Opening Another Can of Worms

Capital Gains Tax

I have no difficulty understanding why many people are strongly in favour of a capital gains tax. They see a minority of New Zealanders enjoying the very good life, living in a luxurious home, going on international trips every year, driving a late model Lexus. They suspect that much of this wealth comes from “unearned” and untaxed capital gains, often on housing investment as a result of the enormous increase in house prices over the last 20 or 30 years.

And from time to time I have myself expressed some support for the view that making enormous and untaxed capital gain, in some cases with no effort and little or no risk, seems grossly unfair.

In my autobiography Incredible Luck, published five years ago, I quoted the case of the 29 hectare piece of land in Flat Bush put on the market in 2013 for $112 million – the land had been purchased for just $890,000 in 1995. I suspect that the owner had done little to the land, and was simply enjoying the huge uplift in value which had been created by the provision of infrastructure by other ratepayers and taxpayers, the restriction of land supply as a result of the Metropolitan Urban Limit around Auckland, and the strong inflow of immigrants to Auckland. It seemed grossly unfair that that enormous capital gain should be untaxed, while the ordinary wage and salary earner was facing a tax rate of up to 33%.

And I still feel deeply troubled by the enormous and currently untaxed wealth increases which accrue to some New Zealanders because of infrastructure paid for by the taxes of others. The best Auckland example of this is probably the effect on the wealth of those who owned land on the North Shore when the Auckland Harbour Bridge was built. Or in the Wellington region, the effect on land values on the Kapiti Coast of the construction of Transmission Gully.

But on balance, I am not in favour of a capital gains tax, and that for a multitude of reasons.

There is no doubt that the introduction of a capital gains tax would greatly increase the complexity of the tax system, and therefore considerably increase compliance costs. I think that that point is generally accepted. One of the issues concerns the proposed Valuation Date, proposed to be 1 April 2021. Not only will it be an enormous challenge to value all assets in New Zealand at that date – all houses other than those occupied by their owners, all commercial property, all farms and lifestyle blocks, all public and private companies and so on – for many assets establishing a market value at any date will be an enormous challenge. How should a private company be valued when its only significant asset is know-how, or a formula which might, if properly marketed, greatly increase meat production while reducing greenhouse gas emissions?

Second, while some advocates of the tax seem to assume that introducing a capital gains tax will make housing more affordable by reducing the attractiveness of investing in residential property, Australian experience would suggest that such hopes are totally without foundation. Australia has a capital gains tax and yet Sydney house prices are, relative to incomes, even higher than those in Auckland.

Third, the revenue generated from that increased complexity is likely to be much more modest than projected by the Tax Working Group if the Government is serious about making housing more affordable. Surprisingly, the revenue assumptions made by the Tax Working Group are based on a steady and indefinite increase in the price of property, residential, commercial and industrial, of 3% per annum. Since buildings tend to depreciate in value as they get older, it is implicitly assumed that the price of the land on which the buildings sit will increase at more than 3% per annum. But given the starting point where, by common consent, residential property at least is grossly overpriced, and given that the Government and indeed all political parties have given lipservice to making housing more affordable – in other words, cheaper – this revenue assumption seems quite unrealistic. Or it means that the Tax Working Group has no confidence that any Government will deal to unaffordable housing.

Fourth, there’s an important and principled objection to taxing a capital gain. The price of an asset today reflects the expectation of what that asset will earn in the future – after taxation on that future income. So to tax the uplift in value of the share and the future earnings is to double tax the earnings of the asset.

Fifth, the introduction of a tax on capital gains in the way proposed by the Tax Working Group would have the paradoxical effect of decreasing local ownership of New Zealand shares and increasing the foreign ownership of those shares. Why? Because New Zealand investors would be liable to pay capital gains tax when selling New Zealand shares, but not when selling foreign shares; whereas foreign investors would not be liable for the tax when they sold New Zealand shares.

Sixth, a further tax on capital would in itself make investment and innovation less attractive than at present, at the very time when we almost certainly need more investment and innovation.

Seventh, with some Maori tribes already suggesting that imposing a capital gains tax on assets owned by them would be a breach of the so-called “principles of the Treaty”, and the Tax Working Group itself raising the possibility that the sale of certain Maori-owned assets should be subject to a lower rate of capital gains tax, it seems very likely that introducing such a tax would open another whole can of Treaty worms.

At the time of writing, nobody yet knows what policy the Government itself will adopt in regard to the capital gains tax. My own strong hunch is that we will not see a tax of the kind proposed by the Working Group, if only because New Zealand First would veto such a tax.

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