TLDR: The Labour Government back-flipped on its plan to apply GST to KiwiSaver fees in spectacular fashion yesterday. A closer look at how and why it happened shows how completely the original sin of Labour’s failure in 1989 to introduce a Capital Gains Tax has polluted our political economy, and ultimately, our society.
A one-day epic tax fail and the 33-year-long epic tax fail behind it (and everything else)
This sixth Labour Government’s embarrassing and politically damaging backflip yesterday on Tuesday’s plan to extend GST to all fund managers’ fees was an epic fail from all angles, but it was only a short-term one.
The real tax failure highlighted by yesterday’s dramas was a much longer-term and much more damaging one for our economy and society: the failure of the fourth Labour Government in 1989 to complete its ‘pure’ redesign of a comprehensive ‘broad-based and low-rate’ tax net to include capital gains or land wealth in any form.
Revenue Minister David Parker’s awkward mea culpa news conference at 1.45 pm yesterday with multiple caveats of blame tossed around (full quotes in all their squirming detail below) served only to emphasise the mess our political economy is now in because of that failure by the last dry Labour policy-wonk-David. It was then-Finance Minister David Caygill inability in the dying days of that Government to complete the pure trifecta of a simple exception-free income tax, a comprehensive value added tax and a capital gains tax, that led to this contortion, which is just the latest of many to try to rectify that failure in a politically acceptable way.
Failing to complete the capital gains leg of that trifecta has changed Aotearoa-NZ in a fundamental and negative way. And now that failure is piling up the political pressure to further pollute the purity and effectiveness of the other two legs.
It is the biggest ‘if only’ in our political history. If only Caygill’s proposal from December 19, 1989 at been implemented, we would be living in a different place now. It created the conditions for our brutally expensive housing market, which now dominates our political landscape, is a major factor in our child poverty, health and education crises, and is holding back our attempts to get to carbon zero.
It was the missing link that would have made our income tax and GST systems sustainable, and removed the tax advantages in leveraged residential land investment that has screwed the scrum of our banking system, dramatically widened inequality and has embedded over $1t in wealth into the minds of voting-home-owners that centrist politicians must now win over to win or retain power.
But first things first.
The short-term epic fail
David Parker denied yesterday that the Labour Government tried to ‘sneak through’ a $225m tax increase by extending GST to fall funds management fees, but the optics did look plenty sneaky.
The initial announcement from Parker early on Tuesday afternoon didn’t even mention the GST change, even though the extra tax raised was five times that of the other main measure and the FMA had warned it would reduce KiwiSaver and other savings by over $163b by 2070. His explanation yesterday was that IRD had checked with a few fund managers, who didn’t seem that concerned, with some opposed and some in favour. The unspoken implication is that the Government hoped it would go through to the keeper, or bizarrely, that big and small fund managers would come out in support of it and the Opposition or media wouldn’t notice or care that much. Whatever the case, it blew up in the Government’s face spectacularly.
The detail about the extra taxes were on page 95 of the bill’s 225-page commentary and the detail about the potential loss of $163b in lost savings was on page 10 of the IRD’s 19-page Regulatory Impact Statement. Here’s the full suite of documents via IRD’s very useful and not-well-trafficked Tax Policy website.
The NZ Herald’s Thomas Coughlan and Stuff’s Rob Stock both reported those key details later on Tuesday afternoon. I found them around 4.30pm. The NZ Herald-$$$’s ‘Government quietly introduces $103b tax on KiwiSaver’ headline caused all sorts of ructions in the afternoon, including attempts to get it taken down or changed. The Herald doubled down with a banner ‘Tax Grab’ headline in the physical paper yesterday morning.
Parker defended the plan on RNZ’s Morning Report yesterday morning shortly after National Leader Christopher Luxon attacked it on Morning Report as a ‘retirement tax’ and a ‘wealth tax’ that he would repeal immediately.
Within an hour or two, Parker and Finance Minister Grant Robertson started talking about how to do a ‘reverse ferret’. In the end, it was a rapid and complete capitulation, as this announcement sent at 1.16pm makes clear.
I’m reproducing it here in full, if only because the explanation is the clearest about the problem the Government wanted to solve, and its justification for first going ahead with it, and then abandoning it within 24 hours.
Inland Revenue and Treasury advised this change be made to remove a loophole used by large financial companies, so they would have to align with how others in New Zealand pay GST.
