Tax change could alter investment behaviour

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If a recommended change to the way savings are taxed is introduced, more people could be tempted to invest in bonds and term deposits.

Wednesday, October 9th 2013, 5:29PM 2 Comments

by Susan Edmunds

The Retirement Commissioner, Diane Maxwell, has suggested that savers should not be taxed on the portion of interest they earn that is at or below the level of inflation.

She yesterday issued the 2013 Review of Retirement Income discussion document.

In it, Maxwell said the age of super eligibility should be increase in line with life expectancy, indexing the pension to the average change in consumer prices and wages, automatic KiwiSaver enrolment and removing the tax on the inflation component on simple savings products.

She said that would reduce the disincentive to save. “The most common complaint is that the incentives provided by taxation divert disproportionate amounts of money away from desirable activities such as saving and investing in the sharemarket into areas such as housing, particularly rental housing.”

She said a promising alternative to removing the incentives for excessive investment in housing would be to remove disincentives faced by the simplest savings products in the form of relatively high effective rates of tax.

“These high relative rates arise from a combination of factors, but the most unfair is taxing the inflation element of interest. In most circumstances, interest paid on savings is made up of two components: one due to inflation – this keeps the real value of the investment at par; and one due to real growth – this represents an actual increase in wealth. Taxing the inflation component contributes to the erosion of wealth and there is a case for this element to be removed.”

Peter Neilson, of the Financial Services Council, said it would make a big difference to investor behaviour. He said the inflation component of interest was not really income because it did not improve a person’s purchasing power. “You pay tax on income you don’t earn.”

Commentator Brian Gaynor said that had been especially galling for investors in the 1970s, when inflation was running at about 17% and interest rates were near the same level. Although their savings were barely keeping pace with rising prices, savers were taxed on their 17% income.

Neilson said if such a change were to be introduced, the Government would have to change the rules so that interest that was paid up to the level of inflation would also have to stop being tax deductible.

One of the reasons that property investment was appealing was that people could deduct the nominal value of interest below the level of inflation even though it was not a real economic cost.

The change would make bonds and KiwiSaver more attractive and rental property less, he said.

Neilson said his organisation was preparing a document that would be released on Monday that would discuss tax issues.

Gaynor said he doubted the changes would be introduced. “I’m not sure if it would change behaviour much… inflation at that level is unlikely to occur again, it’s the Reserve Bank’s job to keep it low. We’ve changed the whole way we manage inflation.”

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