CGT good if income tax rates cut

February 18th, 2016 at 2:00 pm by David Farrar

Politik reports:

Documents released last week under the Official Information Act show Treasury in 2013 proposed lowering the personal tax rate and suggested replacing the lost revenue with a number of alternatives.

And Treasury says cutting corporate tax rates could mean our high level of overseas ownership would see the benefits go overseas.

“Personal income tax cuts may have greater economic benefit than corporate income tax cuts in New Zealand” the paper said.

“ This is primarily because most of the benefits of personal tax cuts would accrue to residents, whereas a larger proportion of the benefits of corporate income tax cuts ’leak’ overseas to non-residents given New Zealand’s high level of foreign capital ownership. “

And Treasury proposes a capital gains tax to replace the revenue lost from the personal tax cuts

“The resulting loss in revenue would need to be offset by base broadening such as a capital gains tax, which would address weakness in current system and reduce the tax advantage towards housing.

I agree with Treasury.

Lowering income tax rates and having a capital gains tax would be a better tax system for New Zealand that would lead to higher economic growth.

But under no circumstances should we bring in a capital gains tax, without a reduction in income tax rates. That would just be a massive new tax impost on New Zealanders.

Capital Gains Tax for property now law

November 16th, 2015 at 10:00 am by David Farrar

The Herald reports:

The requirement for capital gains tax to be paid on investment properties bought and sold within two years has passed into law.

The so-called ‘Bright-Line’ test for residential land was announced by the Government as part of May’s Budget to try to dampen property speculation and better enforce already existing taxes on capital gains. It will require tax to be paid on any gains from residential property bought after October 1 and sold within two years. The exceptions to the rule are the owner’s main home, an inherited property or the transfer of property after a relationship break up.

Revenue Minister Todd McClay said it was an important tool to ensure property speculators paid their fair share of tax. Where properties are sold on after that two year period, the pre-existing law will continue to apply. That means if a property was bought for the intention of making a profit, income tax must be paid on the gain when it is sold.

It will be interesting to see if this has much impact on the property market. Combined with the Reserve Bank new rules, and the requirement for overseas purchasers to have a NZ IRD number, and there could be a reasonable impact.

I actually do support a Capital Gains Tax, but only under these circumstances:

  • Personal income tax rates and company tax rates must be dropped so that overall tax revenue remains the same (or reduces)
  • It must be comprehensive with almost no exceptions, so our tax system remains relatively simple and it doesn’t then provide incentives or disincentives for particular forms of investment.

A comprehensive capital gains tax is estimated to bring in $9.1 billion a year. This would allow us to do the following:

  • Drop bottom tax rate from 10.5% to 5% for income up to $14,000
  • Drop second rate from 17.5% to 10% for income from $14,000 to $48,000
  • Drop the two top tax rates from 33% and 28% to 25% for income over $48,000
  • Drop company tax rate from 28% to 25%

That would cost $8.8 billion.

So we’d have a tax system where you pay 5% and 10% for those earning below the average wage and then 25% for earnings over that – still pretty progressive.

So a broad base low rate tax system is good. But bringing in new taxes, without lowering other taxes should be resisted strongly.

New bright line test for capital gains on housing

May 18th, 2015 at 7:00 am by David Farrar

John Key announced:

“People calling for a new capital gains tax often overlook the fact that under existing rules, anyone buying property with the intention of selling for a gain is liable for tax on that gain,” Mr Key told the National Party’s Lower North Island regional conference in Lower Hutt today.

Mr Key confirmed the Budget this week will contain several measures to bolster tax rules on property transactions and to help Inland Revenue enforce them.

Introducing a new “bright line” test to tax gains from residential property sold within two years of purchase, unless it’s the seller’s main home, inherited or transferred in a relationship property settlement.

This isn’t a major change, but a useful one. Intentions are very hard to prove, so a bright line test will make enforcement easier. It is hard to think of many times that you’d sell a secondary home within two years of buying it, unless it is to make a capital gain.

Requiring non-residents and New Zealanders buying and selling any property other than their main home to provide a New Zealand IRD number.

This may also give us some better data on what proportion of houses are foreign owned, plus of course allow any gains by non-residents to be taxed,

CGT great for tax lawyers

September 11th, 2014 at 9:00 am by David Farrar

Geordie Hooft writes in The Press:

As a tax adviser, I can tell you that CGT tends to be complex – it’s one of the reasons that the Australian Master Tax Guide weighs nearly 40 per cent more than its New Zealand counterpart. One thing is for sure – CGT will be a boon for tax advisers and valuers.

Taxpayers will need to consider those costs in addition to the cost of the tax itself.

