Taxing capital income in New Zealand: an international perspective

Abstract

In the 1980s and 1990s New Zealand undertook a large number of tax reforms designed to improve the performance of the economy. Top marginal income-tax rates were reduced, a value-added tax (GST) was introduced, a system of imputation credits for dividend income was implemented, and the taxation of retirement savings was reformed. As a result of these reforms, New Zealand now a tax system that differs in many ways from the tax systems of other OECD countries. Even though there is no capital gains tax, it is characterised by relatively high taxes on business and capital income and low taxes on labour incomes. Part of the difference occurs because New Zealand has very low social security taxes, and because retirement savings are taxed differently in New Zealand than in most OECD countries. This paper provides a review of the ways that the taxation of capital income in New Zealand may be affecting the economy. It argues that the idiosyncrasies of New Zealand’s tax structure favour investments in urban real estate relative to investments in other productive assets, and that this may be hindering productivity growth. One part of the problem is a lack of a comprehensive capital gains tax, while another is relatively high taxes on business and capital income. The paper discusses some of the different possible reforms that the 2018 Tax Working Group has identified in its Interim Report. While supportive of a capital gains tax, it argues that aspects of the suggested reforms are inconsistent with standard international practice and may (i) further distort the tax advantaged position of owner-occupied property in the economy and (ii) raise effective tax rates on real capital income above statutory rates. Since New Zealand already has some of the highest taxes on capital income in the OECD, further increases in these taxes may adversely affect the accumulation of capital in the economy and make it difficult for New Zealanders to catch up with OECD productivity levels and incomes. Although New Zealand could introduce a capital gains tax without worsening the distortionary effects of the tax system on investment patterns by adopting the standard OECD method of taxing retirement savings, the Interim Report appears to rule this out. Part of the difficulty is that the terms of reference for the Tax Working Group limit its ability to design a tax system for the future by constraining it to adopt many features of the tax system designed in the past. In contrast, this paper supports general OECD recommendations that a country may wish to reduce taxes on business income. For this reason, in addition to introducing a capital gains taxes and reforming retirement income tax policy, a full discussion of the future of New Zealand’s tax system should seriously consider altering the balance between capital and labour taxes by reducing income taxes, increasing taxes on land, and increasing social security taxes. This would bring New Zealand in line with standard OECD practice, and closer to the highly progressive tax systems adopted by most Scandinavian countries.