New environmental taxes get the thumbs up, but commentators are as divided as ever on the thorny issue of a capital gains tax.
The report is out, and as expected the government’s Tax Working Group (TWG) has recommended introducing a broad-based capital gains tax (CGT). While the social justice community applauds the move, business groups are crying into their beer. The TWG’s also recommended tackling risks to New Zealand’s environment with a bold expansion of environmental taxes.
The Spinoff asked a range of commentators to give us their first take on the much-anticipated report. Here are their responses.
Alan Johnson (Salvation Army social policy analyst)
The Tax Working Group has demonstrated commendable courage in recommending the taxation of two of New Zealand’s sacred cows – capital gains and natural resources.
The Group’s reasoning for doing so is entirely sound in that this improves the fairness of our tax system and addresses challenges around wasteful use of natural resources. As motivating ideas for reform of our tax system, these are inarguable and the Government would be wise to start here as it drafts up its response to the Group’s recommendations.
The taxation of wealth is past due in New Zealand if we’re to address the inequity that income from labour – and especially the labour of wage and salary earners – is taxed comprehensively, while the taxation of income from capital is taxed lightly and subject to soft concessions such as arbitrary bright line tests. A more comprehensive taxation of wealth rather than the taxation of realised capital gains would not only be a more reliable source of revenue but will also more effectively address rising wealth inequalities.
The Working Group’s recommendation to begin taxing greenhouse gas emissions, including those from agriculture, is also both fair and sensible. However, a lack of leadership around the taxation of water is regrettable, and it’s a pity that the group hid behind the question of Maori rights as a justification for this.
While it is also reasonable to offset capital gains taxes with reductions in income taxes at the bottom of the income scale, it would have been preferable to make the first $10,000 of income entirely tax-free rather than extending the reach of the lowest tax rate of 10%. That the poorest workers pay any income tax is quite unfair especially when we consider the regressive nature of GST.
“Nothing to fear”
Jarrod Kerr and Jeremy Couchman (Kiwibank economists)
We don’t think people should fear the sort of capital gains tax proposed here today. The Aussies have it, although they deduct everything to lower their tax bill too. The capital gains tax is about expanding the tax base to those with greater wealth (people in the ‘highest decile’). This is at a time when the concentration of wealth is shifting to a declining share of the population, and if nothing changes, wage and salary earners will likely have to pick up an increasing share of the country’s tax bill – this is hardly a fair outcome.
The TWG makes the point that “the inconsistent treatment of capital gains reduces the fairness of the tax system… and risks undermining the social capital that sustains public acceptance of the tax system and so our shared prosperity in the long term” (p.7).
Public acceptance of the tax system is vital. You only need to look at Greece in the lead-up to its debt crisis for a good example. Many Greeks worked the tax system to avoid paying tax because they knew those in power or the rich did exactly that. Greece’s debt crisis was exacerbated because there wasn’t the tax base to address its problems.
It’s important to note that a capital ‘gains’ tax is paid on the gain if and when the investor sells their asset (ie: an investment property). The ‘gains’ would be calculated from the date a (future) new law is implemented. The future date is likely to be in 2021 or 2022. So investor gains to date are baked in the cake. Rational investors will simply add the tax into their calculated returns on the investment beyond this future date. The recalculation may lead investors to adjust their price expectations on property down a little, but not a lot. It’s tempting to say asset prices will have to fall in response, but that wasn’t the Australian experience. The fundamentals of a market, the supply relative to demand, matter much more.
The tax on capital gains will go some way to levelling the playing field on investments (away from property and towards other assets). New Zealand’s problems stem from an underinvestment in infrastructure, residential housing, commercial property and productive assets. Interest rates have been eased to historically low levels. Normally, low-interest rates entice households and companies to invest. But we have not seen the pickup in investment needed to address the severe capacity constraints across key industries, such as construction and tourism, and our housing stock.