Labour’s CGT is so complex that even the MPs who wrote the policy don’t understand it! It is so riddled with exemptions, that it will have massively high compliance costs as even the smallest businesses has to hire expensive tax lawyers and accountants to help them cope with it – and many individuals will find they can no longer safely do their own tax returns, but will need to have a professional do their tax for them.

Labour will tax the family home – when you die!

September 4th, 2014 at 7:00 am by David Farrar

Something that many people have not realised is that the so called exemption on the family home for Labour’s Capital Gains Tax is temporary. Almost all family homes will be taxed on their capital gain, when you die, if not placed on the market immediately.

Most people now die in their late 70s or 80s. Their kids will tend to be in their 40s or 50s and hence have homes of their own. So when you die, it is very unlikely a child will move into the home. They already have one. Plus few people want to live in the home their deceased parents lived in. So the home gets sold. And guess what? Labour will tax any capital gain on that sale.

It’s almost a de facto death duty – you get taxed for dying!

UPDATE: You can avoid the death duty if you decide to sell the home within 30 days of your parents dying. Charming. At a time you are mourning, you will be forced into rushing the home onto the market to avoid the death duty.

On Labour’s Capital Gains Tax

September 3rd, 2014 at 1:00 pm by David Farrar

A parliamentary staffer notes to me:

Not sure how Cunliffe’s attempt to clarify Labour’s CGT squares with the summary below in their policy document, which doesn’t specifically exclude family homes owned by trusts, and in fact says trusts could not be used to avoid the CGT.

Excluding trust-owned houses from a CGT would seem to raise questions about whether different trustees of the same trust, who live in different houses, would be exempt from a CGT on a number of properties, which would become complicated and costly in terms of foregone revenue.

I also wonder whether Labour’s revenue forecasts were counting on homes held in trusts being included? After all David Cunliffe has said their Capital Gains Trust will lead to families and businesses paying an extra $4 to $5 billion a year in tax.

In Labour’s policy summary their exemptions are:

Exemptions: The family home, personal assets, collectables, small business assets sold for retirement and payouts from retirement savings schemes, including KiwiSaver, will be exempt.

It is not at all clear whether this exemption includes family homes in trusts. I expect the IRD will need to hire hundreds of new staff to deal with such a complex CGT.

I support NZ having a Capital Gains Tax, so long as income and company tax rates fall to compensate. But the CGT should be like GST – with almost no exemptions. Labour’s one is so complicated even the guy who designed it (Cunliffe was Finance Spokesperson when Labour adopted it) doesn’t know how it works.

Rob Hosing at NBR also makes a good point. He states that property speculators are already taxed if they buy and sell property to make capital gains. He gives an example of how someone in Auckland who buys a house for $750,000 and sells it a year later for $900,000 will pay (probably) 33% of the $150,000 profit if they are a property speculator.

Under the current law their tax bill would be $49,500. Under Labour’s Capital Gains Tax they will pay just 15% on their capital gain, so just $22,500 in tax.

Now it is hard to prove someone is a property speculator but National gave the IRD $6.65 million to enforce the current law more vigorously and this lead to an extra $57 million in tax revenue from property speculators.

Labour to increase taxation by $5 billion a year

July 8th, 2014 at 4:00 pm by David Farrar

On Q+A, David Cunliffe said:

By the way, a capital gains tax which at full running is going to bring in 5 billion dollars a year, close to, 4 to 5 billion is the single biggest change to New Zealand tax policy in decades and it’s one that I’ve personally championed for years.

That’s appalling. That’s an extra $5 billion a year ripped out of NZ families and businesses, to be spent by Government.

There is a case for a capital gains tax. I support a broad base tax system. However I’m sick of new taxes being added on, with no compensating reduction in income and company taxes.

If Labour’s capital gains tax was really about changing investment incentives, then they’d commit to reducing income and company tax by the same amount of revenue their CGT would bring in.

But in reality, their CGT is just about increase the tax burden on New Zealanders by $5 billion a year.

Capital Gains Tax

July 25th, 2013 at 2:00 pm by David Farrar

The Herald reports:

A capital gains tax on property makes little sense unless it also applies to the family home, says Finance Minister Bill English.

Speaking at today’s Mood of the Boardroom event in Auckland, English told the country’s top business leaders the government was maintaining its “clear position” on the capital gains tax debate.

“We’re not supporting the extension of the current capital gains tax,” he said.

“The overseas experts who tell us we need it all say that it should be comprehensive on all capital gains. And if you don’t do the whole thing then it probably doesn’t make much difference.”

