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Gareth Morgan argues the Government’s 'Capital Gains Tax' is too little, too late

Gareth Morgan argues the Government’s 'Capital Gains Tax' is too little, too late

By Gareth Morgan

The good thing about John Key’s announcement of a selective capital gains tax on Auckland housing is that he has responded to the Reserve Bank’s call to “do something” about the tax distortion around property ownership.

There are two bad things though – firstly capital gains is not a smart tax, and secondly the PM is addressing the symptom of the disease not the illness itself. Substantially, a tax loophole around property remains.

Key’s response is a start…

The Government’s announcement means that anyone selling a house within two years of buying it will be assumed to be doing so for capital gain, and so will pay tax. This won’t apply to primary dwellings (the family home), however that is defined. It doesn’t take too much thought to spot some of the ways to get around this.

But hey, for the PM to finally acknowledge that his policies are even part of the problem around property in New Zealand, is a giant step forward for any ruling politician, no matter what hue. The Reserve Bank needs to be thanked for at last being able to get some acknowledgement from a government that its tax regime with respect to taxing the returns to capital is distortionary and little more than a giant loophole for property owners to exploit.

… but flawed

However, the policy reaction is piecemeal, complex to administer and easy enough to get around; if investors aren’t sophisticated enough to have multiple legal entities, they can always just wait two years before selling the property. We have commented previously on the problems of a capital gains tax, which this policy is despite the Government’s claims to the contrary.

Ultimately this change will encourage the money to focus on more and more expensive houses rather than multiple dwellings (as we saw when the tax was introduced in Australia).

This is quite clearly just a temporary measure to quieten the political noise. Together with the Reserve Bank’s recent measures, they should have some impact, but the disease remains.

Reining in property prices (and inequality) is a much larger challenge

It’s ironic that the Government’s belated acknowledgement of an issue that’s been around for ever comes the same week that The Economist magazine is calling for the end of tax deductibility of interest paid by corporates, property investors and home owners. This is in response to the gross distortion of wealth distribution and inequity in developed countries, which is largely driven by ballooning property prices.

While I would debate the wisdom of such an indiscriminate measure, it does reflect the frustration the economics profession is having with governments that have sponsored an unbridled explosion of debt since financial deregulation, and the obvious consequence of that – a global bubble that threatens to bring down the world’s financial system.

Unfortunately the risk for any single country that tries to swim upstream against this global affliction is it could suffer substantial capital outflows and a collapse of economic growth. The dilemma is of course the longer the distortion persists, the more likely that collapse is anyway – for everyone. In fact we have already seen this play out once in the Global Financial Crisis.

The Economist’s despair about the unbridled explosion of leverage globally is well founded and as we all know, one consequence of that has been the vast enrichment of those in the financial system that has facilitated the debt explosion. That enrichment is well beyond any national productivity gains and so by definition has been the driver of a major surge in inequality within economies of the developed world.

A few weeks ago The Economist proposed that to address this, ideas such as a universal basic income were well overdue, along with taxation of all returns to capital. Both of these measures Susan Guthrie and I proposed in our 2011 book, “The Big Kahuna”.

Change will only come from the people

It is many years since New Zealand showed leadership on anything and so it is unrealistic to expect too much in this sphere. In short, the pressure for change has to come from the people and countries’ independent institutions. Only then will politicians – whose raison d’etre is to remain popular, act.

This is precisely what has happened on this occasion – the cacophony of disquiet over the orgy that is the Auckland property market, has risen to such a level that a shrewd PM has at last swallowed his pride and acknowledged the consequences from continuing to sit on his hands.

Removing interest deductability is also not the answer

What change is needed to remedy the underlying disease? The Economist’s recommendation to try and cap this debt explosion by removing all deductibility of interest, while understandable, is drastic. It would be better framed as removing deductibility of interest paid to any related party. It’s long been a sport to load businesses and investment property up with debt, and use offshore entities as the lender.

This in effect is using thin capitalisation to transfer profits beyond the reach of the local tax authority, and into the clutches of a corporate residing in a low tax area. I write this column as I sit in Monaco, marvelling at all the super yachts in the marina and tiny little apartments where all the tax exiles reside.

Such behaviour is a global phenomenon, all I’m saying is the role of foreign investors in our property and corporate space is not insignificant, and this is a common trick.

A Comprehensive Capital Income Tax is a better solution

The Comprehensive Capital Income Tax proposed in our book The Big Kahuna thwarts a lot of these loopholes because all capital is taxed (every year) at source, at least insofar as it is assumed to yield the owner at least the bank rate (like a deposit). Whether the value of the capital has gone up or down that year is irrelevant, there is a minimum return assumed and that is taxable.

Sadly, for any change to have an impact on house prices and inequality, it needs to include the family home, which is dangerous territory for politicians. Until we actually get politicians that actually lead on correcting the tax and leverage distortions unleashed since the days of financial deregulation, there is no chance of arresting the increased polarisation of income, and more pointedly wealth, that has exploded over recent years.

The John Key measure is belated, begrudging, and defective. It is better than nothing but no more than a temporary patch.

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This article was first published on his blog, Gareth's World. It is here with permission.