It is the capacity constraints, resource consent, and exorbitant costs of construction that demand attention. The lack of confidence among business and households is also a heavy restraint. Having the tax report out of the way and clear guidance on future government plans is critical. Uncertainty kills confidence, and a lack of confidence kills growth.
The TWG sees New Zealand’s income tax rates and thresholds as not being progressive enough. In a progressive system, higher income earners pay a larger share of their income in tax. The working group recommends that the lowest income threshold, 10.5% of income up to $14,000 p.a, should be raised, while the tax rate for the second tier, 17.5% on income between $14,000 and $48,000, should be increased. These changes would mean those on the lowest incomes would benefit the most.
We were surprised that there was no mention of how bunched New Zealand’s tax thresholds are. After all, an income of $70,000 – the point when the top marginal tax rate of 33% kicks in – hardly defines someone as being rich. The TWG, with guidance from the government, has also ruled out a fifth income threshold or lift in the top marginal tax rate for very high incomes. There was also little mention on the adjustment to thresholds to account for inflation and the dreaded ‘bracket creep’.
“Won’t improve housing affordability”
Bindi Norwell (Real Estate Institute chief executive)
We question whether implementing a CGT will improve long term housing affordability.
In the short term, there may be some initial relief in house prices as investors look to sell their property to avoid paying CGT. This may create opportunities for first home buyers.
However, in the long term, it’s likely to push house prices up as people look to invest more money in the family home as there’ll be less incentive to invest in rental properties or other forms of investment (ie: shares).
This will also have a flow-on effect for the rental market with fewer rental properties available for tenants, thereby further pushing up weekly rental prices when they’re already at an all-time high.
The TWG report even recognises that any impact on housing affordability could be small. Therefore we question whether all of the administrative burden and cost to implement a CGT is worth it, especially as it would be coming at the end of a raft of legislative changes the housing market has faced recently: the foreign buyer ban, ban on letting fees, insulation, healthy homes and ring fencing.
The most recent country to introduce CGT in the OECD was South Africa. While it wasn’t the only impact on South Africa’s housing market, house prices there increased by 139% in the first six years following CGT implementation, indicating that the tax did nothing to improve housing affordability.
We’re also disappointed that the rate of CGT is an individual’s marginal tax rate and that there’ll be no reduction in the rate as it is in Australia and the US. This means that New Zealanders will effectively be paying a much higher rate of capital gains tax than individuals in other OECD countries.
However, it’s positive to get confirmation that the Tax Working Group has recommended that the family home be excluded from CGT and that the calculations of gains are not to be retrospective. Additionally, it’s great that some relief in the form of rollover provisions for small farms and businesses have been proposed.
“Divorcing to dodge tax”
Eric Crampton, NZ Initiative chief economist
The Tax Working Group’s proposed capital gains tax would exclude the family home, making for a more politically saleable tax but one which makes far less economic sense.
Not only would it provide incentives to invest in the family home instead of other assets, it also has the potential to encourage couples to ‘divorce’ for tax purposes to be able to exempt two houses rather than just one. If you’re laughing, note that family friends back in the United States would divorce and remarry semi-regularly for tax purposes. They’d have a small party each time they did. Good luck to IRD in policing that.
It would also provide a strong tax incentive to pass the family farm along to the kids rather than sell it, even if the kids aren’t all that interested in farming. Because passing it on rather than selling it allows any capital gains tax to be deferred. We can expect complicated tax arrangements to make selling to the kids to fund the retirement look a lot more like inheritance.
And it hardly applies only to homes. KiwiSaver and other investment portfolios will feel the pinch. While Sir Michael Cullen’s group is certainly right that those assets are disproportionately owned by those on higher incomes, the effect of the tax is far more complicated.
Because the tax would be assessed on nominal investment gains rather than inflation-adjusted gains, the real effective tax rate on investment portfolios could be very high indeed. And the effect of that on business access to capital for investment will have flow-on effects throughout the economy.
Since the group proposed exempting the New Zealand Superannuation Fund from capital gains taxes, the fund would be at a strong advantage over private investors when bidding for assets. One might wonder how long it would be until the Super Fund winds up owning much of the economy.