I broadly agree with this. My position on Capital Gains Tax is this:

  1. We should have a comprehensive capital gains tax (many capital gains are already taxed, but not “incidental” ones)
  2. There should be no exemptions, including the family home. To do so will just encourage tax avoidence by giving each family member a home etc.
  3. Other tax rates (income and company rates) must drop by at least as much as the extra revenue a CGT would generate for the Government.

You need to do all three together, to get a broad based low rate tax regime – which is what is best for economic growth. What you shouldn’t do is bring in an exemption riddled CGT and use it as a way to screw taxpayers over for more money to fund extra spending – which appears to be Labour’s policy.

How much would a CGT raise?

July 7th, 2011 at 1:36 pm by David Farrar

I’ve blogged at Stuff on how much money might be raised by a capital gains tax on investment property only.

Tax Working Group Final Report

January 20th, 2010 at 1:32 pm by David Farrar

The Tax Working Group have released their final report. It is a readable 73 pages.

They first cite three major problems with the current tax system:

  1. New Zealand relies heavily on the taxes most harmful to growth – particularly corporate and personal taxes on capital income.
  2. Differences in tax rates and the treatment of entities provide opportunities to divert income and reduce tax liability. This disparity means investment decisions can be about minimising tax rather than the best business investment.
  3. There are significant risks to the sustainability of the tax revenue base: Compliance is likely to be affected by perceptions that the system is unfair. International competition for capital and labour, especially from Australia, will impact on the sustainability of corporate and personal tax rates.

They have 13 recommendations, in order:

  1. The company, top personal and trust tax rates should be aligned to improve the system’s integrity.
  2. New Zealand’s company tax rate needs to be competitive with other countries’ company tax rates, particularly that in Australia.
  3. The imputation system should be retained.
  4. The top personal tax rates of 38% and 33% should be reduced as part of an alignment strategy and to better position the tax system for growth.
  5. Base-broadening is required to address some of the existing biases in the tax system and to improve its efficiency and sustainability
  6. Most members of the TWG have significant concerns over the practical challenges arising from a comprehensive CGT
  7. The majority of the TWG support detailed consideration of taxing returns from capital invested in residential rental properties on the basis of a deemed notional return calculated using a risk-free rate.
  8. Most members of the TWG support the introduction of a low-rate land tax as a means of funding other tax rate reductions.
  9. The following targeted options for base-broadening should be considered for introduction relatively quickly:
    1. Removing the 20% depreciation loading on new plant and equipment
    2. Removing tax depreciation on buildings (or certain categories of buildings) if empirical evidence shows that they do not depreciate in value
    3. Changing the thin capitalisation rules by lowering the safe harbour threshold to 60% or by reviewing the base for calculating this measure.
  10. GST should continue to apply broadly. There should be no exemptions.
  11. Most members of the Group consider that increasing the GST rate to 15% would have merit on efficiency grounds because it would result in reducing the taxation bias against saving and investment.
  12. There should be a comprehensive review of welfare policy and how it interacts with the tax system, with an objective being to reduce high effective marginal tax rates.
  13. Government should introduce institutional arrangements to ensure there is a stronger focus on achieving and sustaining efficiency, fairness, coherence and integrity of the tax system when tax changes are proposed.

There is little in these recommendations I disagree with, and I hope the Government implements most of them.

The removal of the ability to claim depreciation on buildings as a taxable expense is long overdue, considering almost all buildings actually appreciate in value.

Some of the other recommendations such as a deemed rate of return on investment properties and/or a land tax will help prevent future housing bubbles.

And dropping income tax rates is of course highly desirable.

While I would like to see GST increase, I am not sure that a net revenue gain of just $200 million (after compensating lower income families) from going to 15% makes it worthwhile.

The TWG make clear that they all agree that the status quo is unsustainable and not an option. The Government has pretty much said they agree. So the question is not whether there will be some reform, but how much.

Of course the tax side is half the equation. Maintaining discipline on the spending side is crucial also, and there is more there to be done also.

Is it bye bye to LAQCs?

January 2nd, 2010 at 4:09 pm by David Farrar

James Weir writes in the Dom Post:

The Government has a chance to lift the economy in 2010 with big changes on “crazy” tax breaks for investment property, according to NZX chief executive Mark Weldon.

“Tax is the No1 change,” Weldon said.

The Government has an unprecedented chance to take action and send signals this year.

“That would make meaningful long-term differences to our wealth, growth and standard of living.”

I agree, that some tax reform is much needed.

Investment property should be the target, such as dumping loss attributing qualifying companies (LAQCs) which allowed some wealthy people – including some on the Government’s own Tax Working Group – to pay no tax at all, Weldon said. Weldon is a member of the Tax Working Group.

