The previous Labour Government took Capital Gains Tax (CGT)off the table after the Tax Working Group report, and then in the election promised not to introduce a Net Wealth Tax. While there is not a lot of wriggle room alternatives must be discussed urgently if the COVID recovery is to have any hope for a fairer, flourishing future.
Economists are warning that Inequality and housing affordability are only going to get worse as interest rates drop further. Let’s hope that this new government to not be like stunned possums standing in the glare of impending chaos.
Both CGT and Net Wealth Tax propositions were comprehensive, utopian and, sadly, flawed. An annual CGT doesn’t work in practice. It is game over once it is conceded that only the gains realised on sale can be counted for most assets, and that the family home will be excluded. Mercifully, we were spared agonising months of debate over how assets are to be valued at what start date, who values them, what costs can be deducted, how the family home is treated when it is partially used for business or rental, what exemptions apply, what roll over provisions apply, how inflation and capital losses will be treated, and what tax rate applies, to list but few of the complexities.
The short-term gains under the five years bright-line test is a backstop that needs to be strengthened, extended and properly policed to catch short-term speculation, but a comprehensive CGT is now a pipe dream.
The net wealth tax was doomed as well. Its comprehensive nature to make it fairer made it more complex. It had no sound narrative underpinning it and was easily ridiculed and exaggerated by the Opposition as attacking ‘hard earned’ success. If wealth is amassed from savings out of tax paid income, then a wealth tax looks like a double tax. It certainly managed to scare the horses.
It is time to drop both comprehensive approaches and ask ‘what is the real problem that needs an urgent solution’? New Zealand is not alone seeing low interest rates fuel a housing bubble but the bubble in New Zealand astrides the developed world (see The Economist house price index) and its possible implosion is a grave danger to any fledgling COVID recovery.
Housing unaffordability is at the heart of poverty and the expansion of inequality. A shortage of affordable housing options underpins and reinforces poor outcomes while the wealthy accumulate ever more housing advantage. Market-based reforms in the 1991 “mother of all budgets” set New Zealand on the path of high and persistent levels of after-housing-costs poverty and divisive inequality. Today many families subsist in precarious labour markets or on impossibly low social welfare benefits and face impaired life outcomes with long-term mental and physical health issues. Much more redistribution is needed.
Policies are needed to extract more tax from the undertaxed owners of expensive real estate and residential land, both to restrain price rises and to provide a secure revenue stream. But the government has ruled out introducing any new tax.
One fruitful approach is to revive the narrative of comprehensive income tax. Using our existing tax system we can expand the base of what is captured under an income tax. The persuasive narrative is that income earned from holding assets in whatever form should be treated the same.
Just as we do for the taxation of foreign shares- where they are assumed to earn a 5% fixed rate of return and tax is paid on that, so we could have a tax on the potential income from holding net equity on housing rather than in the bank. Anyone investing in Australia shares/equites understands the mechanism.
Currently someone who has a $100,000 of net equity in housing is treated differently to someone who has $100,000 in a term deposit at the bank. The effect is to make investment in housing very attractive. The $100,000 in the bank will earn an annual interest of say 2%. This will be taxed at the marginal tax rate of the holder of the deposit. Likewise, each person’s total equity in housing and residential land after deducting registered mortgages, could be aggregated and treated as if it were earning interest in the bank. A gross interest of $2000 would generate a tax of between $210 and $666 (or $780 under Labour’s new top rate of 39%.
A wealth tax of 1% on $100,000 of net equity in housing is $1000 regardless of one’s marginal tax rate. Compared to a net wealth tax, treating net equity as earning at least a bank rate of return would be much more progressive.
A personal exemption of, say, $1 million would mean that most home-owners would be unaffected. Unless they have been the beneficiaries of inheritance, younger owners of high-priced homes are likely to have mortgages that reduce their net equity to below the exemption ($2 million for a couple). Older low income people with valuable mortgage-free housing may have significant net equity after the exemption but would pay tax at a low rate: if there is a liquidity problem it can be dealt with using postponement of the debt until sale.
Such a net equity approach has an inherent logic – investment in property should return at least as much as having the same money in the bank. It is fair that taxes are paid on the income for both.
Compared to intractable CGT problems, objections to expand the income tax net this way, such as landlords will “just load up their properties with debt”, or “put their houses in a family trust” or “can’t pay if there is no cashflow” are easily dealt with. Valuation is simple: the rateable values are readily available and regularly updated. No daunting valuation day is needed and over time, if house values increase for whatever reason, the rateable value will increase and with it, the tax base of net equity.
The housing stock would be better used than currently, and the overuse of scarce resources to build larger and more elaborate homes discouraged. Property would stop looking like a sure-fire way to investment riches. Empty houses currently held for capital gains might actually be rented. Houses might be fixed up to keep good tenants. Accountants’ fees to manipulate the profits and loss of renting along with negative gearing would disappear. Good landlords may find in fact, they are rewarded with a simpler system and higher returns than before, meaning there is no justification for rent rises.
The Government must be ready to act decisively and confidently in the first months of the first year of its second term, otherwise the chaos will continue.
Susan St John is Associate Professor of Economics at the University of Auckland Business School and Director of the Retirement Policy and Research Centre.