But I’m sure that others will write many more column inches on the real-world difficulties of trying to bolt a capital gains regime onto a tax system that has, for the past 30 years, evolved around the absence of one. There’s a reason prior tax working groups concluded that it is, on balance, too messy to be worth the effort and that there were strong dissenters within this latest group.
Let’s look instead at some of the less-expected features in the report.
The Tax Working Group recommends shifting towards environmental taxation. In principle, this has a lot of merit. Taxes that correct underlying distortions provide a double dividend. Not only do they raise revenue, but they also improve overall economic efficiency if they’re done well.
The group recommended strengthening the Emissions Trading Scheme and having it shift, in effect, to being more like a tax by having the government sell more of the permits over the longer term. That recommendation should be supported if implemented well.
So too should its recommendation to use congestion charging to help fund the roads – it makes a lot more sense, and is far more equitable, than measures like the Auckland petrol levy that fall very heavily on poorer families with less fuel-efficient cars.
The group also recommended using taxes to improve water quality if the government isn’t able to find better ways of dealing with the problem soon. It suggested water taxes and taxes on fertiliser as potential measures.
Making sure that water users face the cost of that use is important, but tax is a blunt instrument. A tonne of nitrogen fertiliser has very different effects depending on where it’s used. And water taxes have a hard time recognising regional differences in water scarcity. Water should surely be more expensive in Canterbury than on the West Coast, but the government would have a hard time finding the right prices. A cap-and-trade system like the Emissions Trading Scheme is more appropriate.
Other suggestions, like hunting for reasons to justify increasing existing waste levies, or giving tax preference to buildings constructed to tighter environmental standards, might give the appearance of doing good for the environment but seem destined to be a boondoggle if pursued.
“Things could get complex”
Sandy Lau (PWC director)
While the Tax Working Group’s final report provides a roadmap as to what a broad capital gains tax might look like, the debate on this is far from over.
The final recommendation is largely centred on “fairness”, ensuring all income is taxed in the same way and increasing progressivity. But what can’t be ignored is the level of complexity that a capital gains tax will bring to the New Zealand tax system.
If the government’s response is to go ahead with introducing a broad capital gains tax, it will need to make a number of design decisions, likely weighing up political viability as well as complexity and compliance costs. Key design issues will include when an asset enters into the tax base, what assets are captured, the level of rollover relief, and the rate of tax.
On transitioning assets into the base, the TWG has recommended a ‘valuation day’ approach. This will require all assets to be valued by taxpayers. While the report makes a number of suggestions to ease the transition pain (including allowing up to five years to do the valuation), the reality is that this will still be a huge effort for lots of New Zealanders. The alternative – which was considered but rejected by the group – is to bring assets in as they’re acquired after a particular date. This is one lever that can be pulled to make a broad capital gains tax more palatable.
The group has generally adopted as much as possible a “complexity-lite” approach by having relatively limited rollover relief and tax within the marginal rates. However, these design features will likely generate much interest and political debate – any resulting capital gains tax could become much more complex than the one recommended by the TWG.
What’s of more concern is the ambitious timeframe the government has set out to have any resulting legislation enacted before the next election. This doesn’t leave much time for officials to work through these complex design issues. There’s a real risk that the quality of the legislation could suffer because of the compressed timeframe. It may be prudent to take a bit more time to design and consult on any draft legislation to ensure the final product achieves the Government’s policy objectives and is workable for taxpayers.
The other issue that is considered in more detail in the final report is environmental taxes. There is a strong view that the tax system can play a much greater role in sustaining and enhancing New Zealand’s natural capital. The report recommends immediate action to ensure the taxes are used to price negative environmental externalities, moving to using environmental tax revenues to fund a transition to a more sustainable economy, and in the longer term, environmental taxes as a new tax base. This is a powerful recommendation and can result in a second significant change to New Zealand’s tax system in a relatively short period of time which might impact certain business sectors more acutely than others.