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Brash: Opening of ICANZ Tax Conference

Don Brash MP
National Party Leader

06 October 2006

Opening address to the ICANZ Tax Conference

Christchurch Convention Centre

I’d like to talk about three areas of tax this morning - first about the recent Business Tax Review; then about the taxation of overseas share investments; and finally about National’s position on tax more generally.

1. Business Tax Review
As you all know, the Business Tax Review discussion document was released in July this year, after seven months deliberation by officials.

From the outset, it was hyped by the Ministers of Finance and Revenue as being a big and bold review, the bigness and boldness of which might frighten its readers.

When it arrived, however, the Review turned out to be anything but big and bold. In fact it was an embarrassingly lightweight document. It was like being promised a Lamborghini and getting a Lada!

It was certainly not a wide-ranging, comprehensive review, where everything is on the table, lots of alternatives are explored, and nothing is taken for granted.

The model for that sort of review is the 2001 Tax Review, which I have always admired. I note that the next item on the conference agenda is a discussion of the Business Tax Review by two of the authors of the 2001 Review - Ted Sieper and Rob McLeod - together with John Shewan. I am very much looking forward to what they have to say.

But while it was not a comprehensive review, neither was the Business Tax Review a narrow, more precise report which set out how much money was available to spend on business tax measures, what this necessarily constrained the options to, and what the Ministers’ preferences were - with a few limited but well-costed alternatives being presented.

What we got instead was an odd, purposeless sort of report. We still have no idea how much money the Government is prepared to spend on business tax. Only a few ideas were discussed and the report contains only scant costings. The options presented are embarrassingly under-described.

We in the National Party have been curious about why the Review turned out like it did, and have asked for all the background papers under the Official Information Act. Surprisingly, Peter Dunne says that it is not in the public interest for us to see these documents and we have been denied every single one of them. Make up your own minds about what that says.

What we do know from a recent speech by Michael Cullen is that, of the options presented in the Business Tax Review, the Government favours a combination of lowering the company tax rate and offering targeted tax credits, particularly for exporters.

Let me say that we would support a proposal to drop the company tax rate to 30%. This was in fact a key plank of our tax policy at the last election.

We think the headline corporate tax rate does matter, given we are competing for capital with countries spread right across the globe. Across the OECD, the trend is for corporate tax rates to decline. The average company tax rate in the OECD is now 27%. A cut in the company tax rate would make New Zealand a more attractive destination for capital, and boost business investment.

We need especially to look at our company tax rate relative to Australia, given that we may be in competition with Australia as a place to set up headquarters, and because of the amount of investment Australians have in New Zealand. In particular, we need to reduce the incentive for New Zealand branches of Australian companies to stream profits westwards across the Tasman.

We need to drop our company tax rate to at least 30%, to match the rate in Australia.
As I said, this appears to be part of the Government’s favoured package arising from the Business Tax Review, although if I were you I wouldn’t hold my breath in anticipation. Some of you will recall that Michael Cullen told a Hong Kong audience back in early 2000 that he favoured a cut in the company tax rate when fiscal conditions allowed - six years later, and despite enormous fiscal surpluses, we have only vague hints!

The reality is that Michael Cullen has long been opposed to tax cuts, and in particular to business tax cuts. Pressure from Labour’s coalition partner United Future might have brought him to the tax cut well, but we should wait and see whether he is really prepared to drink from it.

The other part of the Government’s preferred package appears to be targeted tax credits, particularly tax credits for exporters.

It is always possible to make a case for these sorts of tax breaks. The Government’s rationale in the discussion document is that there are wider benefits to New Zealand when businesses invest in export market development. Businesses don’t capture all of these benefits themselves. Therefore there is an economic rationale for Government to step in and pay for some of the exporters’ costs.

Here I think we should be far more wary. In general, I think that any argument for tax breaks which depends on the existence of what economists call “externalities” should face a high hurdle for justifying the preferential tax treatment of some goods and services over others. For the Government to say simply that exporting is good for the economy and therefore deserving of special assistance falls well short of the sort of argument that is required. Lots of other industries are good for the economy and provide externalities of various kinds too.

