Tax Working Group Information Release Release Document September 2018 taxworkingroup.govt.nz/key-documents This paper contains advice that has been prepared by the Tax Working Group Secretariat for consideration by the Tax Working Group. The advice represents the preliminary views of the Secretariat and does not necessarily represent the views of the Group or the Government. Coversheet: Potential revenue-reducing options Position Paper for Session 14 of the Tax Working Group 19-20 July, 2018 Purpose of discussion Decide which, if any, revenue-reducing policies should be recommended in the interim report. Consider how to address the Group’s Terms of Reference with regard to promoting “the long- term sustainability and productivity of the economy” and “the right balance between supporting the productive economy and the speculative economy”. Key points for discussion We consider there are four key decisions for the Group: 1. What objectives does the Group wish to prioritise when considering revenue negative reform? 2. What specific measures does the Group wish to recommend within these objectives? 3. How does the Group wish to present these recommendations in its interim report? 4. How should the interim report address the role of tax in promoting “the right balance between supporting the productive economy and the speculative economy”? Recommended actions We recommend that you: a note there are a range of revenue-reducing tax policy options that could be funded from revenue-raising measures. b note that the analysis in this paper has been written on the basis that a capital gains tax is the most significant revenue-raising policy that the Group is currently considering. Social and human capital – progressivity and labour supply c note that transfers are generally more effective than tax changes in targeting the income adequacy of the lowest income households. d note that the following revenue-reducing option could support a distributional or social capital objective: a. increasing progressivity through income tax reductions (rates and/or thresholds) at the low-to-middle parts of the income distribution Financial/physical capital – productivity e note that the following revenue-reducing options (funded by base broadening) would likely have the greatest benefits for productivity: i. reductions in effective tax rates on business investment by reintroducing depreciation deductions for commercial, industrial, and multi-unit residential buildings; ii. reducing disincentives to take risk by reforming loss continuity rules; and iii. reductions in marginal tax rates on individual income. f note that the case for allowing depreciation deductions for buildings is greater if a capital gains tax is introduced. g note that there is international evidence that buildings depreciate and that this evidence is strongest for industrial and commercial buildings. h note that inflation indexation of interest income, interest expenses, depreciation and inventory would be a significant reform that could have efficiency benefits, but would need considerable further work to fully assess its benefits and costs. i note that the Group has previously agreed to recommend the following revenue-reducing measures to support retirement saving: i. providing an exemption from employer superannuation contribution tax (ESCT) for employer contributions to KiwiSaver for employees with income of less than $48,000; and ii. reduce KiwiSaver PIE rates for lower tax rates by five percentage points. Natural capital – supporting just transitions j note that the Group has previously agreed to recommend that environmental tax revenues should be recycled to support just transitions and enhance natural capital. Reducing taxes on future generations k note that, as an alternative approach, the government could save additional revenues to enable lower taxes on future generations (eg, investing additional tax revenues in the New Zealand Superannuation Fund). Interim report l indicate which of the below revenue-reducing options should be recommended in the interim report: Income tax and GST rate and threshold changes i. Reduce income tax rates and/or increase income tax thresholds ii. Annually adjust income tax thresholds for inflation iii. Decrease GST rate Business tax and savings changes iv. Reintroduce depreciation deductions for commercial, industrial, and multi-unit residential buildings v. Relax loss continuity provisions to allow losses to be carried forward in more circumstances vi. Inflation index the tax system (interest income, expenses, capital assets, depreciation and inventory) vii. CAANZ proposal for overhaul of small business taxation (turnover tax and cashflow based tax) viii. Other compliance cost reductions ix. Accelerated depreciation including expensing for equipment x. Reduce company tax rate Reducing taxes on future generations xi. Save revenue from a capital gains tax to reduce taxes on future generations (eg, by investing revenues in the New Zealand Superannuation Fund). m agree that if the Group recommends a capital gains tax to also recommend reform of the treatment of black-hole expenditure to allow it to be deductible over time and consider removal of loss ring-fencing for rental properties. n indicate how the Group would like to address the Group’s Terms of Reference with regard to promoting “the long-term sustainability and productivity of the economy” and “the right balance between supporting the productive economy and the speculative economy”. Potential revenue-reducing options Position Paper for Session 14 of the Tax Working Group July 2018 Prepared by the Inland Revenue Department and the New Zealand Treasury TABLE OF CONTENTS Executive Summary 7 1. Introduction 10 1.1 Purpose 10 1.2 Content