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Opinion: An alternative to a capital gains tax which will remove housing market distortions
November 11th, 2009
By If you wander through central Auckland and try and spot the people on the highest tax rates, the chances are you’ll get it wrong.
It’s not the young man in the sharp suit earning $150,000 or the well dressed lawyer going about her business. Rather, it’s the soon-to-retire woman earning $5,000 interest on top of her $35,000 salary, because lending money is the most highly taxed activity in New Zealand.
This is because the government taxes the inflation component of interest payments. If you lend $1,000 at 7% when the inflation rate is 2%, $20 of the $70 interest is to compensate you for inflation because what cost $1,000 a year ago costs $1,020 now. Only $50 is real earnings.
Nonetheless, the government taxes the full $70 rather than the $50 real interest. Since someone on a 33% tax rate pays $23.10 of the $70 in tax, their true rate of tax on the $50 real earnings is 46.2 %. Despite all the talk of tax reform in recent weeks, little has been said about how odd it is to tax people simply because the government inflates away the value of their money.
The problem is worse the higher the inflation rate or the lower the interest rate. In the last decade, when interest rates averaged 6 percent and the inflation rate averaged 2.6%, the tax on real interest income was 75% higher than the tax on other types of income. It is little wonder investors are attracted to residential property, for capital gains are tax free.
Moreover, if landlords borrow to finance their investment they are allowed to deduct the full nominal interest payment as an expense even though inflation is eroding the value of the debt. So not only does the tax system penalize lenders when there is inflation, but it rewards borrowers.
One way to create a more level playing field would be to introduce a capital gains tax. But an alternative proposal, which has been little discussed, is to exempt the inflation component of interest income from tax. Quite simply, if you earned 7% when the inflation rate was 2%, you would only pay tax on the 5% real earnings. Conversely, you would only be able to deduct real interest payments when calculating taxable income.
A level field would be creating by removing a tax instead of introducing an additional one.
The traditional case to exempt the inflation component of interest earnings from tax has been based on fairness. Not only is the inflation component of interest not income, but this “not-income” is received largely by older and less-sophisticated investors. It is not for nothing that the tax applied to it is sometimes called the widows’ tax.
In addition to being unfair, recent economic analysis suggests the interaction of inflation with the tax system is the root cause of low home ownership rates among younger households. Quite simply, the excessive taxation of interest income (and the excessively generous deductibility of interest payments) makes it more profitable for wealthy middle-aged households to become landlords than it is for them to lend money to would-be owner-occupiers.
The effect becomes larger as real interest rates fall, possibly explaining the recent increase in the number of people becoming landlords.
The modeling suggests that exempting the inflation component of interest income from tax will have very similar effects on the housing market as introducing a capital gains tax. In both cases, homeownership rates would rise, in part because rents would increase, and the additional saving would improve the country’s net foreign debt position.
At first glance, this idea might seem crazy at time of large government deficits. Isn’t the whole point of a tax to raise revenue? Wouldn’t eliminating the tax on the inflation component of interest significantly reduce revenue? Surprisingly, the answer is “No”.
Currently, little revenue is raised from the tax on the inflation component of interest income, because for every dollar of tax paid by a lender, a large number of cents are claimed as deductions by an investor. The Inland Revenue Department doesn’t have good estimates of the net amount of tax collected or rebated, but it is unlikely to be much, and could be negative.
If the idea isn’t crazy, why hasn’t it been done? Largely, it would seem, for two reasons. First, there is a widespread perception that “low” inflation isn’t a big problem. This may be correct — unless you lend money, in which case even low inflation can increase effective tax rates by 75 percent.
Secondly, it may be difficult to implement a tax system that only taxes real interest earnings. This may also seem surprising, since it would appear relatively simple to subtract the inflation rate from the nominal interest rate at the end of the year, and mail out an inflation-tax rebate to lenders.
But tax experts have identified many complications, such as the tax treatment of financial contracts that are hybrid loan/equity products. More importantly, inflation distorts other aspects of the tax system, particularly the way that firms are allowed to depreciate capital assets.
Currently, each year firms are allowed to claim part of the cost of an asset as a cost of doing business, using the historic cost of the capital. Because the replacement cost of capital assets typically rises with inflation, firms’ profits are overstated, and thus they too are over-taxed. This means inflation can reduce capital investment – unless firms are indirectly compensated in another manner, in this case by deducting the inflation component of interest payments from their income. Any move to tax real interest income would eliminate this deduction, and perhaps lead to a reduction in investment.
The accepted wisdom in tax circles is that the inflation component of interest income should not be exempted from tax unless depreciation allowances are also corrected for inflation. Put more bluntly, the cost of ensuring businesses are not penalized from our inability or unwillingness to index the tax system for inflation is the excessive taxation of lenders.
