Guest Post: Rodney Hide on Tax Working Group

Rodney Hide writes:

Sir Michael Cullen may well achieve his career highlight having left Parliament with his appointment as Chair of the Tax Working Group, a position for which he has no qualification or expertise.  It’s given him his best opportunity to whack “rich pricks” good and hard.
“Rich pricks”
Sir Michael has always had a thing with “rich pricks”.
In his maiden speech in 1982 he took the opportunity on interjection to thank the farmers of Canterbury and the Hawkes Bay who had provided him with a scholarship to attend Christ’s College: “I ripped them off for five years then, and I shall get stuck into them again in the next few years”.
He was gleeful powering up unions at the expense of employers in 2000: “Eat that! You lost, we won, it [the ECA] goes!”
His “Eat That! You lost” mentality also saw him increase the top rate of tax from 33 cents to 39.
His descriptions of Sir John Key were classic Sir Michael: “working class scab” and “rich prick”.
Capital Gains Tax
Sir Michael Cullen is again after “rich pricks” through his Tax Working Group.
The Working Group’s Interim Report recommends taxing all capital gains on (p.37):
the sale of land and all property other than the residential home;
intangible property including goodwill;
plant and equipment; and,
shares and other equity interests.
The gain is to be calculated in nominal terms and taxed at the taxpayer’s full rate.  Taxpayers are to be taxed on inflationary gains.
The Working Group’s concern throughout is that it’s the wealthy (“rich pricks”) who make capital gains.
Definition of Income
The Group’s advocacy for capital gains is not a reasoned argument but flows entirely from the Group’s definition of income: it defines income to include capital gains and then declares not taxing capital gains a distortion, inefficient, and unfair (pp. 5, 18, 26, 28, 32, 34).  Further, it’s wealthy men who own capital and so not taxing capital gains favours rich men over women and poor people (pp. 18, 28, 32). That’s it.
The Group explains their definition of income as follows: “realised capital gains provide a basis for consumption in the same way as labour or interest income (p. 24)”.
It’s this definition of income that provides the Group’s entire rationale to tax Capital Gains.
What should be taxed
The Group’s problem is that their definition of income implies much bigger “holes” in the tax base than not taxing capital gains and about which the Group is silent.
The income definition employed is what is known as Haig-Simons: “consumption plus changes in net worth”.
The definition means the “tax holes” include the imputed rentals of owner occupied homes, DIY (such as mowing the lawns, renovating the kitchen), looking after your own children and doing your own housework.  All of these activities and services are untaxed yet provide “a basis for consumption in the same way as labour or interest income”.
Indeed, they are taxed when you pay someone to do them for you.
Applying the Working Group’s argument, all these activities and services should be taxed and should be taxed ahead of capital gains because their value is larger and therefore the distortion, the inefficiency, the loss of government revenue, and the unfairness are greater.
Of course, no one is advocating such taxes (apart from Gareth Morgan’s TOP Party which at the last election advocated taxing imputed rentals).  The Group uses Haig-Simons simply to justify taxing capital gains. The definition itself is not an argument and is wholly inadequate as an arbiter of what should be taxed and what should not be taxed.
That the Group don’t consistently apply their definition shows their ideological bias to taxing capital gains and hence, they believe, in taxing “rich pricks”.
Apples and the tree
The problem of the capital gains tax is that it taxes income twice (three times actually because income tax double taxes capital income: once when you earn it and again on any return from saving and investments).
An asset like an apple tree has value because it produces a future income stream in the form of apples.  A barren tree has no economic value. The value of the tree is entirely a product of the future income stream.
Selling an asset, like the apple tree, is simply selling a future income stream.   Double the income stream and the value of the asset doubles. Tax the income stream by 50 percent and the value halves.
Any capital gain on selling the tree is already taxed because the tree’s value is discounted by the tax that has to be paid.  There is no tax dodged in not paying tax on capital gains because the future income of the asset is taxed and the asset’s value discounted accordingly.
Taxing capital gains is a double tax. There is no distortion, inefficiency, unfairness, in not taxing capital gains.  The distortion, inefficiency and unfairness arises in taxing capital gains.
The effect of taxing capital gains
Taxing capital gains is the most damaging of taxes.  It locks-in assets because it’s only on their sale that tax is liable.  Holding on to assets avoids the tax. Don’t sell the tree, don’t pay the tax.  That makes for a sclerotic economy where assets aren’t so-readily bought and sold and so don’t achieve achieve their best and most economic use.
That makes for a poorer economy.
Taxing capital gains double taxes entrepreneurship, the very engine of a successful economy.  Entrepreneurs typically take their reward by way of capital gains: they build businesses that employ people and generate wealth.  Taxing capital gains means less entrepreneurship.
Taxing capital gains doesn’t cost “rich pricks” but poor workers.  Investment funds are highly mobile around the world. Their supply curve in the jargon is highly elastic.  That means the cost of taxes on capital is shifted to workers. It’s workers who carry the cost through lower wages than they would otherwise enjoy.
What drives investment is risk and after-tax rate of return.  A country like New Zealand increasing their tax on capital lowers the after-tax rate of return.  The flow of investment funds falls until the after-tax rate of return adjusts back to what it was before the tax.  The return on capital remains the same: it’s just that New Zealand workers have less capital to work with and as a result are less productive than they otherwise would be with lower wages as a consequence.

Capital Gains Tax entirely counterproductive
A Capital Gains Tax in New Zealand would prove entirely counterproductive: it would be damaging to the economy with its cost borne by workers, not “rich pricks”.
That tax burdens are shifted has been understood by economists since 1838 (Cournot, Researches on the Mathematical Principles of the Theory of Wealth) and in all text books since 1890 (Marshall, Principles of Economics).
Taxing capital gains won’t even achieve what Sir Michael intends despite its cost.
There should be no surprise by this.  Sir Michael invariably dismisses economic analysis of his policies as “ideological burping”.  

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