Address to Centre for Accounting, Governance and Taxation Research and Institute for the Study of Competition and Regulation

  • Peter Dunne
Revenue

Address to Centre for Accounting, Governance and Taxation Research and Institute for the Study of Competition and Regulation
Tax Policy Conference

‘New Zealand Tax Reform - Where to Next?’

Victoria University, Rutherford House, Lambton Quay, Wellington

Introduction

Thank you for this opportunity to share some thoughts with you on New Zealand’s tax system: where we are right now and where we aim to be in the medium-term. Right now, we are all in the same economic boat, heaving and rolling on increasingly unfriendly seas. 

The current economic storm means governments throughout the world are faced with greater pressures than ever to preserve their revenue base, while balancing the needs and expectations of households, businesses and financial institutions. 

As part of their various responses to the world economic crisis, governments are examining the effectiveness of their tax systems and prioritising tax reforms in the context of global synergies as well as domestic performance.

As New Zealand’s Revenue Minister, I am acutely aware of the need to ensure that our tax system is resilient enough to weather the current economic storm and our revenue base continues to finance Government’s spending on essential services at levels New Zealanders have come to expect.

While I recognise that the risks inherent in the current crisis will, of necessity, monopolise the attention of economic policy makers, it is nonetheless important that we do not lose sight of the critical role the tax system has to play in the ultimate recovery. 

New Zealanders expect our tax system to do many things – from raising the revenue needed to keep schools and hospitals open; to reducing income disparities and social inequalities; making it easier for people to enter the workforce, and for businesses to keep operating.
Our tax system has also been called upon to encourage people to make feature films in New Zealand; retain top quality sports people in this country and to influence various forms of social behaviour.

People want the taxman to stay out of their lives, while doing all these things, and keeping tax rates as low as possible.

So, against that background, it is never too soon to talk about what tax structure would best serve New Zealand’s interests over the longer term.

While our focus is understandably on the immediate crisis the world is facing, when looking at tax measures to enhance the recovery, it is important that we avoid measures that are at odds with our medium-term goals for the tax system. 

Now is not the time for knee-jerk responses to the difficulties we face with the current global crisis, and any changes should be consistent with our longer-term vision.

I welcome this conference, which is focused on important medium-term structural aspects of tax system design. 

Your research and international experience will undoubtedly help inform the debate within New Zealand.

Today I will talk about some of the medium-term challenges and directions I see for the New Zealand tax system – not so much in terms of the current world economic crisis, but as a means of strengthening our tax infrastructures for the longer term – a goal that must always be at the heart of our policy development.

Given the large number of international guests we have here today, I will begin by quickly sketching a picture of New Zealand’s current tax system – one I would describe as having good strong bones, but which can benefit from some attention to raising its fitness levels to make it more resilient and competitive for the future.

Current Tax Framework

It is generally accepted that New Zealand’s tax system has many solid features. 

This was confirmed by the World Bank Group’s 2008 report on the tax regulations of OECD economies, which rated New Zealand second in terms of transparency and ease in paying taxes.

Our taxes are collected over broad tax bases, at moderate rates. 

Revenue for New Zealand’s education, health services, security and social services comes mainly from income tax, which provides more than 70 percent of the total tax revenue. 

GST, New Zealand’s consumption tax, accounts for nearly 20 percent of the Government’s revenue, with the remainder coming from other taxes such as customs duty, road user charges, and various levies. 

Overall, this broad-base, low-rate tax system has served us well. 

Our GST base has been universally admired for its simplicity and comprehensive application, while revenue growth has been strong. 

Taxpayers generally perceive the tax system to be fair and transparent, and the administration cost per $100 of revenue raised is modest by international standards.  It costs 75 cents to raise $100 of revenue in NZ, compared with Australia's 93 cents and Canada's $1.22. 

There are occasional calls to exempt this item or that – food in particular – from the GST system, but successive governments have wisely and accurately declined to do so.

