Tax, Dogma And Economic Illiteracy

We’ve had a few questions from our members about Green Party candidate Robin McCandless’ piece entitled Tax, dogma and The Opportunities Party. It was published in the Green Party members magazine, so wasn’t public and we can’t link to it. It took us a while to get hold of it but there is a scanned copy of it here.

The piece generally reveals a complete lack of understanding of economics on McCandless’ part. Firstly he doesn’t discuss at all what tax should people pay, what tax is fair and efficient. Then he dreams up 3 completely unrealistic scenarios and uses them to compare The Opportunities Party (TOP) Fair Tax reform with the Green Party proposal for a capital gains tax excluding the family home. Finally, at no point does he stop to consider what the driver of capital gains on housing is.

Little wonder he ends up favouring the Green Party proposal despite the fact it hasn’t prevented out of control house prices overseas, and has even been shown to be a handbrake on growth.

Fair and efficient tax system

A fair tax system should tax all income the same, but our tax system doesn’t do that because it ignores imputed rental. Imputed rental is the rent we pay to ourselves when we own the house we live in. Confused? If you put your money in the bank, you would have to pay tax on the interest before you paid your rent. If instead you use the same money to buy a house, you don’t have to pay the tax or the rent. If you don’t believe us Robin, imputed rental is in the GDP accounts, acknowledged as income; look it up.

The reason house prices are rising so fast is because everyone wants to own their home so they can benefit from this tax free imputed rental. Investors know this, so they put all their money into housing too, knowing that you and I will keep bidding up house prices as we exploit the loophole of tax-free imputed rental. This is what causes such strong demand for the asset. So long as we all do it, the outcome is self-fulfilling – house prices rise, way faster than the demand for accommodation. The capital gain that results is in effect the present value of the future tax benefit that ownership confers. Rather than have to wait years for that benefit, the owner can simply sell now and realize the benefit. The fact that they get the capital gain tax-free is simply an added bonus. In other words the problem isn’t that the capital gains are untaxed as the Green Party are claiming, the problem is that the capital gains are happening at all.

We need to decide if we want to deal with our property obsession or continue to simply fiddle around the edges; because like the other Establishment parties, that is all the Green Party are doing. For starters they exclude the bulk of the property market by excluding owner-occupiers. And secondly they simply tax the capital gain without dealing with the root cause of why prices are rising. And to make matters worse because they advocate that a capital gains tax be levied on sale, it discourages selling assets like houses and businesses. That means that people will just hold on to assets longer to avoid the tax. This type of impediment in any market hurts growth.

The Three Scenarios

McCandless sets out 3 scenarios, where each house is worth $500k and each person has invested $500k:

  1. The first person invested in the house they live in, with no debt.
  2. The second invested in one rental property with no debt, returning a 6% yield.
  3. The third invested with five properties with 20% equity, returning a 6% yield. 

McCandless mourns that TOP will tax the homeowner, but ignores the fact they’re getting an effective income from owning the house; the imputed rental. After all, why do people invest in housing, rather than put their money in the bank as is so commonplace in Europe, and just pay rent? The tax advantage in New Zealand makes it a no-brainer. He also overlooks that the revenue gathered by closing this loophole will be recycled into income tax cuts, making 80% of people better off.

McCandless bemoans the fact that since the investors in the examples he presents are already earning taxable return of 6%, they pay no more tax under our regime. Of course they shouldn’t – if they are already paying that much tax why would you want to tax them more? Ours is not an agenda to double tax them just because they are investors – which he’s implying should be the agenda. That’s just Far Left drivel.

But being a little realistic here, what investor in real estate is getting a 6% yield from rent? It is a ridiculous assumption. According to Infometrics the average gross rental return in New Zealand is around 3.5%, and that is before rates and other costs. If an investor is getting a 6% taxable return in this market, there is no case to argue they’re tax dodging.

The loophole argument only arises when they’re not getting a return commensurate with a bank deposit rate – which is the common case in fact. Why would anyone invest in an asset that yields less than the risk free rate? The answer of course is they don’t – it’s just that a significant portion of the return they seek lies beyond the taxable income, it’s the capital gain component which is driven by owner occupiers’ demand as they chase the tax break.

Capital Gain on Housing

McCandless then proceeds to assume all house prices in his example rise 80% (the same as in Auckland over the past five years he points out) to $900k and looks at how that increase in value is taxed.

At no point does McCandless stop to understand the cause of house price inflation – because everyone is chasing the tax-free imputed rental. Why haven’t shares risen the same amount as houses have? After all they don’t face a capital gains tax. The answer is that the real return on shares (dividends) is taxed in much the same way that bank deposits are. The problem with property is that the main source of return - imputed rental – isn’t taxed. It is a massive loophole in our tax system worth around $11b pa. Close that loophole and there won’t be much in the way of capital gains to speak of. That is what our Fair Tax reform does, but where the Greens’ capital gains tax falls short.

Besides, our Fair Tax reform is based on a proportion of the capital value of assets – so any capital gain in those assets will end up being taxed eventually. The only way to get untaxed capital gain under our Fair Tax reform is to increase the taxable return that an asset delivers, and if someone does that then they are paying more income tax anyway.

The truth is that the Greens Party proposal for a selective capital gains tax on property that excludes the family home will be unwieldy and have little or no impact on house price inflation. If you don’t believe us, just look overseas. They need to go back to basics and consider the causes of the capital gain rather than be so politically expedient and attack just some of the symptoms.

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