to considerthe following possible tax incentive options:

Type of incentive Key points / examplesTax deductions ► Should further accelerated deductions be introduced in addition to the

existing accelerated deductions for forestry capital costs and certain typesof environmental expenditures? For example, should there be accelerateddepreciation for energy-efficient and renewable energy property?

Property tax abatements ► Should there be property tax abatements from subnational jurisdictions forrenewable energy property and infrastructure?

Reduced excise taxes ► On alternative fuels and fuelling infrastructure, to encourage increased useof more environmentally friendly forms of transport.

Exemptions for electric vehicles ► Electric vehicles are exempted from road user charges until they make up2% of the light vehicle fleet. Should this exemption be extended?

98 Ibid.99 OECD (2018), Taxing Energy Use 2018:Companion to the Taxing Energy Use Database, OECDpublishing, Parishttp://dx.doi.org/10.1787/9789264289635-en (asat 19 April 2018).100 OECD Environmental Performance Reviews: NewZealand 2017. Seehttp://www.oecd.org/newzealand/oecd-

environmental-performance-reviews-new-zealand-2017-9789264268203-en.htm (as at19 April 2018).101 Seehttp://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=11468922 (as at 19 April2018).102 Tax Working Group, Future of Tax: SubmissionsBackground Paper (March 2018), p49.

Type of tax ExamplesProduct taxes ► Batteries, lighting and other non-green products.Energy taxes ► Oil, coal and natural gas taxes.Other fuel taxes ► In addition to the transport issues raised above, there could be scope for taxes

on fuels used for heating and industrial processes so long as the NZ ETS doesn’tcap greenhouse gas emissions98.

► A key issue identified in a recent OECD report is that input fuels for electricitygeneration are rarely taxed99.

Other resource taxes ► Aggregates and gravel, mineral extraction taxes.

► Should a resource rent tax replace the current royalty regime for miners?Other environmental taxes ► Packaging, waste, noise pollution, industrial air emissions.

► Evidence from the Auckland region indicates that districts applying volume-basedcharges send nearly half of the waste volume to landfills than districts financingwaste management through flat charges included in property taxes100. Shouldquantity or volume based waste charges be imposed at a national level to helpminimise waste?

FBT ► Should the scope of FBT be expanded to incentivise the use of electric vehicles?Consumption tax and rebate ► Through its book Vanishing Nature, the Environmental Defence Society has

suggested an environmental consumption tax and rebate. The tax wouldeffectively put a price on environmental impacts of intensive land uses, such asbiodiversity loss and greenhouse gas production, with land area and intensity ofuse identified from high-resolution satellite imagery and land title information101.

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Type of incentive Key points / examplesGrants ► To encourage sustainability investments.

Renewable Energy Credits ► Purchased by companies and energy providers to comply with governmentregulations requiring certain levels of renewable energy production.

Utility incentives ► From energy providers to encourage energy efficiency as mandated bygovernment regulations.

Feed-in tariffs ► Production-based incentives for renewable energy producers.

Low-interest Government loans ► Allowing organisations to finance renewable energy and energy efficiencyprojects.

An environmental tax credit?The Group should also give consideration toenvironmental tax credits.

As stated by the OECD:

“Innovation plays a critical role in deliveringimproved environmental outcomes at lowercosts. Environmentally related taxes canencourage the development and adoption ofmarket-ready innovations; however, thebreakthrough technologies that will lead tofundamental environmental improvements areless likely to be developed under a tax-onlyregime than under a regime that includesparticular incentives for research anddevelopment103.”

New Zealand has a strong background when itcomes to environmental related research andinnovation, with particular achievements inrenewable energy, water pollution andwastewater management and agriculturalresearch.

With the Government already committed to re-introducing a tax incentive for R&D, can thenew credit be used to boost environmentalrelated research even further? Could theGovernment provide tax incentives forinvestments in, or production from, renewableand alternative energy assets? An enhancedenvironmental tax credit could be effective,giving businesses the space they need to makedecisions without any second guessing by theGovernment.

103 OECD (September 2011), Environmental Taxation– A Guide for Policy Makers based on the OECD’s book

Making the most of technologyTax systems are changing fast. Technology maybe the game changer that gives Sir Michael’s“heresy” more support. Advances intechnology, including artificial intelligence androbotics, can enable the collection of a highvolume of sophisticated data that can beanalysed in real time.

Technological advancements provide a betterchance of designing and administering a smart,targeted tax intervention targeted at changingbehaviour and provide a much stronger case forre-examining the longstanding existing broad-based, low rates tax system.

As already mentioned, the case for using taxesto help achieve environmental goals rests onefficiency. One way of achieving efficiency is byensuring producers and consumers face thesocial costs of their activities. Can we usetechnology to approximate the social costs ofan activity? For example, can we usetechnology to estimate the social costs oftraffic congestion and then impose a tax ontraffic congestion which reflects the socialcost?

A hypothetical solution may be usingtechnology to find out how many plastic bottlesare being produced, who is producing them,who they are being used by and whatproportion are being recycled. Any taxinstrument in relation to pollution from plasticbottles can then be targeted based on aninformative string of data.

Fringe benefit tax on motor vehicles, currentlycalculated based on the value of the vehicle,provides another example. Smart use of

Taxation, Innovation and the Environment (October2010).

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emissions monitoring technology could easilychange that to taxing on the level of pollutioncaused, potentially in real time.

HypothecationIn 2012-15, the National Land Transport Fund(which receives all revenue from the petrolexcise duty and road user charge) mostlyfinanced investment in highways and local roads– public transport, cycling and walkinginfrastructure received only 10% of the fund104.Could technology be used to enablehypothecation in the area of environmental tax,such that tax revenues are allocated toenvironmental spending objectives?

Any such hypothecation would need to be donein a way that does not limit Governmentspending on environmental matters to the taxrevenue received.

104 NZTA, 2015 – see OECD EnvironmentalPerformance Reviews: New Zealand 2017,http://www.oecd.org/newzealand/oecd-

environmental-performance-reviews-new-zealand-2017-9789264268203-en.htm (as at19 April 2018).

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Chapter 5

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“…Taxes are among the most effective tools governments have forreducing inequalities and bringing about more inclusive growth”105.

Snapshot

The current level of wealth inequality challenges theconcept of inclusive growth. It is much moreconcentrated than income inequality. It adverselyaffects social and human capital.

Taxation of capital gains needs to be seen as a part ofthe overall taxation of capital income and householdwealth, not as an isolated issue to address concerns inthe housing market.

The overarching tax principles of efficiency, horizontaland vertical equity and coherence all suggest anintegrated system of taxing capital income and wealth isrequired. In our view, the tax system needs to be clearlyprogressive if it is to be sustainable.

The main potential instruments for capital taxation arecapital income taxes, CGTs, capital transfer taxes (suchas inheritance or gift taxes) and ownership-based taxes(wealth tax or land tax). Redistribution style taxes needto be balanced against the current over-taxation ofcertain savings.

Capital income taxation is ripe for reform.

105 OECD, see http://www.oecd.org/tax/tax-policy/better-design-of-taxes-on-personal-savings-and-wealth-is-needed-to-support-inclusive-growth.htm (as at 20 April 2018).

5. Capital taxation

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Recommendations1. There is a case at the margin for tilting the balance of capital taxation from flows – such as interest

and dividends – towards stocks – such as land and other stores of wealth.

2. The impact of the tax system on income and wealth needs to be considered on a holistic basis:

a. Reconsider the current TTE approach towards taxing private savings.

b. Move towards taxing real rather than nominal gains.

c. Investigate the possibilities of wealth taxes and land taxes (noting their potentialsubstitutability and overlap).

3. If the Government has concerns regarding residential investment property, consider reformstargeted to the specific problem.

4. If the Government has concerns regarding all forms of capital investment, consider a broad-basedCGT.

5. When designing a CGT:

a. The best theoretical design would be wide-ranging, on a broad asset base, with an element ofaccrual taxation. Given the exclusion of the family home and the familiar difficulties withaccrual taxation, we are into a “second best” world.

b. Ideally, tax should be imposed on real rather than nominal gains.

6. We accept that a realisation-based CGT is a much more likely outcome. Design of such a tax shouldbe based on:

a. Minimising the number of realisation events

b. Approximating real gains, for example, by way of taper relief

c. Ring-fencing capital losses

d. Taxing gains from a valuation day

e. Minimising exemptions and reliefs

7. We retain doubts regarding the value of a separate CGT given the family home is to be excluded.

Addressing wealth inequalityOne of the key criteria by which we shouldassess our tax system is through equity andfairness. Our current tax system focusesheavily on taxing income. However, income isnot the only or major source of affluence formany New Zealanders.

Wealth inequality is much more concentratedthan income inequality. When considering theLiving Standards Framework, wealth inequalityadversely affects both social and humancapital. It tends to reduce social cohesion,

106 According to Credit Suisse Research InstituteGlobal Wealth Report (November 2017).

particularly in relation to trust betweendifferent groups in society.

Wealth inequality is an issue in many parts ofthe world:106

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New Zealand is not exempt from the inequalityeffect despite our progressive income taxrates.

The Paper attempts to illustrate the level ofwealth inequality among households in Figure17107. Figure 17 is based on Statistics NewZealand figures for median household networth by quintile for the year ended 30 June2015.

In our view, splitting households into quintilesdisguises the extent to which wealth isconcentrated. We suspect wealth inequality ismore significant than suggested by Figure 17.

Looking at the figures at a more granular level,for the year ended 30 June 2015, the top 10%of New Zealand households accounted foraround half of total wealth, while the bottom40% held only 3% of total wealth108. Whenlooking at individuals, the top 10% ownedapproximately 60% of total net worth, with ourwealthiest 1% accounting for approximately22%109.

In addition, there is evidence that inhabitants insome developed economies may underestimatethe actual extent of wealth inequality in theirown country. Research has shown that, onaverage, Australian adults overestimate thewealth of the poorest quintile by a factor ofmore than seven, while underestimating thewealth of the wealthiest quintile by more than afifth110. Their American counterparts wereprone to similar misperceptions about wealthdistribution in the United States111.

