By Jenée Tibshraeny
New Zealand needs a comprehensive capital gains tax (CGT).
That message from Baucher Consulting tax expert, Terry Baucher, is clear.
We’ve inherited an incomplete tax system from the Rogernomics era that’s contributed to the value of our housing stock increasing 40-fold from 1980 to over $1 trillion.
That’s more than double the size of New Zealanders’ net financial wealth held in assets like KiwiSaver funds, equities, term deposits, bonds, insurance and superannuation schemes ($460 billion).
It’s also nine times the value of all New Zealand-listed stocks. While the values of stock markets in most modern economies are on par with gross domestic product (GDP), the value of New Zealand’s stock market isn’t even equivalent to 50% of GDP.
The IMF is the latest organisation to warn us about this imbalance; the findings of its just-released Financial Sector Assessment Program suggesting “further tax measures related to housing could be considered to reduce incentives for leveraged real estate investments by households.
“Such measures could help redirect savings to other, potentially more productive, investments and, thereby support deeper capital markets.”
KiwiSaver a game changer
Baucher recognises CGT is a political hot potato. Yet he says the proliferation of KiwiSaver means the inequity of our tax system can’t keep being ignored.
There are now more than 2.5 million people enrolled in KiwiSaver - nearly 10 times the number of property investors filing income tax returns. Members and their employers contributed $4.8 billion to funds in the year to June 2016.
Yet the pinch is KiwiSaver funds and savers are paying more than four times as much tax as residential property investors, relative to the sums invested.
“If a government moves to auto-enrol all employees in KiwiSaver, then the pressure to redress the tax distortion in favour of property will increase,” Baucher notes in ‘Tax and Fairness’, the new book he has co-authored with Massey University lecturer, Labour Party candidate and former Inland Revenue employee, Deborah Russell.
“Why should KiwiSaver members be taxed on their locked-in savings while property investors’ capital gains remain largely tax-free?”
Speaking to interest.co.nz in a Double Shot Interview, Baucher discusses how this distortion in our tax system has come about, what it looks like, and what needs to happen to change it.
The legacy of Rogernomics
Baucher says the tax reforms quickly pushed through during the Rogernomics period in the late 1980s were well-intended, but poorly executed.
The overriding policy was to remove tax incentives around certain asset classes (such as tax relief for contributions to a superannuation scheme), so people would judge investments on merit.
A comprehensive CGT was meant to be included in this suite of reforms, but this never happened.
Baucher maintains this fundamental omission weakened the foundations of the system, singling out property as the largest single asset class that isn’t taxed automatically when a transaction occurs or through an accrual basis.
Since then, Baucher says calls for a comprehensive CGT from heavy-weight economists, policy-makers, as well as the likes of the IMF and OECD have fallen on deaf ears.
In fact, a joint statement released by Treasury and the IRD in 2012, shows Treasury saw “merit” in a CGT or land tax, while the IRD believed “a land tax would impose an unacceptable loss on those who hold wealth in land...
“Working through the full details of how best to design a capital gains tax in practice and evaluating whether the pros of the best possible capital gains tax would outweigh the cons would be a very substantial exercise.”
Tax system distortions
So how does the tax system favour property over other asset classes?
Baucher explains the likes of bonds, foreign exchange accounts, foreign currency mortgages, and term deposits fall under the Financial Arrangements Regime.
“What it looks to do is tax the entire economic return over the life you hold that investment. So that means if you hold a bond for three years, you’ll be taxed on the interest and the capital gain. Usually what happens is the gain gets taxed at the final point of maturity or disposal.”
Then there’s the Foreign Investment Fund (FIF) regime, which taxes investments overseas, like shares held in Apple for example.
Under FIF, you have to pay tax on the lesser of 5% of the value of that stock or the actual gains during a year.
“That means there’s a cash flow effect. You’re being taxed on your deemed-to-receive income when you actually haven’t received the cash for it. That also means part - in some cases all - of the capital gain that might arise on that investment, gets taxed.”
Baucher points out the NZ Super Fund paid $538 million of tax on profits of $559 million in the year to June 2016, largely due to the FIF regime. This is despite government contributions to the fund being on hold.
KiwiSaver funds are of course also affected by the FIF regime.
Baucher and Russell, who go into much more detail on this in their book, also note: “Those [property investors] with net tax losses for a year can offset any losses against their other income for the year. This practice – called negative gearing – is not available to investors subject to the FIF regime, who cannot even carry forward investment losses to future years.
“Thanks to negative gearing, highly leveraged property investors can offset tax losses against their other income and wind up with tax refunds.”
Bright line test vs capital gains tax
The government argues its 2015 bright-line test, which taxes gains on residential property if it is sold within two years of being bought and isn’t the family home, levels the playing field.
Baucher doesn’t buy this, saying the two-year line is arbitrary.
“We are over leveraged. The IMF report is quite fascinating because it’s looking at people’s forward debt as a percent of income and it’s sort of at 150% levels. It encourages debt, which weakens the economy basically, weakens savings. Too much is invested in one asset class.”
Baucher says we should have a CGT that includes the family home, but makes gains under a certain level exempt. The US has taken this approach, providing exemptions for gains below US$250,000.
He says it’s also important to remember that if a CGT is introduced, property owners who have held properties for decades, won’t necessarily be taxed on the gain earned from the time they acquired their properties. Rather the gain would be calculated from a more recent point in time.
“What’s been a hurdle with the capital gains system is trying to separate out these inflationary gains from the non-inflationary gains and just tax the non-inflationary gains…
“CGT shouldn’t be seen as the bogeyman that it’s painted as.”
With Australia introducing a CGT in 1985, Canada in 1972 and South Africa in 2001, Baucher says: “It’s not as if a CGT is a journey into the unknown. The FIF regime is. No one else in the world has the FIF regime.”
Yet the Green Party is the only major New Zealand political party to support a CGT.
Baucher puts this down to “the same problem affecting all democracies across the world”.
“There’s a lack of engagement by the younger generation. Because this really affects the younger generations coming through. The ones who don’t hold property, don’t vote. Naturally the older property holding generations do vote... The turkeys aren’t going to vote for Christmas.
“The numbers will change. The key thing that changes everything… is that now 2.5 million people are KiwiSavers... So at some point, a politician will be able to capture that demographic.”
Broader engagement in tax policy needed
Looking beyond politics, Baucher believes New Zealand would benefit from better tax policy if our system was reformed to give a broader range of players a voice at the policymaking table.
Currently: “There’s a strong emphasis on consulting with the taxpayers and professionals... The problem is, it requires active engagement… so then it falls to the larger organisations… the big law firms, the big accounting firms to get involved. And naturally, if they’re representing their clients, it then tends to colour slightly what’s happening.”
Furthermore, he and Russell write: “Inland Revenue has extensive powers of information gathering and enforcement unrivalled by any other government agency.
“Any agency with this kind of concentration of power should be subject to significant oversight but we are doubtful this is currently happening."
Baucher would therefore like to see a taxation board formed, which would include organisations that deal with people on a day-to-day level, like Consumer NZ, the Citizens Advice Bureau, smaller accounting organisations and the Poverty Action Group.
“Tax affects everybody, but it shouldn’t be left to the tax professionals. You want wider engagement.”
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