The move would also have brought New Zealand fund managers more into line with the approach in Australia.
“Smaller fund management providers who were doing the right thing were at a competitive disadvantage compared to others, mostly larger providers, who were using the loophole,” David Parker said.
“Generally it’s bad to have these sorts of distortions in the tax system as bigger players can exploit them, but if the sector as a whole is happy to operate with the status quo then we will leave them in place.
“During extensive consultation views were mixed on the merits of the technical change. The large companies profiting from the current set-up were opposed to the change, while smaller providers were more supportive of the change. This was because these providers who did charge the full GST on their service fees faced unfair competition from the bigger players.
“However since the announcement it has become clear that smaller providers now oppose it too.
“It’s important to clear up some inaccurate representation of the proposal. New Zealanders’ KiwiSaver contributions and balances were not going to be taxed under this legislation. However it is clear from the reaction to this proposal that it has caused concern for Kiwis,” David Parker said.
“I am proud of Labour’s role in introducing KiwiSaver and its role in securing the future of New Zealanders. We will never do anything to undermine it.
“By contrast, National will not commit to keeping KiwiSaver in its current form, and cannot be trusted to support this important scheme. When last in Government National ditched the Kick-Start payment and introduced a tax on employer contributions,” David Parker said.
“Because of the importance of public confidence in KiwiSaver and the need to ensure nothing unduly affects New Zealanders’ willingness to save, the Government will not to go ahead with the proposal contained in the Taxation (Annual Rates for 2022–23, Platform Economy, and Remedial Matters) Bill.”
If only this explanation was made a day earlier? Yeah…nah.
The absence of this rationale from the original release is all the more glaring by its inclusion in the about-face statement.1
In theory, it all made perfect sense and is totally in line with the 30-plus year long quest of IRD and Treasury to design the perfect tax system, which is broad-based, low rate and free of awkward, time-consuming and unfair exceptions. That’s the basis for our current income and GST systems, which is among the world’s least-exception-ridden tax codes in the world.
Except for the biggest exceptions of them all:
capital gains were excluded from the income tax net, except for gains on financial market trading;
financial services such as mortgages, bank fees, credit card fees and life insurance are excluded from the GST net because GST on these were judged a tax on savings, rather than consumption; and,
residential rents are excluded from the net because that also would penalise renters vs owners, who were also in the position of effectively receiving a return on an asset, rather than consuming a service.
We built a perfect tax system, except for the exceptions that turned us into a housing market with bits tacked on, and which mean we have the least affordable housing the world, an endemic child poverty problem and we’re struggling to reduce our climate emissions.
And there is Aotearoa’s political economy and predicament in one sentence.
Sadly, perfect was much more than the enemy of the good in this case. Almost perfect just plain wrecked the good. For good.
The long-term epic fail
Roger Douglas, David Caygill, Geoffrey Palmer and Ruth Richardson were the driving political and legislative forces behind the tax reforms, resource management, public finance and labour law reforms that are now the bedrock of our economy and society. In many ways, their logic and intent was pure and good.
They reformed everything to get away from the all-encompassing morass of tax and industrial law that appeared to bog down the economy in a tangled mess of:
wage and price freezes to fight endemic inflation;
a fixed exchange rate that was bankrupting the nation;
import and export tariffs, controls and subsidies designed to reward farmers and punish consumers to attain trade surpluses;
nationally arbitrated and set wages and conditions to bolster the power of workers at the expense of industrial firms’ profits; and,
a tax code designed to enhance the wealth of the connected and their accountants and advisers, rather than improve the health of the Crown’s finances.
They decided to rewrite the tax code in a ‘broad-based, low rate and neutral way’ to:
lower and simplify personal income taxes by cutting the top tax rate from 66% to first 48% in 1988 and then 33% in 1989 (with just two rates of 33% above $30,000 and 24% below that);
create a value added tax of 10% in 1986 (subsequently lifted to 12.5% in 1989 and 15% in 2010);
removing tax subsidies for savings into pension funds between 1987 and 1990; and,
lowering the corporate income tax rate from 48% to 28% in 1988 (subsequently lifted back to 33% in 1989, cut to 30% in 2008 and then 28% in 2011);
But these were all ultimately reliant on introducing a capital gains tax to fill out the landscape completely, as Caygill pointed out in December, 1989:
“As the Consultative document points out, investments which are not attractive in their own right can be attractive merely because the income they produce is untaxed.