The recent British case of Marks & Spencers’ 13 year battle to prove its chocolate teacake was a cake not a biscuit and that the company has been overcharged ₤3.5 million in VAT since 1973 is a timely reminder of the flaws inherent in applying a consumption tax on some items but not others, and at different rates, which our universal application flat 12.5% rate avoids.

Importantly – and especially so for New Zealand, where 96 percent of businesses have fewer than 20 employees – our tax system has relatively low compliance costs.

We have already started our review of the best approach for New Zealand’s tax system over the medium-term. 

In the past few years, we have undertaken a review of our business tax framework to remove obstacles to growth, productivity and investment.

We have streamlined payment processes for businesses and encouraged greater voluntary compliance by reviewing our penalty rules, and generally focused on ways to make it easier for businesses to comply with their tax obligations.

A country’s tax policy can no longer be set in isolation from international developments, if it really ever could. 

Globalised financial and investment markets have made domestic tax settings increasingly important in determining patterns of investment. 

International tax arrangements, allocation of debt and equity, and transfer pricing have become more important in determining the ability of the tax system to deliver the revenues needed to fund government programmes.

Recognising these developments, the Government has recently reduced the company tax rate in New Zealand from 33 to 30 percent.

For businesses with international interests, we are undertaking a comprehensive review of our international tax rules to improve their competitiveness and bring them more into line with the rules of our main competitors. 

For investors, we have reformed the taxation of managed funds and offshore portfolio share investments with the PIE and FDR rules, bringing greater consistency and certainty to the taxation of New Zealanders’ savings.

These changes were made at the same time as we introduced KiwiSaver, our voluntary national savings scheme, which in less than two years has already attracted over 900,000 members. 

All these changes were crucial to the goal of fostering a savings culture in New Zealand.

And to encourage individual productivity and participation in the workforce and attract skilled workers back to New Zealand, we have introduced a progressive reduction in the personal income tax rates which will result in a top personal tax rate of 37% by 1 April next year.

Overall, our approach has been to develop a tax system that raises taxes efficiently and fairly, is easy for individuals and businesses to comply with, and which is internationally competitive. 

Current Pressures

On the whole, I think we have been pretty successful in developing a tax system that meets New Zealand’s needs across the social and economic spectrum.

However, I think it is also fair to say that we have some emerging challenges that need to be met.

The first is the continued pressure that globalisation exerts on countries to lower their company tax rates to maintain competitiveness. 

Maintaining a robust company tax system is a particular concern for New Zealand because we are unusually reliant on company tax, and because of our high level of trans-Tasman investment.

Add to this the current global recessionary environment, and it is clear how important it is for our tax policies to support international investment in New Zealand and our business relationships in the international marketplace.

Despite the recent reduction in the company tax rate from 33% to 30%, our rate remains higher than many OECD countries. 

This creates an incentive for New Zealand-based multi-national companies to stream their profits away from New Zealand, which in turn creates pressure to lower the company tax rate.

The high level of trans-Tasman investment I referred to earlier was the reason why the Government reduced the rate to 30%, to enable New Zealand businesses to remain tax competitive with Australia.

The challenge we face, of course, is how we deal with further company tax reductions in Australia.

I note with interest comments in the papers for this conference that higher company tax rates can have particularly negative effects and I look forward to reading the reports on your discussions in this area. 

Our other main policy challenge arises from the difference between New Zealand’s top personal tax rate, the rate for trusts, and the new company tax rate.

A company tax rate that is less than the higher rates of personal income tax creates opportunities for people to use company tax structures to shelter their incomes from personal tax.

There is convincing evidence that taxpayers are exploiting this variance to reduce their income tax, thereby undermining the policy intention and integrity of the tax system.

Clearly, we have work to do to resolve these challenges and restore equilibrium to our tax system.

The 30/30/30 Approach

In my view, the introduction of a flat 30/30/30 approach to tax rates, based on the simple principle of a 30 % rate for company tax, 30% for personal tax and 30% for trustees would be a step in the right direction. 

This would mean reducing the top personal tax rate and the trustee tax rate to the level of the new 30% company tax rate.

