By Bernard Hickey
The Reserve Bank's suggestion last week of another look at the tax incentives for landlords has highlighted just how poisoned the well of that debate has become after voters rejected the Labour/Green Capital Gains Tax at last year's election.
Watching Labour Leader Andrew Little squirm over a policy he clearly doesn't want is like watching a hospital pass recipient a split second before Ma'a Nonu arrives.
Even its supporters acknowledge a Capital Gains Tax is slow, clunky, difficult to administer, hard to apply widely and may not raise that much revenue, at least in the short term.
It also applies to plenty of non-landlord activity that risks creating a swathe of collateral damage.
It was easy for Prime Minister John Key to destroy it in the eyes of the public, particularly when then Labour Leader David Cunliffe appeared not to be on top of the detail.
So now that particular tax has solidified into a third rail of New Zealand political life which shall not be touched, what else could the boffins and politicians look at as a better, simpler, cleaner and more targeted reduction of the tax incentives for rental property investors?
The 2010 Tax Working Group looked at the option of a land tax. Arthur Grimes, who is a former Reserve Bank Chairman and a widely respected public policy economist, proposed a land tax.
It is simple, clean and he estimated a 1% tax on the value of land would raise NZ$460 million a year and cut land prices by 17% if it was introduced up front.
It would encourage more intense development of land and also encourage land bankers to build on their land, something that both the Reserve Bank and the Government say they want.
Farmers and Iwi would not be thrilled, but it would be the sort of broad-based and low rate tax which works best and which New Zealand has been effective in introducing.
A less simple, but also cleaner and more targeted option is one proposed this week by former Treasury Deputy Secretary John Crawford.
He proposed the IRD apply a deemed rate of return on rental property and then tax that return at the usual income tax rates.
The 'deemed' rate would be set with reference to a similar market return such as commercial property or to a 'risk free' rate such as the Government bond yield plus a margin of say 4%.
It would mean IRD would look at the council valuation of a property and assume it returned say 8% per annum, which reflected the likely capital gains and cash profits from renting.
For example, a NZ$500,000 rental property would be deemed to have a return of NZ$40,000 and the landlord would have to pay tax on that income.
There would be no arguments about the size of the profit or the value of the property.
The actual income from the property would be tax exempt and so there would be no padding of accounts with expenses in any sort of negative gearing sense.
There would be no escape.
This is a model already applied by the IRD when working out the income earned by investors with money in investment funds overseas.
Mr Crawford proposed that it only apply to residential property investment and not to owner-occupied or commercial properties. That would keep the tax nice and targeted and away from farms and other businesses.
It would address the Reserve Bank's concerns about the tax incentives for landlords pumping up a housing bubble that could burst and damage the banking system.
The Reserve Bank estimates there are 33,000 landlords in New Zealand who own rental properties worth NZ$181.3 billion. At a deemed rate of return of 8%, that would imply taxable income of NZ$14.5 billion and a tax bill of NZ$4.8 billion at the trust and top income rate of 33%.
That would certainly attract the attention of landlords and generate a significant drop in house prices.
Landlords might argue it would force them put up rents because of the removal of the tax incentives inherent in the current system. That would expose the bankruptcy of their current logic when they say they don't have any incentives at the moment. That possible rise in rents is also up for debate given Auckland rents rose just 2.8% in the March quarter from a year ago, Statistics New Zealand reported, while the median house price in Auckland rose 20.1% to NZ$720,000.
Rents are clearly disconnected from prices, so why would tax-induced change in house prices affect rents?
Also, landlords are in no position to complain.
They are the most subsidised industry in New Zealand, as Finance Minister Bill English regularly points out.
Taxpayer-funded Income related rents and accommodation supplements worth more than NZ$2.2 billion a year are spent subsidising more than half of all the rental properties in New Zealand.
Mr English now has a fiscal problem worsened by these subsidies and the prospect that rampant house price inflation may eventually be reflected in higher rents. A tax on landlords at even half the 8% deemed return suggested by Mr Crawford could solve both the Government's fiscal problems and the Reserve Bank's financial stability issues in one fell swoop.
And it wouldn't be quite such a hospital pass in a political sense.
Only 33,000 voters would be in a position to complain.
Why should New Zealand's political and economic debate held hostage by 33,000 voters?
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A version of this article has also been published in the Herald on Sunday. It is here with permission.
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