Taxation in New Zealand

After a severe and protracted economic crisis in the late 1970s and early 1980s, New Zealand radically reformed its tax and banking systems, while also reducing regulation and protectionism, and liberalizing free trade. The results are impressive; the Heritage Foundation’s 2010 survey ranked New Zealand fourth in the world for economic freedom.The New Zealand government also had a tax surplus from 1994 to 2008.

New Zealand does not have capital gains or inheritance taxes. Interest and dividends are taxed as regular income. For individuals, very few expenses are deductible. For example, you cannot deduct mortgage interest or capital losses. The income tax form is short in comparison to the equivalent forms in the United States; for 2010 it consists of forty one “lines.” Property taxes (called “rates”) are low, and apply only to land, not to improvements or other forms of business property. Local city councils collect and spend rates.

[[MORE]]If you make a living working in a certain field, then New Zealand does not consider earnings from that work to be capital gains. For example, if you trade stocks for a living, then those gains would be taxable, whereas if you only make occasional investments in stocks while having a job in another field, then they would not be, nor would losses be deductible.

There are four personal income tax rate brackets. The rates for 2009 ranged from 12.5 to 38 percent, with the maximum rate applied to earnings over NZ$70,000. The rates declined slightly in 2010, and now range from 10.5 to 33 percent. You can claim a credit for income under NZ$9,880, with the effect that if you earn less than that, you will not owe any income tax. Seventy five percent of New Zealand residents are in the intermediate 17.5 percent bracket (up to NZ$48,000). The corporate tax rate is a flat 30 percent, and will be decreasing to 28 percent in 2011.

New Zealand bases personal income taxes on individual income only; there are no “joint” returns or brackets. As an example, assume a husband works and his wife stays at home and they have a joint savings account. The husband will owe tax on his earned income plus half of the interest income. His wife will owe tax only on half of the interest income, potentially at a much lower rate than her husband will.

Employers deduct most income taxes at the source, through the pay as you earn (PAYE) program. Banks and other financial institutions deduct taxes from interest and dividend payments through the resident withholding tax (RWT) program. One way that PAYE differs from RWT is that PAYE includes an additional 2% fee for no-fault accident insurance (ACC). Although New Zealand has a publicly funded healthcare system, people injured in an accident can receive additional benefits, such as physical therapy or compensation for lost wages.

One advantage of New Zealand’s approach to income taxes compared to the United States is that the end-to-end system is reasonably comprehensible by the public. It is possible to estimate accurately the impact of changes in income or tax rates on yourself as well as others. This helps facilitate better economic planning, which is important for a well-functioning economy. If you cannot plan, or if your planning is error prone, it is easy to make a wide variety of financial mistakes. For example, you might end up with a level of debt you cannot afford to service, or you might unnecessarily defer the purchase of assets that you could have put to good use.

The motivation for not taxing capital gains stems in part from a respect for property rights, as well as from a desire to limit the benefits government receives from inflation. When capital gains are taxable, inflation alone can cause a nominal gain, even when there is a loss of purchasing power. For example, if you buy an asset for $1,000, and after one year without inflation, you sell the asset for $900, you would have a $100 capital loss. Now assume that there is 20 percent per year inflation. The sales price would be $1,080; you would have an $80 capital gain, even though there is a loss in constant dollar terms. Inflation plus a capital gains tax will amplify your losses (and your gains) compared to depreciation alone.

New Zealand has a national sales tax called the goods and services tax (GST). Items that you purchase overseas and import into the country are also subject to GST, with a NZ$50 minimum threshold per transaction. Instead of the government providing exemptions for companies and individuals who collect GST on the goods and services they sell, those entities file periodic GST returns where they can claim a credit for GST they have paid. If they pay more in GST than they collect, they receive a refund.

Only a few goods and services are exempt from GST, such as donations to non-profits, which they then sell, financial services such as bank fees, and rent for a residential dwelling. The most interesting exemptions are for fine gold, silver and platinum. The combination of no capital gains tax and no GST has the potential of enabling a form of penalty-free trading using precious metals as money, although such a market has not yet materialized.

The GST tax rate started out at 10% when New Zealand introduced it in 1986; it went up later to 12.5 percent. As part of the legislative package that decreased income tax rates in 2010, GST increased from 12.5 to 15 percent.

In addition to GST, the government also imposes excise taxes (duties) on a number of imported items, including alcohol, tobacco, fuels, carpets, footwear, hats, apparel, bedding, cosmetics, amplifiers, and so on. Typical rates vary from 5 to 10 percent of cost.

A duty used to be payable on gifts over a certain amount. The government has decided to eliminate that tax in 2011, largely due to the high cost of administration compared with the relatively small revenue that was taken in. As a result, gifts of any size are now tax-free. This change also fits with not having an inheritance tax; the idea is that you pay taxes only when you earn the money, not when you give it away, either voluntarily or upon death.

The government raises roughly 45 percent of its total revenue from individual income taxes, and about 20 percent from GST. Corporate taxes, duties, investment income and other taxes make up the remainder.

New Zealand’s central bank is the Reserve Bank of New Zealand (RBNZ). The government restructured the RBNZ charter in 1989, in the aftermath of the financial crisis in the early 1980s. The law under which the government chartered the bank defines its primary function as providing stability in the general level of prices. New Zealand was the first country to adopt a formal inflation target. Unlike the Federal Reserve, the RBNZ charter does not include managing the level of employment or other aspects of the economy. New Zealand does not provide FDIC-like bank deposit insurance, whether through RBNZ or otherwise.

The combination of not allowing mortgage interest to be deductible, having a central bank focused on controlling inflation, and a lack of bank deposit insurance superficially discourages debt and inflation. Even so, it was not enough to prevent the country from having a modest real estate bubble; prices have roughly doubled over the last ten years.

Having lived with the New Zealand tax system since moving here from the United States four years ago, overall I find it to be a breath of fresh air. Eventually, I would like to see the country move to a more limited government that is entirely funded by voluntary fees. The purpose of government should be to protect our rights. Taxation requires force or the threat of force to enforce it. As a result, through this implicit or explicit force, government is violating our rights. This puts government in a constant state of both internal and external conflict: “violating your rights in order to protect them.”

In the near term, on the path to a voluntarily funded government, there are many things New Zealand could do, in addition to the often suggested “cut spending and taxes.” To encourage saving, which helps minimize the true cost of capital, I would like to see taxes on interest income eliminated. To help reverse the decline in domestic industrial growth, the government could reduce personal and corporate income taxes, and offset the revenue loss with an increase in import duties. Import duties are potentially avoidable, so they are a more moral option than income taxes. Import duties could also be made uniform, so they do not damage or benefit one industry more than another.