Is it really impossible to index the tax system for inflation? Not all people think so. A former Governor of the Reserve Bank, Ray White, strongly advocated the indexation of the tax system. The 1989 “Consultative Document on the Taxation of Income from Capital” by the then Minister of Finance (David Caygill) thought it would be feasible to index the tax system “without imposing excessive compliance and administrative costs.”
A comprehensive review in the United States came to a similar conclusion, noting the most difficult part would be the indexation of capital gains for the purpose of calculating capital gains tax liability.
In recent years, Government officials have made repeated calls for people to save more. Currently they are looking for bold measures to improve the way we tax ourselves, notably to remove the distortions in the housing market. But rather than look for new taxes, perhaps they could seek to address both problems by eliminating a tax – the tax on the inflation component of interest income.
It is simpler to do in New Zealand than anywhere else in the world precisely because we don’t have a capital gains tax. And not only would it remove distortions in the housing market, it would end the ridiculous situation that lending money, the simplest way of saving, is the mostly highly taxed activity in New Zealand.
____________
* Andrew Coleman is a Senior Fellow at Motu Economic and Public Policy Research. All of Motu’s research can be found here.
There are several papers on this topic on the Motu website. The two most relevant papers are called “Tax, credit constraints and the big costs of small inflation“, and “The long term effects of capital gains taxes in New Zealand“.
Tags: Andrew Coleman, Capital Gains Tax, Inflation, interest, Motu, tax
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November 11th, 2009 at 4:10 pm
Great to see Motu contributing here.
Finally, some credible, apolitical social and economic researchers.
November 11th, 2009 at 4:23 pm
I’ve not got time to read this closely until this evening, but at last something that looks promising. My interest especially captured by:
A level field would be created by removing a tax instead of introducing an additional one.
Assuming the underlying analysis correct, and other than the complications in the details there does seem to be merit, so nice to finally see a sentence like that written here.
November 11th, 2009 at 5:19 pm
Yes CPI protected interest income tax – brilliant. John I hope your reading this!
November 11th, 2009 at 5:43 pm
This is easily one of the best opinion pieces I have read on this dilemna.
November 11th, 2009 at 5:59 pm
Great idea but why not go a step further and not tax savings at all.
November 11th, 2009 at 6:21 pm
Bingo , Kieran : Why not ! The saver has probably already paid a whack of tax on earnings , before managing to save that money . Why tax it again ! And what a remarkeable incentive to save . No need to chase high yields in risky finance companies , or Fonterrible bonds . Plonk it into the too big to fail Ozzie banks , and get a real return above the inflation rate . And the politicians of NZ hav’nt figured this out , yet . Sad !
November 11th, 2009 at 6:22 pm
A great piece of logic, what a shame that the old school analysts / policy shapers that hold us to ransom with our current crazy system will ignore it.
November 11th, 2009 at 6:57 pm
The Japanese govt has implemented a string of tax incentives to get individuals to invest in the Nikkei to little effect. People are so petrified of the market that they prefer to invest in high-yielding currencies such as the AUD and NZD.
November 11th, 2009 at 7:20 pm
Kieran & Roger,
You are bang on! Have zero debt and capital (savings), and am appalled that I have to pay tax on that interest earned when:
1) I have already paid PAYE (top personal income bracket), ACC, Tax on profit in my Company (a small and simple setup) & outrageous local government/utility taxes!
2) The REAL inflation, that is stealthy and very sneaky cost increases that are not shown in any official inflation figures like food reduced in packaging content but same or slightly higher prices, house cost inflation (not included in CPI)…
…then I have zero incentive to save, even if the CPI content would be exempt!! Simply because the real inflated cost is actually much bigger than the “official” CPI numbers represent.
As an aside, I wish I had a lot more time and money to go out and irrefutably prove that true food price inflation is way above the official numbers and that it affects all people more than we are aware of!
One thing is certain, if National does not have the common sense to remove that tax on basic bank interest earned, AND address the imbalanced tax advantages for property, they will not get my vote again.
November 11th, 2009 at 7:52 pm
The bit I like is tax on the difference of gross gain earned and inflation, as said it’s really simple, and I think it’s fair. It’d be as fair and as a simple to tax on the difference of gross gain earned and inflation on ANY capital employed in say, land and property assets – that are as yet NOT taxed. If we did and stayed revenue neutral, just think how uniform an low paye, corp and trust tax could be? Who wouldn’t want that? Make appropriate cuts in the public sector to reduce the revenue demand, and just think how much lower taxes that WE ALL DO PAY now could be? Who wouldn’t want that?
Who doesn’t want to pay less tax?
November 11th, 2009 at 9:12 pm
Great piece Andrew. This is a very very sensible proposal and whilst one can imagine technical issues (treatment of dividends vs. interest for example) this needs action now.