and scope 10 2. Fiscal context 12 2.1 Capital gains tax revenue 13 3. Assessment framework 16 4. Summary table of options 16 5. Potential fiscally neutral packages of options 20 5.1 Options assessment 20 5.2 Illustrative options 20 Glossary 21 Executive Summary This paper provides advice on a range of potential tax changes with a negative fiscal impact. The Group requested analysis of this list of options at its meeting on 29 June. This advice is provided to support consideration of what proposals the Group wishes to recommend in its interim report. The scope for revenue-reducing options will depend on fiscal objectives and the combined impact of any tax measures on the fiscal outlook. The advice in this paper has been written on the basis that a capital gains tax is the most significant revenue-raising policy that the Group is currently considering. An illustrative fiscal projection is provided that is preliminary and subject to considerable uncertainty. There are trade-offs in choosing which revenue-reducing measures to pursue. The fiscal impact of many of the measures would mean that only some could be implemented within the Government’s fiscal objectives if the Group recommended a capital gains tax. As a result, the Group will need to prioritise its objectives. Given the gradual build up in additional revenue from a capital gains tax, consideration will also need to be given to the phasing of any revenue negative measures. There are choices regarding how to achieve different objectives. In some cases policies beyond the tax system, for example regulation, welfare transfers, or subsidies will be better options than tax policy for achieving specific public policy objectives. The Group will need to decide whether its recommendations to Government will be in the form of a set of independent recommendations, a recommended package of policies or multiple potential packages. Appendix A brings together material on productivity and the balance between the productive and speculative economies. Some of this material could be used in the interim report. The remaining appendices provide detailed assessments of the policy options considered. Some of the information provided in these papers, in particular the fiscal and distributional impacts should be considered preliminary and prepared for the purpose of discussion. If the Group wishes to recommend a specific option, the Secretariat will undertake further quality assurance of the impacts of that option. Improving social capital and human capital – Progressivity and labour supply Whether to recommend tax changes to support lower income households is a value judgement about how progressive the tax system should be and how much tax particular individuals should pay. The primary consideration for specific tax rate or threshold changes is whether these are the highest value measures for a given fiscal cost. Other tax 7 measures may be a higher priority, and there may be non-tax measures that are more effective than tax measures at achieving specific goals. The Secretariat considers that tax reductions are not well targeted towards providing support to households with persistently very low incomes and instead transfers would be more effective. One possible objective of tax reductions is to improve incomes of target low-middle income earners and at the same time provide additional benefits to labour supply, savings and productivity. If this is the objective the Secretariat considers the best tax measures available are likely to be increases in the first and second income tax thresholds or decreasing tax rates on the low-to-middle tax brackets (eg, the 17.5% rate). Taxes on future generations could be reduced through Government saving of additional tax revenue (e.g., by investing additional revenues into the New Zealand Superannuation Fund). In addition, the Group has previously agreed to revenue negative measures to support retirement saving of those low and middle incomes. Financial/physical capital - Productivity If the Group wishes to recommend changes to improve productivity, we recommend focusing on areas where effective tax rates for investment are higher than the statutory rate. We consider effective tax rates in these areas are currently likely resulting in efficient investments not being made by businesses and investors. Removing these distortions would have a double benefit of increasing investment as well as improving investment allocation. Potential measures include reinstating depreciation for commercial, industrial, and multi- unit residential buildings and the relaxation of loss-continuity rules. The case for allowing depreciation deductions is stronger if a capital gains tax is introduced. Income tax reductions that focus on reducing marginal tax rates, would also have positive impacts for productivity. However, the fiscal cost and regressive impact of this option may be of concern to the Group. In the longer-term, inflation indexing the tax system is a significant reform that could have positive efficiency benefits, however this option is complex and requires further assessment of its benefits and costs. A proposal for inflation indexation would require substantial policy work and is not feasible to be implemented in the short-term. If the Group wants to make recommendations regarding inflation indexation we would suggest the Group recommend the Government monitor international developments or undertake further work on the issue. 8 Natural capital – supporting just transitions The Group has previously agreed to recommend that environmental tax revenues should be recycled to enhance natural capital and support just transitions. We understand that Marjan van den Belt will report back to the Group at a later stage on this. 9