Intergenerational equity

Individual net worth is skewed towards older

107 Tax Working Group, Future of Tax: SubmissionsBackground Paper (March 2018), p37.108 Statistics New Zealand household net worthstatistics for year ended 30 June 2015. See alsohttps://www.stats.govt.nz/news/top-10-percent-of-households-have-half-of-total-net-worth (as at 20April 2018).109 Statistics New Zealand household net worthstatistics for year ended 30 June 2015. Seehttps://www.stats.govt.nz/news/top-10-percent-of-households-have-half-of-total-net-worth (as at 20April 2018).110 Michael Norton, David Neal, Cassandra Govan,Dan Ariely and Elise Holland, The Not-So-Common-Wealth of Australia: Evidence for a Cross-CulturalDesire for a More Equal Distribution of Wealth,Analyses of Social Issues and Public Policy, Vol. 14,No. 1, 2014, p344. See

New Zealanders. Statistics New Zealandfigures for the year ended 30 June 2015 showthat young people (15–24 years) had thelowest median individual net worth ($1,000)and older people (65+) had the highest($288,000) 112.

These figures raise issues aroundintergenerational equity, with a prima faciecase that equity would be enhanced shouldcapital stocks (mostly held by older people)bear a greater burden than is currently thecase. Increased capital taxation could allow forsome reduction of labour income taxation,mostly generated by New Zealanders under 65.On a static lifetime basis, there is nointergenerational inequality and any reformcould prove difficult for cash-poor, asset richolder people.

The impact of technology

The inequality debate is not immune from theimpact of technology. A small number ofentrepreneurs involved in the development ofsuccessful new technology may accumulatesignificant wealth and therefore raise the levelof recorded wealth inequality while increasingthe wealth of all.

It is important not to discourageentrepreneurial developments, given thattechnological advancements are likely to begood for the economy and the wellbeing ofmany New Zealanders. Immigration NewZealand actively seeks such investment underits Investor Plus category113 given theeconomic benefits to New Zealand of suchinvestment.

http://www.hbs.edu/faculty/Publication%20Files/norton%20neal%20govan%20ariely%20holland_9c8b4689-d8f7-43c1-82e3-e85f552caca4.pdf (as at 26 April2018).111 Michael Norton and Dan Ariely, Building a BetterAmerica—One Wealth Quintile at a Time, Perspectiveson Psychological Science 2011 6(1). Seehttp://www.people.hbs.edu/mnorton/norton%20ariely.pdf (as at 26 April 2018).112 Statistics New Zealand household net worthstatistics for year ended 30 June 2015. See alsohttp://archive.stats.govt.nz/browse_for_stats/people_and_communities/Households/HouseholdNetWorthStatistics_HOTPYeJun15.aspx (as at 20 April 2018).113 https://www.immigration.govt.nz/new-zealand-visas/apply-for-a-visa/visa-factsheet/investor-plus-investor-1-resident-visa (as at 26 April 2018).

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Holistic approach required

The overarching tax principles of efficiency,horizontal and vertical equity and coherence allsuggest an integrated system taxing all capitalincome and wealth is required. We particularlytake that view given we see New Zealand’s taxsystem needs to be clearly progressive if it is tobe sustainable.

The extent to which the tax system is currentlyprogressive needs to be considered holistically,taking into account our transfer system andboth income and capital taxes. Givenexclusions from the Group’s Terms ofReference114, we concentrate our comments oncapital taxation.

The main potential instruments for capitaltaxation are:

► Capital income taxes, notably the taxationof private savings,

► CGTs,

► Capital transfer taxes – such as inheritanceor gift taxes, and

► Ownership-based taxes – including otherwealth taxes and land tax.

These instruments cannot be used incombination too heavily or capital taxation willcompound to very high rates. We discuss eachof these areas further below, with theexception of capital transfer taxes since aninheritance tax has been excluded by the

114 Terms of Reference: Tax Working Group(November 2017),https://taxworkinggroup.govt.nz/resources/terms-reference-tax-working-group (as at 20 April 2018).115 Terms of Reference: Tax Working Group(November 2017),https://taxworkinggroup.govt.nz/resources/terms-reference-tax-working-group (as at 20 April 2018).

116 Better saved than sorry: The Treasury's positionon New Zealand's saving performance, SpeechDelivered by John Whitehead, Secretary to theTreasury on 13 August 2007,https://treasury.govt.nz/publications/speech/better-saved-sorry-%C2%A0treasurys-position-new%C2%A0zealands-saving-performance (as at 24April 2018).117 Tax Working Group, Future of Tax: SubmissionsBackground Paper (March 2018), p5.118 Tax Working Group, Future of Tax: SubmissionsBackground Paper (March 2018), p26.

Group’s Terms of Reference115.

Taxation of private savings

“Better saved than sorry.116”

New Zealand appears to have a privatesavings problem

New Zealand’s approach to the taxation ofretirement savings is unique. Our tax systemdoes not offer large concessions for retirementsavings117. As the Paper states “somecommentators think that New Zealand shouldtax income from capital at a lower rate toencourage more saving, particularly forretirement. New Zealand’s lack of concessionsfor retirement savings is rare among OECDcountries118.”

The current level of savings is likely to beinsufficient to support many New Zealanders intheir retirement. Despite KiwiSaver and theGovernment’s provision of New ZealandSuperannuation (“NZ Super”), it’s unlikely thatthe level of savings is high enough to allowpeople to retire with a similar lifestyle to whatthey had during their working days119. MostNew Zealanders consider about twice thecurrent level of NZ Super is needed for acomfortable retirement120. Researchconducted for the Financial Services Councillast year shows a $218 average after taxweekly gap between what the retired need tolive comfortably and what they actuallyhave121. Accordingly, there is a strong need

119 Savings Working Group, Saving New Zealand:Reducing Vulnerabilities and Barriers to Growth andProsperity: Final Report to the Minister of Finance(January 2011),https://treasury.govt.nz/publications/saving-new-zealand-reducing-vulnerabilities-and-barriers-growth-and-prosperity-final-report-minister (as at 24 April2018).

120 Financial Services Council, The Tax Barrier toRetirement Prosperity in New Zealand (2013),https://www.fsc.org.nz/site/fsc/files/SuperSize%20Conference%202013/FSC-Taxation%20and%20Savings%20Paper-Final%20copy.pdf (as at 24 April 2018).121 Great Expectations: Retirement Realities for OlderNew Zealanders, Research Paper No. 2, Researchconducted for the Financial Services Council(December 2017),https://www.fsc.org.nz/site/fsc/Great-Expectations-FINAL.pdf (as at 24 April 2018).

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for NZ Super to be supplemented by privatesavings122.

A recent OECD report found there is significantscope to improve the way countries taxsavings, including taxing savings types moreequally to improve both efficiency andfairness123. There are clear indications thatNew Zealanders save less than those in similarcountries124. New Zealand’s tax system is seenas biased towards investment in the propertymarket and against long-term savings such asKiwiSaver and bank term deposits125. This biasnot only has adverse impacts on retirementsavings but may also mean the savings we dohave are being put to relatively unproductiveuse.

New Zealand’s savings problem will becomeeven more pertinent over the next decade or soas the population ages and life expectanciesincrease, calling into question the long-termviability of NZ Super. Intergenerationalconcerns arise around whether the youngerpopulation should face the costs of the ageingpopulation.

In 2011, the Savings Working Group took astrong view of the available evidence. Itstated126:

122 Financial Services Council, The Tax Barrier toRetirement Prosperity in New Zealand (2013),https://www.fsc.org.nz/site/fsc/files/SuperSize%20Conference%202013/FSC-Taxation%20and%20Savings%20Paper-Final%20copy.pdf (as at 24 April 2018).123 OECD (2018), Taxation of Household Savings,OECD Tax Policy Studies, No. 25, OECD Publishing,Paris, http://dx.doi.org/10.1787/9789264289536-en (as at 24 April 2018).124 Savings Working Group, Saving New Zealand:Reducing Vulnerabilities and Barriers to Growth andProsperity: Final Report to the Minister of Finance(January 2011),https://treasury.govt.nz/publications/saving-new-zealand-reducing-vulnerabilities-and-barriers-growth-and-prosperity-final-report-minister (as at 24 April2018). See also Better saved than sorry:The Treasury's position on New Zealand's savingperformance, Speech Delivered by John Whitehead,Secretary to the Treasury on 13 August 2007,https://treasury.govt.nz/publications/speech/better-saved-sorry-%C2%A0treasurys-position-new%C2%A0zealands-saving-performance (as at 24April 2018).

125 Financial Services Council, The Tax Barrier toRetirement Prosperity in New Zealand (2013),

“New Zealanders – the people and thegovernment – are not saving enough.Unless we make some rapid changes, weare risking a major economic disruptionlikely to leave practically all NewZealanders worse off. It’s as if we arestanding on top of a cliff that may collapsedramatically or crumble slowly. Eitherway, it would be a bad fall. We need tomove back from the brink – and fast.”

We acknowledge there are limitations whenlooking at data and statistics around savings.The policy analysis is difficult because no oneset of data provides the ability to drawcategorical conclusions127. Savings can bemeasured in many different ways, there aredata uncertainties at both a micro / householdlevel and at a macro level128. In addition,findings are often dependent on particularassumptions.

Our judgment is the evidence points towards aprivate savings problem in New Zealand. Webelieve there is a case for reconsidering thebalance between private and public savings andthe role of the tax system. Our judgment isbased on a least-regrets approach. We agreewith the position previously put forward byTreasury that when it comes to savings it is

https://www.fsc.org.nz/site/fsc/files/SuperSize%20Conference%202013/FSC-Taxation%20and%20Savings%20Paper-Final%20copy.pdf (as at 24 April 2018).

126 Savings Working Group, Saving New Zealand:Reducing Vulnerabilities and Barriers to Growth andProsperity: Final Report to the Minister of Finance(January 2011),https://treasury.govt.nz/publications/saving-new-zealand-reducing-vulnerabilities-and-barriers-growth-and-prosperity-final-report-minister (as at 24 April2018).127 Better saved than sorry: The Treasury's positionon New Zealand's saving performance, SpeechDelivered by John Whitehead, Secretary to theTreasury on 13 August 2007,https://treasury.govt.nz/publications/speech/better-saved-sorry-%C2%A0treasurys-position-new%C2%A0zealands-saving-performance (as at 24April 2018).128 Better saved than sorry: The Treasury's positionon New Zealand's saving performance, SpeechDelivered by John Whitehead, Secretary to theTreasury on 13 August 2007,https://treasury.govt.nz/publications/speech/better-saved-sorry-%C2%A0treasurys-position-new%C2%A0zealands-saving-performance (as at 24April 2018).

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better to take action now than to be sorrylater129.

Current approach

New Zealand currently taxes savings on a TTEbasis130.

