Findings of the High Wealth Individuals (HWI) research project, which was the “first cab off the rank” under new legislation enabling Inland Revenue (IR) to collect data and undertake research for tax policy purposes are expected to be announced by the end of this month.

The stated purpose of the research project was to fill a gap in IR knowledge about economic measures of income and effective tax rates of wealthy New Zealanders. Broadly, it aims to improve the body of evidence available to IR to assess the distributional impacts on and fairness of the New Zealand tax system. 

IR targeted a group of approximately 400 high wealth families for the research project based on existing operational information and intelligence. A high wealth family group is considered to have estimated wealth greater than $50m or $20m if other factors are present – control of a significant enterprise or significant property interests. 

Income measured over the 2016 – 2021 income years on an annual basis relative to the family unit (individual and partner, dependent children, 17 and under, living at home). Use of the family unit (as defined) should be broadly comparable to the household unit used in the Household Economic Survey. Treasury used the latter survey data in their parallel research project covering all other individual taxpayers.

However, it is important to note that income tax in New Zealand is levied on an individual taxpayer basis and that wealth and income are not always evenly distributed in the family unit. 

Effective tax rate dependent on measure of income used  

An effective tax rate measures tax paid relative to a measure of income. What is included or not included within the relevant income measure will significantly impact the stated effective tax rate. This seems obvious when spelled out but easy to get lost in the hype of the moment – many will be guilty by comparison of the results to the statutory tax rates. The problem with this is that our current tax base does not tax all gains or notions of economic income. 

IR’s HWI project included four separate base measures of income: 

Taxable income - Broadly the income taxpayers are currently taxed on with the addition of fringe benefits
Gross cash income - Taxable income + untaxed monetary receipts + untaxed realised capital gains + net gifts and windfalls (inheritances and other lump sum payments)
Comprehensive income - Gross cash income + accrued capital gains on assets not sold
Economic income - Comprehensive income + imputed rental income for owner-occupied property

Balance and perspective 

With all things being equal you would expect the effective tax rate to reduce as you progress along the continuum of income measures from taxable income to economic income. The amount of tax paid does not change in the context of the research project. The amount of tax potentially payable (ie what could be collected) if the income measure was extended is not considered here. The research findings when they come out are likely to reinforce this.

The narrative is important. The research findings should be interpreted in conjunction with those for the balance of taxpayers to provide balance and perspective. External factors impacting the research projects and key differences between them also need to be considered. Both have the potential to impact findings, even if at the margins.  

The IR HWI project used 2021 as its base year (income measured over a period of years from 2016 on an annual basis). The 2021 year reflected very high capital appreciation for residential housing as the “golden summer years” came to an end. The Treasury project covering everyone other than HWI used 2019 as its base year (where capital appreciation was not as pronounced).
Timing is everything. From the 2022 tax year there has been a significant reduction in residential property capital appreciation, partially unwinding unrealised capital gains attributed to the prior year(s). 

We should also acknowledge that “economic income” is far removed from our current taxation base for all taxpayers. This is a design issue, and not one of compliance.  A limited number of capital receipts are deemed to be income or gains taxable (and then typically only on a realisation basis), while sale of the family home will usually be exempt from the bright line test. New Zealand has also not embraced (attempted to tax as income) an imputed annual rental return on owner occupied residential property.  

Where to … 

The IR HWI and Treasury research project findings will provide a useful foundation of aggregated data to inform future tax policy direction. Given the constructs of our tax system and relevant political considerations the fruits of this research are likely to result in incremental change over time to provide the level of tax revenue required and ensure the long-term sustainability of the tax base.   
A reduction in effective tax rates when wider base measures of income are adopted is simply a reflection of the current boundaries placed on what should be taxed (and when that taxation should arise) to provide our tax base.  

When considering whether to broaden or vary our tax base, the key is that a holistic view of the tax system should be adopted, including who bears the tax burden and is that overall allocation appropriate.

Ad hoc change undermines both the integrity and coherence of our tax system. There is no better example of this than the much maligned and very complex brightline and interest limitation rules for residential property.