The New Zealand tax system is unfair and creates the wrong incentives for investment, particularly in the property sector, says Treasury Secretary John Whitehead.
In a speech to the New Zealand Institute of Managers, Whitehead said the department thinks the tax system is unfairly weighted towards property investors because of the way property is treated for tax purposes.
He said the government needs to stop the tax system creating the wrong incentives, such as losses made through property investment offset against income, as it was encouraging investment in a class that typically made losses rather than profit.
"By illustration, 1996 was the last year that more people made profits than losses from rental properties and there were 115,000 private rentals (according to Inland Revenue Department data), yet the number of private rental properties has very significantly increased since then."
Whitehead questioned why an increasing number of people invest billions of dollars collectively in an area that was unprofitable, saying "it's hard to believe it's not because of some of the tax advantages".
He said tax advantages included the ability to claim depreciation on investment properties - even when most real estate was significantly increasing in value; the ability to deduct tax losses on property against other income; and the fact that if a rental property is sold, the capital gain made, if any, is usually untaxed.
"Across the board, our tax system would benefit from a stricter application of economic principles to the design and implementation of taxes - examples the TWG [Tax Working Group] gave in this area were depreciation and thin capitalisation rules," Whitehead said.
TWG suggestions to remedy the imbalance in the tax system, which are expected to be confirmed in the Budget, include ring fencing property income and losses, and scrapping depreciation allowances on buildings whose value increases.
Last month Finance Minister Bill English said the Victoria University-led Tax Working Group (TWG) over-estimated how much tax could be garnered from the property investment sector and also the amount of money invested in the sector overall, making the Budget tax package more difficult to write.
Those statements have led to speculation that the government will attempt some of the more difficult measures to police, including income ring-fencing, a policy known to concen tax officials because of further distortions such rules can create for other classes of investment.