In effect the money will be subject to anotherlayer of tax, GST, when it is spent. Incomparison, if the income is spent immediatelyit’s only taxed twice – as initial income andwhen it’s spent. This difference discouragessaving131.

While this TTE approach is consistent with aBBLR tax system, many other countries take adifferent approach. A number of OECDcountries take an Exempt-Exempt-Taxed(“EET”) approach where tax is imposed only atthe withdrawal stage132. This EET approachcould be partially explained by the fact thatsocial security pensions are subject to means-testing in many countries133.

Moving towards a fairer TTE system

As stated by the Financial Services Council,common sense calls for change but the taxreform options are not easy134.

129 Better saved than sorry: The Treasury's positionon New Zealand's saving performance, SpeechDelivered by John Whitehead, Secretary to theTreasury on 13 August 2007,https://treasury.govt.nz/publications/speech/better-saved-sorry-%C2%A0treasurys-position-new%C2%A0zealands-saving-performance (as at 24April 2018).130 New Zealand’s “TTE” tax system means• Contributions are made out of income that istaxed (usually an individual’s labour income).• Income earned from the investment, such asinterest and dividends, is taxed (whether earnedbefore or during retirement) though the portfolioinvestment entity tax rates are available.• Amounts “withdrawn” from the investment arenot taxed.See Tax Working Group, Future of Tax: SubmissionsBackground Paper (March 2018), p26.131 Savings Working Group, Saving New Zealand:Reducing Vulnerabilities and Barriers to Growth andProsperity: Final Report to the Minister of Finance(January 2011),https://treasury.govt.nz/publications/saving-new-zealand-reducing-vulnerabilities-and-barriers-growth-and-prosperity-final-report-minister (as at 24 April2018).132 See Tax Working Group, Future of Tax:Submissions Background Paper (March 2018), p26.

In an ideal system all savings would be taxed tothe same extent. The next best alternative is toremove or reduce the bias in the tax systemtowards investing in the property market asopposed to long-term savings. An ideal systemalso needs to be sustainable – it shouldencourage long-term savings where possible,but recognise that some individuals have no orlow ability to save.

There are a number of possible reform optionsavailable, many of which have already beencanvased and explored by others135. There isnot necessarily one superior option for reform:the best solution could be a combination ofoptions.

Adopting an EET approach is likely to be fiscallycostly and would also translate to considerablecompliance costs for existing providers.Changes within a TTE system are moremanageable. This suggests remaining in a TTEsystem with a reduced level of taxation both atthe contribution stage and the income earningstage.

In particular:

► Reducing the level of taxation at thecontribution stage may incentivise some

133 See Tax Working Group, Future of Tax:Submissions Background Paper (March 2018), p26.134 Financial Services Council, The Tax Barrier toRetirement Prosperity in New Zealand (2013),https://www.fsc.org.nz/site/fsc/files/SuperSize%20Conference%202013/FSC-Taxation%20and%20Savings%20Paper-Final%20copy.pdf (as at 24 April 2018).135 See, for example: Financial Services Council, TheTax Barrier to Retirement Prosperity in New Zealand(2013),https://www.fsc.org.nz/site/fsc/files/SuperSize%20Conference%202013/FSC-Taxation%20and%20Savings%20Paper-Final%20copy.pdf (as at 24 April 2018); SavingsWorking Group, Saving New Zealand: ReducingVulnerabilities and Barriers to Growth and Prosperity:Final Report to the Minister of Finance (January2011), https://treasury.govt.nz/publications/saving-new-zealand-reducing-vulnerabilities-and-barriers-growth-and-prosperity-final-report-minister (as at 24April 2018); Taxation of Savings and InvestmentIncome, joint report IRD and Treasury (September2012),http://taxpolicy.ird.govt.nz/publications/2013-other-savings-investment/taxation-savings-and-investment-income (as at 24 April 2018).

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individuals to invest their money intosaving for retirement.

► Behavioural economics suggestsencouragement is required to ensurepeople act in their own interests.Policies based around nudging ormaking the preferred behaviour easyare frequently influential. Somepeople behave in predictable ways,such as hyperbolic discounting offuture benefits, which can becorrected through relatively smallupfront incentives.

► Consideration should be given towhether a reduction in the level oftaxation at the contribution stageshould be targeted towards people onlower incomes.

► Reducing the level of taxation at theincome earning stage is likely to havea significant positive impact on thelevel of savings over the longer term.This “middle T” can significantlyreduce a person’s retirement savings,particularly in relation to long-termor accumulated savings that arereinvested into the savingsinstrument.

Other options the Group should give furtherconsideration to include:

Compulsory KiwiSaver membership

Compulsory KiwiSaver membership may solvesome of the behavioural factors around whypeople fail to adequately save for retirement.People are often prone to short-term bias,where they prioritise their current needs anddesires over long-term ones. There has alreadybeen a change in behaviour from requiringpeople to opt out of KiwiSaver rather than optin.

However, there are individuals within oursociety who do not have the capacity to makeKiwiSaver contributions without a noticeabledecrease in their current quality of life.Accordingly, we believe it would be worthwhileconsidering whether KiwiSaver should be made

136 Better saved than sorry: The Treasury's positionon New Zealand's saving performance, SpeechDelivered by John Whitehead, Secretary to theTreasury on 13 August 2007,https://treasury.govt.nz/publications/speech/better-

compulsory only for those earning over acertain income threshold.

Concessionary tax treatment for investmentin PIEs

PIEs and other similar investment vehicles arebeneficial to the economy and should besupported. They are managed by professionalfund managers who have greater knowledgearound investment decisions and greateraccountability to investors. Professional fundmanagers are also more likely to invest in adiverse range of different risk investments,whereas individual investors are more likely tobe risk averse. The collective nature of suchinvestment vehicles means investors are moreinsulated against those risks on a collectivebasis.

Consideration should be given to loweringprescribed investor rates for PIE funds andlocked-in savings such as KiwiSaver and similarschemes. If New Zealand introduces a CGT,concessionary treatment for gains made byPIEs should be retained.

Specific support for people on low incomes

It should come as no surprise that inadequateretirement saving affects a higher proportionof people on low to middle incomes136.

People who are on low incomes are alreadysubject to relatively low taxation on the “middleT”. However, thought should be given as tohow the level of taxation on the “middle T” canbe reduced further for those on low incomes,such as taxing only a fraction of the totalincome earned from the investment. Otheroptions could include a lower tax rate oncontributions to savings accounts, or a “top up”for those who save above a certain portion oftheir income.

Real vs. nominal gains

In our view, a significant issue that needs to beaddressed is whether tax should be levied on areal or nominal basis.

The starting point of any tax is that it shouldonly be levied on real gains, not nominal gains –meaning there is no taxation of gains solely

saved-sorry-%C2%A0treasurys-position-new%C2%A0zealands-saving-performance (as at 24April 2018).

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attributable to inflation. However, thisprinciple is difficult to apply in practice andmost of our tax system currently taxes nominalgains.

We consider taxing nominal gains as opposed toreal gains to be problematic, especially in a lowinterest rate environment. As stated in thePaper, “As nominal income is fully taxed (thatis, income including the inflation component), a33% tax on the nominal return (that is, the realreturn plus inflation) on savings in a bankaccount is actually a materially higher tax onthe real return137.”

Example: an effective 100% tax

For example, if an individual has a bankaccount with an interest rate of 3% perannum and they have deposited a total of$100:

► At the end of the year they will have$103 – a nominal return of $3.

► Assuming an inflation rate of 2%, $2 isinflation and the real return is only $1.

► If the nominal return of $3 is taxed at33%, the entire $1 real return is taken.

A fairer base would be to tax the real return.

There are a number of options for accountingfor inflation,138 including:

► A risk free return method (an annualinflationary adjustment set at a rate basedon real capital returns),

► Taper relief, and

137 Tax Working Group, Future of Tax: SubmissionsBackground Paper (March 2018), p39.138 The issues caused by taxing nominal gains asopposed to real gains are even more significant in thecontext of a CGT on property that has been held for anumber of years. This matter, along with thepossible options for accounting for inflation, arediscussed further below in the context of CGTes.139 Better saved than sorry: The Treasury's positionon New Zealand's saving performance, SpeechDelivered by John Whitehead, Secretary to theTreasury on 13 August 2007,https://treasury.govt.nz/publications/speech/better-saved-sorry-%C2%A0treasurys-position-new%C2%A0zealands-saving-performance (as at 24April 2018).

► Indexation.

Decreased tax revenue

Reducing the level of taxation at the first andmiddle “T’s”, in combination with theassumption that a reduced level of taxationresults in a higher level of private savings,there will be less tax revenue. This decrease intax revenue may cause NZ Super to becomeless affordable than it already is. However, anincreased level of private savings should reducethe need for public savings in the future.

It is also important to note that increasedsavings are likely to have a positive flow-oneffect for the New Zealand economy as awhole. As stated by the Treasury, “highersaving creates higher income for New Zealandand New Zealanders. It makes more moneyavailable for investment in productive assets,and therefore increases our wealth overtime139.”

CGT and the housing market

In New Zealand, the debate around CGT haslargely focussed on gains made by investors inthe residential property market140. Whilehousing availability and affordability is asignificant issue, we do not think CGT is theanswer.

Is residential rental property under-taxed?

There is evidence to suggest investment inresidential rental property is currently under-taxed when compared to other forms ofinvestment or savings141. This distortion in thetax system may have encouraged investmentaway from other areas and into the residentialrental property market. However, thisevidence is generally highly dependent on

140 See, for example:https://thespinoff.co.nz/society/inland-revenue/31-03-2018/why-the-lack-of-a-capital-gains-tax-is-letting-property-companies-off-lightly/;http://www.newshub.co.nz/home/election/2017/07/housing-capital-gains-are-soaring-in-new-zealand.html; and https://www.tvnz.co.nz/one-news/new-zealand/capital-gains-tax-on-investment-property-bold-call-from-reserve-bank-6288439 (as at20 April 2018).141 A Tax System for New Zealand’s Future: Report ofthe Victoria University of Wellington Tax WorkingGroup (January 2010).

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underlying assumptions and should not berelied upon as the sole reason for introducing aCGT.

For example, Figure 21 of the Paper shows amarginal effective tax rate (“METR”) on savingsof 29.4% for rental property, which seems lowwhen compared to the next lowest METR of47.2% for portfolio investment entity,superannuation fund and non-distributingcompany investments142. However, Figure 21is based on assumptions around whatproportion of the return is on rental yield andwhat proportion represents real capital gain143.Changing these assumptions to show a slightlyhigher rental yield and lower real capital gainwould produce a different result. Thevariability of results is demonstrated bycomparing the findings of Figure 21 to a recentOECD study which shows residential rentalproperty to be taxed relatively highly in NewZealand compared to other asset types144.