November 11th, 2009 at 10:49 pm
Another mickey mouse proposal that has no prospect of implementation
November 11th, 2009 at 11:37 pm
@ ctnz
I have been looking at the same things – you can no longer buy a 1kg block of tasty cheese from the “name brand” – 800g seems to be the maximum you are allowed!
in 2007 I could buy a budget loaf of bread for $0.99 from pak’n’save – that same loaf now costs $1.49 – by my calculation that is well above the 2% cpi number.
What we have to realise is that the govet benifits from an increase of prices due to GST. It is in their best interests to have inflation.
November 11th, 2009 at 11:42 pm
Les – who doesn’t want to pay less tax?
I think Andrew is talking about increasing tax with the comments “if landlords borrow to finance their investment they are allowed to deduct the full nominal interest payment as an expense even though inflation is eroding the value of the debt.” with a form of targeted tax which will which will level the playing field between property and other taxed vehicles.
It sounds like a good idea to me as I don’t own investment property but ask the majority of National, Labor and the Maori Party mp’s who do and you’d probably get a different opinion.
November 11th, 2009 at 11:46 pm
The premise of the article is not bad, but there is one thing to consider – it is unstated govt policy to confiscate wealth by inflation. This is the proof – interest payments being taxed in nominal terms rather than inflation adjusted terms.
All those people who think our governent is working for us – think again… Look no further than the auckland super city – less and less representation for the population. Next step – regional councils and then finally a national council???
Over the past decade we have become a feudal society again – we have sold our souls for nodeposit – 36 months interest free….
November 12th, 2009 at 3:29 am
I like is tax on the difference of gross gain earned and inflation, as said it’s really simple, and I think it’s fair. It’d be as fair and as a simple to tax on the difference of gross gain earned and inflation on ANY capital employed in say, land and property assets – that are as yet NOT taxed.
November 12th, 2009 at 4:22 am
I also think this is one of the best articles on this website for a long time. Timely and intelligent. But I can see a few wrinkles in this – the main one being computing an accurate and up-to-date value for “true inflation”. The CPI basket bears little relation to business expenses and given it excludes mortgage payments is a bit out-of-step with individual consumer expenses too. Added to which it is always at least 3 months out-of-date by the time it is published. Point (1) could perhaps be fixed by a closer look at the make-up of the basket (I believe the BoE also publishes an RPI that includes mortgage payments) and perhaps discrimination between business and individuals. Point (2) is probably unsurmountable and we would just have to put up with the interest and inflation rates being out-of-step with each other (would this lead to floods of hot short-term money chasing tax-free interest after high quarterly inflation figures are announced?).
November 12th, 2009 at 7:11 am
A very interesting piece….figuring out the net interest might be a bit fun though…and it would have to be somesort of legally binding method…ie Govn’s have a nasty habit of adjusting the calculation to suit their political ends….like inflation is to high take out X as its “distorting” the picture…but even then there would be some compensation for lost value of the capital due to inflation…
regards
November 12th, 2009 at 7:18 am
@Kieran: All income is taxed that’s why and its fair it should be….ie I dont se that a worker who’s labour is his capital be taxed when someone who’s capital is $ doesnt.
and it should be as flat and as wide as possible so that there is no incentive to dodge tax by claiming it under a different category. By flat I dont mean non-progressive just if you pay 39% in one area that 39% applies across all your investments.
The other distortion is in family income…if one earns a high wage and one doesnt then they pay more tax than two with equal but lower incomes but the same total, seems strange…but there are lots of “distortions” in any system, WFF is one huge one.
November 12th, 2009 at 8:12 am
Steven I think the government is slowly trying to move away from income based tax system to more of a consumption/property based tax system. Anything that encourages more saving and less debt has to be good. It would mean more money available to business for capital investment which would lead to greater productivity (as long as it doesen’t all go towards housing that is) I would argue that WFF and progressive taxes are good beacause they are income distribution measures which give more money to those on lower incomes to spend which is actually good for our economy because it increases the size of the domestic market for goods and services. For example its better for business to have 80% of the population spending money rather than only 60%
November 12th, 2009 at 8:27 am
The original article looks at an alternative to a CGT in an attempt to affect house prices and investment in second houses etc. Surely this, as usual misses, the point. A tax system that doesn’t tax capital gains is an inequitable tax system – period.
The number of houses built and the cost of them is a supply demand problem. The ownership of them can get distorted by the tax system, but not the total number built. The price of them can get distorted by the tax system, but only for a while, unless the system also encourages inflation.
The suggestions should be as well as a CGT, and the CGT should allow for inflation to be removed from the calculation only if the PAYE tax take is adjusted for inflation also. Perhaps by moving stopping bracket creep with inflation adjustments to the brackets every year.
