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The tax barrier to retirement
prosperity in New Zealand
www.fsc.org.nz
The tax barrier to retirement prosperity in New Zealand Contents Executive Summary page 3 1 The Tax Barrier to Retirement Prosperity in NZ - Introduction page 12 - Taxation and Savings page 14 - The Impact on the Level of Savings page 18 - Savings and Retirement Income Provision page 19 - The Impact on the Allocation of Savings page 20 - Housing and Retirement Savings page 23 2 Real Estate and a Level Playing Field for Savings in Financial Assets - Introduction page 24 - The Issue page 24 - Possible Responses page 26 3 The Over-Taxation of Accumulating Savings - Introduction page 29 - The Issue page 29 - Possible Responses page 34 - Fiscal Issues page 41 Technical Annex - Tax bias between investment in real property and retirement savings page 42 - Saving $450,000 for retirement page 43 - Effective tax rates on different types of investments, compound interest and inflation page 44 - Required statutory rate for long-term savings to even the playing field page 48 - Fiscal Costs page 49 References to Major Reports referred to in the Paper page 50
EXECUTIVE SUMMARY
The Financial Services Council of New Zealand New Zealand Superannuation (“NZ Super”) provides the first pillar
commissioned this paper on how our current tax rules OF OUR RETIREMENT INCOME POLICY "Y ITSELF IT IS NOT SUFlCIENT )N
affect savings, retirement provision and New Zealand’s general, most New Zealanders consider about twice the current
overall economy1. The conclusion reached is that tax LEVEL OF .: 3UPER IS NEEDED FOR A COMFORTABLE RETIREMENT 4HIS
changes are necessary. The issues are not easy but the do requires New Zealand Superannuation to be supplemented by
nothing option accepts that: PRIVATE SAVINGS n A RETIREMENT FUND OF TO
For most people their first priority is likely to be paying off the
s /UR ECONOMY WILL CONTINUE TO HAVE LOWER PRODUCTIVITY GROWTH
home mortgage and then meeting their retirement savings target
s 7E WILL CONTINUE TO HAVE HIGHER OVERSEAS DEBT AND THUS BE BY BUILDING UP INVESTMENTS )NTERNATIONALLY A NORMAL WAY OF DOING
MORE VULNERABLE TO INTERNATIONAL EVENTS this is by saving throughout one’s working life in a retirement
s (OUSING WILL INCREASINGLY BE UNAFFORDABLE FOR THE AVERAGE FUND INVESTING MAINLY IN lNANCIAL INSTRUMENTS )N .EW :EALAND
.EW :EALAND HOUSEHOLD THIS IS LIKELY TO BE A +IWI3AVER SCHEME .EW :EALANDERS ARE NOT
HOWEVER SAVING ENOUGH IN THIS WAY /UR CURRENT TAX RULES ARE A
s )NCREASINGLY PEOPLE WILL HAVE INADEQUATE SAVINGS AVAILABLE MAJOR REASON FOR THIS
TO FUND A COMFORTABLE RETIREMENT
KiwiSaver and PIEs
+IWI3AVER IS A VOLUNTARY SAVINGS SCHEME DESIGNED TO ENCOURAGE .EW :EALANDERS TO SAVE FOR THEIR RETIREMENT 4HE GOVERNMENT
PROVIDES MEMBERS WITH A ONE OFF KICK START PAYMENT OF TO EVERYONE WHO JOINS THE SCHEME 4HE GOVERNMENT ALSO PROVIDES
an annual member tax credit (MTC) of 50 cents for every dollar of member contributions up to a maximum of $1,042 contributions
PER ANNUM SO THAT THE MAXIMUM ANNUAL -4# IS #ONTRIBUTIONS TO THE SCHEME ARE MADE BY MEMBERS AND THEIR EMPLOYERS
%MPLOYEES CAN CONTRIBUTE OR OF THEIR SALARY OR WAGES TO +IWI3AVER 0EOPLE CAN ALSO MAKE OTHER EXTRA PAYMENTS INTO
THEIR ACCOUNTS 4HE EMPLOYER CONTRIBUTION IS A COMPULSORY OF SALARY AND WAGES 3AVINGS IN +IWI3AVER ACCOUNTS CANNOT IN MOST
CIRCUMSTANCES BE WITHDRAWN UNTIL THE MEMBER REACHES THE AGE OF YEARS
#ONTRIBUTIONS EMPLOYER AND MEMBER INTO THE SCHEME REMAIN TAXABLE AS INCOME 3CHEME EARNINGS ARE TAXABLE ON AN ANNUAL BASIS
AS THEY ARISE 4HIS IS EITHER AS A WIDELY HELD SUPERANNUATION SCHEME WITH THE RATE BEING A mAT OR AS A 0ORTFOLIO )NVESTMENT
%NTITY 0)% WHERE THE RATE IS OR A MAXIMUM OF DEPENDING ON THE OVERALL INCOME OF THE MEMBER ! +IWI3AVER 0)%
PAYS TAX ON THE SCHEME INCOME BASED ON THE INDIVIDUAL RATES OF MEMBERS AS NOTIlED TO THE PROVIDER 0ROVIDED THOSE RATES REmECT
the members actual income under rules set out in the legislation, members face no further tax on the income attributed to their
ACCOUNTS 7ITHDRAWALS FROM +IWI3AVER ARE NOT TAXED
4HE TAX TREATMENT OF +IWI3AVER COMPARES UNFAVOURABLY WITH THAT OF HOME OWNERSHIP OR AN INVESTMENT IN RENTAL PROPERTY (OME
OWNERSHIP IS OUTSIDE THE TAX NET AND NOT TAXED )NCOME FROM RENTAL PROPERTY THE RENT IS TAXABLE AND EXPENSES DEDUCTIBLE BUT A
LARGE PART OF ANY RETURN IS NORMALLY IN THE FORM OF GAIN IN THE VALUE OF THE PROPERTY 4HIS IS MOST LIKELY TO BE A TAX FREE CAPITAL GAIN
BUT EVEN IF THIS IS TAXABLE THE TAX IS LEVIED ONLY WHEN THE HOUSE IS SOLD WHICH CAN BE OR MORE YEARS AFTER THE GAIN lRST ARISES
1
4HIS 0APER HAS BEEN PRODUCED WITH THE ASSISTANCE OF 0AUL -ERSI A FORMER TAX PARTNER OF 0RICEWATERHOUSE#OOPERS AND A MEMBER OF THE 3AVINGS 7ORKING 'ROUP AND
2OBIN /LIVER -.:- A FORMER $EPUTY #OMMISSIONER OF )NLAND 2EVENUE IN CHARGE OF TAX POLICY 4HE 4ECHNICAL !NNEX IS BASED ON MODELLING WORK DONE FOR &3# BY %9 WITH
THE PARTICULAR INPUT OF 0ETER 'OSS $IRECTOR 4RANSACTION !DVISORY 3ERVICES AND !ARON 1UINTAL $IRECTOR 4AX BOTH OF WHOM WERE PREVIOUSLY IN 4REASURY TAX POLICY AND "LAIR
4OMBLIN 3ENIOR #ONSULTANT 4AX WHO WAS WITH )2$ 0OLICY !DVICE $IVISION 4HE 0APER HAS BEEN REVIEWED BY 0ROFESSOR *OHN 0IGGOTT OF THE 5NIVERSITY OF .EW 3OUTH 7ALES
AND A MEMBER OF THE (ENRY 2EVIEW IN !USTRALIA AND THE MODELLING WORK HAS BEEN REVIEWED BY *OHN 3AVAGE A FORMER .:)%2 3ENIOR %CONOMIST
www.fsc.org.nz PAGE 3
Our Income Tax is Skewed Against Savings in Home ownership stands at one extreme as being the most highly
Financial Instruments TAX FAVOURED FORM OF INVESTMENT &OR A HOME OWNER EVERY DOLLAR
used to repay the mortgage reduces mortgage interest costs that
The problem is that our income tax is heavily skewed against
ARE NON DEDUCTIBLE AND HAVE TO BE PAID OUT OF AFTER TAX WAGES
SUCH A SAVINGS PROGRAMME )NTERNATIONALLY .EW :EALAND STANDS
The return on an investment in mortgage repayments is thus
OUT .O OTHER COUNTRY HAS OUR COMBINATION OF COMPREHENSIVE
TOTALLY TAX FREE "EING A TAX FREE INVESTMENT THE TAX BENElT OR
taxation of the return on debt instruments as they accrue, no
subsidy is equal to the total equity investment in the home times
superannuation tax concessions, no tax on capital gains on rental
the income a person would get from investing this money in, for
properties, and the unconstrained deductibility of the nominal
EXAMPLE A BANK ACCOUNT TIMES THE PERSONS MARGINAL TAX RATE
value of interest against other income on debt used to purchase
So if a person has $200,000 equity in a home which they would
RENTAL PROPERTY !S A RESULT .EW :EALAND STANDS OUT COMPARED TO
have otherwise received 6% interest on, and they are on the top
comparable economies by having one of the highest tax biases in
33% marginal tax rate, then the benefit is $3960 per annum
favour of investing in real estate and against investing in financial
AT AT A TAX RATE 4HIS IS THE TAX THE PERSON
ASSETS SUCH AS +IWI3AVER AND BANK TERM DEPOSITS
would have paid had he or she put the funds into a bank account