Even if residential rental property is under-taxed, many other aspects contribute tohousing price inflation

Any under-taxation of capital gains onresidential investment properties is unlikely tobe the main cause of housing price inflation. Agrowing population, immigration, internalmigration to urban centres, construction skillsshortfalls, changing housing expectations,housing regulations and a shortage in thenumber of new houses being built may all bebigger contributors to the current state of thehousing market. The tax system cannot dealwith many of these issues.

Even so, there is value in structuring our taxsystem to ensure incentives to invest are notdistorted in a way that favours residentialhousing.

Is a CGT the best option for addressing housingconcerns?

CGTs tend to address wealth inequality bytargeting capital which is typically held by high

142 Tax Working Group, Future of Tax: SubmissionsBackground Paper (March 2018), p40.143 See Tax Working Group, Charts and Data - Futureof Tax: Submissions Background Paper (March 2018).Small, but credible, changes to those assumptions –such as a reduced real gain in asset price – couldreverse the effect.144 OECD (2018), Taxation of Household Savings,OECD Tax Policy Studies, No. 25, OECD Publishing,

wealth individuals. However, for many NewZealand households a lot of their wealth is tiedup in the family home145. Accordingly, while aCGT may help to address wealth inequality insome ways, the exemption of the family homemeans much of that wealth may not betargeted by any potential CGT and limitsrevenue-raising potential. In fact, a CGT whichexempts the family home may encourageindividuals to invest more into their familyhome as an untaxed source of capital.

We acknowledge the practical challengesassociated with the family home and also theinternational precedents as a consequence.One way of addressing concerns regarding thefamily home while still contributing to aprogressive tax system could be to includegains on high-value owner occupied homes, forexample, if the proceeds exceeded a certainthreshold.

Other options for taxing residential rentalproperty

There are many options available to addressthe taxation of residential investment property(and other similar property-relatedtransactions), with a CGT being one. However,the scope of a CGT could go far beyond taxingthese types of gains. As the debate aroundCGT has focussed heavily on the housingmarket, there has been insufficientconsideration of other types of gains that mightbe taxed.

If the Group’s view is that New Zealand shouldtax investment gains in the property market,consideration should be given to more specific,tailored approaches to tax only those particulartypes of capital gains, such as a risk free returnmethod, discussed below. In addition, as NewZealand is largely a small business economy, asignificant source of capital gains exist inbusiness goodwill. Consideration will need tobe given as to the extent to which these gainsare taxed.

Paris, http://dx.doi.org/10.1787/9789264289536-en (as at 24 April 2018).145 Statistics New Zealand household net worthstatistics for year ended 30 June 2015. See alsohttps://www.stats.govt.nz/news/top-10-percent-of-households-have-half-of-total-net-worth (as at 20April 2018).

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Current approach

New Zealand currently taxes real propertygains through a series of provisions in subpartCB of the Income Tax Act 2007 (“ITA 2007”).These provisions cover certain types of land-related businesses such as land dealing146 andland development and subdivision147. Othergeneral property transactions are covered by sCB 6 of the ITA 2007, which requires incometax to be paid on gains made on propertyacquired for the purpose or intention ofdisposal. In our view, IRD has not sought toapply this test with sufficient rigour, resultingin a perception that residential property gainsare untaxed.

The introduction of the “bright-line” test in2015 has gone some way to providing clearrules that tax gains made on short-termproperty investments, however the impetusremains on IRD to enforce the lawappropriately. The test currently requiresincome tax to be paid on any gains that arisefrom residential property disposed of withinfive years of acquisition, subject to someexemptions148. As this test has only applied tointerests in land acquired after 1 October2015149, it is difficult to evaluate its success incapturing certain types of propertytransactions or to assess its impact on thehousing market.

As is the case with CGT in most overseasjurisdictions, s CB 6 of the ITA 2007 and thebright-line test focus on taxing realised capitalgains – i.e. gains which arise at the point of sale(or certain other disposal events). This timinghas little effect on the problems faced by NewZealand’s housing market and can in factexacerbate these problems. Many residentialinvestment properties are held by their ownersfor a significant period of time. The investmentcan often be seen as a form of retirementsavings or used as security against furtherborrowing. Taxing realised gains providesfurther encouragement for property investorsto defer sale of the property to defer taxation,

146 Section CB 9 ITA 2007.147 Section CB 10 ITA 2007.148 Section CB 6A ITA 2007.149 Taxation (Bright-Line Test for Residential Land)Act 2015.150 Tax Review 2001, Final Paper also known as the“McLeod Report”.

or to potentially avoid it altogether in the caseof a bright-line test. Such deferral impacts theavailability of houses for sale and consequentlythe affordability of houses.

Risk-free rate of return method

Another option for taxing investment in certaincapital gains (including in the residential rentalproperty market) was supported by both theMcLeod Report in 2001150 and the VictoriaUniversity of Wellington Tax Working Group151

in 2010. The Report published by the VictoriaUniversity of Wellington Tax Working Groupstates “[t]he majority of the Tax Working Groupsupport detailed consideration of taxing returnsfrom capital invested in residential rentalproperties on the basis of a deemed notionalreturn calculated using a risk-free rate152.”

A risk free return method (“RFRM”) of taxationon certain capital gains should be considered asa way of targeting issues in the housing marketwithout any of the associated issues of a CGT.We agree with both the McLeod Report and theVictoria University of Wellington Tax WorkingGroup that significant research and analysiswould need to be undertaken before such a taxcould be implemented153. We encourage theGroup to consider inviting further submissionson an RFRM-based tax.

An RFRM-based tax seeks to tax the capitalgain in an asset’s value based on an annualnotional rate. The notional rate is calculatedbased on a risk-free real rate of return - i.e. therate at which the return would be if the fundshad been invested in risk-free governmentbonds (with an adjustment for inflation). AnRFRM-based tax is calculated as follows:

(Net asset value at start of the year) x(statutory risk-free real rate of return) x(investor’s tax rate).

The primary appeal of a RFRM-based tax is thatit could address the current distortions in the

151 A Tax System for New Zealand’s Future; Report ofthe Victoria University of Wellington Tax WorkingGroup (January 2010).152 A Tax System for New Zealand’s Future; Report ofthe Victoria University of Wellington Tax WorkingGroup (January 2010), p11.153 McLeod Report, p27; A Tax System for NewZealand’s Future; Report of the Victoria University ofWellington Tax Working Group (January 2010), p53.

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taxation of different investment vehicles andtypes.154 Key issues for consideration include:

► The accuracy of the method in taxing gainsin the value of capital,

► What assets would be subject to the tax(possibly including commercial property),

► Methods for determining asset value at thestart of the year,

► Integration with other aspects of the taxsystem (including company taxation andthe personal tax rate),

► Liquidity issues for taxpayers paying sucha tax annually,

► How within year sales or acquisitions ofassets should be accounted for, and

► Transitional measures.

We would be happy to make further detailedsubmissions on a RFRM-based tax on assets,specifically addressing the issues raised above.We recommend the scope of any RFRM-basedtax be limited, at least initially, to propertytransactions (excluding the family home, due tothe Group’s Terms of Reference). Thislimitation would specifically seek to solve thecurrent problem of under-taxation of this typeof capital without capturing other forms ofcapital which are already sufficiently taxed.

CGT applying across asset classes

The Government has charged the Group withexamining the merits of a system of taxingcapital gains on assets more broadly thanresidential property. The Group thereforeseeks comment on detailed CGT design,regardless of the merits of such a tax.

The insert below does not presume we see abroad-based CGT as desirable.

Developing a broad-based CGT

1. Objectives

a. Revenue raising, progressive targeting of wealth inequality or targeting selected assetclasses?

b. Political sustainability, with which removal of the family home will assist.

2. Revenue

a. Given New Zealand’s already broad income tax, a CGT would be supplementary and marginalin terms of total tax revenues.

b. Assume a slow build-up of revenues over time.

3. Main design issues

a. The scope of capital subject to the tax (any exemptions or concessions),

b. Tax base (if on accrual basis),

c. Tax base (if on realisation basis),

d. Realisation events,

e. How to calculate capital gains / asset bases,

f. The treatment of capital losses, and

g. Transitional measures.

154 A Tax System for New Zealand’s Future; Report ofthe Victoria University of Wellington Tax WorkingGroup (January 2010), p52.

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We set out a summary of suggested design elements in the table below, followed by furtherelaboration on these points.

Feature Design Comment

Scope / asset base Real property (excluding the familyhome), gains on shares, chattels,business goodwill and other intangibleproperty

Broad base supports horizontaland vertical equity

Tax base (if onaccrual)

RFRM Would address distortions inthe taxation of differentinvestment types

Tax base (if onrealisation)

Nominal gains, on a taper basis Pragmatic alternative to taxingreal gains

Realisation events Minimise number of realisation events To reduce complexity andcompliance burden

Asset valuations Use arm’s length prices Likely source of dispute

Capital losses Ring fence Risk of selective lossrealisation if full offset withincome tax losses

Transitionalmeasures

CGT should apply to all assets sold afterthe effective date

Reduces the need for acomplex system of “grand-parenting” provisions

4. Scope

a. A CGT should be designed to maximise simplicity and apply to all forms of capital withrelatively few carve-outs or exemptions so as not to distort behaviour. If a CGT is to focuson reducing wealth inequality, it should apply to all forms of capital including real property,personal property, shares, intangibles, collectibles etc.

b. While there may be various public policy reasons to support certain types of exemptions,these are often difficult to apply, exacerbate compliance costs and continue to distortinvestment behaviours. In a study of CGT in Australia and the UK, complexity was found tobe the biggest driver of compliance costs in both countries:

“[i]t is difficult to envisage any other tax where compliance costs will often exceed the taxpayable. And yet the majority of UK respondents and nearly 30% of Australian respondentswere able to agree that this was often the case with CGT.155”

c. Both the UK and Australia have a number of carve-outs including personal propertyexemptions, roll-over relief, a venture capital exemption in Australia and entrepreneur’srelief in the UK.

d. A broad-based CGT, levied on real gains from all classes of capital asset likely to appreciateon an accruals basis, has strong theoretical appeal. Given the exclusion of taxation of the

155 Evans, The operating costs of taxing the capital gains of individuals: a comparative study of Australia and the UK,with particular reference to the compliance costs of certain tax design features (2003).

