II. Investment Income

9.74. Ownership of property can give rise to various forms of investment (or property) income, notably rent, interest, dividends and capital gains. Their tax treatment is analysed in a number of places in this report. Imputed rent from owner-occupied dwellings is dealt with in Chapter 7, dividend income in Chapter 16, income from investment in superannuation and life assurance in Chapter 21, and capital gains in Chapter 23. A further aspect, the levying of a special surcharge on property income, is considered in Chapter 14 and there rejected. An issue not taken up in Chapter 14, however, is whether there are grounds not merely for rejecting the surcharge but for actually granting concessional treatment to investment income. This is the issue considered here.

9.75. One possible justification for concessional treatment is to encourage saving, either in general or in particular forms. In Chapter 21 the Committee has commented on the objective as justifying special treatment of superannuation funds and life insurance.

  ― 129 ―

9.76. A second possible justification for concessional treatment is that consumption may be thought a better indicator than income of ability to pay tax. If this is accepted, it follows that imposing an income tax, including tax on income from savings, is horizontally inequitable because individuals are treated differently according to how they spread consumption over their lifetime, the effective rate of tax on postponed consumption being greater than the rate on current consumption. Given the retention of income tax, however, the consumption approach suggests a need to give relief to income saved as distinct from relief to income from saving, and it is this philosophy that underpins much of the discussion on superannuation and life insurance in Chapter 21.

9.77. As already pointed out in Chapter 3 and 6, conventional procedures for establishing income subject to tax under conditions of inflation can result in ‘illusory’ rather than ‘real’ gains being brought to tax. This leads to inequities of a horizontal kind, and perhaps vertical inequities too. The Committee discusses the problem for recipients of business income in Chapter 8, and its proposals in regard to capital gains are spelled out in Chapter 23.

9.78. In times of inflation, recipients of interest income, too, face the prospect of being taxed on ‘illusory’ gains. This is particularly noticeable when interest rates lag behind the rate of inflation, in which case tax is imposed on what are in reality negative gains. For this reason the Committee considers that some form of concessional treatment should be provided for taxpayers in receipt of interest income.

9.79. One means of providing concessions would be the broad-brush approach of indexing all monetary debts. This is a radical proposal, raising issues beyond the Committee's terms of reference. Were a move to be made in this direction, the initiative would have to come from the government, which might as a first step issue indexed bonds.

9.80. An alternative approach would be to make ad hoc adjustments to the income tax base. Canada has recently introduced legislation to this end. In computing taxable income, an individual in Canada may deduct interest income from securities such as bank and trust company deposits, mortgages and bonds. The deduction is limited to the lesser of (a) $1,000 or (b) the taxpayer's interest income for the year minus the amount, if any, deducted by him in computing his income on account of interest paid on borrowed money for the purpose of earning income from a business or property. New Zealand also has tax concessions for persons receiving interest income, and these have recently been extended. An exemption is given of $100 of interest from any source; in addition, $200 of savings bank interest is exempt. There is also a special exemption of $500 in respect of savings certificates and national development bonds. In the short run at least, ad hoc adjustments such as these appear to be the most appropriate.

9.81. If legislation were to be introduced along these lines, the following general principles should be followed:

  • (a) The deduction should be available for interest income on as wide a range of securities as possible to avoid introducing new distortions into the capital market. Consideration might be given to making the deduction available in respect of dividends on preference shares which carry no rights to capital beyond the amounts subscribed.
  • (b) The deduction should be limited to net interest in the sense of interest received less interest that is deductible, whether as costs of deriving income or by a virtue of a concessional deduction provision.

  •   ― 130 ―
    (c) The deduction should be limited in amount and be personal to the individual taxpayer.