November 12th, 2009 at 9:03 am
@Keiren: “Anything that encourages more saving and less debt has to be good.” Consumption taxes eg GST are regressive….I dont immediately see that consumption tax (say) achieves this, ie more saving and less debt. The problem with WFF is it encourages large families which is a problem as increasing population damages the environment and consumes resources. So there is more competition for resources which when scarce drives up the price…I generally agree with progressive taxation, this is really a tax on disposable income and not essential income…however it should not get out of hand, there have to be incentives to get off Welfare and to advance and take (sensible) risk…WFF for me has too many minuses, its a short term and short sighted social policy that I think sends the wrong messages that will be detrimental long term.
@Brian W: Bracket creep is how a Govn gets more income without actually having to raise taxes “obviously” so inflation is the Govn’s friend. My biggest issue with a CGT is adverse effects, ie most ppl end up paying more tax effectively by stealth. The increase in value of a family home is also un-realised paper wealth, so paying tax on a figment of imagination seems ludricous….also what happens if houses drop in value? does that mean ppl can claim tax back? if you can pay tax on the gain then you should be able to claim on the loss. Arguably today houses are 40% over-valued…a severe correction to the norm should leave the Govn with a huge tax liability.
regards
November 12th, 2009 at 9:12 am
Brian W – it’s just the usual, “Hands off my, other tax-payer subsidised, tax-free capital gain, if you please.” Nothing new in terms of the institutionalised protection of avoidance, just a different tactic. What will they come up with next? It’s fun to watch though.
November 12th, 2009 at 9:48 am
On the surface I like the concepts…need to think it thru a bit more.
Its almost going back to a basic system of the late 60s 70s
KISS keep it simple stupid.
Kieran Says:
“Great idea but why not go a step further and not tax savings at all.”
This needs to be looked at more in depth..
One one hand the Gov for a long time has saying we need more savings
Affordablity for 1st home buyers in many ways extend from this…raising a deposit cause they grew up in a time that borrowing rather than saving was the ‘trend’
From memory it was not just 1st home buyers but saving for a fishing boat and a farm???
Then we have the affording retirement in the coming yrs.
IF special a/cs like in the 70s, these saving a/cs the interest was not taxed and money into super retirement schemes ….(they where treated different cant rem exactly now)
This would encourage saving…
Then If we took savings from ppl who are retired, didnt tax them on their interest
And maybe even those INDIVIDUALS who earn under the EMPLOYED household income where also exempt from tax on savings…
This then leaves the Gov options open how to handle things like super…age and even means testing….bad word…but at the end of they day the mum and dad on middle to low incomes have had a subsidy during their working life on their returns on their retirement savings…..
Still thinking this sort of concept thru…
The RB gets back their tool for saving to loan ratio abilties….so they have a bigger ‘pool’ of local money to borrow and lend against….and this would also increase bank incentive to encourage local savings….returns to savers.
Our economy needs to return (not by RB warnings but real incentive) to a population that saves and pays cash for what they possess, rather than disincentive to save and use HP/credit cards instead.
This is REAL wealth.
November 12th, 2009 at 10:08 am
Steven – CGT should only be collected when the gain actually happens, and of course the family home should be excluded. Whether you live in a mansion or a squat doesn’t matter, that’s just revenue at the edges of the system. If you own a mansion and you die the estate pays. Tax gets delayed – that’s all. The Maori collectives will never pay because they think differently about land and never want to sell – that’s also OK. If the money is all locked up and not moving or growing in some funny way to do with inflation that’s fine.
If you realise a gain you pay tax. Simple. Yes if you have a tax loss you can offset it. But you only get a cash credit from IRD if you have exceeded the loss in payments. Just like any regular tax a company pays.
November 12th, 2009 at 10:11 am
YES…. I believe that this is the biggest distortionary factor that has lead to our heavy preference for Real Estate.
The Reserve Bank has known about this for years.. ( I think either Brash or Bollard wrote about this).
What amazes me is that NOTHING has ever been done.
This is the first time I have read a serious piece, offering some serious policy ideas.
I Say… Andrew for next reserve Bank Governor… or maybe head of Treasury.
If there was an inflation deduction for interest… we would see a major shift in investment flows.
I am a big believer in going back to first principles… Money is a depreciating asset.. By not allowing a “depreciation allowance”… distortions occur.
The irony is that it is the Governments’ own Fiscal and Tax policies that have created
this preference for Real Esate…
We, the pepole have simply done the wise thing, by choosing real estate.. Earning interest has been a MUGS Game… and there have been times where real returns on deposits have been negative…
Vey good.
November 12th, 2009 at 10:39 am
Would this mean that people keep money in the bank rather than investing it in the productive sector like people are saying we should. if we give it to the banks and then the banks give it to the productive sector, aren’t we just providing the middleman with a margin?
I get confused about all the calls for money in the bank, then the calls about money needs to go into the stockmarket and productive sector for growth etc?
Growth sounds evil to me. If we had a policy of not growing combined with living within our means [i.e. debt becomes very hard to obtain] would that not be sustainable?
