Polity: What tax would Warren Buffet pay in New Zealand?

Some commentary on my post yesterday about tax rates suggested that, while New Zealand has relatively low headline tax rates for top earners, the various exemptions that people can claim in other countries mean we actually tax top earners more heavily. The famous example cited was Warren Buffet, the billionaire investor who has access to enough tax exemptions that he pays a lower tax rate than his secretary.

I think this critique is wrong for two reasons, one very simple and the other a bit more involved.

Wage earners

First, there a good percentage of top earners in all countries earn most of their money through wages. Top public servants, Ministers, senior staff in big corporates, and so on. For those people, the headline rates really are what we should look at, because most of the exemptions overseas do not apply to wage income.

Earners from capital

Second, and more involved, what kind of tax rate would a person who does a lot of investing pay in New Zealand? And how does that compare to Warren Buffet’s tax rate in the US?

The key point is that capital gains are currently not taxed at all in New Zealand. Unless, that is, the IRD thinks you purchased your assets with the intention of reselling them for profit. In practice, this mind-reading clause is not often used by the IRD, which means the super rich can mostly make capital gain returns on housing¹, shares, and the like without paying any tax at all.

But investors in equities will often also receive some dividends, which are taxable. So how does it all shake out?

Consider a very rich person who has $10 million in assets. If they invest that in the share market, their capital growth rate is likely to be around 5% in an average year, which is $500,000. They may choose to take that gain as cash by selling some shares, or keep it in shares for later use. For these purposes it does not matter. Whenever they realize these gains, it will be tax free, whether it is $500,000 every year, or nothing for three years then $2,000,000 in year four.

They will also likely collect dividends that are worth a bit less, somewhere around 2.5% of their portfolio a year based on long term average payout rates. That would be $250,000 in income in our example, and that money can be taxed.

Under New Zealand tax rates, the total tax on that dividend income is $73,420, or 29.4% of the dividends²But as a percentage of the total income (capital gains plus dividends), that $73,420 plummets to just 9.8%.

And there you have it. A Warren Buffet-style character in New Zealand would likely pay less than 10% in tax. Even in the USA Warren Buffet pays 17.4% in federal income tax.

That is the kind of absolute outrage you invite when you do not have a capital gains tax.

1. Unless they are a professional property developer, which most are not
   
   
2. This estimate uses ordinary income tax rates, because the company tax paid on the pre-dividend corporate profit can be offset against personal tax liability using imputation credits. So in technical terms, the investor would be voted $250,000 in pre-tax dividends, and some of the tax taken out would be company tax, the rest personal income tax, leaving the investor with $250,000 – $73,420 = $176,580 in the bank.