Our tax system is not just unfair and making housing unaffordable; it is stuffing the rivers too.

Most Kiwis are aware of the speculation in our housing market. It is the demand for housing and land as a tax-favoured investment over and above the demand simply for shelter or comfortable housing. This sends prices spiraling ever upwards, making house prices and even rents unaffordable for many, driving up our debt (most of it foreign), and starving our businesses of the money they need to grow.

 It’s a problem that is all too obvious to people now. But it doesn’t just apply to housing, it also applies to our largest industry; farming. And this is, in turn, stuffing our rivers. 

We know the story for housing

For decades now the returns from capital gain have dwarfed those from rental returns. Now the expectation of capital gain means investors are prepared to accept rental returns below what they would get from a bank deposit. Land owners don’t bother to build because their land will be worth more tomorrow from doing nothing. Developers can’t build because all the available credit is going out via mortgages to buy existing houses.

In short, the game is rigged so that prices only go up. Politicians know it, which is why they too buy multiple houses. The only way to fix the problem is through our tax reform policy, which will kill speculation.

We are farming for capital gain, not real return

The impact of our tax system is having a similar impact on farms. For decades now we have been farming for capital gain rather than return from the actual business of farming. And why would you want returns from farming when it is taxed? Better off to run as many of your living expenses as you can through the farm, invest every dollar you make in capital improvements or buying another farm and sell the lot when you retire, without having to pay a cent of tax. It just makes good business sense.

It becomes a self-fulfilling prophecy because as land prices rise, it becomes harder and harder to farm for return, so instead you rely on capital gain. For example, sheep and beef farmers historically have received a paltry 2% return on investment, making far more money through capital gain (which in recent decades has averaged a whopping 9% per year). It’s a ponzi scheme that like housing, relies on prices going up forever – driven by the tax advantages from ownership of these assets. Sadly that can’t keep happening.

Capital gain spurs environmental destruction

Aside from buy and hold, one popular way to increase a farm’s capital value is to intensify and increase production. That is why we have seen conversions to dairy, and now even sheep and beef farmers are using intensive methods like ‘spray and pray’ on hill country.

This intensification doesn’t always happen purely for economic reasons. Because some investments are taxed (e.g. a bank deposit, Kiwisaver) but others aren’t (property) it makes sense to invest where there is no tax. Therefore a farmer may be willing to make an investment with a relatively poor return if it increases the value of the farm, because the capital gain isn’t taxed. The fact that tax loopholes create an incentive for intensification has also been pointed out by Motu

Further, without environmental controls we have seen a gold rush as farmers intensify production blissfully immune to the costs inflicted by the additional environmental degradation, and pocket the untaxed capital gains flushing the environmental side-effects downstream.

This trend has been encouraged by an industry that profits from intensification (e.g. irrigation, fertilizer and palm kernel sellers) and relies on increased milk volume as part of its growth strategy (Fonterra).

And finally the high land prices provide yet another reason for intensification. The only way some farmers can pay the mortgage is through intensifying land use, so thanks to speculation on land prices intensification becomes inevitable.

High land prices make environmental controls difficult

Now that we have seen the light and are implementing environmental controls, these problems are coming home to roost. Land prices that rose in the absence of environmental controls are now under threat of falling. That is why dairy farmers, their banks and their lobby groups are fighting back so hard. For an industry built on capital gain rather than return, it spells disaster.

That is why we’re seeing Fonterra and Dairy NZ weighing into regional discussions about environmental controls. Above all else they want to protect dairy farmers existing rights to pollute. Why? So they can lock in current land values.

Such a consequence has the industry championing ‘grandparenting’so that the cost of environmental improvements are not borne by the largest polluters but rather shared across all in the industry. This includes farmers that are farming at a much lower intensity or have already invested heavily in reducing their pollution. Such protectionism is unfair, and very inefficient.

Capital Gain trumps Emissions Trading

The Emissions Trading Scheme is also beset by this problem. The Emissions Trading Scheme was designed to encourage forestry, but that hasn’t worked out in reality. This hasn’t been helped by the Government’s gerrymandering of the carbon price by accepting dodgy foreign units. But another problem is that the greatest capital gain accrues on land with the most options; which means bare land. You can always plant bare land, but as soon as a landowner plants and is in the Emissions Trading Scheme their options reduce.

The most important factor for forestry is the land price; a high land price means a poor return and in an industry that faces a 30 year wait for harvesting, that risk is unacceptable. That is why some forestry insiders claim that once the wall of wood currently planted is harvested, those credits will be paid back and the forests will not be replanted. If this is true, then our government faces a massive carbon liability in 2030. Any new incentive to plant will work in the same way; the potential for capital gain will always be higher with bare land, so no one will plant trees. For planting to work we have to change the tax system to kill off the hunt for capital gain and replace it with a hunt for yield farming. This would reduce real land prices over time and put forestry on a level playing field with other farm types.

The Solution

The only solution to this problem is to sort out both the distortions in our tax system as well as the lack of environmental controls. TOP is the only party proposing this approach.

Note: the Green Party’s proposed capital gains tax won’t solve this speculation problem. For starters it won’t eliminate capital gain, it will just tax it. Secondly it excludes the ‘family home’, which most farmers will argue includes their farm also.