November 12th, 2009 at 10:58 am
Why is inflation always a target?
People it is what has given more people wealth!
Without inflation there would not be 1200 billionaires or millions of millionaires, we would still have royal families and landlords owning everything.
Inflation, although not ALL good, has been instrumental in allowing more people to join the ranks of wealthy (e.g. 12m+).
The distribution of that increased money supply is the problem (e.g. capitalism Vs Solcialism, etc).
Also that secret inflation is built into everything! Not just cash deposits, the house seller is also a victim, as the asset gets liquidated (i.e. turned into cash), hello the capital gain is not really worth as much – that “I” word again!
November 12th, 2009 at 11:04 am
at last a logic suggestion, but as some others have commented if savings are to be encouraged why tax at all or introduce a much lesser rate, nice piece
November 12th, 2009 at 11:12 am
Paul,
Here is a link to a BBC series called the ascent of Money
http://video.google.com/videoplay?docid=-545930454338776455#
When we see how money, Banks, Bonds…etc evolved , we can get a better perspective on how it should all work… and how it can be useful..or not… ( the disasters that happened along the way , )
Mark H posted a link to a great Article about Mise ( famous economist)
It mentions a little about how interest Rates should balance supply and demand for credit…. ( just as price balances the supply/demand for , lets say, potatoes.)
http://online.wsj.com/article/SB10001424052748704471504574443600711779692.html
The current System we have… is very Contrived, manipulated, and Centralist.
We have a Central Bank that can lower deposit rates form 8% to 3%… and the preach that we should be better Savers.
A central Bank that can allow Money Supply to expand by 12% and more in a year..
A currency that is more volatile than someone with Anger issues.
(What we have leads to many distortions…) One of them being that in the Western World the Financial Economy/sector is more important than the productive sector.
Yeah… there can be some Madness when it comes to economics…
How crazy is it when we expand the money supply by 9% in a year… ( mainly thru increase in Credit )… and then say we have had a wonderful year because GDP grew by 3%..??????
Seems Mad to me.
I agree with u… a Fixation on growth.. just for the sake of growth … is a bit dumb to me.
November 12th, 2009 at 11:45 am
Steven whats so bad about encouraging larger families? Our fertility rate at the moment is below replacement, we either have natural population growth or get taken over by countries and cultures that do. The current economic and financial system is totally dependent on growth we just have to live it. Its a bit like emmision trading whats the point doing it unless everybody else does it as well, otherwise it just gives massive advantage to those that don’t and they end up getting bigger and stronger which is what is happening.
November 12th, 2009 at 12:02 pm
Kieran, I agree we need more people. Look at singapore, they are looking at another 3 million people to increase workforce and tax take. Take away everyone TV sets – it will do it…
November 12th, 2009 at 12:13 pm
We have enough problems with the people we have now, yet we want more of them?
Reduce numbers, reduce pressures. Aim for sustainability, not growth.
November 12th, 2009 at 12:14 pm
i’ve been arguing for this for ages. It is ridiculous that savers wear the full cost of their interest earned. But since when was logic, fairness and long term economic health criteria for our tax system.
November 12th, 2009 at 12:19 pm
In previous comments I have made exactly this suggestion.
I also tagged it with the idea that the Government could telegraph its “nominal” inflation rate for the next year or years. After all, they include spending projections for up to four years on that side of the Budget.
So if they thought control was needed the nominal rate could be set at the very high end of expectation or if stimulation was needed , the opposite could be done.
Indeed it could become part of the RB statements to record thoughts on future trends.
It would encourage local bank deposits to replace overseas sources too
November 12th, 2009 at 12:34 pm
Off the topic but who cares and someone else raised it.
Why do we need more people?
The only real reason is to make an easy path for business to expand its captive market without having to work at exporting products and services.
Each individual requires the most resource use at early life , briefly, and then at the end of life.
All we do with immigration is build up the future burden while adding depreciating capital stock which needs continued maintenance at higher levels.
November 12th, 2009 at 1:04 pm
Less people less pressure – excellent logic. Look at Iceland…. only 300,000 people and the country poked!
November 12th, 2009 at 1:13 pm
Great piece, straight forward simple and effective – Innovation!!!
Unfortunately, poli’s hate anything straightforward, simple and effective. Hmmmm I can’t wait for the waffling BS excuses if it does get put forward to JK or BE.
November 12th, 2009 at 1:19 pm
Tax should be consider as having two purposes: 1) To generate income for the government to pay for things as a society we want or need. 2) To regulate behaviour so to maintain healthy self-interest.
Some people might agree or disagree with either purposes. Whatever the case.
Ignoring the first case, you can argue about government spending as much as you want. The discussion is about distortion in the real estate market and capital markets that is been driven in part by investment decisions made by individuals due the tax environment. Notwithstanding the input by investment distrust in other asset classes and the impact of the baby bloomers.
