How do we fairly tax the rich?

The holes in New Zealand’s income tax net become more apparent by the day. When it comes to the several hundred Kiwis with fortunes of more than $50 million, nearly half of them – according to IRD research – pay a lower tax rate than minimum-wage workers.

They take much of their income as untaxed capital gains, or find other means to avoid or evade making a larger contribution to the public purse.

At least one-third of those fortunes, my own analysis suggests, are being handed on to the next generation. Those inheritances are income, just in a lumpier, more irregular form than conventional salaries. Yet those lucky few will pay no tax on that income, as New Zealand – unlike many other countries – has no inheritance tax.

Further down the ladder, a similar unfairness applies. People who sell properties after the brightline test expires pay no tax on their income, while salaryearners pay it on every cent. Inheritances increasingly allow some young people to buy houses while others languish, propertyless.

Both capital gains and inheritances, of course, are good in and of themselves; the problem is simply that not all income is being taxed equally. Every fortune has been generated partly by drawing on a common pool of resources – public roads, schools, ultrafast broadband, other infrastructure – and tax is an essential way to replenish that pool.

For this reason, a landmark 2018 OECD report recommended that countries levy both a capital gains tax and an inheritance tax. Both can be designed to exempt smaller amounts of income, enhancing their fairness and political feasibility. Some capital gains taxes exempt the family home, or the first few hundred thousand dollars of its value.

Ireland’s lifetime inheritance levy, meanwhile, allows people to receive gifts of up to NZ$540,000 tax-free, but taxes all subsequent inheritances they receive. The revenues can then be used to compensate those unlucky enough not to inherit. The focus on taxing the receiver of the income, rather than the giver, makes it harder to avoid than New Zealand’s old estate tax, scrapped in 1992.

Alternatively, the OECD report found, countries can deploy a wealth tax: an annual levy on the largest fortunes – those of more than, say, $2m or $5m in New Zealand. This effectively taxes the above flows of income once they have accumulated as wealth.

This requires upper-end wealth, including family businesses, to be valued annually, making it slightly more complex than levies that, like a capital gains tax, are applied when a sale has already been made. But Switzerland has a wealth tax, and raises several billion euros a year from it.

Some would argue New Zealand’s rich would simply head offshore. But where would they go?

Both capital gains and inheritances, of course, are good in and of themselves; the problem is simply that not all income is being taxed equally.

Australia, with its capital gains tax? Britain, with its inheritance tax? The United States, with its capital gains tax and its inheritance tax? In all these places, New Zealand’s well-off would also pay higher tax rates on their standard salaries – 45% in Australia, for instance.

Wealthy people are less mobile than we think. In America, where each state levies its own income tax, research shows multimillionaires do not move to the states with the lowest rates. Despite its wealth tax, Switzerland has not been suddenly abandoned by its billionaires. Family ties, a country’s ability to ensure peace and order, and the quality of its infrastructure all hold people in place.

The wealthy might still move not their physical selves but their assets, hiding them in the Bahamas and other secrecy states (or tax havens, as they were formerly called). Countries’ inability to track and seize the assets of Russian oligarchs shows the success of such contemptible methods.

But that failure will only further spur the decades-long growth of automatic exchanges of information, in which tax authorities provide their foreign counterparts with details of the income and wealth held in their country by overseas residents. The international community is slowly repairing its tax net. New Zealand should do likewise.