A new idea at last

A quiet little comment slipped into a speech by Finance Minister Michael Cullen to an unlikely audience - the Ladies’ Probus Club of Cornwall Park in Auckland held in the Baptist Church, signals a major change for New Zealand's savings regime.

The comments, which Good Returns was first to report, relate to Cullen's enthusiasm for introducing a risk free rate of return (RFRM) method for taxing investments and shares.

The irony of his enthusiasm is that the idea was first floated last year by the McLeod review on tax that was generally panned by the Government (yet supported by the people on the political right). In the first draft of the report McLeod suggested using RFRM to tax equity in property investments, and this was, quite rightly, shot down in a screaming heap.

While no detailed work has been done on the implementing the RFRM basis, however it appears to be a simple solution that will solve many of the unfriendly tax issues that face New Zealand savers.

Under the RFRM model investors would pay tax on their assumed gains, which would be set at the so-called risk-free rate, as opposed to their real gains.

Say the risk-free rate of return was set at 4% then investors tax would be taxed on the basis that their capital at the start of the year generated 4% returns, no matter what happened to their money.

Any returns above 4% would essentially be tax free, however if they lost money during the year they would still have to pay tax, as opposed to the current situation where an investor would be entitled to a credit.

The final perspective, which is more political, is that Michael Cullen has again shown he is prepared to address savings issues in New Zealand, and where necessary look at new solutions to old problems.

National leader Bill English said if his party wins this year's election it would bring in tax incentives for savings (however he provided no details of how these would work).

Many experts do generally not favour tax incentives as they distort the economy and money tends to get allocated on a tax basis, not an economic one.

Also, much of the evidence says they don't work.

The supporters have recently said they are useful as they encourage people to save money, and that's OK even through the money is being invested for the wrong reasons.

There is now a clear point of difference between National and Labour in this area. National wants to use a failed policy from the past while Cullen's wants to try a more innovative and new solution to an age-old problem.

As the tax committee head Rob McLeod says, RFRM will be considered by many people to be a tax incentive. Under such a system the Government is likely to collect less tax revenue, therefore it follows that investor will pay less tax on their investments than they currently do.

Put more simply they get to keep more of their returns under an RFRM system.

It's a plus for them. It's also a plus as it irons out many of the complex tax issues (such as the FIF and CIC regime) which hamper New Zealand savers.

Cullen should be applauded for supporting a new idea that appears to be good for savers and the savings industry.

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