It is difficult to make clear international comparisons of effective INSTEAD OF BUYING A HOUSE
tax rates given various assumptions that need to be made
!S THE 3AVINGS 7ORKING 'ROUP NOTED OWNERSHIP OF RENTAL
AND DIFFERENT TAX LAWS 4HE FOLLOWING TABLE IS DRAWN FROM WORK
ACCOMMODATION IS ALSO TAX FAVOURED TO A LESSER EXTENT 4HIS IS
UNDERTAKEN BY TAX REVIEWS IN THE 5NITED +INGDOM AND !USTRALIA
largely due to the non-taxation of capital gains and the ability
and work commissioned by the Financial Services Council in New
to deduct the inflation component of interest costs against other
:EALAND $ESPITE THE DIFlCULTIES OF INTERNATIONAL COMPARISONS IT
INCOME "Y CONTRAST AN INVESTMENT IN DEBT INSTRUMENTS IS TAX
demonstrates how much New Zealand stands out in its adverse
PENALISED WITH AN EFFECTIVE TAX RATE UP TO ALMOST
tax treatment of investments in financial assets (bank accounts
AND SUPERANNUATION )N THE 5NITED +INGDOM AND !USTRALIA 4HE TAX PENALTY ON SAVINGS IS MADE UP OF A NUMBER OF COMPONENTS
superannuation is tax subsidised (it faces a negative tax rate)
s )NCOME TAX INHERENTLY PENALISES SAVINGS WHEREAS '34 DOES NOT
whereas in New Zealand the equivalent KiwiSaver investment is
If future and present consumption are treated as two goods,
TAXED OVER ITS LIFE AT MUCH HIGHER THAN THE STATUTORY RATE 2ENTAL
income tax, by taxing interest income, taxes future consumption
property by contrast is more lowly taxed in New Zealand because
MORE THAN PRESENT CONSUMPTION
of the absence of a tax on the capital gains and the deductibility
of the nominal value of interest against other income on debt s 4HIS PENALTY ON SAVING IS ESPECIALLY HARSH ON LONG TERM OR
USED TO FUND THE PURCHASE OF RENTAL PROPERTY $ETAILS OF HOW THESE accumulating savings since it is higher the more years over
RATES ARE CALCULATED ARE SET OUT IN THE 4ECHNICAL !NNEX 2 WHICH THE SAVING TAKES PLACE !S THE 3AVINGS 7ORKING 'ROUP
NOTED THIS BY ITSELF MEANS THAT COMPARED WITH '34 INCOME
INTERNATIONAL COMPARISONS tax over a person’s working life, halves the sum available for
OF EFFECTIVE TAX RATES (ETRs)
RETIREMENT
"ANK Rental Super-
Account 3 Property annuation 4HE UNEVEN INCOME TAX LAW COMPOUNDS THE PROBLEM 7HEREAS
5NITED +INGDOM 48 (40) 4
it is estimated that debt instruments face an effective tax rate
(0% leverage) of 50% or more, home ownership faces a 0% rate, with other
INVESTMENTS IN BETWEEN THESE EXTREMES 4HIS IS CAUSED BY THE
Australia Not calculated 46 (30) 5
– above the (0% leverage) fact that debt instruments are taxed on:
statutory rate
OF
New Zealand 49 24 6 38
(0% leverage
The tax rates for UK and Australian superannuation shown in (brackets) are negative
tax rates. They are tax subsidies so that in effect people are paid by the tax system
to hold these investments.
2
)N ALL CASES A SAVING PERIOD OF YEARS IS ASSUMED )N THE REST OF THIS 0APER THE BASE PERIOD USED FOR ANALYSING EFFECTIVE TAX RATES IS YEARS 4HE DIFFERENCES ARE HOWEVER
MARGINAL )F YEARS IS USED FOR .EW :EALAND THE REAL %42 FOR SUPERANNUATION REDUCES FROM AFTER YEARS TO AFTER YEARS &OR RENTAL PROPERTY THE REAL %42
LEVERAGE REDUCES FROM TO )N ALL CASES THE EFFECTIVE TAX RATES ARE FOR THOSE ON THE TOP MARGINAL TAX RATE 3 Tax rates are higher than the statutory rate because of the
TAXATION OF THE INmATION COMPONENT OF INTEREST 4 %MPLOYER CONTRIBUTION PENSION SCHEME 5 !USTRALIAN SUPERANNUATION GUARANTEE SCHEME 6 In the rest of this Paper the more realistic 80%
GEARING ASSUMPTION IS USED AS A BASE CASE 4HIS PRODUCES AN EFFECTIVE TAX RATE OF FOR RENTAL PROPERTY HELD FOR YEARS +IWI3AVER SCHEME
PAGE 4 The tax barrier to retirement prosperity in New Zealand
s ! COMPREHENSIVE BASIS TAXING ANY CHANGE IN CAPITAL VALUE AS
Real Effective Tax Rates and Required
INCOME 4HERE IS NO TAX FREE CAPITAL GAIN AS OPPOSED TO FOR
Marginal Tax Rates to Level the Playing Field
EXAMPLE AN INVESTMENT IN RENTAL ACCOMMODATION
The Real Effective Tax Rate (Real ETR) is the tax wedge
s !N ACCRUAL RATHER THAN REALISATION BASIS TAXING INTEREST ANNUALLY
AS IT ARISES 4AX IS LEVIED EACH YEAR ON INTEREST WHEREAS EVEN BETWEEN THE POST TAX RETURN AND THE PRE TAX REAL RETURN 4HE
if another investment is taxed on capital gains, tax is deferred required marginal tax rate is the statutory rate required to
UNTIL THAT GAIN IS REALISED ON BEING SOLD 7ITH ACCUMULATING produce the same return from different investments assuming
savings, compounding investment income is reinvested each BOTH HAVE THE SAME PRE TAX NOMINAL RETURN 7HEN CONSIDERING
YEAR AS FUND CAPITAL 7HEN TAX IS LEVIED ON AN ACCRUAL BASIS what rate is required to, for example, make an investment in
these annual additions reinvested in the fund are only the
KiwiSaver as attractive from a tax viewpoint as an investment
AFTER TAX AMOUNT 7HEN TAX IS LEVIED ONLY UPON REALISATION THE
in rental housing, the appropriate rate to consider is the
savings are built up much more rapidly out of pre-tax returns
as there is no tax deduction from the amount of earnings that REQUIRED MARGINAL TAX RATE 4HESE TERMS ARE EXPLAINED IN MORE
IS RE INVESTED EACH YEAR DETAIL IN THE 4ECHNICAL !NNEX
s 4HE PART OF INTEREST WHICH IS NOT REALLY INCOME BUT SIMPLY
COMPENSATION FOR INmATION OVER THE TERM OF THE INVESTMENT
This is why the tax rate on financial instruments, such as
BONDS CAN EXCEED THE STATUTORY RATE OF SAY
Rental property (after home ownership) is probably the most
tax preferred investment alternative to saving via financial
INSTRUMENTS SUCH AS +IWI3AVER 4HE TAX PREFERENCES FOR RENTAL
property increase the longer it is held until sold and the more
HIGHLY IT IS GEARED lNANCED BY DEBT 4HIS IS DEMONSTRATED IN
THE FOLLOWING TABLE
HOW LEVERAGE AND THE PERIOD OVER WHICH
PROPERTY IS OWNED IMPACTS ON EFFECTIVE TAX RATES
9EARS BEFORE
rental property Leverage ratio
is sold
0% 50% 80% 100%
10 years
20 years
30 years
40 years
50 years
The table assumes a 33% marginal tax rate (the top rate) for a person holding
property as an investment. The table uses 100% gearing as one example. This
means that the rental property is fully funded by debt and there is no equity
investment. Such gearing is possible if an investor uses equity in their own home as
security to purchase rental properties. A professional couple who have $400,000
equity in their $500,000 home can borrow $1 million to purchase two $500,000
houses to rent out. The couple have then used $200,000 of equity in their own
home so that the bank is prepared to lend the full $1 million to purchase the rental
properties. For tax purposes the two rental properties are 100% geared (funded
“New Zealand stands out compared to comparable
by debt). The couple can then deduct the full interest cost, to the extent it exceeds economies by having one of the highest tax biases
rental income, from their other professional, income. in favour of investing in real estate and against
4HE ABOVE TABLE IS EXPRESSED IN TERMS OF REAL EFFECTIVE TAX RATES investing in financial assets (such as KiwiSaver
and bank term deposits).”
