Will the Government tax paper gains, not real gains?

Louis Houlbrooke from NZTU writes:

Each year we get richer on paper, even when in real terms our buying power remains the same. The paper value of an asset tends to increase by about 2 per cent each year, regardless of any real increase in value.

Should we be taxed for these paper gains? The Tax Working Group’s chairman, Sir Michael Cullen, thinks so. At a recent public symposium, he appealed to a sense of consistency, pointing out that we don’t inflation-adjust other parts of our tax system. Why break the trend with capital gains tax?
Here’s why: to levy this tax on inflationary gains would be to stealthily devastate the finances of New Zealanders who are not actually getting richer.

The effect of inflation on capital gains is striking for assets held long-term. Consider a family bach in remote coastal New Zealand, worth $400,000 when the capital gains tax is introduced. After one year, we can expect the property to see a paper capital gain of about $8000. After 10 years of compounding 2 per cent inflation, this gain becomes $87,000. After 20 years, the bach is worth an extra $194,000, merely in inflationary gains.
Now imagine the owner of the bach sells up – or they die, passing the bach on to a relative. Either event triggers the capital gains tax, meaning the seller – or inheritor – is faced with a tax bill from Inland Revenue of $64,000.
That’s based on the Working Group’s suggestion that the tax would apply at the marginal rate of 33 per cent, one of the highest capital gains tax rates in the world. So our bach seller (or penniless inheritor) loses $64,000 in tax on a completely illusory capital gain.

That’s a great example of how the Government won’t just tax you on your actual gains, but will profit from inflation. You end up paying $64,000 extra tax on a zero real gain.

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