The crime is not being rich, the crime is we don’t tax all the income that wealth can earn says Morgan Foundation's Geoff Simmons

The crime is not being rich, the crime is we don’t tax all the income that wealth can earn says Morgan Foundation's Geoff Simmons

By Geoff Simmons*

In our last blog we looked at whether the claims of ‘rock star’ economist Thomas Piketty held any water or not.

Short answer is that some did, some didn’t.

In this blog we turn to what we should do about his insights.

The purpose of taxes, benefits and the government provision of services is (at least partly) to redistribute income.

We don’t pursue equality as that would crush any incentive to get out the bed in the morning to create wealth, however there’s a general social contract that our economy should be fair.

As a result, we champion equality of opportunity, so that everyone has the resources they need to get started, and has the incentive to work hard, to work smart. A fine balance is required and there’s plenty of room for argument over the detail here.

Piketty’s charge is that inherited wealth will beat hard graft every time, which doesn’t sound like a good thing if protecting equality of opportunity is the aim.

However by taxing wealth out of existence the solution he suggests pretty much roasts the goose that lays the golden egg.

We suggest that the Comprehensive Capital Income Tax (CCIT) put forward in the Big Kahuna is actually the Goldilocks ‘just right’ middle ground that addresses the unnecessary causes of the polarisation Piketty admonishes capitalism for.

We’ll start by looking at the standard responses – progressive income taxes and a capital gains tax – and why they don’t cut the mustard.

Raising the top tax rate & Capital Gains Tax aren’t the answer

Piketty has suggested a return to Muldoon-type tax rates – up to 80% for the top income earners.

The trouble is that this approach doesn’t work; it is complicated, and the wealthiest people don’t pay the top rate of income tax anyway.

A Capital Gains Tax is no better – especially with an exemption on the ‘family home’ – more loopholes for the wealthy to exploit to their advantage. Capital gains taxes are complicated to administer, are an unreliable source of revenue (some years they would lose the government money), and even if they were imposed efficiently, it’s highly likely whether taxing capital gains is taxing the symptom rather than addressing the problem. We do not agree with capital gains taxes.

In short, the Labour/Greens proposals to raise the top tax rates and introduce a tax on capital gains were pretty much just symbolic, they wouldn’t have solved the problem.

Piketty’s answer – taxing wealth

Piketty is on the right track here – the tax on the effective income people reap from their wealth is nowhere near as complete as the tax on income earned by labour. The problem with capitalism, he points out, is that we don’t tax capital (or better said, the effective income from capital) enough.

However, Piketty goes too far.

Depending on the size of the fortune, Piketty suggests taxing wealth itself using tax rates of 0.5%-10% per year. This would be on top of any income tax paid on the income produced by the wealth (such as interest from bank accounts).

Piketty’s proposal could cut a massive swathe through a fortune over time. In doing this he is trying to bring the returns to capital down to the same level as increases in other income like wages, so the owners of wealth don’t grow richer.

There are a couple of problems with taxes on wealth of the magnitude Piketty prescribes. Any country trying to do this would see its capital owners flock overseas. You’ll never get a global agreement because it would always be in the interests of some country to offer up a tax haven.

But the most serious flaw with Piketty’s proposal is that it removes the very heart of a capitalist economy. Why would anyone bother to work hard and accumulate wealth if they were taxed on it to the extent that they couldn’t grow richer? It’s just silly to remove the incentive to get rich, it lies at the heart of capitalism.

A comprehensive capital income tax avoids these problems

There is an alternative that addresses the core of the inequity and inefficiency in capital’s role in our economy. We proposed it in the Big Kahuna: Turning Tax and Welfare on its Head.

The income from assets that are returning cash income, like bank accounts and shares, are already fully taxed and shouldn’t be taxed again. Piketty has gone too far in suggesting this.

But what about assets that aren’t returning cash returns? They are still providing a return to their owners, otherwise they wouldn’t invest in them. So why do we not tax these returns too?

Here is an example – owner-occupied housing. If you didn’t own your own house you’d have rent someone else’s – and they would pay tax on that rent. That’s a clue to the size of the rewards owners get from their houses – it’s equal to the tax implicit in the rent they would otherwise have to pay.

A second example is businesses people run simply as tax shelters. They claim all the depreciation on the assets they deploy to make no profit – at least no profit after the wages they’ve paid themselves. Farmers are into this like robber’s dogs but so are many other self-employed. It is nothing but a tax loophole. Utilising the business assets for personal use is almost a national sport for the self-employed. It is a tax rort.

Our insistence on selectively exempting the non-cash income a capital asset can endow its owner is of significant consequence. This tax loophole is worth about $6 bln, and the wealthy and middle class Kiwis that own their own homes are all cashing in. It alone – let alone the ease of leveraging this type of investment via mortgage finance – explains our obsession with investing in housing, and the investment bubble we have as a result.

A comprehensive capital income tax – which applies the tax rate to a deemed risk free return that capital could be applied to – would tax zero or minimal profit-making businesses on the income they’re enjoying from the assets they deploy, and would tax owner-occupied housing as if owners were paying themselves rent. It would put the biggest part of our national wealth – housing and land – on a par with all other assets and firmly within the tax net.

It would have the added bonus of popping the investment bubble in property and placing it on a level playing field with investment in other types of capital – factories and software for instance. And it would rid us of pseudo businesses that are nothing but a tax dodge – something the FBT has failed to achieve.

A comprehensive capital income tax doesn’t fall prey to the same problems as Piketty’s proposal. There is no double taxation going on.

