Complicated Tax Ideas Never Work

Tony Alexander the Chief Economist for BNZ says:

A Capital Gains Tax?
The media are reporting that next Thursday Labour will announce they will go into the election with a set of tax raising proposals including a capital gains tax on investment property perhaps at 15% effective for new purchases from a future date. The aim it appears is to turn NZers back into a nation of home owners as opposed to renters – back to someone’s view of the good old days – and raise revenue to pay for a tax free threshold of perhaps the first $5,000 of income and the removal of GST on fresh fruit and vegetables (what an admin nightmare that will be, and why not books as well, or school charges, detergent, rates, electricity, water charges?)
If a tax were introduced what would the impact be? The analysis is actually quite simple and it goes like this. Australia has a capital gains tax and their housing is less affordable than ours. Most other countries also have a CGT and their housing markets have experienced major booms and busts. Therefore introducing a CGT is not likely to lead to noticeably cheaper houses or stop the house price cycle. We will still borrow and buy housing when we believe prices are going to rise, and sell them when we feel prices will fall.
The long term effect on NZ house prices is likely to be to increase rather than lower them. This arises first because investors with existing properties will be reluctant to trade them. That is, if you already hold one investment property and want to sell that then a bit later on get a new one you will shift your capital from tax free to taxed status. Therefore those with properties purchased before the CGT effectiveness date will tend to hold onto them and not make them available either for other investors or owner occupiers. These properties may be redeveloped however depending upon the treatment under the tax system of such activity. If such activity results in being captured by a CGT then they may be allowed to run down.
In addition, if you are thinking about building houses to let the introduction of a CGT will reduce the likely long term return therefore this will lead to a combination of higher rents and reduced construction. This latter effect would not matter if we had an ample supply of houses in NZ, but we do not. We have a shortage of about 45,000 dwellings and by reducing returns to investors the resulting reduction in construction will lead to an even greater shortage. That is where the upward pressure on house prices will come from – after what would likely be a short term dip.
As we pointed out some time ago, the horse has bolted with regard to introducing a CGT on residential investment property. Had it been introduced when houses were plentiful the reduction in investor construction may have had not much long term impact. But now it would be a sizeable factor keeping prices up. There should of course be a CGT on residential investment property and its absence does cause a distortion of investment choice in our country. But the time has passed to introduce it – unless that is one makes substantial changes which will permit a rapid increase in housing supply and reduce other costs facing property developers. That is where real change needs to occur to address NZ’s worsening housing issue – cut the costs of building new houses. This would involve a substantial loosening up of zoning restrictions, an easing back on the building code, removal of developers levies imposed by councils, somehow boosting competition in the building materials sector, encouraging us to buy low unit cost cookie-cutter houses rather than our preferred individually designed ones , etc. The chance of any of these things happening seems fairly low – as in nil and buckleys. And finally, it pays to remember that one of the factors driving the surge in house prices and the eventual oversupply in the United States was a set of policies aimed at increasing the home ownership rate. People were encouraged to buy property they could not actually afford – the zero equity, near zero documentation loans for instance. Now many of those folk are destitute. New Zealand’s deficiency is not in some theorised cultural preference for housing for which we have never seen documented evidence, but our fairly obvious preference for borrowing over saving. Where we differ substantially from other countries is not home ownership or our investment in housing but our lack of financial assets caused by our lack of saving.
Will introducing a CGT, raising the top marginal tax rate, and whatever other tax boosting proposals to come from Labour cause us to save more, to work harder, to gain more education, to take more business risks, to stay in New Zealand? Or will we join our cuzzies across the ditch? Plus, if Labour introduce a CGT it seems reasonable to extrapolate the taxing trend into a tax on farm land price gains – especially given Labour’s recent attack on the low tax they claim flows from the farming sector. On that issue, this week I spoke with farmers in a number of locations in the deep south and some have noted that they’ve only paid tax in 4 – 9 of the past 30 – 40 years. Their wealth accumulation derives from higher land prices and not production yield even though that is where all their invention and innovation goes.
Is it likely that we will see a capital gains tax on residential investment property soon? Not really given what the political polls are showing.

Posted in News & Articles | 1 Reply

One thought on “Complicated Tax Ideas Never Work

  1. First the Labour party have to get in and at the moment this tax should be a wee way off.

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