The Tax Working Group Report: The Good, The Bad and the Predictable

The Tax Working Group Report: The Good, The Bad and the Predictable

The Good

Let’s start with the good stuff, and there is a bit of that, mainly around the environmental tax proposals. The Tax Working Group has acknowledged that the notion of a ‘circular economy’ has informed their recommendations.

The proposed changes to the Emissions Trading Scheme (to reduce carbon emissions) and congestion charging all seem positive. If done well they could help shift us to a sustainable economy by making polluters pay, and rewarding sustainable businesses. However, the devil will be in the detail. For example the revenue from the Waste Levy seems to have been poorly spent in the past, so we have to think carefully before we raise it further.

Congestion charging hasn’t been used yet, but is a much better alternative to petrol taxes to raise the money required for transport projects. By charging for congestion we can ensure that those using infrastructure under pressure pay more, encouraging people to change where and when they drive and help raise money for that infrastructure to be upgraded.

The concept of putting a price (not a tax) on water use and pollution is sound but has been previously ruled out by NZ First. This is bizarre when we are simultaneously talking about how to allocate a scarce resource and looking for funding to clean up our waterways. Surely water bottling companies, irrigators and electricity companies should be paying for the water they use. Similarly, polluters should be paying for the pollution they cause.

The one exception to the generally good environmental tax suggestions is the proposal of a fertiliser tax. This is a blunt tool. The issue of nitrogen is vastly different in different catchments. As the report notes, instruments based on outcomes are a superior approach. 

The Bad

With that comes a lot of bad stuff, particularly around the Capital Gains Tax. Top of that list has to be the impact on business. Apart from inequality and rising house prices, the key problem with our economy is that there is a strong incentive to invest in property speculation rather than productive businesses that create jobs and grow our incomes.

Unfortunately this proposed Capital Gains Tax will apply to business as well as property. The extra tax burden and compliance costs for business means that there is no more incentive to invest in business over housing.

Given these downsides to business, the least damaging option would be to apply this Capital Gains Tax (CGT) only to the treatment of land based assets (including farms). NZ First seems set to rule out including farms, leaving us with a CGT only on investor property. You have to ask if this is worth the bother.

The biggest concern in this scenario would be that it hurts the poor. Modelling suggests that house prices would fall a bit as some landlords sell up to first home buyers. The downside is that the rental market would shrink, and given that rentals have higher occupancy rates than “family homes” we could see rents rise significantly. Such a narrow tax will probably not raise enough revenue to compensate the poor for higher rents, so they would be worse off.

Some other problems from the CGT are likely to include:

1. Exemptions for the family home, the family farm, rollover relief, reliance on valuations and deductions for improvements make for a complex system that will be costly to administer and provide gainful employment for accountants and lawyers. 
2. The revenue for government will be unpredictable, and could even turn negative in a downturn.  
3. Taxing on realisation (sale of the asset) provides an incentive to not sell the asset (business or house) which is bad for the economy. The concerns around cash flow motivating this approach are not consistent with other parts of the tax system (e.g. foreign shares and rates). We will talk more about this in coming blogs.

The Predictable

The Achilles Heel of this review has always been the Terms of Reference with the Labour led Government excluding the family home. Ultimately that will hamstring the effectiveness of any change.

We can see the likely effect of this tax overseas. Australia is second to last ahead of New Zealand in terms of housing affordability. Australia has a CGT excluding the family home. This is not even a second best policy, it is a second to last policy. 

Excluding the family home excludes 3/4 of the value of our housing stock. A 33% tax on 24% of the market is an 8% tax. This may slow the rise in property prices slightly, but certainly not stop it. If anything there will be an increased incentive to invest in owner occupied housing because of its tax free status. This is called the "Mansion Effect", which we have seen in Australia. 

As a result a Capital Gains Tax may slow the increase in inequality (depending on what happens with rents), but certainly won't stop it. Remember that housing - house price and rent rises - is the main driver of increased inequality in the last 20 years.

The Opportunities Party Fair Tax Reform provides an alternative that would reduce income taxes substantially (making 80% of people better off), kill off property speculation and encourage Kiwis to invest in businesses that actually grow our incomes. The key to achieving that is to tax all assets equally – including the family home.

We don’t need to tax capital gain, we need to end it.