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Taxing capital gains – an idea whose time has come?

13 February 2009

New Zealand is unusual in not having a capital gains tax and there is a developing view that the tax system and our economy may be the weaker for it.  Certainly the Treasury has recommended that the Government seriously consider the idea. 

Treasury’s call sparked supporting calls from both the New Zealand Manufacturers and Exporters Association and the Productive Economy Council.  Their concern is that the absence of a CGT siphons investment away from the productive sector, where profits are fully taxable, and into property where they can be tax free. 

The effect of this ‘tax preference’ is particularly troubling in the re-sale property market.  While building new houses clearly benefits the country, buying and selling the same house at forever escalating prices does not.  In fact it arguably depletes the national wealth, as the higher prices result in higher mortgages and thus greater interest payments - the profits from which flow overseas to the predominantly foreign owners of New Zealand’s banks.

Unsurprisingly the Treasury’s recommendation was immediately rejected by the Government which – like governments before it – seems to think that even to debate a CGT would be political poison.

Introducing a capital gains tax will always be controversial but, if well-designed and targeted, need not necessarily be politically suicidal.  Further, there are alternative, less intrusive approaches which could confer the same benefits as a CGT at less cost - for example, a claw back at sale of interest deductions.

The reasons the Government gave for its opposition to a capital gains tax were that:

  • property investors are principally ‘mums and dads’ and a CGT would ‘punish’ them for saving for their retirement;
  • it would push up rental prices; and
  • it is political suicide.

It is interesting to hear the Government refer to tax as punishment, a view which many share but few expected to have confirmed.  But it does not explain why people who invest in property should avoid such punishment, while those who invest in the productive sector, or who work even, should not. 

The point is fair in so far as investors who bought property on the understanding that their gains would not be taxed would be disadvantaged were a tax was now imposed.  But this could be easily dealt with by having the CGT apply only to property acquired after the tax’s introduction date (as is the position in Australia).

Further issues concern whether the impact of a CGT would push up or depress house prices.  One would have thought that any upward pressure would be minor, given that people buying for the purpose of resale are currently taxable anyway while investors buying for the purpose of rental should not be strongly influenced by any tax on subsequent resale. 

On the other hand, whether a CGT would achieve the results desired by its advocates very much depends on the exact form it takes.  While a ‘pure’ CGT which taxed all profits from the sale of capital assets might pull prices down, this effect could be significantly mitigated by exempting the family home.

It worth noting that New Zealand has the second to worst housing affordability according to a recent Demographia study of six countries.  The least affordable country is Australia, which has a CGT.  The Australian CGT however only taxes individuals on 50 per cent of any capital gain made on the sale of capital assets held for 12 months or more and does not tax gains from the sale of the primary residence.  Australia’s CGT therefore still creates a tax incentive for property investment. 

But, even if one accepts the general desirability of a CGT, a recession is perhaps not the right time to introduce it.  In a falling market, taxpayers will generally be making capital losses rather than capital gains.  Consequently, introducing a capital gains tax now would likely only entitle taxpayers to claim capital losses in the immediate future, which could then likely be offset against future capital gains. 

A better time may be when a market recovery is securely underway.  

One alternative to a CGT would be to claw back any net deductions in respect of a property to the extent the property was sold for an otherwise non-taxable gain.  This would make the tax treatment of property similar to the position prior to 1990.  It would also address the real tax advantage of much property investment, in that the net costs of holding a negatively geared property are wholly deductible but the profit from sale is not taxable (thus effectively tax subsidising the investment). 

This proposal also should not result in greatly increased rentals (as the net deductions would still be available for offset against other income in the interim), and would not violate the Government’s statement that it will not introduce a capital gains tax. 

The views expressed here are those of Sam Rowe, and may or may not be shared by clients of the firm or those within it.

For more information, contact our Web Editorwebeditor@chapmantripp.com+64 9 357 9622

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