“There is no difference between a rental property, a share, bond or bank account, so treat them all the same [for tax],” he said. If they were all treated equally for tax purposes, then money would go where it should, rather than chasing tax breaks.

Weldon makes a good point. Far too much property investment is because of the tax breaks. And this means capital is tied up in residential property insteaad of other areas which could grow the economy more.

But capital gains taxes – taxing a house when it was sold at a profit – showed mixed results around the world.

“You are a lot better off with a low-level land tax. It is administratively efficient.”

Such taxes could be imposed at, say, 0.2 per cent of the land value, raising a few hundred dollars a year, which would not upset house values.

Raising such a property tax would allow for personal income tax rates to be brought down and might allow company tax rates to be reduced if Australia dropped their company tax rates further.

I do not support a capital gains tax but do support a land tax, if income tax is reduced to compensate. A land tax would be administratively very simple –  Councils already levy rates on properties, so it would be merely added to that.

If listed companies were the same size as the value of all rental properties in New Zealand, shareholders in listed companies would theoretically pay about $11b in tax.

In stark contrast, investors in rental properties actually got back $150 million from the government from tax breaks.

This is the nub of the problem. Over $100 billion invested in residential property, and the “investment” generates a loss or effective subsidy from taxpayers.

“You look at that imbalance – you are taxing the productive sector and not the unproductive sector,” he said. Weldon questioned the concept of allowing depreciation on rental properties which was supposed to be for things that wore out. There was no depreciation on shares or bonds, which are supposed to go up in value.

That is a change worth considering also – no depreciation on residential property. One can claim 3% a year depreciation off tax, which is a lot of money. Now eventually when you sell, the tax claimed has to be repaid – but you have had the benefit of that money interest-free for possibly a couple of decades.

Has any residential property ever actually decreased in value, such that depreciation makes economic sense? Not over any extended period of time. In fact they constantly appreciate.

Kerr on Capital Gains Tax

October 8th, 2009 at 10:15 am by David Farrar

Roger Kerr writes:

A gains tax on housing would not reduce inflation. Inflation is an ongoing increase in the general level of prices, not a one-off change in some prices.

The introduction of the Goods and Services tax resulted in a one-off increase in the consumer price index – it did not lead to ongoing inflation.

Similarly, a capital gains tax might reduce property prices initially but it would not affect longer-term inflation.

True, and any increase in GST would be a one off bump.

Moreover, if such a tax on housing were applied only to realised gains as is likely, house prices could even rise. This is because of the lock-in effect, with owners holding on to homes to defer the tax on gains. Anything that reduces supply is likely to lead to an increase, not a decrease, in price.

One could do it on unrealised gains, but that would be pretty draconian.

Evidence confirms what theory suggests: the inflation performance of countries with a capital gains tax doesn’t differ systematically from countries that don’t.

Australia, the US and Britain, which tax capital gains, have all had large and volatile house price movements this decade.

I always like a look at empirical evidence.

A second mistaken assumption is that investment in rental housing enjoys tax privileges.

As the deputy commissioner of Inland Revenue, Robin Oliver, told a select committee in 2007: “Rules about expenses for deducting costs such as interest, upkeep and maintenance, as well as paying tax on income, are the same for investments in shares or anything else. In fact under the housing case … there are tighter rules regarding what is a capital gain.”

People are misled into thinking that rental housing is tax-preferred since highly geared rental property may record tax losses. This is because the full economic income (including the change in the market value of the assets) earned on rental property is not taxed.

However, this is a quite general feature of the taxation of real assets, including plant and equipment and farms.

A real issue though is whether it is sensible to allow property owners to claim 3% depreciation on their property annually, when the empirical evidence is that almost no residential property depreciates in value – in fact it appreciates.

Tax Working Group

October 5th, 2009 at 10:00 am by David Farrar

A summary and papers from the third session of the Tax Working Group are online at Vic Uni. Some extracts from the work:

Capital Gains Tax:

  • Treasury estimate a realisation based CGT on residential property excluding owner occupied would bring in $1.5 billion a year. This would allow the top income tax rate and company tax rate t be lowered to 30c.
  • CGT would make tax system more progressive as the wealthier benefit more from it (and the wealthier would benefit most from drop to 30c income tax so overall effect on progressivity might be limited)
  • IRD say an accrual based CGT not viable but an realisation based CGT may reduce economic efficiency as it will distort decisions on land-use decisions
  • Overall IRD say the benefits of a CGT would not outweigh its disadvantages
  • Some worry that as a CGT is so progressive, it might encourage wealthy people to leave NZ. Recommended that if there is a CGT, it apply at same levels as income tax for individuals