www.fsc.org.nz PAGE 5
The Tax Bias has Important Consequences The retirement income that a person can expect to be generated
from KiwiSaver or similar savings is therefore largely going to be
This tax bias against financial instruments used to build up a
FROM THE COMPOUNDING INCOME THE SCHEME GENERATES 4AXING THIS
RETIREMENT FUND MATTERS )T PENALISES SUCH SAVINGS AND MAKES
compounding income substantially reduces the source of 90% of
IT HARD FOR PEOPLE TO SAVE TO MEET THEIR RETIREMENT OBJECTIVE
EXPECTED RETIREMENT INCOME
4HE 3AVINGS 7ORKING 'ROUP ESTIMATED THAT ON REASONABLE
assumptions up to 90% of a person’s retirement income comes This simply reflects the importance of compounding interest
from the tax penalised compounding investment income and IN BUILDING UP A SUBSTANTIAL FUND OF SAVINGS OVER TIME 4HIS IS
only 10% from the initial annual contributions out of salaries DEMONSTRATED IN THE FOLLOWING GRAPH 4HIS SHOWS HOW AN INITIAL
AND WAGES MADE OVER A PERSONS WORKING LIFE $100 deposit grows over 50 years to $1,842 if untaxed, $1,319
IF TAXED ONLY WHEN WITHDRAWN AND ONLY IF TAXED ANNUALLY
7HEN IT COMES TO ACCUMULATING SAVINGS WHETHER TAX IS LEVIED
ON AN ACCRUAL BASIS )N OTHER WORDS IN THIS EXAMPLE TAXING THE
each year as income accrues (the tax treatment of KiwiSaver
deposit earnings reduces its value to the saver by about one third
and bank term deposits) versus taxing only when the savings
but taxing those earnings as they accrue year by year reduces the
are withdrawn (the tax treatment of a property taxed on gains
SAVINGS BY
when it is sold) makes a big difference to the eventual post-tax
SAVING FUND THE LONGER THE SAVINGS ACCUMULATE
THE IMPACT ON VALUE OF TAXATION ON A REALISATION BASIS
VALUE ($)
TAX FREE
0 5 10 15 20 25 30 35 40 45 50 TAX ON REALISATION
TAXED AS ACCRUED
YEARS
Assumptions: nominal return of 6%, marginal tax rate of 30%. $100 is invested for up to 50 years.
PAGE 6 The tax barrier to retirement prosperity in New Zealand
This tax bias also encourages people to invest in housing not jobs, an economy that is vulnerable to offshore financial crises,
lNANCIAL INSTRUMENTS 7HEREAS lNANCIAL INVESTMENTS ARE LIKELY TO unaffordable housing costs, and a higher exchange rate that
be used to increase the productive potential of the economy, more MAKES IT DIFlCULT FOR EXPORTERS TO COMPETE ON WORLD MARKETS
jobs and higher future incomes, tax induced housing investment
This is the result of tax rules that penalise saving in financial
IS LIKELY TO FLOW THROUGH TO HIGHER LAND PRICES 4HIS DOES LITTLE
instruments and provide subsidies to housing and alternative
if anything to increase the real wealth of New Zealand nor our
INVESTMENTS 4HE LEVEL OF SUBSIDY FOR HOUSING IS VERY HIGH 4HE TAX
ABILITY TO EARN HIGHER INCOMES -OREOVER MUCH OF OUR HOUSING
subsidy on owner occupied housing is estimated to be $4 billion
INVESTMENT IS LIKELY TO BE FUNDED ULTIMATELY BY OFFSHORE BORROWING
PER ANNUM 4HIS IS ABOUT TWICE THE LEVEL OF ASSISTANCE THE #ROWN
The tax system encourages offshore borrowing so that New
spends each year to meet the housing needs of lower income
:EALANDERS CAN BID AGAINST EACH OTHER TO INCREASE LAND PRICES
New Zealanders through rent subsidies for state home tenants
As a result housing becomes increasingly less affordable for lower AND IN THE ACCOMMODATION SUPPLEMENT )T IS NO WONDER THAT AN
INCOME EARNERS AS DEMONSTRATED BY THE FOLLOWING GRAPH ESTIMATED OF HOUSEHOLD WEALTH IS IN THE FORM OF HOUSING
It is not a surprise that most New Zealanders do not think they
Numerous government reports have concluded that this flows
ARE SAVING ENOUGH TO FUND THE SORT OF RETIREMENT THEY WANT
through to a low performing economy, lower incomes and less
RATIO OF AVERAGE HOUSE PRICE TO AVERAGE HOUSEOLD DISPOSABLE INCOME
VALUE OF RATIO
6
5
4
3
2
1
0
1962 1965 1968 1980 1983 1986 1989 1992 1995 1998 2001 2004 2010 2013
YEARS
3OURCE 2ESERVE "ANK OF .EW :EALAND "RIGGS AND .G
“The level of subsidy for housing is very high.
The tax subsidy on owner occupied housing is
estimated to be $4 billion per annum. This is
about twice the level of assistance the Crown
spends each year to meet the housing needs
of lower income New Zealanders through rent
subsidies for state home tenants and in the
accommodation supplement.”
www.fsc.org.nz PAGE 7
Options for Change REAL EFFECTIVE TAX RATES ON
DIFFERENT TYPES OF INVESTMENTS
#OMMON SENSE CALLS OUT FOR CHANGE "UT THE OPTIONS FOR CHANGE
ARE NOT EASY Tax rate
0% 28% 30% 33%
4HIS PAPER CANVASSES NUMEROUS TAX REFORM OPTIONS 4HESE RANGE
/WNER OCCUPIED 0% 0% 0% 0% 0%
FROM REPLACING INCOME TAX WITH '34 TO TAXING CAPITAL GAINS TO home, debt-free
changes in the manner in which housing or financial instruments 'ENERAL RENTAL 0%
ARE TAXED (ISTORY DEMONSTRATES THAT ANY REALISTIC REFORM NEEDS property
not only to have economic merit, but it also needs to be feasible (100% leverage)
AND POLITICALLY PALATABLE /N THAT BASIS REFORM INVOLVING A 'ENERAL RENTAL 0%
substantial tax on currently tax exempt owner occupied housing property
(80% leverage)
DOES NOT SEEM VIABLE
'ENERAL RENTAL 0%
A more modest and realistic objective is to recognise that home property
OWNERSHIP WILL REMAIN THE PRIORITY FOR MOST PEOPLE 7E SHOULD (50% leverage)
however, ensure that the tax system provides a level playing field 'ENERAL RENTAL 0%
property
with respect to how people invest their discretionary savings
(no leverage)
OVER AND ABOVE THEIR HOME OWNERSHIP NEEDS 4HIS REQUIRES A
PIE / KiwiSaver 0%
more even tax treatment of savings for retirement in financial with no
ASSETS AND INVESTMENTS IN RENTAL ACCOMMODATION 4O GET A MORE subsidies8
even tax treatment, the tax on savings in financial instruments Foreign shares 0%
needs to be lowered closer to the effective rate applying to rental "ANK ACCOUNT 0%
PROPERTY 4HE EFFECTIVE TAX RATE ON RENTAL PROPERTY VARIES ACCORDING term deposit
to the assumptions made as to, for example, the length of time
the rental property is held and the degree to which an investment Where the tax rate is in (brackets) it represents a subsidy to the investor.