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family home from the Group’s Terms of Reference156, the discussion below concentrates onsecond-best alternatives.

e. Given our comments above on increasing private retirement savings, the Australasian shareexemption for PIEs should be retained and should be extended to cover global shares. (Thisrecognises the fact that with a CGT, the current foreign investment fund regime would needto change).

5. Real vs. nominal gains

a. As noted above, the starting point of any tax is that it should only be levied on real gains,not nominal gains – meaning there is no taxation of gains which are solely attributable toinflation. However, this principle is extremely difficult to apply in practice and most of ourtax system currently taxes only nominal gains.

b. For the majority of capital income, inflation can be immaterial given that tax is leviedrelatively close to the time of its derivation over a short period. For assets held over alonger-term, the effects of inflation may be significant necessitating some form of allowanceto attempt to minimise the taxation of inflation created gains.

c. We believe the single biggest CGT design issue is how to account for inflation, particularly onassets held long-term.

6. Inflation. There are several options that can be adopted to account for inflation. Our preferredoptions, in order of preference, are:

a. An accrual based CGT, such as the RFRM discussed earlier. This method makes an annualadjustment for inflation which is relatively easy to apply and can be set at a rate based onreal returns on capital. We believe this method would most easily and accurately allow foradjustments for the effect of inflation.

b. Taper relief. Many countries have taper relief systems – where the amount of tax levied onthe capital gain decreases or is eliminated if the asset is held for a certain period.

c. In Australia, assets held for over a year qualify for a partial exemption from CGT (a 50%discount for individuals and trusts and 33.33% for complying superannuation entities).

d. Holding period thresholds for taper relief vary significant across countries. Australia and theUnited States have a one year minimum holding period whereas Germany and France have aminimum period of 10 and 30 years respectively.

e. We recommend a taper-style system with a scale for different rates. For example, an assetheld for five years might qualify for a 10% discount CGT rate, and an asset held for 10 yearsmight qualify for a 25% discount CGT rate. Such a scale would allow the taper to moreaccurately reflect the trend of inflation over time, rather than marking a single point in timeand applying the concessionary rate at that point. We would not recommend any discountrate beyond 50% because it is unlikely that inflation would effect a gain to this extent exceptover a very long time (e.g. 30 years). The taper could be periodically reset approximating toinflation outturns over the holding period.

f. Indexation. While indexation is likely to be more accurate than a taper relief system, itwould also be more complex. Australia previously had an indexation system but this systemwas replaced in 1999 with tax relief. The UK has also wound back indexation both forindividuals and, more recently, companies.

156 Terms of Reference: Tax Working Group (November 2017), https://taxworkinggroup.govt.nz/resources/terms-reference-tax-working-group (as at 20 April 2018).

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7. Accrual vs. realisation basis

a. All OECD countries with a CGT tax capital gains on realisation157. However, an accrual basismay be preferable as realisation based CGTs cause “lock-in” where there are incentives toretain assets to defer taxation. In addition, it can take a long time for steady revenue toarise from a realisation-based capital gains system, making it hard to assess the trade-offwith compliance costs.

8. Realisation events

a. If a realisation-based CGT was to be introduced, we support a system that has relatively few“realisation events” as these are often complex and create a large compliance burden.Looking at CGTs internationally, there are a variety of different definitions of “realisationevents”. For example, Australia has over 55 separate “CGT events” which can give rise tocapital gains or losses. This is in part because of the wide variety of capital assets andtransactions which are subject to CGT.

b. Particular consideration should be given to finding a balance between minimising complexrealisation rules and reducing opportunities to subvert the CGT through certain taxstructuring activities, for example granting exclusive rights to an asset without transferringactual ownership. Realisation rules will also need to cover a number of other situations,including:

i. Assets or asset holders leaving New Zealand,

ii. Different rights to use assets, and

iii. CGT assets becoming subject to other tax rules such as the trading stock or financialarrangements rules.

9. Calculating capital gains and losses

a. Most countries with a CGT determine the amount of capital gain or loss by taking thedifference between the value of the asset on the date of acquisition and the value on thedate of realisation158, possibly subject to transitional concessions (discussed later).

b. One of the more significant challenges a CGT will face is how to determine the value ofassets at the date of acquisition. Some assets may have a natural cost base, for exampleassets purchased from a third party, however other assets, such as shares in a privatelyheld company, do not have any clear cost base. For all assets other than listed shares, theopportunity to manipulate value based on the market concerned and the availability ofdifferent valuation methods is problematic.

c. We would expect to see significant valuation activity following the introduction of a CGT,leading to subjective but defensible valuations by taxpayers using specialist resources whichmay not be available to Inland Revenue. While commercial valuations are a forward-lookingmeasure generally based on the net present value of future cash flows, professional valuersfrequently quote a wide range of possible valuations and buyer/seller valuations differsubstantially.

10. Treatment of capital losses

a. We believe any CGT should ring fence losses similar to the system in Australia – i.e. capitallosses can only be offset against capital gains and cannot be offset against other forms of

157 Harding, M. (2013), “Taxation of Dividend, Interest and Capital Gain Income”, OECD Taxation Working Papers, No.19, OECD Publishing, Paris, p32. See http://dx.doi.org/10.1787/5k3wh96w246k-en (as at 26 April 2018).158 Harding, M. (2013), “Taxation of Dividend, Interest and Capital Gain Income”, OECD Taxation Working Papers, No.19, OECD Publishing, Paris, p32. See http://dx.doi.org/10.1787/5k3wh96w246k-en (as at 26 April 2018).

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income. Capital losses should be able to be carried forward subject to standard losscontinuity rules.

b. Allowing capital losses to be offset against other forms of taxable income would likely leadto tax planning opportunities where individuals try to maximise capital losses to offsetagainst other forms of taxable income, while deferring gains.

11. “Black hole” and feasibility expenditure

a. Implementation of a CGT strengthens the case for ensuring all “black hole” and feasibilityexpenditure is deductible.

b. An Australian provision that allows a deduction (spread over five years) for capitalexpenditure not otherwise deductible could be a useful model to follow.

12. Transitional measures. There are two choices for transitioning to a CGT. A CGT could:

a. Apply to any asset sold after the effective date, based on the gain over valuation at theeffective date. This approach was adopted by Canada when introducing a CGT, or

b. Apply to any asset acquired after the effective date. This approach was adopted byAustralia when introducing a CGT.

c. We prefer the first approach which results in an effective date where all assets are broughtwithin the scope of the CGT. No specific “grandparenting” provisions are required whichhave been a source of complexity in the Australian system.

d. While this approach could lead to a flurry of activity before the effective date (as taxpayerstry to offload capital assets to avoid taxation), we believe this outcome is preferable to acomplex system of “grandparenting” provisions and an extended period where many capitalassets will remain outside the scope of the CGT. We understand the practical issues withthis approach.

Asset-based taxes

Capital income taxation alone doesn’t tacklewealth inequality. It is also necessary toconsider asset-based taxes.

There are two main forms of asset-based taxes:wealth taxes and land taxes, with land taxesbeing a subset of wealth taxes. These taxes areconsidered further below.

Wealth taxes

Globally, net wealth taxes have becomeunfashionable in practice. In 1990, 12 OECDcountries levied net wealth taxes159. In 2017,only France, Norway, Spain and Switzerlandimposed them (with Iceland having reinstatedits wealth tax as a temporary fiscal measure).

159 OECD (2018), The Role and Design of Net Wealth Taxes in the OECD, OECD Tax Policy Studies, No. 26, OECDPublishing, Paris, http://dx.doi.org/10.1787/9789264290303-en (as at 26 April 2018).160 See http://www.ey.com/gl/en/services/people-advisory-services/hc-alert--france-publishes-2018-finance-bill (asat 26 April 2018).161 OECD (2018), The Role and Design of Net Wealth Taxes in the OECD, OECD Tax Policy Studies, No. 26, OECDPublishing, Paris, http://dx.doi.org/10.1787/9789264290303-en (as at 26 April 2018).

As of January 2018, France has replaced itsnet wealth tax with a “real estate wealth tax”on high value immovable property160.

Nevertheless, the perceptions of high levels ofwealth concentration have spurred a renewedinterest in the redistributive potential of wealthtaxes161.

Wealth taxes in practice

Wealth taxes can take many forms and overlapwith other taxes to the extent to which thoseother taxes are also imposed on wealth asopposed to flows of income or expenditure.

An accrued CGT is an example of a wealth tax,being a tax on appreciation. Land taxes are

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effectively a wealth tax restricted to stocks ofland.

Our comments here centre around wealth taxin the form of an annual tax on net worth. Inprinciple, a wealth tax would apply to the netvalue of all assets held by an individual –shares, houses, pension funds, beneficialinterests in trusts, chattels etc. The Group’sTerms of Reference narrow the scope of anypotential wealth tax by excluding changeswhich would apply to the family home162.

Advantages of wealth taxes

Potential benefits of an annual tax on net worthinclude:

► Wealth taxes contribute to horizontal andvertical equity, or fairness.

► Wealth taxes contribute to horizontalequity as they are indifferent to theform in which wealth is held.

► In terms of vertical equity, wealth isfar more concentrated than income –wealth taxes would therefore bestrongly progressive, more so thanany plausible personal income taxscale.

► Wealth taxes promote efficiency.

► Given the tax is based on assets held,active income generating use ofthose assets is encouraged, includingpotentially disposal to a moreproductive user.

► Administering the wealth tax alsopromotes coherence within the tax system.

► The data required by Inland Revenueto assess the tax should prove usefulin administering other parts of thetax system.

► Wealth taxes can encourage a substitutionfrom physical to human capital (assuminghuman capital will be exempt).

► As human capital is important forlong-term growth, the actual harm of

162 Terms of Reference: Tax Working Group(November 2017),https://taxworkinggroup.govt.nz/resources/terms-reference-tax-working-group (as at 20 April 2018).

wealth taxes to economic growthmay be overstated.

► Where asset values are updatedfrequently, a net wealth tax effectivelyfunctions as a tax on accruals, avoiding the“lock-in effect” promoted by taxation onrealisation.

Disadvantages of wealth taxes

Various counter arguments exist:

► New Zealand would become a lessattractive place for non-residents toallocate capital.

► Revenue raising potential may be limited.

► Owner-occupied housing accountsfor about 30% of a household’s totalassets163. If the Government decidesto introduce a land tax (effectively awealth tax on a subset of wealth),and if the family home is exemptfrom any wealth tax, the revenue onoffer could be limited.

