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Houses for sale and sold in central Auckland suburbs (Photo by Fiona Goodall/Getty Images)
Houses for sale and sold in central Auckland suburbs (Photo by Fiona Goodall/Getty Images)

PoliticsMarch 6, 2019

Our tax system is rigged. A Capital Gains Tax would help address that

Houses for sale and sold in central Auckland suburbs (Photo by Fiona Goodall/Getty Images)
Houses for sale and sold in central Auckland suburbs (Photo by Fiona Goodall/Getty Images)

A capital gains tax is urgently needed not so much for the revenue it will raise, but because the tax system is currently fundamentally unfair, writes policy director and economist for the Council of Trade Unions Bill Rosenberg. 

Our tax system is unfair. It’s not equipped for many of the needs which we, as New Zealanders, face. It is not doing well in one of its most important tasks: assisting in the equitable allocation of resources to all. 

We all know that the government gathers revenue through taxes. This revenue is what then allows us to teach our children, treat our sick, and build a country fit to face the pressing challenges of the future. Tax is the way we as a society share our resources to look after each other and our common needs. New Zealand is not a poor country but the way our resources are shared mean that too many low and middle income Kiwis miss out despite the contributions they make to the common good. A fair tax system would help them to live the decent lives they deserve.

Our tax system must change if it is to serve the needs of our people.

OECD data shows that our income tax system is one of the weakest in the OECD at reducing income inequality, and so is our system of welfare benefits and tax credits (Working for Families). Each has got steadily worse at reducing inequality since the 1990s according to MSD research.

Add in GST which taxes low income households at a steeper rate than high income households because people with low incomes cannot save as much, and it’s easy to see how unfair out tax system is.

No wonder we are in the worst third of the OECD for income inequality; there are some who are able to buy multiple houses and live in luxury, while there are so many who have too little to meet their needs for decent housing and other fundamental basics.

To fix our neglected health, education and housing, lift families out of poverty and continue to look after our increasing older population we need more revenue, and most of that will need to come through the tax system. People who are paid wages and salaries are receiving a declining proportion of the nation’s income. Our wage setting system is one reason for that, but if technology use intensifies, that proportion is likely to fall further as more income flows to the technology’s owners – the wealthy elite or the owners of capital. Taxation of capital will therefore become increasingly important.

So our tax and welfare system needs a lot of repair work.

Much of it was outside the Tax Working Group’s terms of reference, but one area of unfairness that we could investigate was the taxation of income from capital. New Zealand is unusual in the OECD in rarely taxing the income that owners of assets receive as a result of their assets rising in price – capital gains. The Tax Working Group agreed with economists and tax experts: gains from rising asset prices are income just like wages, salaries, dividends, and interest. The rise in price of a house or shares leaves the owner with greater wealth at the end of the day, just as does any other form of income that is not spent.

So currently the situation looks a bit like this – Rewi works in the forestry industry. Over the last five years he has earned $250,000 averaging $50,000 a year. Before his salary arrives in his pocket he is automatically taxed close to $8,000 each year: a total of over $40,000 over the five years.

Meanwhile, Tracy is a property investor and pays zero tax on the $250,000 made on the sale of a rental house which they purchased five years ago.

Both Rewi and Tracy are making $50k income a year. Why treat one different to the other? 

Taxing the same income in quite different ways is doubly unfair because income from capital gains is very unevenly distributed. Research for the Tax Working Group estimated that 70 percent of the assets whose capital gains it proposes be taxed (which exclude the family home) are owned by the wealthiest 10 percent of households.  The bottom 70% have only 10% of those assets, and lowest income 30% just 1 percent. This subsidy given to a particular source of income overwhelmingly benefits the wealthy. Most households would be virtually untouched by this tax.

It is probably even worse than that. Some of the wealthiest individuals avoid paying existing taxes by effectively converting income from their private companies into untaxed capital gains.

Some argue that income from capital gains should be taxed at a lower rate than other income. Previous Governments have disagreed with this, including the bright line test brought in by National. It would leave loopholes that are used to avoid other taxes and most of the unfairness. US billionaire Warren Buffett, who advocates higher taxes on the rich, complained that he was probably paying a lower tax rate than his secretary because most of his income comes from capital gains, taxed at only 20 percent, while hers came from wages.

We currently subsidise over-investment in assets like urban land whose capital gains provide a tax-free return but don’t add to our productive capacity. This is a drag on productivity and encourages rocketing property prices. Some are concerned that it would make other investment less attractive. I am not convinced. Firstly, New Zealand reduced taxes on capital income in the 1980s and again in 2008 and 2010, yet its poor productivity and investment performance has deteriorated over that period. The impact of taxation is very small. Secondly, the higher taxes will be paid by investments with a high capital gains component – often a heavy loading in land. It is those we want to rebalance away from. Most OECD countries tax income from capital gains and that has not stopped them having superior productivity performances to New Zealand.

Taxing the income from capital gains would provide a modest but useful source of revenue for the government, which is currently facing huge needs in a long list of creaking and understaffed public services and infrastructure. Though variable from year to year, Treasury estimates that it would rise to increase revenue by about 4 percent on average.  

It would add to the fairness of our tax system, make New Zealand a fairer society and help make our economy more productive and less burdened by speculation.

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