in such property is geared (the level of debt used to buy a rental
PROPERTY 4HE HIGHER THE LEVEL OF MORTGAGE DEBT HELD IN THE RENTAL
property and the longer the time it is owned the lower is the
EFFECTIVE TAX RATE
The Financial Services Council commissioned work from
independent experts on the various effective tax rates on different
TYPES OF INVESTMENTS UNDER CURRENT .EW :EALAND TAX RULES )T SHOWS
how effective tax rates vary greatly and how much housing is tax
PREFERRED RELATIVE TO SAY +IWI3AVER 4HE RESULTS ARE SUMMARISED
IN THE TABLE BELOW
8
4HE +IWI3AVER GOVERNMENT INCENTIVES ENCOURAGE PEOPLE TO JOIN A SCHEME BUT DO NOT INCREASE RETURNS AT THE MARGIN AND SO DO NOT CHANGE THOSE RESULTS 4HE RENTAL PROPERTIES ARE
ASSUMED TO BE HELD FOR YEARS IN THESE EXAMPLES
PAGE 8 The tax barrier to retirement prosperity in New Zealand
The tax rates necessary to even the playing field between rental property (with different levels of leverage) and KiwiSaver at the different
marginal tax rates are as illustrated below:
REQUIRED MARGINAL PIE TAX RATES TO EVEN THE PLAYING FIELD
Rental property – no leverage Rental property – 50% Rental property – 80% Rental property – 100%
leverage leverage leverage
Tax rate Required Required Required Required
Real ETR marginal tax Real ETR marginal tax Real ETR marginal tax Real ETR marginal tax
rate rate rate rate
Assumes the property is sold after 20 years
The most reasonable assumption seems to be rental property In effect we are saying if we cannot fix the comprehensive
LEVERAGED TO AND A TAX RATE OF THE TOP 0)% TAX RATE income tax base we should fix the tax rates on locked-in savings
This shows that the required tax rate on KiwiSaver to level the like KiwiSaver to ensure there is no barrier to sensible saving
PLAYING lELD WITH AN INVESTMENT IN RENTAL PROPERTY IS BEHAVIOUR
$ETAILS ON THESE RATES AND ASSUMPTIONS USED ARE PROVIDED IN THE Clearly any reduction to the tax rate on financial instruments
4ECHNICAL !NNEX OR +IWI3AVER TYPE SCHEMES WOULD HAVE A lSCAL COST (OWEVER
if necessary, work commissioned by the Financial Services
This work estimates that, on reasonable assumptions, the highest
Council demonstrates that most of any fiscal cost could be
tax rate on savings in a KiwiSaver scheme needs to be lowered
met by removing the current government funded incentives for
from the current 28% to 1% assuming that the alternative
KiwiSaver (the $1,000 kick-start payment and the member tax
investment to KiwiSaver is an investment in rental property that
CREDIT CURRENTLY ESTIMATED TO COST SOME MILLION PER ANNUM
IS GEARED AND IS HELD FOR TWENTY YEARS UNTIL SOLD )N OTHER
7HILE THE +IWI3AVER INCENTIVES ACT AS A STRONG INCENTIVE TO ENROL IN
words, only if investment returns in KiwiSaver are taxed at a rate
KiwiSaver, they do not offset the tax bias that exists for investment
of about 1% would that investment offer a comparable after-tax
IN RENTAL PROPERTY OVER INVESTMENTS IN +IWI3AVER /VER TIME IT IS
return to investing in rental property geared to 80% (assuming the
estimated that the KiwiSaver incentives could be used to fully pay
SAME NOMINAL PRE TAX RETURN 4HIS PAPER CONCLUDES THAT SUCH A
FOR IN NET PRESENT VALUE TERMS A mAT +IWI3AVER TAX RATE OF
reduction in the tax on saving in financial instruments could be
IF THE INCENTIVES WERE REMOVED FROM )F THE UPFRONT
achieved by either lowering the tax on all financial instruments
incentive was retained and only the $521 annual tax credit was
(by, for example excluding the inflationary compensation
REMOVED FROM THAT WOULD FUND A +IWI3AVER 0)% mAT
embedded in interest from the tax base) or by providing lower tax
RATE 4HIS ASSUMES THE ANNUAL TAX CREDIT IS INDEXED TO THE
RATES ON LOCKED IN SAVINGS SUCH AS +IWI3AVER SCHEMES )DEALLY
FUTURE GROWTH IN WAGES AND THAT NO BEHAVIOUR CHANGE OCCURS
a lower scheme tax rate would be based on a proportion of the
It is thus possible, at no fiscal cost, to go a long way towards
appropriate marginal tax rate of each individual scheme member
removing the current bias against saving by way of financial
BUT IF THIS IS NOT PRACTICAL A SINGLE LOWER RATE SEEMS JUSTIlED 4HE
INSTRUMENTS LIKE +IWI3AVER
options here have advantages and disadvantages and these are
CANVASSED IN THE PAPER
www.fsc.org.nz PAGE 9
FISCALLY NEUTRAL KIWISAVER PIE TAX RATES EFFECTIVE TAX RATE IMPACTS INCREASE THE LONGER
THE TERM OF SAVINGS
NPV 0 Tax Rate –
NPV 0 Tax Rate –
$521pa MTC and Impact of tax
2EFORM /PTION $521pa MTC only 9EARS
$1000 kick-start Annual savings required on cumulative
removed of saving
removed return
Phase out incentives No tax 7ITH 4AX
from 2015 10
Remove incentives 20 $15,112
from 2015
30 $8,024 $10,529
The above demonstrates that if necessary a significant reduction 40 $6,930
IN THE +IWI3AVER TAX RATE COULD BE ACHIEVED AT NO FISCAL COST 50 $2,948 $4,845
7E ALSO EXPLORED THE OPTIONS OF A FISCALLY NEUTRAL REDUCTION
Assumptions: 4% real rate of return, 2% inflation, 28% PIR (Prescribed Investor
in KiwiSaver tax rates while retaining the progressivity of rates Rate). Required annual savings shown is in 2013 dollars, and is assumed to
so that a greater benefit would be able to be delivered to lower increase with inflation.
INCOME SAVERS 4HIS PRODUCED THE RESULTS IN THE FOLLOWING TABLE
EXAMPLES OF FISCALLY NEUTRAL PROGRESSIVE As a consequence, a person would effectively be incentivised
PIE TAX RATES to delay saving for their retirement until a later time, thereby
reducing the real effective tax rate impact on their KiwiSaver
Progressive PIE tax rates Low rate Middle rate Top rate
investment but greatly increasing the amount of contributions
Current PIE tax rates
needing to be made annually in order to have enough savings
Fiscally neutral if only
FOR A COMFORTABLE RETIREMENT 3AVING A LITTLE FOR A LONG TIME IS
$521pa MTC removed
therefore not a tax effective retirement savings strategy for New
Fiscally neutral if $521pa
MTC and $1000 kick-start :EALANDERS BUT SAVING OVER A SHORTER TIME PERIOD IS UNAFFORDABLE
removed
As noted above, most New Zealanders consider that private
$ETAILS OF THE TAX RATE NUMBERS REQUIRED TO EQUATE SAVING THROUGH SAVINGS OF TO IE IN ADDITION TO .: 3UPER
KiwiSaver with investing in a rental property, a comparison of ARE NEEDED TO BE ENOUGH TO LIVE COMFORTABLY IN RETIREMENT 4O
current effective tax rates on different types of investments and accumulate $450,000 of savings in KiwiSaver, a person would
fiscal implications of reform options are included in Chapter III NEED TO SAVE APPROXIMATELY ANNUALLY OVER YEARS )N
AND IN THE 4ECHNICAL !NNEX TO THIS PAPER doing so, however, the person’s cumulative investment returns
WOULD BE REDUCED BY 4HAT IS THEIR AFTER TAX RETURN AT THE
A high tax rate on KiwiSaver investments has consequences
END OF YEARS WOULD BE LOWER THAN IT WOULD BE IN THE
FOR THE LEVEL OF RETIREMENT SAVINGS IN .EW :EALAND ! MARGINAL
ABSENCE OF TAX A REDUCTION OF MORE THAN HALF 4HE IMPACT OF
tax rate on KiwiSaver above that applying to rental property
tax on the cumulative return for a 10-year savings horizon falls
investments (such as the prevailing 28% rate for many savers)
TO BUT THE REQUIRED ANNUAL SAVINGS INCREASE TO MORE
means that the rental property provides much better after-tax
than $40,000 per year, a prohibitive amount for the average
RETURNS 4HE EARLIER A PERSON STARTS SAVING FOR THEIR RETIREMENT IN
.EW :EALANDER
KiwiSaver, the higher the real effective tax rate impact becomes
due to, in large part, the taxation of the inflation component of It is also noted that the current high taxation of compound returns
INVESTMENT RETURNS 4HIS IS ILLUSTRATED IN THE FOLLOWING 4ABLE in financial instruments is another reason why New Zealand
financial institutions are reluctant to provide annuity type products
so that lump sums can be turned into pensions for retirement and
.EW :EALANDERS ARE RELUCTANT TO BUY SUCH PRODUCTS
A much lower tax rate for investments in financial instruments
or KiwiSaver-type schemes, as proposed in this paper, would
“Saving a little for a long time is therefore not reduce the disincentive effect and encourage more people to save
a tax effective retirement savings strategy FOR THEIR RETIREMENT FROM AN EARLIER STAGE OF LIFE 4HIS IS CRITICAL TO
for New Zealanders but saving over a shorter ensure that New Zealand builds a more solid economy for the
time period is unaffordable.” future and that people have a comfortable standard of living in
THEIR RETIREMENT YEARS
