Taxation of Savings and Investment

Matt Benge Seminar: Department of Commercial

Law, Auckland University 7/03/2014

Taxation of Savings and Investment Review

In 2012 Treasury and Inland Revenue undertook “Taxation of Savings and Investment Review.”

Full report:http://goo.gl/MjbbzR .

Report results of CGE modelling but many of most important issues cannot be modelled easily.

Taxation of savings and investment

Savings and investment review looked at the impacts of different tax changes.

Responds to the Minister of Finance’s question of whether there are substantial benefits to further tax reform.

Treasury commissioned D&Z model to help answer these questions.

Important with any reform that the tax system remains coherent.

Framework questions

Is a cut to the company tax rate efficient (i.e. good for welfare)?

What tax cut is most efficient (i.e. best for welfare)?

Is an income tax cut that is limited to domestic savings efficient (i.e. good for welfare)?

Main Tax Changes Examined

Cut in company rate.

Cut in all personal income tax rates.

Cut in tax on interest income.

Dual income tax.

Allowance for corporate equity.

Results

Company tax rates - trends

Company tax rates

Theory 1 – under certain assumptions company tax on inbound equity: – borne by NZers not foreign residents; – results in higher cost of capital for NZ firms; – reduces capital and labour productivity; – is passed onto domestic labour (less efficient than

direct tax on labour).

Theory 2 – reducing company tax on inbound equity = windfall loss to NZ due to: – less than perfectly elastic capital; – presence of location-specific economic rents.

Company tax cuts - results

Cut to the company tax cut results in increase in GDP but welfare loss: – Cutting company rate increases foreign investment,

capital stock and GDP;

– But NZ loses more income from giving up tax revenue to non-residents than it gains from higher GDP;

– Company tax not fully borne by NZers;

– Replacement taxes are likely to be;

– Imputation system means little increased investment incentives for NZ-owned companies.

What’s the best tax to cut

Answer –personal income tax – why? – Benefits largely accrue to NZ residents;

– Increase incentives for NZ residents to save and invest;

– Increased work incentives.

Also – cutting income tax rates on interest income for NZ residents is good for welfare – why?

Savings Taxed on TTE Basis

Currently: – contributions to a savings account are out of taxed

income (the first T);

– as funds accumulate in a savings account the accumulation is taxed (the middle T);

– withdrawals from an account are not taxed or exempt (the final E).

Tax on middle T distorts savings decisions – in some models particularly distorting; – at the same time allows income tax rates to be

lower than otherwise.

Effect of taxing middle ‘T’ on long-term saving

Wage tax, GST and income tax

Year 0 Year 1 % extra cons

No Tax 100 110 10%

Wage Tax 80 88 10%

GST 80 88 10%

Income Tax 80 86.4 8%

Taxes and savings incentives

While a general income tax reduces incentives to save, a wage tax or a GST would not.

Wage tax and GST are very similar.

Some qualifications: – possible differences between GST and wage tax if

bequests;

– GST when introduced lowers value of existing wealth (lump-sum tax on existing wealth).

Cutting income tax rates and boosting GST is another way of cutting tax on interest.

Key conclusions Supportive of keeping with current broad-based,

low rate approach (keeping tax rates broad and tax rates as low as possible consistent with a government’s equity objectives): – within this framework general personal income tax cuts

are most beneficial.

ACE and dual tax systems do not appear advantageous, nor does indexing the tax base: – Recommend these be taken off the agenda in the

medium term.

Future work should therefore be focused on refining BBLR approach.