Kiwiblog

Cactus Kate blogs on the recommendations of the Tax Working Group. With respect, I disagree with her on one aspect. She says:

Much has been made of building depreciation. Those who still think this is a starter should read up on the IRD website about “depreciation recovered” . It is erroneous to say that the current system doesn’t already have a clawback on sale where depreciation has been overclaimed. As it does for other fixed assets depreciated in business as well.

Now it is true that when a building is sold, you have to pay back the cost of the tax on the claimed depreciation. Everyone knows this. But Cactus misses the point – you get to have interest free use of that money in the interim – this is like interest free student loans, but even better.

It is effectively lending landlords taxpayers money for free. Residential buildings do not generally depreciate – they appreciate (along with the ladn they are on).

Let me give an example. Say you purchase a house and the building is deemed to be worth $200,000 of the total price. You can claim 3% depreciation diminishing value. In year one that is $6,000. Now if you pay 38% tax, then you effectively end up with $2,280 extra cash.

Now even if you are the worst investor in the world, let us assume you can at least earn the risk free rate of return of 6.29%. So you earn $143.41 of your $2,280.

Now that doesn’t sound much. However in year two you then have $2,423.41 of money to invest plus you claim $5,820 off your income as depreciation, which at 38% which is a further $2,212 to invest. So then your return courtesy of the taxpayer is $291.54.

If you sell your property after ten years, you will have claimed $52,515 off your income, resulting in reduced taxation of $19,956. But you will by then have $28,774 of extra money (at the conservative risk free rate of return), so after paying back the claimed depreciation you still have $8,818 left over.

If you keep your property for 30 years, then after paying back the depreciation you will have $106,639 surplus from being able to use that money interest free. Now this is in nominal terms, so won’t be as much in real terms. But it is still money for nothing and bad economics – just like interest free student loans are bad.

Depreciation is a necessary tax loss, when the asset really does depreciate, as it allows you to fund the cost of replacement. But when we have decades of evidence that residential buildings appreciate, not depreciate, I’d rather not give out interest free loans to property owners to claim a depreciation that doesn’t exist.

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.