The government's Tax Working Group has released its latest update on its progress towards reform recommendations to the government, agreeing that it favoured a land tax over a capital gains tax because it would harder to avoid, less complicated and more efficient. (Update 1 includes session summary/Update 2 includes highlights from papers presented at conference on CGT/Update 3 includes highlights from papers on Land Tax/Update 4 includes IRD estimates of at least US$214 million of current property tax not collected/Update 5 includes Mark Weldon saying the NZ$200 billion worth of rental properties in New Zealand generated NZ$500 million of losses last year) The Tax Working, which includes economist Arthur Grimes, PWC partner John Shewan, NZX CEO Mark Weldon, economist Gareth Morgan and Rob McLeod, met on September 16 at Victoria University to discuss taxation reform ideas relating to property and property investment. The papers from this meeting, including the summary, were released on Friday afternoon. "Broadly, implementing a more comprehensive system of capital gains taxation would extend an existing tax base (the income tax base) to include capital income in taxable income; whereas a land tax involves the creation of a new base of tax," the Tax Working Group said in the summary.
"They would both increase tax rates in an area (particularly land) that is currently untaxed, and the bases overlap to some extent. Therefore although they may have some similar effects they are not necessarily substitutes for each other," they said. "A comprehensive land tax is likely to be easier to implement, comply with and administer than a CGT. The integrity of the tax system could be improved by the adoption of either; although a land tax is likely to have a higher degree of integrity, particularly if the CGT is restricted to certain types of assets." "In relation to vertical equity (tax burden rises as ability to pay increases), a land tax is broadly proportional, whereas a CGT would be highly progressive; however the land tax is a one-off tax on existing wealth in the form of property, which compromises its horizontal equity relative to capital gains taxes. " Summary highlights Capital Gains Tax
- US academic Len Burman presented a paper on what a CGT would look likeand its pros and cons.
- Burman said the current system where capital gains are untaxed "distorts saving and investment decisions, encourages tax shelters, adds unnecessary uncertainty, and reduces the tax base, requiring higher rates of personal income tax."
- Burman said the current system was inequitable and difficult to comply with. It also meant "the wealthy tend to hold higher-value assets. Not having an effective CGT undermines the progressivity of the tax system and means the wealthy pay less tax on their total income than the less well-off"
- Burman said a realisation based capital gains tax may encourage 'lock in' where people avoid selling to defer the tax pain, but the evidence in America was that this effect was limited.
- Burman suggested two options for a capital gains tax. Firstly, he suggested a hybrid approach where shares and unit trusts are taxed on accruals basis while other assets were taxed on a 'Risk Free Return Method (RFRM). Secondly, he suggested a realisation based CGT on all property.
- Burman concluded: "Despite some practical difficulties, a capital gains tax would improve system efficiency, raise revenue, be progressive, and it could pay for other tax cuts."
- Treasury then presented a paper saying a realisation based CGT that excluded owner-occupied housing would raise NZ$1.5 billion over time and nearly offset the costs of moving to a flat 30% rate for income, corporate and trust rates.
- Treasury downplayed CGT's disadvantages, saying: "The impacts of lock-in, loss ring"“fencing, and design and transitional issues, should not be overestimated."
- Inland Revenue and Treasury presented a 62 page paper on the pros and cons of a capital gains tax, concluding the cons made a CGT very difficult.
- Inland Revenue concluded an accruals based CGT was not viable because it would encourage listed firms to delist. It said the only viable option was an accruals based system.
- Even then, Inland Revenue argued such a CGT would be unattractive and reduce economic efficiency. It said: "While there are some benefits in theory from a more comprehensive treatment of capital income, in practice, lock-in, ring fencing, and the treatment of losses are likely to mean that a CGT reduces rather than increases economic efficiency."
- A CGT which exempted owner occupied housing would distort land use decisions, IRD said.
- If owner-occupied property is excluded it may trigger a shifting into this remaining tax-free area, IRD said.
- IRD concluded: "On balance, Inland Revenue argued that the advantages of a real-world CGT would not outweigh its disadvantages."
- The Tax Working Group discussed the avoidance opportunities with a CGT. "These could include sheltering of income in companies, and loss manipulation.
- "Lock-in effects could be a problem - and some group members noted that this impact could be more severe given New Zealand's high levels of investment in real estate," the group said.
- A CGT would be highly progressive (ie hit the rich more than the poor), the group said. "However, given this, there may be mobility concerns with the introduction of a CGT, with higher income people having a potential incentive to leave New Zealand."
- Andrew Coleman from Motu produced a paper detailing the long term impact of a CGT, including the following conclusion: "The model suggests that capital gains taxes will raise rents, increase homeownership rates, rebalance the housing stock towards smaller houses, and increase the net foreign asset position."