New Zealand is rightly admired for having a relatively clean and simple tax system. We should be very wary of rushing in to deviate from a comprehensive company tax base, not least because it creates opportunities for tax planning and, quite frankly, for rorting the tax system. Relatively ad-hoc changes also inevitably generate on-going lobbying for ever more changes. Every special preference creates pressure for more special preferences, and requires an increase in the rate of tax applied to income still within the net. That’s the last thing we need.

It’s worth recalling that the mess we had before the big tax reform of the mid-eighties - where the company tax rate was 45% and the top personal rate was 66%, and where there were lots of exemptions, preferences, and special deals - was not created by a single decision, but gradually, by many decisions over many years. John Shewan recently observed that over 90 tax concessions were listed in a 1981 Tax Information Bulletin.


2. Taxation of overseas share investments
Next I would like to talk about the Government’s proposals for changing the rules around the taxation of investment and savings.

The Bill currently before the Finance and Expenditure Committee attracted some 3,000 submissions, which is extraordinary for a tax bill. Many of you at this conference will’ve had a hand in preparing a submission.

If so, you’ll be well aware that the Bill proposes two new sets of tax rules.
One set of rules puts the taxation of managed funds - or at least those managed funds which become Portfolio Investment Entities - on more or less the same footing as the taxation of direct investors. National has welcomed this move - we think it’s fair and we think it will encourage people to save.

The other set of rules relates to the taxation of offshore share investments, and has been far more controversial. While no-one has done a precise count, it appears that at least 2,999 of the select committee’s submissions, possibly more, were opposed to the provisions in the Bill.

Because of this stiff opposition to the Bill’s proposals, the Government, at the 11th hour, has now changed its mind yet again, and has put forward a different set of proposals for taxing offshore share investments.

As we’ve also recently seen with the KiwiSaver Bill, having the Government come in at the last minute and make major changes to tax bills, after the Select Committee has heard submissions, makes a mockery of the tax policy consultation process. It will be poor law-making indeed if people are not to be allowed to make submissions on these latest proposals, and have them analysed properly by the Committee.

In any case, it’s worth recapping what the new proposals are.
For individual investors, the new proposal is either to tax all dividends and capital gains, or to tax 5% of the opening value of the investor’s shares, whichever is the lower.

For managed funds, the “either-or” is scrapped, and they will simply be taxed on 5% of the opening value of their shares. This is essentially a risk-free-rate-of-return method.

It is worth noting here that, with respect to managed funds, Michael Cullen has dumped his original plans in favour of a scheme he has rejected three times before - from the 2001 Tax Review, from the Treasury and IRD’s original discussion paper, and from the Stobo Review.

These new proposals are an improvement on those in the Bill, particularly for individuals. But big problems still remain.

For example, the new proposals do nothing to change the fact that the Government is effectively penalising many people for directly investing their savings outside Australasia.

Of course, there’s nothing wrong with investing in Australia and New Zealand, but a well-diversified portfolio should also include a significant proportion of foreign equities. After all, the New Zealand and Australian equity markets are tiny by world standards.

New Zealanders already have a “home bias” to their investments, in part because of our imputation system, and tend to invest disproportionately in New Zealand and Australian equities. They also tend to over-invest in housing. The new rules will just accentuate these tendencies.

Secondly, while the proposals seem relatively simple, the devil, as always, is in the detail. The devil includes things like valuing assets which aren’t listed on a foreign stock exchange; dealing with acquisitions and sales; dealing with bonus share issues; and dealing with regular contributions to foreign superannuation schemes.

IRD will no doubt sort these issues out by adding a few dozen pages to the Income Tax Act, but individual investors will still struggle with all of this. People are going to need a good accountant and should be prepared to write him or her a healthy cheque each year. That may be music to the ears of all the accountants here this morning! But compliance costs aren’t usually counted as positive features of tax legislation, let alone the effect they have on people’s return on their investments.

Thirdly, because unrealised capital gains may still be taxed, people may still encounter cash-flow problems. In other words, they may not have the cash from their investments to pay their tax bill. This is likely to be a problem for retired people in particular.

Fourthly, the proposals make something of a mockery of the supposed neutrality between individuals and managed funds, not least because it would always be more advantageous, in tax terms, to invest directly yourself.