► Capital is increasingly mobile.

► Individuals could seek to shift assetsoutside the scope of IRD’s ability tolocate them. While tax transparencyis increasing, it remains possible thatindividuals may seek to hide manyforms of wealth – whether in theform of cryptocurrencies, preciousmetals or gemstones, or behinddiscretionary trusts.

► Valuation may be difficult.

► For those assets which are disclosed,beyond land and listed investment,valuation would be at best inexact.

► As discussed above, New Zealand is oftenregarded as having a savings problem.Any meaningful wealth tax would includeKiwiSaver and other forms ofsuperannuation – would such a reform bedesirable or sustainable?

163 Statistics New Zealand household net worthstatistics for year ended 30 June 2015. See alsohttp://archive.stats.govt.nz/browse_for_stats/people_and_communities/Households/HouseholdNetWorthStatistics_HOTPYeJun15.aspx (as at 20 April 2018).

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► Asset allocation issues may arise. Forexample, if residential property is exempt,that would seem to exacerbate anyperceived bias towards investing inhousing.

► Individuals with high value assets but lowrealised income may encounter cash flowissues when paying the tax.

► Individuals who save more while young toconsume while older will pay more taxcompared to those who spread theirincome more equally over their lifetimes,resulting in horizontal inequity.

While a potential wealth tax may be worthfurther investigation as part of a review of NewZealand’s system for taxing capital income, thedisadvantages outlined above may mean awealth tax could be impractical for NewZealand at the current time. In particular, awealth tax is likely to be hard to implement andcould send a negative signal to investors.

Land taxes

“When applied uniformly across a broad base,land tax is one of the most efficient means ofraising revenue.”164

Land taxes are essentially a subset of wealthtaxes. As with wealth taxes, on balance landtaxes promote efficiency – they are likely toincrease the efficiency with which land is used.Of the different forms of wealth, land is well-suited to a tax – the stock is fixed and the taxnon-distortionary.

Expanding these arguments:

► Land tax has the ability to collectsustainable and substantial amounts oftaxation using a low rate, provided thereare few exemptions (like in Denmark whichcollects 1.3% of GDP per year from landtax165).

164 Australia’s Future Tax System: Final Report: Part1 – Overview – Chapter 6: Land and resource taxes(released in May 2010),http://taxreview.treasury.gov.au/content/FinalReport.aspx?doc=html/publications/papers/Final_Report_Part_1/chapter_6.htm (as at 26 April 2018).165 Morgan Foundation, Alex Staples and GeoffSimmons, Taxing Wealth & Property: What Works? Areview of wealth and property taxation around theworld (April 2016),http://morganfoundation.org.nz/wp-

► Revenue can be used to fund other tax ratereductions while using a low broad rate oftaxation.

► A land tax will improve the equity andfairness of the current system as property,an investment, will be taxed as otherinvestments are.

► Administration is unlikely to be complex -based on the ability of local councils to levy“rates” based on land or property values –and the costs of administering a land taxare likely to be low in proportion torevenue raised166.

Implementation will be challenging

Should a land tax be introduced, there areconcerns which would need to be resolved priorto introduction. When considering thedesirability of a land tax, the Group shouldfocus on how to mitigate the following issues:

► The reaction to past land tax proposals hastended to focus on the ability to pay forindividuals and businesses that may beasset rich but cash poor. This impactwould most likely be on retirees, Māoriauthorities and farmers.

► In relation to cash poor farmers, theobligation to pay land tax could reduce thepurchase of fertiliser and/or reduce orprevent money being put towards otherproductive investments. In effect, thepromoted efficiency gains may go intoreverse for cash-constrained farmers.

► A land tax might not be politicallysustainable and could be vulnerable torepeal. Concerns around the politicalsustainability of a land tax were raised bythe Victoria University of Wellington TaxWorking Group in 2010167.

content/uploads/2016/04/MF_WealthTaxation_Report.pdf?bcsi_scan_01d939382f6c0b14=0&bcsi_scan_filename=MF_WealthTaxation_Report.pdf (as at 26April 2018).166 Most of these, and other points in this note, weremade by the Victoria University of Wellington TaxWorking Group or the Morgan Foundation.167 A Tax System for New Zealand’s Future: Report ofthe Victoria University of Wellington Tax WorkingGroup (January 2010).

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► Even if a land tax is not repealed, pressureis likely to build for exemptions which havehistorically tended to undermine loopholes.Which exemptions are justified?

► It is possible that uncertainty around thelongevity and scope of any potential landtax could result in unstable land prices anda reduction in efficiency. A land tax couldcause investment decisions to be madebased on uncertainty around future ratesof return as opposed to current rates ofreturn.

► Land tax is likely to depress land values.By how much? What impact will that haveon existing finance secured over land?

► It is possible that depressed land valuescould delay land development. Cash thatcould have been used for landdevelopment may need to be used todecrease debt levels and smooth equityvalues.

► Given the likelihood of exemptions, landtax burdens tend to fall on the middleclass, as exemptions exclude the poor andthe wealthy find loopholes to exploit.

► The introduction of a land tax will putpressure on the accuracy of landvaluations.

Revenue raising potential

The Group’s Terms of Reference exclude theland under the family home from the ambit ofany land tax168.

While we are not aware of any recent estimatesof the total value of New Zealand land, aconservative estimate could be around $500billion in total, of which perhaps $200 billion isresidential owner-occupied land169.

A 1% per annum land tax, before exclusionsbeyond the family home, could potentially raise$3 billion per annum. Assuming the land taxwould be a deductible expense for income taxpurposes, perhaps $2 billion would be realistic.This revenue could be recycled into a range ofenhancements to other parts of the tax system

168 Terms of Reference: Tax Working Group(November 2017),https://taxworkinggroup.govt.nz/resources/terms-reference-tax-working-group (as at 20 April 2018).

and/or go towards managing the impact of thetax on selected individuals.

Possible measures to reduce impact

Cash flow issues could be managed by way ofdeferral for selected taxpayers until theproperty is sold (for example, retirees or Māoriland). Use-of-money interest could be chargedon the deferred amount, perhaps at rateslinked to inflation rather than at the standardIRD rate.

Māori land is typically held in perpetuity sodeferral could in substance become permanent.Taonga/heritage land assets will particularlyneed consideration. Furthermore, much of theland held by Māori organisations may either beundeveloped or employed in low yieldindustries (e.g. forestry).

Rates could be varied based on the class ofland. For example, farmland or Māori landcould attract a differential rate of tax. Lowvalue land could potentially be excludedentirely to manage equity concerns.

Given the fixed nature of land supply, it wouldbe possible to vary land tax rates by regionshould this be seen as desirable for regionaldevelopment or other purposes.

169 Land tax: Background Paper for Session 3 of theVictoria University of Wellington Tax Working Group,drawing on Fiscal Distribution and Efficiency Impactsof Land and Property Taxes, Coleman Andrew andArthur Grimes (2009).

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Chapter 6

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”The fact is, in New Zealand, the richest 10% of households spendtwice as much on food and six times more on clothing than thebottom 10%. So they pay twice as much GST on food and six timesmore GST on clothing. Only 15% of the benefit from an exemptionon food in New Zealand would have gone to the bottom 20% ofhouseholds by income.”170

Snapshot

The GST system is an exemplary revenue raiser. NewZealand captures 97% of GST’s potential revenue. TheOECD average is 56%.

Taken in isolation, GST is mildly regressive, but GST isnot paid in isolation. It forms part of a tax system whichis progressive in overall terms.

Recommendations

1. Maintain existing GST base as the case for selective zero rating or lower rating is weak.

2. Address any distributional concerns through other parts of the tax system.

Of all the VAT/GST systems in the OECD NewZealand has the second most efficient model interms of potential revenue captured (behindLuxembourg)171. In the 2016 OECD report onconsumption tax trends New Zealand captured97% of GST’s potential revenue172 – significantlyabove the next closest country Switzerland(71%) and the OECD average (56%)173. In 2017the Government collected around 20% of its

170 Douglas, Sir Roger (2007), The New Zealand GST Policy Choice and its Political Implications, GST in Retrospectand Prospect, Thomson Brookers.171 OECD (2016), Consumption Tax Trends 2016: VAT/GST and excise rates, trends and policy issues, OECDPublishing, Paris. 106.172 At 105173 At 105174 New Zealand Treasury (2017), Financial Statements of the Government of New Zealand for the year ended 30June 2017,New Zealand Treasury, Wellington. 7.

total revenue from GST174, despite the GST ratebeing significantly lower than income tax rates.

An efficient and comprehensive tax

This efficiency comes from our long-standingpolicy of having a comprehensive rate of GSTon all goods and services, with very fewexceptions. New Zealand’s GST system is themost functional element of our overall tax

6. GST is New Zealand’s most effective tax

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system, altering the scheme with newexceptions should be approached with caution.

Weak case for GST exemptions on particulargoods or services

GST is a great tool for revenue-gathering butnot for redistributing wealth. Because GST isapplied on all goods and services equally thereis no variation in tax burden depending onincome levels. This has led to suggestions oflowering GST on specific goods and services togive GST a more progressive nature.

One of the more popular subjects for GSTreduction is fresh fruit and vegetables. Theinefficiencies of lowering GST can bedemonstrated through this example:

► Limited benefit to low income consumers:high income earners will typically purchasemore fruit and vegetables than lowerincome earners. This will in fact be thecase for virtually all goods and services. Assuch, while the price of a given vegetablewill decrease uniformly, those with higherincomes will see the greatest benefit interms of money saved.

► Alternative mechanisms would be bettertargeted: it is also argued the policyincentivises lower income earners topurchase more fruits and vegetables as aresult of lower prices. The issue here isone of poor targeting. More effective reliefcould be provided to lower earners byadjusting income support.

► Inefficient administration and scopecreep: from a retailer perspective,additional difficulty compounds the issueof efficiency. Once an exemption has beengranted for “fruit and vegetables” it is inthe interests of a retailer to classify asmany goods as “fruit” or “vegetables” aspossible. While something like a bag ofpotatoes is obviously covered, we can startplacing goods along a spectrum of“vegetable”. Does a bag of frozen potatowedges count? Should potato fries at fastfood restaurants be exempt? There issignificant scope to apply exemption togoods that perhaps should not be

175 Dimitris Chronopoulos (2016), Future Issues inBank Taxation, University of St Andrews, Fife. 14.

captured; and the cost of regulating this islikely to be high.