It is an important discussion. Personally I think the distortion is too much and I’d get rid of LAQC in the first instance. Not adding a tax, but removing a tax avoidance mechanism. Any change in one place should mean change in another to promote what you might want.
How about creating a basic CGT and reducing GST to increase consumption? This should drive local business and increase jobs.
November 12th, 2009 at 2:42 pm
Nicholas Lee – The last paragraph is a good idea, but unfortunately the government presently is looking for more money so they won’t be reducing taxes!
However I don’t agree that the discussion is about distortion in the real estate market. The distortion in the real estate market is a symtom of what’s been happening. The root cause is an inequitable tax system. Some of the population don’t pay their fair share of tax, which means the rest pay more. The problem is further exacerbated by the fact that holders of non productive assets are the ones benefitting from this anomoly. Regardless of their voting or phillosophical preferences any democratically elected government should be looking for an equitable tax structure. I haven’t seen any argument at all on all the blogs about this that argues that lack of a capital gains tax is an equitable tax system.
November 12th, 2009 at 2:49 pm
Taxes are for the peasants to pay. The pigs at the trough know all the loop holes. That’s why there will be NO change from the current policy of running a property ponzi economy porked with waves of immigrants and foreign loot turned into mountains of credit. How many times must Wally hammer the point. It’s pigs one…peasants nil. Always will be.
November 12th, 2009 at 3:02 pm
So Wally, you have spoken of your full trough before, want to pass any advice onto a peasant?
Gingerbreadman, it depends on how you set yourself up to play the game that will make one sustainable. Not the amount of people playing [within reason ofcourse]. It is my understanding that Iceland was not playing the game relative to their situation, they were sticking their noses in Wallys trough.
I am sure we will never agree on what is a “fair tax” as by definition of tax is to take something from some one. I guess it is just like people nicking stuff, they try to take it from people that will not complain as much as the other, or are not in significant enough number to cause a problem should they gang together.
Sounds like revolution talk to me
November 12th, 2009 at 3:47 pm
@NAT Best blog ,if that happened house prices would drop overnight ,all the smart money would be invested in simple interest accounts.
November 12th, 2009 at 4:04 pm
The price of housing is set by the cost of building a new one, or perhaps knocking down an old one and replacing it with a new one. From time to time it happens that new building prices actually exceed the cost of buying an old house at market prices.
The only problem is when people use investment in non productive assets as a way to not only avoid paying their share of tax via capital gain, or in our case also get a subsidy from everyone else. It is even more inequitable if the state also then takes more tax from the poorest workers who perhaps are contributing to economic wealth to make up the balance.
Capital gains tax is just an equity question – nothing more.
November 12th, 2009 at 4:05 pm
Correct me if i am wrong – much negative has been said about LAQC. However, LAQC is the only structure that the directors are responsible for all financial obligations. If the LAQC failed, directors are liable for all taxes and to creditors. So as far as tax liability goes, LAQC is an easy option for IRD to chase any outstanding tax amount. I am not an accountant and was told of thsi facts. any tax experts out there???
November 12th, 2009 at 4:10 pm
You’d be suprised (?!) how many directors of companies have no personal, recoverable assets, when what-ever-it-is that they are invloved with fails,GBM! LAQC or no LAQC…IRD or no IRD….I know! I’ve just spent 4 years in the courts trying to untagle a spiders nest of LAQC’s…to no avaail.
November 12th, 2009 at 4:57 pm
CGT isn’t about housing price bubbles, it’s about fairness and equity in the tax system. Every time the argument is allowed to drift into all these other things it suits the asset holding section of the community who aren’t paying their share of tax.
CGT captures all sorts of capital gains – as it should because it’s about taxing everyone more equitably and removing subsidies where they exist. Farmers would benefit greatly if a CGT did reduce land values. We all need them to be farming for profit from productive activity. Productivity would rise if a big cost (servicing debt on the land value) fell. ROI improves so that would be pleasing for all the stakeholders including their lenders.
November 12th, 2009 at 5:04 pm
Gosh, someone else understands this too.
A simpler way to achieve the same result is just to tax interest income at a lower rate. Linking tax to CPI will result in political pressure to massage the cpi figures.
November 12th, 2009 at 5:25 pm
Brian W – yep, some farmers do think it’d be a good idea:
http://www.ruralnews.co.nz/Default.asp?task=article&subtask=show&item=14936&pageno=1
More visionary ones perhaps who are intersted in a sustainable industry for their kids and grand-kids. Shame more of us don’t think like that.
(Y’ gotta admit threads on this topic can be so entertaining eh?)
November 12th, 2009 at 5:29 pm
Extending the argument.
Home owners get no tax benefit from their mortgage interest. Investors do get full benefit, and more.
Anything that rebalances this situation is positive.