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17 Comments

jk has opened the door to peek out, can not be closed now. Since it is open we now need to look far and wide for the best system that suits us.
supply, we have to make a system that encourages building
demand we need to give kiwis first crack i.e no sales of existing stock to non citizens or residences
and last we need to discourage investing in homes whilst encourage investing in NZ businesses
in short we need to get away from encouraging of taking on big debt and instead raising capital to fund expansion

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"Only then will politicians – whose raison d’etre is to remain popular, act."
Also they need to demonstrate an appearance of leadership, or a perception, not actual problem solving.

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troll bait.

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Land value taxes catches unproductive capital and doesn't distort productive capital as much as other taxes. It is an easy tax to administer and a hard tax to avoid.

Excellent discussion on transportblog about property taxes.
http://transportblog.co.nz/2015/05/18/do-property-taxes-affect-housing-…

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Gareth , the key problem with your Comprehensive Capital Gains Tax is the same one that afflicts PAYE and company profits tax , it hits the productive sector .... these taxes inhibit the desire to work , to improve , to innovate and establish ...

... a simple land-tax ( as 2002 tax working paper author Arthur Grimes alluded to , and our own Bernard Hickey championed ) can raise massive amounts of money from natural resource " rents " , hitting the speculators and hoarders of land / air / water rights .... land-tax really is the ultimate Robin Hood way of redistributing from the rich to the poor ...

Why belt the living daylights out of the productive sector once again , with a CCGT , when there's a cheap and easy way of skinning some of the unearned capital winnings from the rich and the speculators ?

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Not really as all gains should be taxed so we have a level playing field. Now provided other taxes are reduced so the effect is neutral (say reduce GST) then those previously overpaying for those under-paying will be less.

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... the owners of natural resources are getting a tax free ride ...

If you want the current amazing concentration of wealth that is in the hands of a rich and powerful elite to get even worse , just keep taxing wages , company profits .... and biff in a CGT too , for good measure ... put your boot onto the neck of creativity , productivity , and sharing ..

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I am a little concerned and may have misunderstood how Gareth would have the tax applied, but i am mortgage free, and been in my home for over ten years. I am already taxed through rates. I am concerned that Gareth's model would see an additional tax burden placed on me, that I could not afford, thus forcing me out of home ownership into rental property which would likely be worse. Is he actually proposing a model that would ultimately legalise the theft of my property by civil authorities?

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no politician will ever put the family home in the CGT,
then you have a problem which is the family home and which is not, it will create loopholes, and i think that is what he is pointing out.
even if they go to payable on death or sale you still have problems what if its in a trust and gets handed onto new beneficiaries to live in

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Gareth Morgan's tome is a brilliant academic exercise
You need to read the original "Big Kahuna" a number of times to get your head around it
Brilliant in theory
Good bed-time-reading
Problematic in practice, some serious flaws make it unworkable

The consequences are draconian
Requests for clarification have been posed to him on a number of occasions
He never responds

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... true , he spouts his stuff , but doesn't like to respond to us ...

I guess it must be 100 % infallible , huh !

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My articles get published on several sites and It's hard to be everywhere. I am happy to answer any reasonable question, from a reasonable person. I just may not get to them all

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FTFA:

[T]he cacophony of disquiet over the orgy that is the Auckland property market, has risen to such a level that a shrewd PM has at last swallowed his pride and acknowledged the consequences from continuing to sit on his hands.

Alternatively, Gareth... A PM with a "F*** you all, losers!" attitude toward his countrymen is counting down the days until his lavish Hawaiian retirement, but recent pressure has him worried things may turn to custard on his watch and somehow spoil his upcoming tropical getaway.

No?

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... no need to apologise Gareth , you're keeping busy ...

So , your opinion of Arthur Grime's suggestion that New Zealand should introduce a land-tax ?

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..gawd...ever tried working with the current shambles? I'd suggest it is way more unworkable than the Kahuna. Latest debate around the new 2 yr specualtor tax and all the loopholes case in point. Tax industry and high priced professional tax rorters a sure sign it's a dog. There are so many vested interest in keeping this sick pup alive that you can be sure the Kahuna won't get a look in...too many potential job losses...after all, XERO is destryong accounting jobs by the day..

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You may face an increased tax burden depending on you circumstance. e.g The Big Kahuna CCIT is served up with a flat tax and an unconditional basic income of 12k. Roughly, if a couple owns their own house with a value of $480k you would be no worse off. CCIT on your home is calculated by taking the equity you have in your house, assuming it would get you a rate of return which is the same as a govt bond, and taxing the income at the marginal tax rate. Under our proposal, this would be a flat tax rate. You can see how things would work out for you by using this calculator http://www.bigkahuna.org.nz/calculator/personal.aspx

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Gareth Morgan.....you appear to have a poor understanding of the problems that the IRD have had in collecting taxes from people trading property......you have always had to pay taxes if you were trading in the housing market!! Many of the people who should have been paying tax on their trading have not been paying those taxes...The IRD did not know who those people were....as basically the tax collection system has relied on those trading to have a degree of honesty and declare their trading activity........the IRD knows every legitimate trading business as they are already registered for tax purposes with the IRD and making different tax type returns on a regular basis. These businesses are able to be regularly audited.

Many of the people who are trading real estate are on salaries/wages and have no contact with the IRD on an annual basis.....these people do not furnish income returns to the IRD!! As a property is bought and sold the transaction will now carry a tax number and so the IRD can ensure that they get their tax if the activity is considered to be one where tax is payable!!

How the heck you can twist the story into the one that you have spun here is beyond me.

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