Tax-break cash in the bank?
Janine Starks | The Press | 7 May 2010

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"The Australians came up with an incredible idea this week." Uttering those words grates. But pat down the hackles, because it's an idea for a tax-break.

It wasn't any old tax-break either; it will have seen the Reserve Bank, Treasury and every banker on both sides of the Tasman scurrying for their calculators. If this one gets airtime in Australia it would put more than a little pressure on the New Zealand Government to do the same.

What is it? It's a proposal for a 40 per cent tax discount on interest earned on savings accounts. That's right, the Australian tax review, or the Henry Report as it's known, suggested those with bank deposits should get a big tax incentive. A 40 per cent discount is roughly like a 33 per cent taxpayer paying only 20 per cent tax on their deposit interest.

Ken Henry proposed 138 tax changes and this gem can be found at number 14 on the list. Banks would be thrown a funding lifeline as deposits flooded their doors and savers would be in for a nice perk. Forbid the thought, but it might even keep a lid on the property market as a few cash up and head for tax incentives at the bank. Would we ever consider doing the same?

While our neighbours have been taking a long hard look at their tax system this week, we've been watching their every move. We exhaled as the Australians kept company taxes within spitting distance of our own. Finance Minister Bill English didn't need that pressure. We watched their retirement riches grow, as they plan to carve off 12 per cent of each pay packet into the compulsory super scheme. But we're Kiwi and we'd hate to insist that anyone was forced to save money. Politically, that's a "kill-Bill" policy. It's in the same bucket as capital gains tax - the Australians have it; we run a mile. We eye in wonder the billions of tax dollars which will flow from the new super-profit mining tax, but they can keep them, because we'd rather not have anything bigger than a rabbit hole on our turf.

Despite divergence with Australia, when it comes to banking we're inextricably joined at the hip. Whether we like it or not, our banks are their banks and we've got a vested interest in being collaborative. When the Henry report came up with the idea of tax incentives on deposits, it will have jolted the attention of New Zealand banking chief executives. Why? Because it's a solution to a raging war in our banking system. The war for the deposit dollar, aka "the funding problem".

Have any of us noticed this war? Probably not. If anything, savers are feeling the pinch as short-term rates (less than one year) are only 3-5 per cent and we all recall being offered term deposits at 7-8 per cent a couple of years ago. With interest rates falling, most savers have no idea how well they are being paid by banks right now. The war is for deposits with a 1-5 year term. Banks are paying over the odds to attract money in that space. ASB will pay 5.40 per cent for a one-year deposit, when the wholesale rate is only 3.65 per cent; that's 1.75 per cent in extra funding costs. ANZ and National will pay 6 per cent a year for a three-year deposit; 1.10 per cent above market levels. Westpac and BNZ are topping up five-year deposits by 1.40 per cent as these now attract a fairly healthy 6.75 per cent fixed interest.

Rewind things, back before the Global Financial Crisis hit, banks were paying only 0.30 per cent more than the market rate. It's now five to six times higher. Some might assume banks need to pay a top-up, because interest rates have fallen and savers won't part with their money. Not true, banks are not that kind. The big increase is as a direct result of new rules the Reserve Bank has enforced. The consequence is that banks are forced into a deposit war and those with mortgages can't take advantage of a low fixed interest environment.

A few weeks ago, the Reserve Bank of New Zealand was the first in the world to implement a policy controlling how banks fund themselves. It's called the Prudential Liquidity Policy and the crux of it lies in getting more deposits from regular Kiwis to make the system more stable. In fact 65 per cent has to come from customer deposits or long-term funding. Those deposits must be at least a one-year term. To stoke the fire, that ratio is increasing to 75 per cent during the next two years. If you're a saver who can put money aside for one to five years, banks will dance over hot coals to attract your cash.

Kiwibank has expressed dissatisfaction. They've prided themselves on raising funds locally, but the competition for the limited pool of home grown dollars is now hot and expensive. ANZ has admitted the new policy will keep interest rates high, which is not what borrowers want to hear.

The new rules have some good motives; banking stability and limited credit growth, which keeps a lid on property prices. Unfortunately it's also making it expensive for businesses to lock in affordable longer-term rates on their debt and that hinders growth in corporate New Zealand. With only one accelerator and brake controlling both, it's a challenge. Capital gains or land taxes would act as a secondary brake, but we cry foul of those.

From the ideas incubator of Australia, they've come up with a new lever. Giving savers a 40 per cent tax discount on deposits could drastically change choices between property and cash. It would be an inventive way of softening the deposit war, while keeping the funding local.

Would it be tax neutral for the government coffers? Perhaps. Cash is the most highly taxed asset class. If we discount it, the government could lose money. But if we save more and attract money from under taxed areas like property, maybe it could even out. While the funds management sector would be miffed to see tax incentives on cash savings, we do need to face the fact that the funding problem has the consequence of high borrowing costs and subdued business growth, which isn't good for the sharemarket.

In the case of the Australians, they're proposing a 40 per cent tax discount on savings income, matched by a 40 per cent capital gains tax discount. It would be a tax system which is neutral between property and cash. We'll watch in envy at the sensibility of that, but would we follow suit? The tax perk on savings might sweeten the deal, but it's a politically difficult move for our Government.