Grant Robertson instructed The Tax Working Group (TWG):
“to consider a package or packages of measures which reduces inequality, so that New Zealand better reflects the OECD average whilst increasing both fairness across the tax system and housing affordability“.
Inequality is a number one issue for Western countries like the US, UK Australia and New Zealand. It not the same as the poverty issue. The growth in extreme income and wealth differences has gathered momentum as tax-free gains accumulated at the top end compound asset values, while disadvantage and debt compound negatively at the bottom end. The fortunes of the top and the bottom are inextricably linked. To begin to reverse the growing wealth divide, policy must address the balance sheets of both.
But the TWG have both hands tied behind their collective backs by the terms of reference that excluded:
- Increasing any income tax rate or the rate of GST
- Inheritance tax
- Any other changes that would apply to the taxation of the family home or the land under it, and
- The adequacy of the personal tax system and its interaction with the transfer system
The TWG interim report and the two conferences last week suggest that at best the TWG will offer a realised capital gains tax that will be enormously complicated and politically fraught. In terms of fairness, that may improve some aspects of horizontal equity, sometime in the future, but only if capital gains, not capital losses, are made.
The controversial and complicated issues around the introduction of a comprehensive capital gains tax on realisation by 2021 include: the timing of the valuation of all assets, how they are valued; lock in and roll over problems; valuing goodwill; defining the excluded family home; allowing for inflation; holding assets for different time periods; and what happens on death.
Can anyone see the Labour government embracing a comprehensive capital gains tax to take into the 2020 election? National are not co-operating on this one and have promised to reverse any legislation. The last time Labour produced such a blueprint (the 1989 consultative document on the taxation of income from capital) they abandoned all of it as they entered the 1990 election.
In light of these challenges it appears that some TWG members would prefer an incremental to a big bang approach: building on the current capital gains policies such as bright line tests and ring-fencing rental losses and including more asset classes gradually.
What might they have come up with if they focused on the real housing inequality problem? To start they would refuse to be bound by the terms of reference that make their task impossible.
The kind of inequality that has been the most damaging is not trading in shares or Art collections. It is surprise, surprise, housing. Runaway fortunes have been made in real estate and New Zealand is chart topper in unaffordability of housing as the Economist shows.
Ireland used to be in the place that New Zealand now occupies. There may be a decade of capital gains tax losses in store for NZ such as happened in Ireland when the inevitable crash came. The exemption of owner-occupied housing for the TWG capital gains tax is another nail in the coffin. As in Australia this will just encourage an even worse over-investment in the exempt family home.
The sad fact is that a 7 % annual capital gain sees the $10milion mansion become a $20m mansion in just 10 years. This week the NZ Herald reports a couple who bought their Herne Bay home for $27.5 m after selling their Remuera property for $25.5m to a Chinese buyer. That same couple are reported to have bought an Auckland property for $3.9 million and sold it four years later for $62.8m.
One would hope that the later sale falls within the ambit of the existing bright line test. But even with a comprehensive capital gains tax, the likely considerable gains on the family home are exempt.
Scarce resources of labour and materials are sucked into the expansion of the luxury mansions built for the wealthy along with the resources for their maintenance, gardening and smooth operation. Often foreign-owned and lavish in the extreme, they are far more than a family home. This tragic misallocation of resources has been at the expense of basic housing for low income people.
Like food and education adequate shelter is a fundamental human right. But instead it has become a commodity to be hoarded and then traded for profit. Houses bought by investors too often are not even rented. Those that are rented, frequently offer no security of tenure, generating tax deductible losses for the owners while they wait for capital gain. In such a world any talk of economic efficiency in tax design rings hollow. How can inadequately housed families facing uncertain futures and multiple shifts produce children who are ready and able to learn? How can housing transience support their parents to be productive workers.
A different TWG might have sought to reduce the wealth divide rather than focus on tax on possible future capital gains. The Risk Free Rate Method (RFRM) or net equity approach would be considered a serious policy option to achieve a meaningful reduction in housing inequality by generating certain revenue and changing the attractiveness of investment in housing.
Under a net equity approach all housing wealth would be aggregated and only registered first mortgages deducted to give a person’s net equity. It would aim to affect only the top 20% of wealthiest property owners and absentee owners by allowing an exemption of maybe $1million against the person’s family home ($2 million for a couple).
The logic is that had the person had this net equity in cash it could earn a return on fixed deposit, so the housing net equity is treated as if on term deposit earning 3-4% taxable interest. Current 5 year bright line tests would be retained for short term gains.
Most of the problems of the comprehensive capital gains tax disappear- roll over, lock in, timing, inflation, accounting for capital expenditure. All houses and land zoned residential would have an official CV at the beginning of the year. Any mortgages repaid during the year would increase net equity. Of course, young people with high mortgage debt would have little net equity while older people who benefited from past gains would have more. The exemption of $1 m net equity for the family home means that the vast majority of people would be unaffected.
Landlords would no longer be able to write off interest costs or generate rental losses. They would not have to pay accountants to determine what is capital and what is deductible expenditure. All they would do is pay the tax on the interest imputed from their net equity. Accruing capital gains would be captured as they inflate the net equity base. If there is a serious crash then net equity would fall as the CVs fall.
Landlords would have an incentive to rent their houses and not just let them stand idle. Overseas owners would not have any family home exemption and any home held by a trust would not have an exemption either. Home owners would be free to generate income from Airbnb, boarders flat mates and home offices to help meet any net equity tax.
Most importantly the net equity tax would divert resources from luxury housing and change the culture of housing as an investment commodity leading to a much better use of housing stock. Revenue generated could be diverted to repairing the balance sheets of the worst-off by repaying debt and enhancing their asset accumulation.