PAGE 10 The tax barrier to retirement prosperity in New Zealandwww.fsc.org.nz PAGE 11
1 The tax barrier to retirement prosperity in New Zealand
Introduction percentage of KiwiSaver funds can be expected to be invested)
IS ABOUT 12 This estimate has been confirmed by work
The cost of government-provided “NZ Super” is a significant
undertaken by independent experts for the Financial Services
fiscal burden on our government (and taxpayers) and that cost
#OUNCIL SUMMARISED IN THE 4ECHNICAL !NNEX TO THIS PAPER
is forecast to increase over time as the population ages and
7HAT THIS MEANS IS THAT PEOPLE NEED TO SAVE ALMOST TWICE
LONGEVITY INCREASES 4HERE HAVE BEEN A NUMBER OF PROPOSALS TO
as much when investing savings in financial products (such as
REDUCE THIS EXPECTED COST SUCH AS RAISING THE AGE OF ENTITLEMENT
KiwiSaver) in order to generate the same income as investing
$ESPITE THE HIGH lSCAL COST OF .: 3UPER IT DOES NOT PROVIDE WHAT
IN HOME OWNERSHIP
most New Zealanders consider to be a comfortable retirement
INCOME )N GENERAL MOST .EW :EALANDERS CONSIDER ABOUT 7E ESTIMATE LATER IN THIS PAPER THAT THE GOVERNMENT EFFECTIVELY
twice the current level of NZ Super is needed for a comfortable provides something like over $4 billion per annum in tax subsidies
retirement9 )N OTHER WORDS FOR MOST PEOPLE THEIR .: 3UPER WILL TO OWNER OCCUPIED HOUSING 4HIS HOUSING TAX SUBSIDY IS OF THE
need to be supplemented by income from investments of about same order as the total income of managed funds (including
A YEAR THE AFTER TAX LEVEL OF SUPERANNUATION FOR A SINGLE KiwiSaver funds) and is about twice the $2 billion the government
PERSON LIVING ALONE SPENDS DIRECTLY EACH YEAR ON HOUSING ASSISTANCE13 It is difficult
to persuade people to invest in financial assets and products
"UILDING UP SUCH A LEVEL OF PRIVATE RETIREMENT INCOME REQUIRES
when government tax policy is now so heavily skewed towards
substantial savings, a lump sum on retirement at age 65 years of
ENCOURAGING PEOPLE TO INVEST IN HOME OWNERSHIP INSTEAD
between $300,00010 and $450,00011 WOULD BE NEEDED )T WOULD
be consistent with government policy for most New Zealanders to It is appreciated that the bias in favour of home ownership is
aim to build up such a retirement fund mainly via their KiwiSaver UNLIKELY TO BE REMOVED ENTIRELY .OR IS HOME OWNERSHIP THE
SCHEME (OWEVER UNDER CURRENT POLICY SETTINGS THIS IS NOT only form of investment favoured by our current tax system
HAPPENING /NE MAJOR REASON IS BECAUSE THERE IS A MAJOR TAX OVER SAVING IN lNANCIAL INSTRUMENTS OR PRODUCTS )NVESTMENT IN
IMPEDIMENT TO DOING SO 4AX RULES HEAVILY DISCRIMINATE AGAINST RENTAL HOUSING IS ALSO TAX FAVOURED ALBEIT TO A LESSER EXTENT )N
savings in financial assets (whether directly or via KiwiSaver or looking at comparable overseas tax jurisdictions, New Zealand
OTHER TYPES OF FUNDS RELATIVE TO INVESTING IN HOME OWNERSHIP STANDS OUT .O OTHER COMPARABLE COUNTRY HAS THE COMBINATION OF
(OME OWNERSHIP IS OUTSIDE THE INCOME TAX NET !N INVESTMENT comprehensive taxation of the return on debt instruments as they
IN A HOME FACES A ZERO TAX RATE 4HIS TAX FREE STATUS OF HOME accrue, no superannuation tax concessions and no tax on capital
OWNERSHIP IS IN EFFECT A TAX SUBSIDY FOR THIS FORM OF INVESTMENT GAINS ON RENTAL PROPERTIES !S A RESULT .EW :EALAND STANDS OUT BY
The tax benefit or subsidy is equal to the total equity investment having one of the highest tax wedges between investment in real
in the home times the income a person would get from investing ESTATE AND lNANCIAL ASSETS
this money in, for example a bank account, times the person’s
It is difficult to make clear international comparisons of effective
MARGINAL TAX RATE 3O IF A PERSON HAS EQUITY IN A HOME
tax rates given various assumptions that need to be made
which they would have otherwise received 6% interest on, and
AND DIFFERENT TAX LAWS 4HE FOLLOWING TABLE IS DRAWN FROM WORK
they are on the top 33% marginal tax rate, then the benefit is
UNDERTAKEN BY TAX REVIEWS IN THE 5NITED +INGDOM AND !USTRALIA
PER ANNUM AT AT A TAX RATE 4HIS IS
and work commissioned by the Financial Services Council in New
the tax the person would have paid had he or she put the funds
:EALAND $ESPITE THE DIFlCULTIES OF INTERNATIONAL COMPARISONS IT
INTO A BANK ACCOUNT INSTEAD OF BUYING A HOUSE
demonstrates how much New Zealand stands out in its adverse
The option to rent or buy a house is strongly influenced by this tax tax treatment of investments in financial assets (bank accounts
DIFFERENCE "Y OWNING YOUR OWN HOME YOU DO NOT HAVE TO PAY RENT AND SUPERANNUATION )N THE 5NITED +INGDOM AND !USTRALIA
FROM YOUR AFTER TAX INCOME 3O ANOTHER WAY OF LOOKING AT THE TAX superannuation is tax subsidised (it faces a negative tax rate)
benefit is that by owning your own home you get the benefit of the whereas in New Zealand the equivalent KiwiSaver investment is
RENTAL VALUE OF YOUR HOME GROSSED UP BY YOUR MARGINAL TAX RATE TAXED HIGHER THAN THE SAVERS STATUTORY MARGINAL TAX RATE 2ENTAL
property by contrast is more lowly taxed in New Zealand because
"Y CONTRAST THE 3AVINGS 7ORKING 'ROUP ESTIMATED THAT THE
OF THE ABSENCE OF A TAX ON THE CAPITAL GAINS $ETAILS OF HOW THESE
marginal effective tax rate on debt instruments (in which a large
RATES ARE CALCULATED ARE SET OUT IN THE 4ECHNICAL !NNEX 14
9
(ORIZON 2ESEARCH POLL CONDUCTED FOR THE &INANCIAL 3ERVICES #OUNCIL $ECEMBER 10 "ASED ON THE 2ETIREMENT 0LANNING CALCULATOR ON WWWSORTEDORGNZ FOR A PERSON RETIRING
AT YEARS OF AGE REQUIRING AN INDEXED PENSION OF POST TAX 11 !.: -EDIA 2ELEASE !UGUST 12 3AVING .EW :EALAND REDUCING 6ULNERABILITIES AND "ARRIERS FOR
'ROWTH AND 0ROSPERITY 3AVINGS 7ORKING 'ROUP &INAL 2EPORT TO THE -INISTER OF &INANCE *ANUARY h3AVINGS 7ORKING 'ROUP 2EPORT v PAGE &INAL REPORT AND OTHER
MATERIAL AVAILABLE ON LINE HTTPWWWTREASURYGOVTNZPUBLICATIONSREVIEWS CONSULTATIONSAVINGSWORKINGGROUP 13 About $620 million on Income Related Rents, $1,240 million
ON THE !CCOMMODATION 3UPPLEMENT AND MILLION ON 4EMPORARY !DDITIONAL 3UPPORT PER ANNUM 14 )N ALL CASES A SAVING PERIOD OF YEARS IS ASSUMED )N ALL CASES THE TAX RATES
ARE FOR THOSE ON THE TOP MARGINAL TAX RATE
PAGE 12 The tax barrier to retirement prosperity in New ZealandINTERNATIONAL COMPARISONS OF EFFECTIVE OF CAPITAL GAINS ON RENTAL PROPERTY 7HEN OTHER FACTORS SUCH AS
TAX RATES (ETRS) the deductibility of nominal interest costs, are also taken into
"ANK !CCOUNT15 Rental Property Superannuation ACCOUNT THE TAX BIAS IN FAVOUR OF RENTAL PROPERTY INCREASES 4HE
5NITED +INGDOM 48 (0% (40)18 Technical Annex to this paper calculates that rental property
leverage) GENERALLY HAS AN EFFECTIVE TAX RATE OF IF THE PROPERTY IS
Australia Not calculated 46 (0% (30)19 GEARED AND IS HELD FOR TWENTY YEARS UNTIL SOLD %VEN WITH
– above the leverage) GEARING THE EFFECTIVE TAX RATE IS AROUND FOR MANY TAXPAYERS
statutory rate of
These highly concessionary rates arise in large part from the
deductibility of interest costs on mortgages and the absence
New Zealand 49 2420 3821
(0% leverage of tax on the capital gains, thereby clearly demonstrating the
PREFERENTIAL TAX TREATMENT OF RENTAL PROPERTY
To correct the tax system’s current bias against saving via financial
instruments, it may be more realistic to aim for a more even The impact of these policy settings is felt well beyond retirement
treatment of savings in financial assets and investment in rental POLICY 'OVERNMENT SPENDING PRIVATE SAVING HOUSING THE
accommodation rather than trying to offset the heavier bias in exchange rate, our vulnerability to international financial crises
FAVOUR OF HOME OWNERSHIP 4HIS WOULD RECOGNISE THAT RETIREMENT are all inter-related issues and as various government reports
saving and home ownership are the two main channels of long have noted the tax treatment of savings is a critical factor in all
term life cycle saving with, in New Zealand, investment in rental THESE AREAS 4HIS IS THE SUBJECT OF THIS PAPER 7HAT IS THE IMPACT
accommodation (after home ownership) being the main alternative of the current tax treatment of savings and what are the options
TO SAVING VIA lNANCIAL ASSETS AS A FORM OF RETIREMENT SAVINGS to produce a less distorted outcome so that: the New Zealand
economy invests its savings more productively than it does
4HE 3AVINGS 7ORKING 'ROUP ESTIMATED THAT RENTAL ACCOMMODATION now, we reduce our vulnerability to overseas developments, we
INVESTMENT FACES A TAX RATE IN THE ORDER OF TO 4HE increase overall welfare, and secure better retirement outcomes?
