The Herald today has a piece by Mark Lister bemoaning the lack of investment in the productive economy, with too much cash going into housing instead. On Thursday, Brian Fallow wrote how Kiwis are being shut out of home ownership by investors who see capital gain from housing as an easy win while workers are made to pay tax to effectively subsidise property investors who pay none. Is it time for a capital gains tax?
First Lister’s piece:
New Zealand has a well-documented savings problem, with households spending roughly 2 per cent more than they are earning. Clearly this situation would be helped if incomes were higher, with our GDP about 15 per cent below the OECD average, and even further behind Australia.
However, our current tax settings on investments are not helping the situation either. With no capital gains tax or inflation indexing, the existing regime favours borrowing over saving, and capital assets over income assets.
In its final report, released in January, the Savings Working Group (SWG) suggested that households would be more inclined to save if the Government considered a number of changes to the taxation of investments.
Tax settings are an important driver of investor behaviour and there are a number of changes that should be implemented to deliver a less distorted, more investor-friendly and efficient environment for New Zealand investors.
To begin with, let’s focus on what is wrong with our tax rules on investments. Investment capital in New Zealand is essentially taxed three times. The money that is saved has been taxed already, because it comes out of your after-tax income that has seen PAYE deducted.
The income generated by the investments is then taxed again and when you finally spend that income, you are taxed via GST. It makes sense, therefore, to avoid a layer of tax by simply earning it then going straight to the spending phase, rather than earning, saving and then spending.
With no capital gains tax, the system further distorts investment decisions. It makes more sense to borrow (and obtain the interest deduction) and buy capital assets like rental property than it does to save in higher-income investments such as deposits (and higher-yielding shares, for that matter), which incur tax on this income with no adjustment for inflation.
Regardless of its merits, there is no chance of a capital gains tax being introduced in New Zealand.
Really? Why not? If it’s a good idea, and my google search is struggling to come up with any authoritative voices who say it isn’t (even National mouthpiece David Farrar supports it), why can’t a major political party have the courage to grab the bull by the horns? The Greens, who are always at the front of the pack, have been calling for a capital gains tax to fund green investment and/or their idea for a tax-free bracket for years. Labour has also proposed a tax-free bracket, and there is speculation in the media that they have a major announcement coming on how they will fund it. It would be a bold move if they go down this track and it would attract a lot of praise from those who care about the economy.
Fallow points to the housing bubble and how it made some people very rich without paying a cent in tax:
How much has the demand side of the market been stoked by tax policy, or by unrealistic expectation about the returns from housing relative to other investments?
Although expectations eventually adjust to market reality, the commission says, the adjustment can be very disruptive and take a long time, with long-lasting effects.
It has been argued that the surge in house prices in the middle years of the last decade cannot have been driven by population growth. If it had been, there should have been much more pressure on rents than was observed.
During the five years to the end of 2007 when house prices doubled, rents increased by an average 3 per cent a year according to the consumers price index.
Data from tenancy agreements, which cover new rental agreements, show swifter growth, about 6 per cent a year, but still less than the double-digit increases in house prices.
A survey of landlords in 2003 – still in the foothills of the housing boom – found capital gains the most commonly cited benefit of investing in property.
And those gains are untaxed.
For some reason our political leaders don’t trust us to be able to grasp the proposition that it makes little sense to tax people if they increase their wealth by the sweat of their brow but not if they increase their wealth by holding the right asset over the right period.
So a capital gains tax would fix an equity issue, as well as an allocation of investment capital issue. Why should a dollar earned by holding an asset (that is, arguably, deferring consumption) not be taxed when a dollar earned by working is? Doesn’t that mean that everyone paying PAYE is subsidising those who are making a living from untaxed capital gains? Is that fair?
It’s not even just a rich vs poor thing – although the wealthy are obviously those who make the most income from capital gains – it’s also people with similar incomes but one faces no tax when their income comes from capital gain and the other faces a tax of up to 33 cents in the dollar (plus ACC). A capital gains tax doesn’t have to be about raising more revenue, it could be about reducing the tax on work and rebalancing investment incentives.
If we want to be a wealthier country we’ve got to change the incentives that see a small portion of the population soak up huge amounts of capital running around paying each other more and more for the same properties (and the best time to start doing that is before the next bubble forms), at the same time, we need to increase the attractiveness of investment in productive capital and working. A capital gains tax would allow all that to happen.
Nearly every other developed country taxes capital gains because it makes sense. So why can’t we?
– Bright Red