“The tax exemption therefore encourages investment in areas offering low pre-tax returns.
“On that basis, and on the basis that the advantage of existing concessions is greatest for those with most wealth, it is both efficient and fair to include currently untaxed income in taxable income.” Then-Labour Finance Minister David Caygill in his December 19, 1989 speech.
The third leg was just left hanging (with a few nudges)
The rest is history. Labour lost the 1990 election and never got the chance to introduce it. National didn’t introduce one and both National and Labour have been trying to directly or tangentially fill the hole ever since. Meanwhile, home-owning voters, savers, investors, businesses and the whole economy more broadly has been sniffing out the hole and piling into it with a passion. Renters can only stare into the edges of the abyss as it recedes into the distance with their dreams of bringing up families in their own secure and healthy homes.
National won the 2011 and 2014 elections, at least partly, by campaigning against Labour’s plans for a CGT beyond the family home, but even it introduced the ‘bright line’ test for taxable capital gains on property trading by landlords in 2015 to try to squeeze the hole a bit. Labour extended National’s two-year test to five years in 2018 and then ten years in 2021 in what was a politically adept move to squeeze the hole down a bit more.
Also in an attempt to fill the hole from a distance and at an angle, the current Labour Government has tried to throw sand and mud into the gears2 of home owners using their untaxed and leveraged home equity to buy ever more rental properties. It has done that by ring-fencing rental property losses from other income (2019) and removing interest as a deductible expense for tax purposes for residential landlords.
All of these ‘fixes’ are a long way from the pure and simple model laid out in the 1980s. They create confusion, break basic principles of taxation and create ‘grey areas’ and boundary issues all over the place.
No wonder the tax geeks in IRD and Treasury jumped at the chance to do something ‘pure’ by removing some of the confusion about whether funds management fees were eligible for GST or not. Some used to be. Most weren’t. Now all aren’t. That’ll learn them.
And then there’s the awfulness of WFF and AS
Meanwhile, the politics of imposing capital gains taxes got ever tougher as the leveraged and tax-free gains got ever larger and harder to give up. That led to increasingly expensive, difficult to build and unhealthy housing. That creation of housing as the preferred investment class (along with other factors driven by the low-tax and low-investment structure of Government created in these reforms meaning housing supply was restrained by infrastructure investment droughts) have made it politically impossible to achieve a capital gains tax.
So other ways to help those struggling with housing costs were dreamed up and delivered via the income tax and welfare systems. Working For Families (WFF) was created as a rebate scheme to help low-to-middle income earners with children cope with high housing costs and low wages, both of which were driven by low public and private investment in infrastructure and business technology (because any surpluses were being ploughed into land values).
Now WFF has created an income tax system pocked with the most awful ulcers of marginal tax rates nearing 100% at points. The Accommodation Supplement (AS) along with emergency housing costs and emergency benefit costs, are now approaching $4b a year. That would be more than enough to service $100b of debt to build half a million homes.
All because we couldn’t get a capital gains tax across the line 32 years ago. Now that was an epic and long-term tax fail.
A post script on David Parker’s train-wreck standup
I like David Parker. He’s a policy wonk with a long-term vision to fill the hole I’ve written about above. He is playing the ultimate long game, which you have to admire in this world of 24 minute news cycles around games of political optics, ‘rule-in, rule-out question lines and rule-by-focus-group in the interests of median voters.
But yesterday’s ‘stand-up’ on the tiles was one for the ages. A good politician walking in front of a bus, three tractors and an industrial hedge trimmer. I felt for him as I and others accelerated, reversed, and accelerated again just to feel the bumps.
Here’s the audio just to make your teeth grate.
And here’s the quotes I’ve transcribed for those who don’t like to grind their teeth.
'We didn't think it would be an issue'
Parker said the Government had expected funds would absorb much of the increase through lower profits, although IRD had advised otherwise.
Asked if all the $225m in extra taxes would be passed on to KiwiSavers, he said: "It depends what would be the competitive response to New Zealand fees. New Zealand fees are already higher than they are in Australia. Even though in Australia, they already have the GST treatment that we were proposing."
Asked why he had defended it this morning, but backtracked by midday, he said: "We weren't expecting the backlash that we've experienced against this."
He argued that was the reason it had not been included in the news release announcing the tax changes.