3AVINGS 7ORKING 'ROUP TOOK INTO ACCOUNT ONLY THE NON TAXATION
15
4AX RATES ARE HIGHER THAN THE STATUTORY RATE BECAUSE OF THE TAXATION OF THE INmATION COMPONENT OF INTEREST 16 %MPLOYER CONTRIBUTION PENSION SCHEME !USTRALIAN SUPERANNUATION SCHEME
18
)N THE REST OF THIS 0APER THE MORE REALISTIC GEARING ASSUMPTION IS USED AS A BASE CASE 4HIS PRODUCES AN EFFECTIVE TAX RATE OF FOR YEARS 19 +IW3AVER SCHEME
www.fsc.org.nz PAGE 13Taxation and Savings would be optimal under certain assumptions concerning market
completeness and liquidity 21 4HE UNDERPINNING ECONOMIC
The largest cost by far borne by those saving for retirement is
analysis is essentially that which leads this report to assert that
THE TAXATION OF THE RETURN ON SAVINGS !S THIS PAPER EXPLAINS
HEAVY CAPITAL TAXATION IMPEDES PRODUCTIVE INVESTMENT -ORE RECENT
the effect of taxation can be to reduce a person’s private
academic analysis is more nuanced, but there is still no economic
RETIREMENT INCOME ON A GIVEN LEVEL OF SAVINGS BY ALMOST HALF
justification for taxing labour and capital at the same rate, and
This is because the New Zealand government, like governments
MUCH TO BE SAID FOR TAXING CAPITAL INCOME AT A LOWER RATE
of other developed economies, relies heavily on income tax
TO MEET ITS REVENUE DEMANDS )NCOME TAX BY REDUCING THE An income tax which exempts the taxation of saving is really an
return an individual receives on his or her savings, significantly expenditure tax (the equivalent under certain assumptions of relying
ADVERSELY IMPACTS SAVINGS 4HAT IS ESPECIALLY THE CASE WITH LONG SOLELY ON '34 FOR REVENUE 4HIS IS CLOSER TO WHAT ECONOMISTS MIGHT
term or accumulating savings where savings are made over THINK OF AS A TAX STRUCTURE SUPPORTING EFlCIENCY AND GROWTH )N MOST
time and the return is reinvested each year in the instrument developed countries this is achieved through two provisions in the
OR SAVINGS FUND 4HIS TYPE OF SAVING IS THE BASIS FOR SUCCESSFUL income tax code: the owner-occupier housing exemption, and the
RETIREMENT SAVINGS PLANS 4HE TENSION BETWEEN THE NEED TO NON TAXATION OF PENSION FUND EARNINGS -OST LIFE CYCLE SAVING
raise government revenue via an income tax and the adverse TAKES PLACE THROUGH THESE TWO CHANNELS !SSUMING THAT MUCH
impact this has on accumulating savings is managed in most private saving in an economy is undertaken for life cycle purposes,
other countries by generous tax concessions for retirement these two provisions serve to remove the double taxation of saving,
SAVINGS .EW :EALAND MOVED AWAY FROM RETIREMENT SAVING TAX and reduce the inter-temporal price distortion inherent in the
CONCESSIONS IN 4HIS MAKES IT ALL THE MORE IMPORTANT COMPREHENSIVE INCOME TAX
that our tax policy settings reach an appropriate balance
Further, if it is accepted that the income taxation (imputed rent
BETWEEN REVENUE AND OTHER OBJECTIVES
and capital gain) of the owner-occupied home is not currently a
This paper considers these issues largely in the context of feasible policy option, then the pension fund earning-exemption
New Zealand’s existing and traditional tax policy settings REMOVES A MAJOR INTER ASSET PRICE DISTORTION AS WELL )T HAS BEEN
OF A COMPREHENSIVE INCOME TAX AND GOODS AND SERVICES TAX demonstrated that the efficiency costs of adverse asset allocation
In recent years other models for taxation have been advanced that CAN BE VERY SERIOUS22 Again, this economic analysis underpins
differ significantly from this by, in particular, recommending that the report’s concerns about the differential taxation of real estate
labour and capital income and the income of residents and AND lNANCIAL ASSETS
non-residents be taxed, not on the same basis as under
A fundamental shift in our tax policy away from the traditional
A COMPREHENSIVE INCOME TAX BUT AT DIFFERENT RATES OR BASES
comprehensive taxation of all forms of income has been
A notable example of this line of thinking has been the Mirrlees
considered in New Zealand by a number of reports, most recently
2EVIEW IN THE 5NITED +INGDOM20
by the Treasury and Inland Revenue paper on the Taxation of
The thinking behind this is that labour income and capital Savings and Investment Income 23 4HAT REPORT REJECTED SUCH AN
income should be thought of as two economically distinct APPROACH FOR .EW :EALAND AT LEAST IN THE MEANTIME #RITICALLY
BASES 4HE UNDERLYING ASSETS THAT GENERATE THESE FORMS OF successive governments have also consistently resisted such
income are quite different, and their tax treatment should CHANGES 'IVEN THIS STATE OF AFFAIRS WE HAVE CHOSEN IN THIS PAPER
REFLECT THEIR PARTICULAR FEATURES not to pursue such arguments further (although options such as
moving to a Nordic type tax system are briefly canvassed later in
The comprehensive income tax treats income from capital and
this paper) and proceed with our analysis and recommendations
LABOUR IN THE SAME WAY 4HE IDEAL OF A COMPREHENSIVE INCOME
on the basis that any future policy changes only have a chance
tax is most often associated with three mid-twentieth century
of proceeding if they can be justified in the context of a
ECONOMISTS n 2OBERT (AIG AND (ENRY 3IMONS IN THE 5NITED
COMPREHENSIVE INCOME TAX )N OTHER WORDS IF WE CANNOT lX
3TATES OF !MERICA AND 3IR *OHN (ICKS IN THE 5NITED +INGDOM
the tax base we should look to fix the tax rates on locked-in
The idea of such a tax as some kind of ideal persisted for several
savings like KiwiSaver to ensure these are not a barrier to
DECADES COMING UNDER CHALLENGE ONLY IN THE S AND S
SENSIBLE SAVINGS BEHAVIOUR
where the analysis demonstrated that a zero capital income tax
20
4AX "Y $ESIGN 4HE -IRRLEES 2EVIEW )NSTITUTE OF &ISCAL 3TUDIES /XFORD 5NIVERSITY 0RESS 21 3EE FOR EXAMPLE #HAMLEY # h/PTIMAL 4AXATION OF #APITAL )NCOME IN 'ENERAL
%QUILIBRIUM WITH )NlNITE ,IVRSv %CONOMETRICA VOLUME -AY PAGES 22 3EE (AMILTON 2 AND 7HALLEY h4HE 4AX TREATMENT OF HOUSING IN A DYNAMIC SEQUENCED
GENERAL EQUILIBRIUM MODELv *OURNAL OF 0UBLIC %CONOMICS VOLUME *ULY PAGES n 23 4REASURY 2EPORT 4 OF 3EPTEMBER
PAGE 14 The tax barrier to retirement prosperity in New ZealandThe issue of the appropriate tax policy settings for savings COMPETITIVENESS AND EXCHANGE RATE )T HAS ALSO BEEN EMPHASISED
is critical for the ability of people to provide a comfortable that tax and savings policy impacts on New Zealand’s ability to
retirement income by saving a relatively small proportion of PROVIDE AFFORDABLE HOUSING
their income throughout their working years (saving a little for
/UR GENEROUS TAX TREATMENT OF HOUSING RELATIVE TO OTHER
A LONG TIME (OWEVER THE ISSUE OF HOW BEST TO TAX SAVINGS
INVESTMENTS mOWS THROUGH INTO HIGHER LAND AND HOUSE PRICES
REACHES WELL BEYOND RETIREMENT INCOME POLICY .UMEROUS
As a result, over time there has been a steady increase in the
government publications over the last decade have emphasised
MULTIPLE OF HOUSE PRICES TO INCOMES WHICH IS CONTINUING 4HIS
how this is also critical to New Zealand’s economic performance
IS DEMONSTRATED IN THE FOLLOWING GRAPH
– productivity growth, international vulnerability and our
RATIO OF AVERAGE HOUSE PRICE TO AVERAGE HOUSEHOLD DISPOSABLE INCOME
VALUE OF RATIO
6
5
4
3
2
1
0
1962 1965 1968 1980 1983 1986 1989 1992 1995 1998 2001 2004 2010 2013
YEARS
3OURCE 2ESERVE "ANK OF .EW :EALAND "RIGGS AND .G
www.fsc.org.nz PAGE 15Examples of recent reports in this area are: borrowing and lower vulnerability, more affordable housing and
LESS PRESSURE ON THE EXCHANGE RATE 4HESE REPORTS ALSO POINT
s -C,EOD 4AX 2EVIEW n hTHE -C,EOD 2EVIEW v24
to the tax preferences for housing especially owner-occupied
s 2EPORT OF THE (OUSE 0RICES 5NIT $EPARTMENT OF THE 0RIME HOUSING 4HERE IS GENERAL AGREEMENT THAT TO THE EXTENT TO
-INISTER AND #ABINET 25 which it is equity funded, owner occupied housing is an untaxed
s 2EPORT OF THE #APITAL -ARKET $EVELOPMENT 4ASKFORCE n investment whereas the effective tax rate on bonds and similar
