Getting realistic about capital gains tax

Recently there have been renewed calls to tax capital gains on housing.

Opposition leader Phil Goff has indicated Labour would be open to talks.

Parliament's Finance and Expenditure Committee considered the taxation of housing in its 2007-08 monetary policy inquiry.

It found that the monetary framework was sound, with monetary policy being necessary and sufficient to maintain price stability. Only the Green Party recommended a capital gains tax (CGT) on housing (other than the family home).

Monetary policy is a powerful instrument. Tight monetary policy dampened inflationary pressures through 2007.

Current loose monetary policy, combined with indications from the Reserve Bank that it expects to keep interest rates low well into next year, carries risks of an unbalanced recovery and a resurgence of inflation.

Could these risks be reduced by altering the tax treatment of housing?

Some have suggested such action could curb house price inflation, reduce the alleged tax advantages of rental housing, and channel investment to more productive sectors of the economy.

These arguments are largely fallacious.

A CGT on housing would not reduce inflation. Inflation is a monetary phenomenon: essentially too much money chasing too few goods. It is an ongoing increase in the general level of prices, not a one-off change in some prices.

The introduction of GST resulted in a one-off increase in the CPI; it did not lead to ongoing inflation. Similarly, a CGT might reduce property prices initially but it would not affect longer-term inflation.

Moreover, if a CGT on housing were applied only to realised gains, that is, as properties were sold, house prices could rise because of 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.

Empirical evidence confirms what theory suggests: the inflation performance of countries that apply a CGT does not differ systematically from countries that don't.

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

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

As Inland Revenue deputy commissioner 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.

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 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.

Moreover, any attempt to increase the taxation of investment in rental housing could well push up rents as investors seek to restore after- tax returns.

A third issue is owner- occupied housing. It's true that this category of housing (which represents two-thirds of the housing stock) is tax-favoured because imputed rents (the value of housing services to owners) are untaxed.

Rather than attempt to tax imputed rents (which would logically be the first step) or impose a CGT on housing, my preference would be to lower and flatten the income tax scale, as the 2001 McLeod Tax Review recommended.

While not eliminating the tax preference for owner-occupied housing, such moves would reduce it whereas the previous government's move to raise the top income tax rate increased it.

There can be fair debate about how far we should tax real capital gains, although in my view the practical problems make major moves unattractive and the revenue gains would be small.

However, the debate has nothing to do with monetary policy and inflation, and myths about tax preferences and their effects should not be perpetuated.

Taranaki Daily News