Capital gains tax not worth the hassle

Labour leader Jacinda Ardern hasn't ruled out introducing a capital gains tax should the party win the general election.
MAARTEN HOLL/STUFF

Labour leader Jacinda Ardern hasn't ruled out introducing a capital gains tax should the party win the general election.

OPINION: Despite what Labour says, introducing a capital gains tax is not a technical matter. It is a tax reform of a different kind and nature to, say, adjusting the rates of existing taxes. And, when you drill down into it, the question is a philosophical one.

We are one of the few developed countries without a comprehensive capital gains tax. Despite protests to the contrary, the "bright line" test for residential properties is not one. Properly considered, it is a tax on income.

When buying a property for resale purposes, you have always had to pay income tax on your profit. What the bright line test does is remove subjectivity in determining your intention for certain transactions. Sell within two years and, unless an exception applies, the IRD deems you to have purchased for resale. A capital gains tax, by contrast, is a tax on the increased value of an asset. Your intention at the time of acquisition doesn't come into it. It is not the same thing.

The fact that we are one of the few countries without a capital gains tax is not, in itself, good reason to adopt one. Compared to most other countries, our system of taxation is simple and elegant. Tax simplicity is one of our few competitive advantages. This is sometimes under-appreciated by those who only pay PAYE and GST, but is not something New Zealanders should take for granted.

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It is also no coincidence that, compared to other countries, we also have a very high rate of tax compliance. Tax simplicity is wonderful.

Taxing capital gains is an invariably complicated exercise. Before implementing the tax, you need to determine the types of assets to be taxed and when it will be payable. Will art be captured? What about shares? KiwiSaver portfolios? What if it's jointly owned and one person dies? What if it's left to you in a will? What if it's in a family trust? All these things require complex rules for implementation, administration and compliance.

In return, you don't actually raise a lot of revenue.

Phil Goff campaigned on imposing a capital gains tax in 2011, which obliged him to put some numbers forward. In the first year, Labour projected its tax would only raise $17.5 million, which is barely half the cost of a flag referendum. While that amount was to rise over time, capital gains tax would never be more than a drop in the bucket of total tax receipts.

So why go to all the effort? For a long time, advocates touted a capital gains tax as a control for housing costs. This falls apart when you think about house prices in places  such as San Francisco, Sydney or London. They are all places with runaway housing costs, all places with a capital gains tax on investment properties.

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Indeed, a capital gains tax can exacerbate things. If the family home is exempt, for example, there's an incentive to pour more money into improving it. When you come to sell the extravagantly improved house, you can demand an extravagantly improved price.

Also significant is that gains are taxed, but losses can rarely be offset against other tax liabilities. In other words, a capital gains tax socialises profits while privatising losses. This is a deterrent against riskier investments and an incentive for safer ones.

If that sounds like a good thing, think again. There are few things riskier than investing in a start-up company – and we need more investment in that field. Conversely, New Zealanders perceive residential property to be "safer" over the long term.

Then there is the "lock-in" effect of a capital gains tax. Because the tax is payable on sale of an asset, it can be easily avoided by not selling it. Freeing up capital to invest in something promising becomes harder and more expensive. Productive opportunities fall by the wayside.

So why bother? I suspect it comes down to what you think about the purpose of taxation.

Under Bill Clinton, the United States lowered the top rate of its capital gains tax from 28 to 20 per cent. The Inland Revenue Service collected more revenue under the lower rate than it did under the greater rate. Under George W Bush, the rate fell to 15 per cent. Once again, receipts were greater under the newer, lower rate.

In 2008, then-presidential candidate Barack Obama campaigned on increasing capital gains tax. During one debate, moderator Charlie Gibson asked him why, given that it might reduce revenue. "Well, Charlie," the future president replied, "what I've said is that I would look at raising the capital gains tax for purposes of fairness."

This is the heart of the matter.

If you think the point of taxation is for the Crown to raise money for spending as unobtrusively as possible, you will likely be sceptical of a capital gains tax. If you think it is about imposing "fairness" – even if everyone is worse off as a result – then it's a terrific idea.

 - Stuff

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