The GST and financial services conundrum

The main GST exemption is the provision offinancial services. Banks make money throughinterest rate spreads. Having higher interestrates on money lent than interest paid fromdeposits.

For example a bank may lend $100 with aninterest rate of 6%. The loan would yield $6.The bank may also offer 1% on deposits, so if anaccount holder deposited $100, the bank wouldpay $1. The bank’s net interest is $5, thoughGST cannot currently be applied to thatearning. The issue is that there is no explicittransaction that has granted that $5; it is theresult of two other transactions that in realterms are completely disconnected.

In theory, it should be possible to overcome thisdifficulty, but in practice we have yet to seegood outcomes. For example:

► Unbundling: some financial institutionshave sophisticated activity based costingsystems and funds transfer pricingsystems which could be developed infuture to calculate the value added on eachtransaction. Widespread implementationof these systems is not currentlycommonplace however, and attempting toforce compliance at present is likely toyield low tax revenue. Research into asimilar system in the US reported a yield ofonly 0.4% more revenue to the IRS175.Where the US has a much higherproportion of financial services as part ofits GDP.

► Proxy taxes: for example, the IMF floateda Financial Activities Tax in 2010176. Thetax would proxy GST by taxing the sum ofcash-flow profit and remuneration for eachtax period. The effect being that a tax isapplied to the net financial intake of thefinancial institution, representing theservice they provide. Such a tax wouldrequire detailed information about thebank in question, some of which is unlikelyto be available. To apply the tax anelement of estimation or speculation would

176 European Commission (2010), Financial sectortaxation, Taxation papers, Office for OfficialPublications of the European Communities,Luxembourg. 14.

Future of TaxEY’s submission to the Tax Working Group EY ÷ 64

be needed. Because of the difficulty increating a fair system in thosecircumstances we believe that a FinancialActivities Tax is difficult to justify atpresent.

GST as part of a wider progressive tax system

At any given point in time, GST is regressive asindividuals who consume a higher proportion oftheir income are taxed proportionately more asa fraction of that income.

Taking a lifetime basis, the picture changes.Most savings are eventually converted intospending on goods and services. A regressiveelement remains in that unspent income is nottaxed on death.

But GST does not exist inside a vacuum, and isbetter considered as part of the wider taxsystem. The combination of our GST, incometax and transfer system is redistributive, andthe extent of that redistribution is bettermanaged through its non-GST elements.

Moving away from the current broad GST basecomes with significant concerns for efficiencyand equity. We recommend it is in NewZealand’s best interests to maintain the currentsystem.

GST and managed funds and link to retirementsavings

Under this heading of GST, we also wish to addour support to the submissions made by othersabout the GST treatment of fees charged tomanaged funds and the flow-on link toretirement savings. As we have noted above,New Zealand has a private savings problemwhich will not be helped by investors suffering alayer of non-recoverable GST on fees chargedto managed funds either directly or indirectly.

Future of TaxEY’s submission to the Tax Working Group EY ÷ 65

Chapter 7

Future of TaxEY’s submission to the Tax Working Group EY ÷ 66

“No man is an Iland, intire of itselfe; every man is a peece of theContinent, a part of the maine”177

Snapshot

For the last 25 years, the Generic Tax Policy Process has– mostly - delivered policies which meet governmentobjectives. But governments today need access to awider, and faster, set of advice.

It is time to reform GTPP.

Recommendations

1. Retain GTPP, but encourage earlier, less formalised, consultation beyond a narrow group of taxprofessionals.

2. Establish a board of taxation, under the direction of the Minister of Finance and/or Minister ofRevenue with a mandate to:

a. Review draft legislation prior to its introduction to Parliament to ensure workability andtechnical accuracy,

b. Carry out post-implementation reviews of tax policy, encompassing both operations andlegislation,

c. Recommend remedial changes to tax law,

d. Assist in facilitating wider consultation on topical issues, and

e. Carry out other enquiries as requested by the Government.

3. Appoint members to the board of taxation on a rotating basis, drawing on a range of skills andperspectives including business, Māori, academic, civil society and tax professionals.

4. Create a Taxation Select Committee to ensure more in-depth Parliamentary scrutiny of tax policyand operational matters.

177 John Donne, Devotions Upon Emergent Occasions (1624)

7. Tax reform process improvementsrequired

Future of TaxEY’s submission to the Tax Working Group EY ÷ 67

A good tax system must be sustainable, withthe ability to reform and evolve over time.

The Generic Tax Policy Process has fallenshort of its potential

The Generic Tax Policy Process(GTPP) has served New Zealandwell. It has three main objectives:

► To encourage early, explicitconsideration of key policyelements and trade-offs,

► To provide an opportunityfor substantial external inputinto the policy formationprocess, and

► To clarify the responsibilitiesand accountabilities ofparticipants in theprocess.178

In substance, GTPP has tended totake the form of the Governmentproposing change through someform of consultation document,considering written submissions,and legislating its final decisions.

Implementation and review of policy has been aparticular weakness: Parliament is not well-placed to oversee detailed, technical rules whilepost-implementation reviews have at best beena token rubber stamp, if they have in factoccurred at all.179

GTPP is no longer sustainable in its currentform

The world of tax has seen more transformationin the past five years than in the past 50; thenext five are likely to bring even more change.

Fatally, GTPP assumes it is possible for a smallgroup of (mainly IRD) officials to gathersufficient, high quality external views in thischanging world.

Small open economies, however, no longer haveautonomy on tax policy issues – no country isan island. Our agenda is driven from overseas(as with the BEPS and digital tax issues),through non-tax priorities (environmental

178 Sir Ivor Richardson, Report on the OrganisationalReview of the Inland Revenue Department (1994)179 Emerging problems with GTPP were detected asearly as the McLeod Review (2001) and reaffirmedby the Victoria University of Wellington Tax WorkingGroup (2010).

issues, housing) and forces outside the ambit oftax professionals (technology, populationageing).

Forces impacting on New Zealand tax policy

Even a well-run and well-resourced GTPP will beunable to respond to all of these forces. Itneeds institutional support.

Tax policy struggles to deliver efficientoutcomes

Voters will always be poorly informed on taxpolicy.180 Chances are, any given issue will beseen in isolation, with disconnected policydebates on the rise.181 Institutional reformswhich improve transparency and publicunderstanding can mitigate, but not eliminate,this problem.

There are also inherent biases in policymaking:

► Retention of the status quo - anygovernment policy creates a support groupwhich will argue in favour of its retention.That policy will be built into pricing andindustry eco-structures – so will be hard toeliminate if the government priorities

180 This will be so even for the Group,notwithstanding the innovative social mediatechniques adopted and the Group’s open approachto communications beyond the tax professionalaudience.181 Discussion around sugar taxes is a case in point.

Future of TaxEY’s submission to the Tax Working Group EY ÷ 68

change. R&D tax incentives and filmproduction incentives are two suchexamples. If New Zealand wishes to be aninnovative, creative country with a screenproduction industry, these two items willbe part of its toolkit.

► Official orthodoxy predominates – for atechnical subject such as taxation, theability to implement technical changes lieswith the executive, which in turn dependson IRD officials.

Unequal access - concentrated, organisedgroups have a disproportionate advantage inseeking policies from which they benefit, as thecosts will be spread across the entirepopulation, which will be unlikely to opposewhat may be a small or invisible impost.

Parliamentary scrutiny is weak

Parliament is not well placed to address thesebiases. It is unreasonable to expect the currentFinance and Expenditure Select Committee todevote scarce Parliamentary time to correctinglegislation, or to carrying out in-depth post-implementation reviews of policy.

The reality is that Parliament has neither thetime nor the skill nor the desire to undertakeany systematic or effective examination ofwhatever tax rules the government of the dayplaces before it for its approval.

A stronger Parliamentary consideration of taxissues would include a meaningful and informeddebate about taxation policy. Parliament needsto discuss the economic implications ofproposals and alternative policy choices. It ishard to see that fixing technical errors in draftlegislation is a good use of Select Committeetime.

One option would be to create a separateTaxation Select Committee giving membersmore exposure to tax issues and with greateraccess to specialist expertise.

A strong focus on supply of taxation statisticsto inform policy debate will assist

As outlined in this submission, tax policyrequires a complex interaction of globalcompetitiveness with policy drivers, applied to

182 http://www.afr.com/news/ato-tax-statistics-top-10pc-pay-45pc-of-net-tax-top-1pc-pay-17pc-20180427-h0zcn1

the actual facts of New Zealand incomes,wealth and tax payments.

As noted earlier, the natural behavioural desireof participants to seek their own agendas, thereare challenges if the population does not haveaccess to high quality tax statistics.

We observe for example that Australia has seenin recent months a strong debate aboutperceived inequality of income and tax“fairness” of payments but the top percentageor quintile bands of Australian taxpayers. Thedebate release by the Australian Taxation Officeof statistics demonstrating the significant taxpayments by the top income bands182 hasadded significant light onto the debate, but thedelay in that release has potentially distortedthe debate in the intervening period.

For this reason we highlight the need, in today’sknowledge economy, of timely, consistent andfrequent releases of key data about relevantdata relevant in the tax policy context.

We see that such data and statistics areimportant to retain public confidence andpolitical confidence in the appropriateness ofNew Zealand tax policies.

We suggest therefore a substantial focus on taxstatistical transparency and information, todrive the debate going forward.

A board of taxation could improve scrutiny

In 2000, Australia established a Board ofTaxation, charged with contributing a businessand broader community perspective toimproving the design of taxation laws and theiroperation. A comparable board for NewZealand could:

Through its membership, broaden the range ofskills and interests brought to bear on tax policyissues.

► Bring an enduring focus on tax reform togovernment.

► Review “exposure draft” or equivalentlegislation to ensure it works on a technicallevel: that is, the legislation deliversgovernment policy.

► Carry out post-implementation reviews of

Future of TaxEY’s submission to the Tax Working Group EY ÷ 69

tax policy, operations and legislation.

► Recommend remedial amendments to taxlaw within the framework of governmentpolicy.

Membership could appointed on a rotatingbasis, according to the needs of thegovernment of the day, to include business,Māori, academic, civil society and taxprofessional skills.

The appointment criteria used for Crown entityand State Owned Entity boards could prove auseful model to follow.