hTHE #APITAL -ARKET 2EPORT v26 financial instruments used to fund retirement savings is higher
THAN THE STATUTORY TAX RATES 4HIS DISTORTS INVESTMENT DECISIONS BY
s 2EPORT OF THE 6ICTORIA 5NIVERSITY OF 7ELLINGTON 4AX 7ORKING
favouring investment in housing rather than savings in financial
'ROUP n hTHE 47' 2EPORT v
instruments (the latter likely to contribute to growth in jobs and
s "UDGET PRODUCTIVITY -UCH OF THIS HOUSING OVER INVESTMENT APPEARS TO
BE REmECTED IN EXCESSIVE URBAN LAND PRICES 4HERE IS GENERAL
s 2EPORT OF THE 3AVINGS 7ORKING 'ROUP hTHE 37' 2EPORT
agreement in the reports that while our tax rules discourage
v28
saving in general, their most adverse impact is to misallocate
s 0RODUCTIVITY #OMMISSION (OUSING !FFORDABILITY INQUIRY n what savings New Zealanders are able to accumulate by directing
hTHE 0RODUCTIVITY #OMMISSION 2EPORT v29 them into real estate with consequentially high land and housing
s ! 4REASURY)NLAND 2EVENUE 2EPORT ON THE 4AXATION OF 3AVINGS PRICES 4HIS CAN BE SEEN IN THE STEEP RISE IN .EW :EALAND HOUSE
AND )NVESTMENT )NCOME OF 3EPTEMBER n hTHE /FlCIALS and land prices over recent years as shown in the graph below
2EPORTv30 WHICH MEASURES LAND AND HOUSE PRICES OVER TIME 32
s "USINESS 'ROWTH !GENDA 0ROGRESS 2EPORT &EBRUARY 31 House and land prices are also influenced by other factors such
as the impact of monetary policy on interest rates, levels of
!LL THESE REPORTS AGREE THAT TAX HAS A MAJOR IMPACT ON SAVINGS
immigration, growth in incomes, the number of homes being built
Higher savings better employed would lead to capital deepening
AND RESTRICTIONS ON ACCESS TO LAND SUITABLE FOR HOUSING
(more capital per worker) and greater productivity, less overseas
24
-C,EOD 4AX 2EVIEW 4AX 2EVIEW &INAL 2EPORT 4HE 4REASURY .EW :EALAND 25 &INAL 2EPORT OF THE (OUSE 0RICES 5NIT (OUSE 0RICE )NCREASES AND (OUSING IN .EW :EALAND
DEPARTMENT OF THE 0RIME -INISTER AND #ABINET 26 #APITAL -ARKETS -ATTER n 2EPORT OF THE #APITAL -ARKET $EVELOPMENT 4ASKFORCE $ECEMBER A Tax System for New
:EALANDS &UTURE n 2EPORT OF THE 6ICTORIA 5NIVERSITY OF 7ELLINGTON 4AX 7ORKING 'ROUP *ANUARY 28 3AVING .EW :EALAND 2EDUCING 6ULNERABILITIES AND "ARRIERS FOR 'ROWTH AND
0ROSPERITY 3AVINGS 7ORKING 'ROUP &INAL 2EPORT TO THE -INISTER OF &INANCE *ANUARY 29 .EW :EALAND 0RODUCTIVITY #OMMISSION 4HE (OUSING !FFORDABILITY )NQUIRY 30 Treasury/
)NLAND 2EVENUE 4AXATION OF 3AVINGS AND )NVESTMENT )NCOMEv 4 OF 3EPTEMBER 31 "USINESS 'ROWTH !GENDA 0ROGRESS 2EPORT &EBRUARY 32 New Zealand
0RODUCTIVITY #OMMISSION (OUSING !FFORDABILITY )NQUIRY PAGE
PAGE 16 The tax barrier to retirement prosperity in New ZealandHOUSE PRICES REAL AND NOMINAL
Note: Real house prices are measured as the ratio of actual house prices to the CPI
250
INDEX (BASE: 2000Q1=100)
200
150
100
50 REAL
NOMINAL
0
1980 1985 1990 1995 2000 2005 2010
YEARS
Source: Housing Affordability Inquiry, NZ Productivity Commission 2012, Pg 1
We save too little and invest those savings badly. RETIREMENT INCOMES 4HIS IS GENERALLY CONCEDED TO BE THE MORE
SIGNIlCANT PROBLEM 4HE #HAPTER CANVASSES OPTIONS TO REDUCE
7E NEED TO MOVE AWAY FROM TAX RULES THAT ENCOURAGE OVERSEAS
THE TAX PREFERENCE FOR HOUSING 4HIS WOULD BE THE BETTER WAY TO
debt, low levels of productive assets and inadequate savings in
reduce incentives the current tax rules provide for housing and
lNANCIAL INSTRUMENTS 4HIS PAPER SURVEYS THE ECONOMIC COSTS
land investment as opposed to accumulating savings in financial
OF THE CURRENT TAX SYSTEM 4HE NEXT TWO CHAPTERS CONSIDER
ASSETS )T IS STRESSED THAT THESE OPTIONS TO BE EFFECTIVE NEED
IN MORE DETAIL THE IMPACT ON RETIREMENT SAVINGS AND HOUSING
to target owner-occupied housing (where the tax incentives are
4HE CHOICES ARE DIFlCULT 4HE EFFECTIVE TAX RATE ON EQUITY FUNDED
HIGHEST AS WELL AS RENTAL HOUSING )F POLICIES ALONG THESE LINES
owner-occupied housing is zero so, to equalise the tax impact on
are not possible, consideration needs to be given to reducing
savings, the tax rate on savings in financial assets would need
the tax bias favouring housing by reducing tax on accumulating
ALSO TO BE ZERO 5NLESS THERE IS POLITICAL SUPPORT FOR INCREASING TAX
SAVINGS IN lNANCIAL ASSETS #HAPTER ))) CANVASSES OPTIONS IN THIS
on housing (in particular on owner-occupied housing, which has
AREA 4HE CONCLUSION REACHED IS THAT THE MORE VIABLE OPTIONS
BEEN POLITICALLY UNPALATABLE TO DATE THEN THINGS WILL STAY THE SAME
that can be seen as best fitting within current tax policy settings
/PTIONS TO AT LEAST REDUCE THE DISTORTIONS CREATED BY CURRENT POLICY
would be to provide tax relief to all savings by, for example, not
must be explored as the do-nothing option accepts that:
taxing a component of the return on savings simply attributable
s /UR ECONOMY WILL CONTINUE TO HAVE LOWER PRODUCTIVITY GROWTH to the effects of inflation or providing lower tax rates on (potentially
s 7E WILL HAVE HIGHER OVERSEAS DEBT AND THUS ARE VULNERABLE TO restricted locked-in) savings in KiwiSaver and similar locked-in
INTERNATIONAL EVENTS SCHEMES
s (OUSING WILL INCREASINGLY BE UNAFFORDABLE FOR THE AVERAGE .EW Measures along these lines would obviously need to take into
:EALAND HOUSEHOLD ACCOUNT THE GOVERNMENTS lSCAL POSITION !S THIS PAPER LATER
demonstrates, measures along these lines could be funded by
s )NCREASINGLY PEOPLE WILL HAVE INADEQUATE SAVINGS AVAILABLE TO
removing or reducing the up-front KiwiSaver incentives costing
FUND A COMFORTABLE RETIREMENT
MILLION PER ANNUM33 THE GOVERNMENT NOW PROVIDES 4HAT
New Zealand tax rules give rise to two problems in the savings would clearly have a lower impact on participation in KiwiSaver if it
area: they discourage savings, and they distort the way what were accompanied by measures that would make participation less
SAVING WE DO IS ALLOCATED )DEALLY BOTH SHOULD BE ADDRESSED VOLUNTARY )N ANY CASE THE CRITICAL NEED IS TO ESTABLISH A PATHWAY FOR
Chapter II focuses on the misallocation of saving away from REFORM AND TO IMPLEMENT THAT AS lSCAL CIRCUMSTANCES ALLOW
savings in financial assets that can be available to fund
33
"UDGET +ICK START MILLION AND +IWI3AVER 4AX #REDIT MILLION
www.fsc.org.nz PAGE 17The Impact on the Level of Savings 4HE 3AVINGS 7ORKING 'ROUP 2EPORT NOTED THAT AVAILABLE ECONOMIC
literature came to two tentative conclusions with respect to the
The need to address the tax treatment of savings is often seen
effect of reducing tax on savings to increase savings:
AS AN ISSUE RELEVANT TO OUR LEVEL OF RETIREMENT PROVISION )N PART
THAT IS THE CASE BUT IT IS ONLY PART OF THE STORY 4HE ISSUES RAISED “The first is that tax incentives increase retirement saving
in this paper need to be addressed not only as part of sensible MOSTLY BY REALLOCATING EXISTING SAVINGS 3ECONDLY WHILE THERE IS
retirement income policy but also if New Zealand is to meet our some evidence that tax incentives for retirement savings may
ECONOMIC EXPECTATIONS produce a small amount of new savings, the increase is lower
THAN SUPPORTERS OF TAX INCENTIVES OFTEN ADVOCATE (OWEVER TAX
!S THE &EBRUARY "USINESS 'ROWTH 0ROGRESS 2EPORT NOTED34
incentives may reduce the relative tax advantage of other classes
“New Zealand’s level of national savings has tended to be lower of investments (such as owner-occupied housing or investment
THAN OUR LEVEL OF INVESTMENT &OR SEVERAL DECADES WE HAVE [in rental accommodation] made for capital gain) and thus
supplemented national savings with foreign savings, which has IMPROVE THE OVERALL ALLOCATION OF SAVINGSv35
LED TO GROWING OFFSHORE DEBT )NCREASING NATIONAL SAVINGS AND
“For anything other than a revenue-neutral shift away from
reducing offshore debt will help make New Zealand more resilient
income tax, there is a high degree of uncertainty over whether or
to external shocks and will put downward pressure on interest