I have long advocated in both this and the former Government this flatter alignment of tax rates as a simple solution to deal with problems that arise as a result of the differences in these tax rates – such as companies and trusts being used to shelter personal income. 

And while the present Government has also indicated its support for this arrangement, current fiscal forecasts and the economic climate at this time make an immediate move to this alignment of rates difficult.

Nevertheless, the 30/30/30 approach remains the Government’s medium term stated objective.   

But, as we all well know, any changes to the tax system must be carefully weighed in the context of fiscal constraints and the current economic climate. 

In this matter, the December 2008 economic and fiscal forecasts have shown that the Government’s fiscal position has deteriorated significantly since the pre-election update in October.  

This weak outlook for our economy is likely to reduce income and profits, resulting in less tax revenue and likely increases in expenditure on social benefit payments as the Government moves to cushion people from the worst effects of the recession.

International trends

 

Against this background, and in our role as a partner in the world economy, our future responses to tax policy development must be approached in the context of what is happening elsewhere in the world, yet tempered by our own unique social and economic circumstances.

That includes the tax developments of Australia, as our closest economic partner, which under the Henry Review, is today embarking on a wide-ranging review of its tax policies. 

We will obviously keep a close watching brief on the Australian review, and the developments that come from it will be reviewed as part of our overall ongoing evaluation of New Zealand’s international tax rules.

As I mentioned earlier, one of the most significant tax policy developments in progress at this time is the reform of New Zealand’s international tax rules. 

Legislation currently before Parliament will give effect to the first phase of changes arising from a continuing review of our international tax rules – specifically, the way we tax the offshore income of our controlled foreign companies.

The central feature of this reform is the introduction of a tax exemption for active income resulting from the offshore operations of New Zealand-based businesses, a move aimed at making New Zealand a more competitive base for internationalised firms, and enabling New Zealand-based businesses to compete more effectively in foreign markets. 

Under the current system, offshore income of New Zealand-resident companies is taxed as it accrues, outside of a grey list of eight countries. 

Under proposals before our Parliament, New Zealand will move to provide an exemption for active business income to level the playing field for New Zealand businesses investing abroad.

I am expecting this legislation to be passed by Parliament by the middle of this year.

While developments overseas are clearly important to the decisions we make about moving our international tax reforms forward, the consultation process that is an inherent part of our tax policy-development process – and the specific character of New Zealand’s business environment – will determine the final shape of any changes to the tax system.

Take the issue of imputation, for example. 

We have raised some questions around the most efficient functioning of New Zealand’s imputation system during a government review of the system last year. 

While some countries have moved away from the use of imputation credits, we have found that overall, the system works well for New Zealand. 

Still, there are some technical matters that we are looking at to improve the function and integrity of the imputation credit system. 

In Closing…

The challenges I have raised with you today have been clearly identified by my officials in their briefing to the new Government. 

That briefing also indicated a number of other ways of looking at issues and proposed possible solutions. 

As I have said today, fundamental to any changes is the need to reduce complexity and make the tax system simpler and fairer for individuals and businesses. 

At the same time, it is important to maintain government revenues and provide an efficient framework for economic activity.

This has always been a difficult balancing act for governments and it is no easier in a world that is fast-changing and more complex than ever. 

At the same time, tax reform is more than just a mechanical process. Tax changes need to fit within the overall cultural norms of a society.

In New Zealand, that norm is best represented by a view that tax takes should be as low as possible, but should enable the government to carry out the traditional services expected of it, which is why suggestions of low flat taxes, balanced by more personal responsibility to finance health, education and superannuation requirements have never really been taken all that seriously here.

In a nutshell, our challenge is to find reasonable solutions to increasingly complex problems. And we will do it.

This conference provides a unique forum for such issues to be discussed in a frank and open manner among experienced tax academics and policy-makers from around the world. 

I have no doubt you will make the most of this opportunity for a meeting of minds, and that we will benefit from your thoughts, views and deliberations.

I wish you a productive series of sessions and look forward to hearing the results of those discussions in the near future.

Thank you.