The Gummint can balance the sides of its own books by using the revenue from tax on residential investment against the credit given to private bank deposits.
The bonus is that retirees will use the bank and not chase chimeral finance company offerings.
November 12th, 2009 at 5:41 pm
@Paul “Fair tax” is probably about framing the right question.
Personally, I’m happy to pay for Schools, Hospitals, Roads, etc. Even if I didn’t have kids (now), I’m happy to help other people’s kids. They might be my future employees, doctors, taxi drivers, whatever.
I’m not concerned about opinions basic human rights to education or whatever. But education, I think, is an invest in my social environment.
Health is more complex. What is fair health? In 15 years when the baby boomers are pushing the health system. Although productivity might be higher, what if the baby boomers have not “saved” enough via the current taxes to invest in their future costs? Will it be fair for the smaller set of future tax earners to reduce their potential wealth to pay for the larger electoral body? You tell me.
In general though, I’d say less tax is better. Especially if it can be done while providing the same level of “service”. Productivity is something the government should seek to reach as well.
November 12th, 2009 at 5:42 pm
Brian W Says:
November 12th, 2009 at 4:04 pm
The price of housing is set by the cost of building a new one, or perhaps knocking down an old one and replacing it with a new one. From time to time it happens that new building prices actually exceed the cost of buying an old house at market prices.
I was told by a well known financial commentator, that the price of a house is based on what you could rent it out at. Therefore you base the value of the house on the returns you could get. He said that apartments the price you pay, should be based on a 10% rental return.
The price to build a house is largely based on what someone is prepared to pay to build that house. It’s supply and demand, and both labour and material costs will go down if their is no demand for them. Comparing building an old house, with building an new house is impossible, as the cost to build an old wooden house with those materials, would probably be far more expensive than buying an existing house of the same era. This is different from building a new house with new materials eg one of those nasty Gold homes, which is cheaper to build with cheaper materials.
November 12th, 2009 at 5:43 pm
Nicholas Lee Says:
November 12th, 2009 at 5:41 pm
@Paul “Fair tax” is probably about framing the right question.
Personally, I’m happy to pay for Schools, Hospitals, Roads, etc. Even if I didn’t have kids (now), I’m happy to help other people’s kids. They might be my future employees, doctors, taxi drivers, whatever.
Agree, but the problem is a lot of them are going offshore where they can earn a lot more, so that NZ investment is going towards the economy of another country.
November 12th, 2009 at 7:54 pm
Rob’s comments about the fiancial advisor working out how to value a house are believable. I had that explained to me as I was organising the maintenance on a group of buildings for a big developer in 1987 just before the crash. He was buying me breakfast while he explained all this which was just as well because the eating motion stopped my jaw from staying down. He went on to become the boss at one of the big property company failures at that time.
What he had trouble with was that sometimes, because of a building being really well made (expensive), or maybe in the wrong area or something similar you could only get a 5% return on your building. Similarly sometimes you can get more than 10% and the building then is actually worth less than one that could attract only a 10% return. (Think about it!)
Because all the banks loaning the money were also convinced the 10% return story was right they kept loaning him money. They figured it had miraculously gone up in value since the time he had bought it. Of course he went broke. Wasn’t too good at maths. By the way he was a registered valuer.
November 12th, 2009 at 8:32 pm
Thanks for what are in the main pretty positive comments.
A couple of extra comments. First, it has been long established in the economics literature that a tax on the inflation component of interest income is distortionary. The great Jacob Viner argued this in 1923; Nobel prize winner Franco Modigliani argued the point in the 1970s. The US Department of the Treasury made the taxation of inflation-adjusted income the centrepiece of their wonderfully named 1984 tax document “Tax reform for fairness, simplicity, and economic growth,” arguing that the interaction of inflation with the taxation of capital income was one of the largest distortions in the US tax system. The curious thing is why economists don’t highlight the issue more often. It is hard to remember when the Minister of Finance of either party, or the head of Treasury, focussed attention on the potential problem of taxing lenders at 75% above normal rates simply because the Government didn’t see fit to adjust nominal interest income for inflation. Perhaps they haven’t wanted to highlight the issue because it is ludicrous to claim on one hand that New Zealanders save so liitle and on the other hand admit that lending is very highly taxed.
Secondly, while my own preference is not to have a capital gains tax because of the administrative difficulties, if there is a CGT, both interest income and capital gains should be adjusted for inflation. or otherwise taxes on real capital income will be higher than other taxes. Introducing a CGT without trying to fix the tax-inflation issues will still leave us taxing lenders at extremely high real tax rates – something the Treasury and IRD have been quite comfortable doing for a long time, but something which seems add odds with promoting saving.