- Coleman also concluded a capital gains tax that excluded owner occupied housing would raise little revenue, while a CGT without exemptions would raise enough to cut GST.
- Treasury and IRD said a CGT that exempted owner occupied housing and included shares would raise around NZ$4.5 billion per annum, while a full CGT would raise about NZ$9.1 billion, although this would take 15 years to reach that level, assuming only gains after introduction are taxed.
- Economist Arthur Grimes then presented a paper on a Land Tax by himself and Andrew Coleman from Motu saying that a land tax would be more efficient than a property tax which included the value of both the land and buildings.
- Grimes said the introduction of a land tax would trigger a one-off fall in land values, which would hurt landowners, but improve affordability for first home buyers. "A land tax would be likely to cause home ownership rates to rise slightly, and gross debt to GDP and net foreign assets to GDP ratios to fall due to lower foreign borrowing. "
- Grimes said the taxable land base in New Zealand, which excludes government and conservation land, was worth NZ$460 billion. A 0.1% land tax rate would raise NZ$460 million, although this would fall to NZ$160 million if agriculture, forestry and owner-occupied land was excluded.
- Retired people would be hurt most by a land tax as they held proportionally more land and would not benefit as much from other tax changes in any reform package.
- A land tax would be easy and cheap to impose because it was already set up for local government rates, Grimes said. It would be almost impossible to evade, he said.
- "Thus a central government land/property tax could be added as an adjunct to the current system with virtually no additional administrative cost. Furthermore, the ability to avoid (or evade) the tax is virtually non-existent since the land/property is valued by an independent agency and the land/property is available as collateral in cases of non-payment of tax."
- A land tax would capture foreign owners of New Zealand land, Grimes said. "One currently untaxed sector that it would fall on is foreign-domiciled owners of New Zealand property, who otherwise pay no income tax and who pay no GST if they do not purchase goods and services in New Zealand. A shift to a land tax would therefore widen the tax base not just in terms of the base of assets on which tax is raised but also in terms of the number of people (i.e. non-New Zealand residents) who become taxpayers."
- A 1% land tax would immediately reduce land prices by 17%, while a land tax phased in over 20 years would reduce land prices by 11.5%, he said.
- A property tax with an exemption for home owners would cause the rental market to collapse, he said.
- Grimes said a property tax and the resulting fall in property prices would over time reduce New Zealand's foreign debts. "Put simply, high domestic property prices raise the portion of the country's production that is paid annually to foreigners, and a policy that reduces these prices is likely to lead to an increase in net foreign assets and in the fraction of income available for consumption."
- Residential land makes up 65% of all land values, while agricultural and commercial forestry make up 24% of the land value. A land tax would hit agricultural based households harder than residential households because each rural household owns proportionally more land.
- The average land value for residential properties is NZ$215,000, meaning a 1% land tax would cost each household NZ$2,150 per year.
- A 1% land tax would raise NZ$4.6 billion, which is equivalent to 20% of income tax.
- A land tax would effectively transfer wealth over time from the old to the young. "The retired cohort would be more likely than younger cohorts to incur a wealth loss (in absolute terms) given the higher initial value of their housing assets. They would also likely face an increased overall tax burden if a land/property tax was matched by an income tax reduction, simply because their incomes tend to be low in relative terms. Younger cohorts would face reduced current and future income taxes that, on balance, would generally more than make up for their higher lifetime land tax payments."
- Grimes suggested some variations on a land tax that would reduce the impact on farmers and lower income people, including a reduced rate on farmland or a per hectare rebate.
- He also pointed out a rebalancing of the New Zealand economy could boost productivity and per capita living standard.
Current tax avoidance
- IRD says it can raise an extra NZ$400 million extra for every extra NZ$100 million it spends policing the rules.
- "Particular areas for the application of additional funding would be an increase in focus on the hidden economy, losses, tax debt and property industry compliance."
- IRD has identified 2,000 people who have bought and sold 6 or more properties over a period of 4 years. Of this group, 312 people appear to have bought and sold 20 or more properties (and should therefore have paid taxes on trading profits) and owe up to NZ$214 million in tax.
- There is another 5,112 people who have bought and sold 3 to 5 properties during the same period.
- IRD then asked for more funding as its current funding runs out in June 2010.
- NZX CEO and Tax Working Group member Mark Weldon told Andrew Patterson's Sunday Business on Radio Live the NZ$200 billion worth of rental properties in New Zealand generated NZ$500 million of losses last year.
The group's summary of its third session is below: Tax Group Session 3 Summary