Land Tax

  • Very efficient as land is immobile. More efficient than a property tax.We have much lower land and property taxes than most countries.
  • A land tax would lead to a one off decline in value of land, which would increase home ownership rates.
  • The taxable land base is $460 billion so a 0.1% annual tax would raise $460 million a year.If you exclude agricultural land, forestry land and owner occupied land then revenue would be only $160 million a year.
  • Average farm land value is $1 million and average residential land value $200,000 so a 0.1% land tax would cost average farmer $1,000 a year and average home owner $200 a year.
  • Retired persons might be most disadvantaged as they benefit less from reductions in income tax to compensate
  • A land tax will bring foreign owners of land into the tax base, and has high degree of integrity as hard to avoid.

Rental Property

  • The tax revenue from the $200 billion rental property sector is negative and has trended down since the 39% tax rate came in.
  • An option is to remove income tax from rental of land, and also remove deductibility of expenses relating to the investment, replacing both with income tax on a risk free rate of return on the equity of the property.
  • Also discussion on whether rental housing and commercial properties really do depreciate, and should such depreciation be able to be claimed off tax. Depreciation on buildings is worth $1.3 billion a year of foregone income.

I am pleased to see the group backing away from a capital gains tax, but more favourable towards a land tax. I think the land tax (so long as income tax is cut to compensate) has considerable merit. I also think there is merit in concluding most buildings do not depreciate (in fact they appreciate massively) and disallowing depreciation in future. Again this is contingent on the overall level of taxation not increasing.

The website above, has papers which go into great details of the pros and cons. One paper looks at a 0.5% property tax if there is elastic supply. It says:

  • 33% income tax rate could drop to 30%
  • 20% income tax rate to around 18%
  • Average house price drop from $384,500 to $378,000
  • Average rent from $11,850 to $12,700
  • A 1% land tax or a 0.55% property tax would raise $4.6 billion

Hat Tip: Bernard Hickey

Labour on Capital Gains Tax

September 14th, 2009 at 5:57 am by David Farrar

NZ Herald reports:

Labour leader Phil Goff says his party is prepared to discuss a capital gains tax with the Government, opening the way for an accord on a tax that has long been a political hot potato.

Mr Goff said the party’s bottom line would be that the tax would not apply to family homes.

This means it would effectively target investment properties.

The issue is being considered by a Government tax working group, and neither Prime Minister John Key nor Finance Minister Bill English will rule it out.

A capital gains tax on property investment is seen as one way to reduce the tax advantages of rental housing, curb house price inflation and send investment into productive sectors of the economy.

It is commendable that Labour are not ruling such a tax out, and saying they will judge any proposal on its merits. That will allow the Government to have a sensible consideration of the pros and cons.

My strong expectation is that any revenue from expanding the tax base, should be offset by reductions in existing tax rates. Certainly that is the remit of the Government taskforce looking at the tax system.

I hope Labour’s flexible stance will extend to the merits of a land tax also.

Treasury talks capital gains tax

June 4th, 2009 at 9:57 am by David Farrar

Brian Fallow writes:

The Treasury has renewed its call for reform of the tax system, including the issue of capital gains from property investment.

It wants the system to have a broader base and lower rates, Treasury Secretary John Whitehead told an Institute of Directors function yesterday. “And at the risk of being chased down by an angry crowd with pitchforks and flaming torches, yes this should include consideration of moving the boundaries to tax more capital gains – for example on investment property – and shifting more of the tax base towards consumption,” he said.

Without changes to the tax system, there was a real risk that the Government’s revenue base would be unsustainable in the medium term, given growing international competition for capital and skilled labour, and an ageing population.

“A key priority has to be reducing effective marginal tax rates and increasing the rewards for effort. There is a growing view that the high mobility of our skills base means high personal income taxes are especially harmful for New Zealand’s growth and productivity,” he said.

I used to be fervently against a capital gains tax on investment property. Since the credit crisis, partly caused by rampant borrowing for property, I have started to change my mind.

So long as other taxes were cut, so overall tax revenue does not increase, I think the time is right to now take a serious look at capital gains tax. And I say this as someone looking to buy an investment property.

“I know there is a lot of passionate debate on this matter, but capital gains or property taxes would be beneficial for encouraging investment in productive activity.

“A more complete capital income tax base reduces the impact of tax distortions on investment decisions, thereby improving the allocation of capital in the economy.” And greater reliance on GST – aligned with reduced income and corporate tax rates – should help strengthen incentives for savings, he said.

I don’t expect the Government to say they are in favour of a capital gains tax. But I do hope they will allow Treasury to work on proposals for how one could work, so it can be debated in the fullness of time.