Thirdly, it might be more straightforward to adjust interest income and payments for inflation now than in the past, not only because of advances in computing technology, but also because of the Reserve Bank’s inflation targetting regime. Rather than adjusting for actual inflation every quarter or year, it might be possible to adjust for average inflation – say the inflation target midpoint. This might be similar to a tax regime where capital income tax rates were lower than labour income tax rates in order to adjust for the additional effect of inflation. This seems a question for further analysis.
Andrew Coleman
November 12th, 2009 at 9:27 pm
Andrew,
Another thing that needs to be revisited is how to best measure inflation..
Inflation IS NOT the CPI index…. We use the CPI index to measure inflation.
By having such a fixation on the CPI index… Central banks have allowed Money Supply to be “elastic” …. and grow at double digit rates… ( resulting in Bubbles )
I believe that general Price Inflation is a function of Money Supply Growth…. a Monetary phenomena.
Because of the impact of Globalisation and particularly, China over the last 15 yrs… the CPI is not a very good measuring tool for inflation… Inflation can manifest in different ways, and in different asset classes… and not , necessarily, just Consumer Prices.
.
SO… if we are thinking about having inflation adjustments for tax… we really have to properly define what inflation is and how best to measure it.
Non Tradable inflation is probably a better measuring tool than the CPI.
This brings up the whole debate about whether Central Banks should have more of a focus on Monetary aggregates…
your thoughts..??
November 12th, 2009 at 10:37 pm
“… we really have to properly define what inflation is and how best to measure it.”
Thank you Raf.
Which brings us back to Mish Shedlock:
http://globaleconomicanalysis.blogspot.com/2006/02/inflation-what-heck-is-it.html
“Inflation is best described as a net expansion of money supply and credit.”
and more recently:
http://globaleconomicanalysis.blogspot.com/2009/11/what-is-inflation-and-how-does-one.html
which incidentally concludes with this extract:
“Bernanke, Obama, Congress, the Fed, and Central Bankers worldwide have all failed to learn anything from:
1) The Great Depression
2) Two Lost Decades In Japan
3) The Dot-Com Bubble
4) The Housing Bubble
Instead they follow unwise and disproved Keynesian and Monetarist tactics that have failed to accomplish anything but create bigger bubbles. However, this is the end of the line. Housing was the bubble of last resort, nothing can come close to the number of jobs created by the global housing bubble.
Further attempts to reflate will do nothing but create a currency crisis, crash the economy, and add to future liabilities that cannot be paid back. A global economic crisis is coming. When and how it manifests itself is all that remains to be seen.”
The GFC is not over by a long way. Stocks are going gaga not because of fundamentals but simply because the fed has stated they will keep rates low for an “extended period”. Bubble mania all over again, there’s no way out for the fed, a crash is inevitable. Hopefully the RBNZ is concerning itself more with the fallout of this scenario rather than house prices, which will be the least of our worries in a year’s time.
November 13th, 2009 at 10:55 am
JUST DO IT!!! Level that playing field – enforce CGT and fix up the BS surrounding tax on interest earned in a savings account/term deposit. What’s so unjust about that? I despair for this country at times. I coined a phrase recently and it springs to mind right about now – “too much HUI and not enough DUI”. I like it.
November 13th, 2009 at 1:43 pm
Andrew – “Secondly, while my own preference is not to have a capital gains tax because of the administrative difficulties, if there is a CGT, both interest income and capital gains should be adjusted for inflation.”
Yes, as per Australia, see:
http://www.pec.org.nz/2009/10/pec-believes-john-key-is-just-tinkering-with-the-economy/
“Capital Gains Tax only applies on the difference between inflation and the realised value (as Australia does)”
However, why do you throw up the notion (red herring) of “administrative difficulties”? If Auz and others can implement and administrate CGT, why can we? They aren’t smarter than us are they?
If there is a WILL to create a fairer, rebalanced tax system leading to a more productive New Zealand, “administrative difficulties” may be a price worth paying.
You are obviously a clever bloke and work with a lot of clever people at Moto, when you get on your next smoko how about you and your mates list down the “administrative difficulties” and solutions for them. I’m sure if clever people like you guys have the WILL to change, the change WILL be easier.
Good article. Cheers, Les.
November 13th, 2009 at 1:55 pm
Andrew Coleman obviously a wiser man than I said
“….it might be more straightforward to adjust interest income and payments for inflation now than in the past, not only because of advances in computing technology, but also because of the Reserve Bank’s inflation targetting regime. Rather than adjusting for actual inflation every quarter or year, it might be possible to adjust for average inflation – say the inflation target midpoint. ”
Earlier I made the comment
“the idea that the Government could telegraph its “nominal” inflation rate for the next year or years. After all, they include spending projections for up to four years on that side of the Budget.
So if they thought control was needed the nominal rate could be set at the very high end of expectation or if stimulation was needed , the opposite could be done.”
In other words the inflation figure could be a ‘nominal’ one that could be a tool of management of expectations and projected as far ahead as the Government thought fit.