"It's one of the reasons why we're doing we were highlighting other issues like the reduction in fringe benefit tax, the changes to GST on Airbnb, and Uber. So this backlash has been a surprise to us based on the information that we had from Inland Revenue, which was that there was some providers that were in favour of the change."
Parker would not name which funds had supported it.
He denied the Government had tried to 'sneak it through.'
He was then asked about his blaming the media for the reaction.
"Well, one of the headlines, and one of the major newspapers said that this was a tax on KiwiSaver. So it gave people the impression that their KiwiSaver savings were going to be subject to GST, which was never the case. Now we are the parents of KiwiSaver. It's the other side that have undermined it by withdrawing tax credits and subsidies for fees etc. And we just weren't willing to put at risk the reputation of KiwiSaver," Parker said.
"I can blame the media and in respect of misrepresentative headlines which suggested that GST was going to be charged on KiwiSaver contributions and the funds that people have in KiwiSaver," he said.
Seriously. Dude. What were you thinking?
Asked if he had 'read the room wrong,' he said: "Maybe I shouldn't have been surprised at how well banks defend their profits. They're the owners of the big KiwiSaver firms."
He rejected the advice of both the IRD and FMA, who estimated it would reduce funds under management over time. The FMA estimated a reduction of over $160b in total by 2070.
"They've made no allowance for what would be the competitive response in an increasingly competitive KiwiSaver market," he said.
Parker also blamed the Opposition for putting KiwiSaver's reputation at risk.
"The reaction to the proposal has been overblown, and it's included assertions that it was a wealth tax...that was one of the assertions from one of the providers. Someone else said that it was going to be a tax on KiwiSaver, implying that it was a tax on KiwiSaver contributions. And that has been one of the reasons why people who have KiwiSaver accounts have been so alarmed.
"The effect on fees would have been far lower than the changes made to the KiwiSaver scheme by the prior government when they took away the tax contributions," he said.
Asked if it was the banks' fault for the reaction, he said: "They're the big winners today."
'We did it to save KiwiSaver's reputation'
Asked again why the Government had made the u-turn, he said:
"Because we thought that the reputation of KiwiSaver in the meantime was being besmirched in the way that undermine public confidence in it."
Asked if the u-turn was embarrassing, he said:
"We would obviously have preferred that the people that we thought were going to come out in support of this had.The fact that they haven't causes us to reverse our position. We think that's the right thing to do. Because we think that the furore around this was denting public confidence in KiwiSaver."
"There has been engagement with the the funds management sector before this proposal came out. And the feedback that I had from the Inland Revenue Department was that there were some in favour and some against."
So in summary:
the Government thought few in the public would notice or care;
and when the public did it was, it claims, because of fund manager, media and Opposition misrepresentations;
it thought the IRD and FMA were wrong in their advice about the likely taxes raised and the eventual reduction in funds saved;
it thought some small fund managers would support the plan (!); and,
then the Government had no choice but to reverse the policy to contain the damage from the misrepresentation.
An epic short term fail from a Labour policy wonk minister called David because of an even more epic long-term fail by a Labour policy wonk minister called David.
Both of whom I admire and respect, but sometimes disagree with.
Ka kite ano
BernardElsewhere in the news overnight and this morning:
Russia turned off its main gas pipeline to Europe gas completely for at least three days, adding impetus to European Union moves to break the connections between gas and electricity markets Reuters;
Europe’s inflation rate hit 9.1% in August and Britain’s inflation rate was forecast to rise as high as 22% early next year as the continent braces for a ‘Putin Recession’ in the northern winter months Reuters;
America’s jobs market showed some signs of cooling in a new measure of employment in August suggesting a mild recession in the world’s largest economy is possible late in 2022 CNBC; and,
China’s Covid lockdowns widened in both the southern factory areas of Shenzen and Guangzhou and north, adding to the risks of a recession in our largest trading partner Reuters.
I have had to consult a thesaurus for ways to describe the change without using ‘U-turn’, ‘flip-flop’, ‘back-track’ and ‘reversal’, which have been widely used elsewhere in the last 24 hours, along with ‘tax grab’, ‘tax grab’ and ‘tax grab’. In the end I went with ‘back-flip’, ‘reverse ferret’ and ‘about-face’. You’re welcome. $19 worth of work right there. :)
Or maybe that should be gearings… ;)
The anatomy of two tax failures