Future of TaxEY’s submission to the Tax Working Group EY ÷ 70

Chapter 8

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Chapter 1: Framework for a good tax system

Recommendation Revenue InclusiveGrowth

Equity LivingStandardsImpact183

1. Endorse and use established criteria to assesswhether the tax system is sustainable.

↔ ↔ ↔

2. Draw on the Living Standards Framework as apointer for future work, but not yet for policyrecommendations – it remains insufficientlydeveloped.

↔ ↔ ↔

3. Changes should first be assessed againstwhether they will damage our existing strongposition.

↔ ↔ ↔

Chapter 2: The future of work

Recommendation Revenue InclusiveGrowth

Equity LivingStandardsImpact

1. Tax reforms should allow for flexibility inworking arrangements.

↔ ↗ ↗ S H

2. One option would be to create a class of“dependent contractors”; those who have acontractor relationship, but are effectivelyunder a high degree of control.

↔ ↗ ↗ S H

3. Simplify the tax obligations for dependentcontractors, potentially by restrictingdeductions.

↗ ↗ ↗ S H

4. Develop smart withholding techniques toreplicate income tax for dependent contractors(and potentially contractors in general).

↗ ↗ ↗ S H

5. Apply “dependent contractor” status in astandardised way across all employment laws.

↔ ↗ ↗ S H

6. Use technology, such as Blockchain, tostrengthen integrity of tax administration forindividuals.

↗ ↗ ↗ S H

1. 183 References are to the Four Capitals in the Living Standards Framework – Financial/Physical (F/P),Human (H), Natural (N) and Social (S).

8. Summary of our recommendations andtheir potential benefits

Future of TaxEY’s submission to the Tax Working Group EY ÷ 72

Chapter 3: Taxes and productivity

Recommendation Revenue InclusiveGrowth

Equity LivingStandardsImpact

1. Consider reforms to the corporate tax system toenhance productivity.

↔ ↗ ↔ F/P H

2. To that end, further investigation of:

a. Targeted measures which may have a moresignificant impact on business investment,

↘ ↗ ↔ F/P

b. Bespoke rules for SMEs based on theintegration principle, and

↔ ↗ ↗ F/P

c. Whether design challenges associated withprogressive corporate tax rates for SMEscan be overcome.

↔ ↗ ↗ F/P

3. Consider rebalancing taxes towards immobilefactors such as land.

↔ ↗ ↗ F/P

4. Where possible, tax at the corporate levelshould be fully integrated with tax at theownership level:

↔ ↗ ↗ F/P

a. For smaller businesses, seek to achieve fullintegration.

↔ ↗ ↗ F/P

b. For larger businesses, imputation remainsthe best approximation of integration.

↔ ↔ ↔

c. Extend Māori authority regime to includewholly owned subsidiaries.

↔ ↗ ↗ S F/P

5. New Zealand should respond to tax challengescaused by digitalisation of the economy:

a. Investigate nexus, profit allocation rulesand place of consumption for digitalbusinesses.

↔ ↔ ↔

b. Monitor digital services tax developments,for example, current EU proposals.

↔ ↔ ↔

6. Radical reform to New Zealand’s corporate taxbase or taxation of SMEs is currently notrequired.

↔ ↔ ↔

Note these recommendations are finely balanced, as:

1. Economic literature provides sufficiently strong advice on a general direction of reform, but not onthe size or enduring growth effect.

2. Studies are not based on New Zealand data so take little or no account of imputation.

3. Other policy priorities, such as coherence or ease of administration may outweigh the productivitybenefits of corporate tax reform.

4. Both economic theory and country practice will develop in the next decade - other countries mayovercome the practical and theoretical challenges of radical reform. In that case, New Zealandshould consider becoming a fast follow of other productivity enhancing reforms.

Future of TaxEY’s submission to the Tax Working Group EY ÷ 73

Chapter 4: Opportunities for effective environmental taxation

Recommendation Revenue InclusiveGrowth

Equity LivingStandardsImpact

1. Tax should be part of the Government’s toolkitfor dealing with environmental issues.

↗ ↔ ↘ N S

2. The Group should agree good principles forenvironmental taxation including:

a. An initial presumption against theintroduction of selective taxes temperedby the understanding that theGovernment’s international commitment totake transformative action on climatechange is compelling.

↔ ↔ ↔ N

b. Environmental tax bases should betargeted to the pollutant or pollutingbehaviour.

↔ ↔ ↔↘ N S

c. The scope of an environmental tax shouldmatch the scope of the environmentaldamage.

↔ ↗ ↘ N S

d. The tax rate should be commensurate withthe environmental damage.

↔ ↗ ↘ N S

e. The tax must be credible and its ratepredictable

↔ ↗ ↘ N S

f. Distributional concerns should beaddressed through other policyinstruments.

↔ ↔ ↗ N S

3. There is a prima facie case for furtherinvestigation of:

a. Including agriculture within the NZ ETS orany future carbon tax. We believe there isa case for bringing agriculture within theNZ ETS sooner rather than later.

↗ ↗ ↘ N S

b. Pricing roading taxes taking into accountenvironmental factors as well as transportneeds.

↗ ↗ ↘ N S

c. Broadening roading taxes from ad valoremto include an element of congestioncharging.

↗ ↗ ↘ S N

d. A resource rent tax or royalty on theexploitation of natural resources notcurrently subject to royalties, such aswater.

↗ ↗ ↗ N S

e. Considering how the Group’s preferredprinciples for environmental taxation applyto water quality and usage.

↗ ↗ ↗ N S

Future of TaxEY’s submission to the Tax Working Group EY ÷ 74

Chapter 5: Capital taxationRecommendation Revenue Inclusive

GrowthEquity Living

StandardsImpact

1. There is a case at the margin for tilting thebalance of capital taxation from flows – such asinterest and dividends – towards stocks – such asland and other stores of wealth.

↔ ↔ ↗ S

2. The impact of the tax system on income andwealth needs to be considered on a holistic basis:

a. Reconsider the current TTE approachtowards taxing private savings.

↘ ↗ ↗ F/P S

b. Move towards taxing real rather thannominal gains.

↘ ↗ ↔ F/P

c. Investigate the possibilities of wealth taxesand land taxes (noting their potentialsubstitutability and overlap).

↗ ↗ ↗ F/P S

3. If the Government has concerns regardingresidential investment property, considerreforms targeted to the specific problem.

↗ ↗ ↗ S F/P

4. If the Government has concerns regarding allforms of capital investment, consider a broad-based CGT.

↗ ↗ ↗ S

5. When designing a CGT:

a. The best theoretical design would be wide-ranging, on a broad asset base, with anelement of accrual taxation. Given theexclusion of the family home and thefamiliar difficulties with accrual taxation,we are into a “second best” world.

↗ ↗ ↗ S

b. Ideally, tax should be imposed on realrather than nominal gains.

↘ ↗ ↗ F/P

6. We accept that a realisation-based CGT is a muchmore likely outcome. Design of such a taxshould be based on:

f. Minimising the number of realisation events ↔ ↔ ↔

g. Approximating real gains, for example, byway of taper relief

↘ ↗ ↗

h. Ring-fencing capital losses ↗ ↔ ↔

i. Taxing gains from a valuation day ↔ ↔ ↔

j. Minimising exemptions and reliefs ↗ ↔ ↘

7. We retain doubts regarding a separate CGT giventhe family home is to be excluded.

Future of TaxEY’s submission to the Tax Working Group EY ÷ 75

Chapter 6: GST is New Zealand’s most effective taxRecommendation Revenue Inclusive

GrowthEquity Living

StandardsImpact

1. Maintain existing GST base as the case forselective zero rating or lower rating is weak.

↔ ↗ ↔ S

2. Address any distributional concerns throughother parts of the tax system.

↔ ↗ ↗ S

Chapter 7: Tax reform process improvements requiredRecommendation Revenue Inclusive

GrowthEquity Living

StandardsImpact

1. Retain GTPP, but encourage earlier, lessformalised, consultation beyond a narrow groupof tax professionals.

↔ ↔ ↔ S

2. Establish a board of taxation, under the directionof the Minister of Finance and/or Minister ofRevenue with a mandate to:

↔ ↔ ↔ S

a. Review draft legislation prior to itsintroduction to Parliament to ensureworkability and technical accuracy,

↔ ↔ ↔ S

b. Carry out post-implementation reviews oftax policy, encompassing both operationsand legislation,

↔ ↔ ↔ S

c. Recommend remedial changes to tax law, ↔ ↔ ↔ S

d. Assist in facilitating wider consultation ontopical issues, and

↔ ↔ ↔ S

e. Carry out other enquiries as requested bythe Government.

↔ ↔ ↔ S

3. Appoint members to the board of taxation on arotating basis, drawing on a range of skills andperspectives including business, Māori,academic, civil society and tax professionals.

↔ ↔ ↔ S

4. Create a Taxation Select Committee to ensuremore in-depth Parliamentary scrutiny of taxpolicy and operational matters.

↔ ↔ ↔ S

Future of TaxEY’s submission to the Tax Working Group EY ÷ 76

Chapter 9

Future of TaxEY’s submission to the Tax Working Group EY ÷ 77

ACE Allowance for Corporate Equity

BBLR Broad-base low-rate

BEPS Base erosion and profit shifting

CBD Central Business District

CBIT Comprehensive Business Income Tax

CFT Cash Flow Tax

CGT Capital gains tax

EET Exempt-Exempt-Taxed

EU European Union

FBT Fringe benefit tax

GDP Gross domestic product

Group Tax Working Group

GST Goods and services tax

GTPP Generic tax policy process

IFA International Fiscal Association

IMF International Monetary Fund

IP Intellectual property assets

IRD Inland Revenue

IRS United States Internal Revenue Service

ITA 2007 Income Tax Act 2007

METR Marginal Effective Tax Rate

MIT Managed Investment Trust (Australia)

NCI Normal Corporate Income (Singapore)

NZ ETS New Zealand’s Emission Trading Scheme

NZTA New Zealand Transport Agency

OECD Organisation for Economic Co-operation andDevelopment

PAYE Pay-as-you-earn

Paper Background Paper of the Tax Working Group

Paris Agreement Paris Climate Change Agreement

PIE Portfolio investment entity

PPP Public private partnership

PSGEs Post-settlement governance entities

9. Glossary

Future of TaxEY’s submission to the Tax Working Group EY ÷ 78

R&D Research and development

RFRM Risk free return method

RWT Resident withholding tax

SGX Singapore Exchange Limited

SME Small and medium-sized enterprise

SOE Small-Open Economy

S&P Standards and Poor’s

TTE Taxed Taxed Exempt

UK United Kingdom

US United States

VAT Value added tax

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