And fifthly, the 5% rate seems rather high, especially when you consider that the 2001 Review proposed 4% as an inflation-adjusted risk-free rate of return, and PricewaterhouseCoopers’ submission to the Committee proposed 3%.

My wariness around this tax rate is reinforced by the comment made by Ministers in the press release accompanying these new proposals, that 5% is realistic because historical returns on equity investments have averaged around 8% over the second half of the last century. But since these returns included capital gains as well as dividends, this would seem to scotch the Government’s assertion that they are only after a fair dividend, and are not taxing capital gains.

3. National’s position on tax
Finally, I would like to talk briefly about National’s position on tax more generally.
If there is one message I would like to leave you with this morning, it is that National’s overall policy on tax remains the same as it was last year and the year before that, and the year before that.

Put simply, we remain committed to lowering tax rates over time. I’ve always been of the view that if New Zealand is to be a more prosperous country, with per capita incomes approaching those of the top countries in the OECD, then we need to reduce tax rates. In particular, we need to substantially reduce personal income tax rates.

This is not to say that such reductions can or should be achieved overnight, or in one large round of tax cutting. A National Government would have other priorities as well, in education, health, law and order, defence and the environment, amongst others, and we believe in effective public services and strong public institutions.

What we need to do is to embark on a programme of incremental tax reform, reducing the tax burden over time as we can afford it. In this regard, Australia is an excellent example to us, having either cut tax rates, or increased tax thresholds, in each of the last five years.

In contrast, we have been standing still, if not going backwards. The shame is that over recent years we have had every opportunity to lower tax rates. Every surprise in the tax take has been on the upside. The Government has had an embarrassing amount of tax revenue to spend, with Core Crown revenue growing more than 60% over the past seven years. But it still couldn’t bring itself to allow those who earn the income to keep a little more of it.

The nearest we’ve come to a tax cut was a promise that personal tax thresholds would be indexed to inflation in 2008, but even that is now on hold. Tax cuts are long overdue.

Over recent years, National’s priorities for tax reductions have been tax relief for low-to-middle income families, and a cut in the corporate tax rate. At the last election, for example, our policy was to have a 19% tax rate from $12,500 to $50,000 of income. 85% of all taxpayers would therefore have faced a top tax rate of 19%. And I’ve already spoken about our commitment to drop the company rate to 30%.

These two areas - low-to-middle income families and company tax - remain our top priorities today.
I also have concerns about other tax issues. For example, I am concerned about the high effective marginal tax rates created by Working for Families, particularly as they apply to the second earner in a family, and about the way this scheme is delivered. Many women contemplating a return to the workforce face effective marginal tax rates of more than 50%, and this produces a significant barrier to re-entering the workforce for some people.

Taxes on savings are high as well, especially measured as a real rate of return. Take an experienced teacher earning more than $60,000, with a term deposit at the bank. If she’s lucky, she might be getting 6.5% interest on that deposit, but by the time she pays tax at 39%, her real return - bearing in mind that inflation is currently running at 4% - is non-existent, indeed it’s negative. That’s hardly an incentive to save.

Other tax issues, such as the top personal rate, are also a priority, and over time I’m still keen to see a flattening of the personal income tax scale, as every study of the tax system, whether here or abroad, advocates, in the interests of encouraging economic growth, reducing compliance costs, and fairness.

It’s worth noting that Peter Dunne, the Minister of Revenue of course, is on record as favouring a company tax rate of 30% and a cut in the 33% and 39% rates to 30% also. In the long term, that would be good tax policy.

But while our overall tax policy has not changed, the precise formulation of our policies will have to wait until closer to the next election, when we see what shape the economy is in.

At that stage, we will outline in detail our plan to ease the tax burden, to improve work incentives and enable people to get ahead in this country. As I’ve said, our focus will be on what can be achieved over a number of years, not just in year one.

We will not be sacrificing valuable public services in achieving that goal, but we will be holding the bureaucracy accountable for every dollar spent. I believe governments should budget and spend taxpayers’ money as carefully as hardworking families have to do every week.

And so, good luck and best wishes for your conference. Good tax policy and good tax advice always benefit from discussions amongst peers, and I’m sure your conference will be no exception.

ENDS

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