not cutting the tax rate on private saving alone will increase or
RATES AND THE EXCHANGE RATEv
DECREASE NATIONAL SAVING 4HUS DECISIONS ON WHETHER OR NOT TO CUT
“It is important that government policy settings provide New taxes on capital income should not be made primarily in terms of
:EALANDERS WITH THE RIGHT INCENTIVES TO SAVE 4HIS MEANS THEIR EFFECTS ON THE QUANTITY OF NATIONAL SAVINGSv 36
appropriate tax settings that do not discourage saving or distort
)N A JOINT 4REASURY)NLAND 2EVENUE 2EPORT OF 3EPTEMBER
how people save, as well as good information about investment
2012 officials considered whether changing tax settings could
PERFORMANCEv
lead to a material improvement in economic performance by
In short, current policy does not provide New Zealanders with improving efficiency, incentives to save and invest, and reduce
the right incentives to save but discourages and distorts saving MACROECONOMIC VULNERABILITIES 4HAT 2EPORT CONSIDERED A NUMBER
DECISIONS !S NOTED ABOVE THIS IMPACTS NOT ONLY ON RETIREMENT of tax reforms and recommended further work be undertaken
POLICY BUT ALSO MACRO ECONOMIC PERFORMANCE 4HIS IS TRUE EVEN on reducing personal income tax rates and on reforming the tax
under the assumption that our tax system will continue to be RULES FOR 0ORTFOLIO )NVESTMENT %NTITIES 4HIS IS IN LINE WITH OPTIONS
BASED ON A COMPREHENSIVE INCOME TAX AS THE NORM CANVASSED IN #HAPTER )))
A higher level of New Zealand savings, other things being equal,
can reasonably be expected to increase New Zealand’s economic
PERFORMANCE OVER TIME )T WOULD HAVE BROAD POSITIVE ECONOMIC
EFFECTS 4HESE WERE CANVASSED IN THE 2EPORT OF THE 3AVINGS
7ORKING 'ROUP &UNDAMENTALLY IF WE SAVE MORE TODAY
WE HAVE MORE TOMORROW BUT LESS TODAY
34
"USINESS 'ROWTH !GENDA 0ROGRESS 2EPORT &EBRUARY PAGE 35 0AGE 36 0AGE 4AXATION OF 3AVINGS AND )NVESTMENT )NCOME 4 OF 3EPTEMBER
PAGE 18 The tax barrier to retirement prosperity in New ZealandSavings and Retirement Income Provision s 2EDUCE OVERALL HOUSEHOLD SAVINGS IN THE ECONOMY ON THE BASIS
that retirement savings makes up a large part of household
.EW :EALANDS RETIREMENT INCOME PROVISION RESTS ON TWO PILLARS
SAVINGS ASIDE FROM HOME OWNERSHIP
First, NZ Super which is a moderate taxpayer funded pension
paid to everyone reaching a certain age (presently 65 years) and s 0LACE INCREASED lSCAL PRESSURE ON THE GOVERNMENT TO PROVIDE
MEETING CERTAIN RESIDENCY TESTS 4HE PENSION IS MODEST A MORE GENEROUS RETIREMENT INCOME THROUGH .: 3UPER
PER ANNUM GROSS FOR A SINGLE PERSON LIVING ALONE AND
The strategic issue is therefore to have all savings taxed to an equal
GROSS FOR A MARRIED COUPLE 4HIS lNANCES A MODEST RETIREMENT
extent but, if this is not possible, to remove or at least reduce tax
lifestyle lower than the expectations that most people have for
penalties on accumulating savings so that savings are not directed
their retirement and the pressure on future government finances
BY THE TAX SYSTEM AWAY FROM lNANCIAL INSTRUMENTS !CCUMULATING
MEANS THAT THIS IS UNLIKELY TO SIGNIlCANTLY INCREASE IN REAL TERMS
savings are long term savings that are re-invested within the
For New Zealanders to have more than this minimum retirement
instrument or the savings product so that savings grow through a
lifestyle they need to provide for themselves by saving to build up
COMBINATION OF CONTRIBUTIONS AND THE RETURN ON THE CAPITAL SAVED
capital that can be invested to produce a supplementary retirement
Accumulating savings also manifest themselves in the form of
INCOME 4HIS IS THE SECOND PILLAR OF OUR RETIREMENT INCOME PROVISION
directly held bonds, government stock, bank term deposits and
7HILE PEOPLE CAN BUILD UP A RETIREMENT FUND IN A NUMBER OF WAYS BANK ACCOUNTS 7HILE PEOPLE CAN HAVE VARIOUS OBJECTIVES FOR THEIR
(such as building up a business or buying and paying off a house) long term savings (purchase an expensive asset such as a house,
for the great majority of New Zealanders, the expectation is that start a business, precautionary savings and so forth) a normal
this will be by way of saving directly in financial assets (such as PURPOSE OF LONG TERM SAVINGS IS TO FUND RETIREMENT
shares or bank deposits) or using one of the products provided by
An individual’s retirement savings needs to replace working income
THE lNANCIAL SERVICES INDUSTRY AND IN PARTICULAR A +IWI3AVER FUND
and therefore is, of necessity, a large sum relative to annual working
In most other countries with a developed income tax, retirement
INCOME 4HUS A SUCCESSFUL RETIREMENT SAVINGS SCHEME INVOLVES
SAVINGS FUNDS RECEIVE VERY GENEROUS INCOME TAX CONCESSIONS
saving over a large part of a person’s working life gradually building
'ENERALLY CONTRIBUTIONS INTO RETIREMENT SAVINGS CAN BE PAID FROM
up savings out of contributions and investment returns over a
pre-tax income, the fund earnings can accumulate tax-free, and
LIFETIME )N THIS SCENARIO THE ULTIMATE LEVEL OF A PERSONS RETIREMENT
tax is deferred until savings are paid out in retirement as a pension
savings will be determined predominantly by the fund’s investment
AN %%4 REGIME 4HAT IS NOT THE CASE IN .EW :EALAND 3INCE
RETURNS RATHER THAN THE ACTUAL CONTRIBUTIONS MADE 4HE 3AVINGS
our general rule has been that contributions to retirement savings
7ORKING 'ROUP IN ITS &INAL 2EPORT38 quoted the example of a 35
should be made out of after-tax income, the fund should be taxable
year old worker who saves a fixed percentage of an increasing
as and when income is received or accrues, and payments out of
payroll stream until retirement at age 65, and then draws down
THE FUND AS A LUMP SUM OR PENSION SHOULD BE TAX FREE 4HIS IS A
AN INFLATION INDEXED PENSION UNTIL AGE 5SING REASONABLE
NON CONCESSIONARY INCOME TAX REGIME n A 44% SYSTEM
assumptions with no tax on investment income it is calculated
This is a long-standing New Zealand tax policy position and the that 90% of retirement income is generated by compounding
merits or demerits of our unique approach to the taxation of INVESTMENT INCOME AND ONLY FROM ACTUAL CONTRIBUTIONS MADE39
RETIREMENT SAVINGS ARE NOT ARGUED HERE (OWEVER THIS DOES PLACE
The retirement income that a person can expect to be generated
considerable importance on ensuring that the tax system, while
from KiwiSaver or similar savings is therefore largely going to be
not providing concessions for retirement savings, does not go
FROM THE COMPOUNDING INCOME THE SCHEME GENERATES 4AXING THIS
beyond that and penalise retirement savings or distort decisions
compounding income substantially reduces the source of 90% of
BETWEEN DIFFERENT FORMS OF SAVINGS )F SUCH SAVINGS ARE PENALISED
EXPECTED RETIREMENT INCOME
this is likely to:
This simply reflects the importance of compounding interest
s #REATE A DISINCENTIVE TO SAVE FOR RETIREMENT SINCE PEOPLE COULD
IN BUILDING UP A SUBSTANTIAL FUND OF SAVINGS OVER TIME 4HIS IS
then gain a greater benefit from doing something else that is
DEMONSTRATED IN THE FOLLOWING GRAPH 4HIS SHOWS HOW AN INITIAL
NOT SO TAX PENALISED INCLUDING SPENDING MORE AND SAVING LESS
$100 deposit grows over 50 years to $1,842 if untaxed, $1,319 if
s 2EDUCE THE FUNDS MOST PEOPLE HAVE FOR THEIR RETIREMENT ON THE TAXED ONLY WHEN WITHDRAWN AND ONLY IF TAXED ANNUALLY ON AN
basis that, except for very high income earners, people save ACCRUAL BASIS )N OTHER WORDS IN THIS EXAMPLE TAXING THE DEPOSIT
for retirement out of money not needed for day to day living earnings reduces its value to the saver by about one third if taxed
COSTS 4HEY MAY NOT BE IN A POSITION TO INCREASE SAVINGS TO only at the end of the 50 years but taxing those earnings as they
COMPENSATE FOR A LOWER AFTER TAX RETURN FROM THOSE SAVINGS ACCRUE YEAR BY YEAR REDUCES THE SAVINGS BY
38
3AVINGS 7ORKING 'ROUP REPORTED IN *ANUARY 39 3AVINGS 7ORKING 'ROUP 2EPORT PAGE
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