In many ways this is just a proper income tax – taxing all the benefits owners get or could get from their assets, not just the cash income they may or may not earn.

In essence there is a minimum tax that all owners of capital must pay – whether via income tax or the CCIT on the value of the capital. Such closure of the tax base for capital would bring much effective income within the gambit of the tax base for the first time.

The major change would be that for the first time we’d be taxing at least part of the true returns to housing and land.

Got my house, boat, bach – I’m alright Jack

People will whinge at the thought of a new tax, as the concept of taxing our housing or land is an anathema to most Kiwis.

It’s important to understand it’s not a new tax, it is merely income tax properly and comprehensively applied – quite different to the current income tax regime that hits PAYE payers properly but nobody else.

By defining the tax base properly we could also remove the progressivity in the income tax regime, which is another source of gaming the tax regime. In fact our view is a flat rate of income tax is critical on every dollar earned.

As we suggested in the Big Kahuna, the revenue raised from this tax could help fund an Unconditional Basic Income of $200 per adult per week. The triple of a CCIT, a UBI and a flat rate of income tax is the meaningful reform of our tax and welfare regime required for the system to be fair and efficient.

If we are serious about reducing inequality of opportunity and giving everyone a fair go, as well as getting the most efficient deployment of our capital resources then we have to move away from this idea of accumulating assets and then sheltering them from the tax man.

Have you ever wondered why the Coromandel Peninsula is full of multi million dollar homes that are unoccupied most of the year?

Now you know – property is the most tax efficient place for the rich to stash their cash.

More and more this Kiwi dream of home ownership is becoming the preserve of a privileged few, and the national pastime of accumulating housing is severely distorting our economy.

Worse of all the distortion drives the problems that Piketty has raised.

If we want to tax wealth as Piketty suggests, then a Comprehensive Capital Income Tax is the best place to start.

Want more on all this stuff?

Listen to Susan Guthrie from the Morgan Foundation discuss Piketty’s thesis in the New Zealand context with Kathryn Ryan on Nine to Noon – Radio National

The Piketty Phenomenon – New Zealand Perspectives (released October 23)

Collected in this BWB Text are responses to this phenomenon from a diverse range of New Zealand economists and commentators. These voices speak independently to the relevance of Piketty’s conclusions. Is New Zealand faced with a one-way future of rising inequality? Does redistribution need to focus more on wealth, rather than just income? Was the post-war Great Convergence merely an aberration and is our society doomed to regress into a new Gilded Age?

Capital in the 21st Century – Thomas Picketty

What are the grand dynamics that drive the accumulation and distribution of capital? Questions about the long-term evolution of inequality, the concentration of wealth, and the prospects for economic growth lie at the heart of political economy. But satisfactory answers have been hard to find for lack of adequate data and clear guiding theories.

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Geoff Simmons is a senior economist at the Morgan Foundation. This article was first published on the blog garethsworld.com and is re-published here with permission.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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I like the general idea of CCIT and a UPI. Note that it becomes even more attractive if we are indeed heading towards a society where capital (i.e., automation) replaces labour, as some commentators suggest. I am not a fan of flat taxes (because the utility of money is non-linear) but this is not actually one (because of the UPI) - it is a very simple tax (and welfare policy) that will save vast amounts on administration.
However, with the impact on retirees coupled with NZ's love of property it would be political suicide for any party to suggest it as currently proposed. Although not ideal, I would suggest introducing an exemption for the primary residence up to $500k (say). If this is not indexed to inflation then eventually it becomes unimportant. Yes, retirees in expensive Auckland suburbs will either have to downsize or "eat their house" (as is currently suggested), but for most retirees in the country they will not be affected. 

The government sets taxes for the wealthy people. Then because their donations are vital to their re-election they create a whole pile of loop holes so they do not have to pay their taxes.
Dont believe me - just look at America.
 
No matter what the government does the wealthy will avoid paying. That is why they are wealthy.
 
Say for example you tax the house of the head of a corporation. They just get a big bump in salary to compensate. Ordinary people cannot do that. Also they can make the house a company house and claim house expenses on their tax. Ordinary people cannot do these things.
 
I can only assume you live in your own little bubble.
 

Henry T et al your comments on this for farmers? 
http://www.stuff.co.nz/business/farming/dairy/10638742/Dairy-fund-banks-...
 
Who needs CCIT when your lenders are going to screw you for your capital gains.

The sharks are circling

CO, well AW and Coy have a history of being full of new ideas, however, dealing in second mortgages (as depositholder, or borrower) has not always be okidoki (Landbase way back)
better your accountant pull several together to save someone....
the deal described above was released in Singapore to investors there more than a month ago, without looking at numbers it seemed 10% was around what was offered deposit wise - not assuming $5 yrs this and next.
http://www.reuters.com/article/2014/09/26/acfnz-trust-dairy-idUSL3N0RR3CQ20140926
(Reuters) - Aquila Capital Farms NZ is marketing its first New Zealand dairy farming trust to regional investors, betting on growing overseas interest in the country's key export industry and demand for steady returns from this sector.
and    Aquila Capital Farms NZ is a joint venture between Germany-based alternative asset manager Aquila Capital and New Zealand's AGInvest Holdings Ltd, which manages 47 dairy farms in the country with assets of around NZ$550 million. (1 US dollar = 1.2653 New Zealand dollar) (Reporting by Rujun Shen; Editing by Ryan Woo)
but whats in a name...... myf who.
$100m is not much, more a fighting fund for a portfolio of say $500m...
generally main banks do not like a second mortgage holder, unless they are looking to slip the client - as their triage processes are slick enough (using the my little baby approach)..
 
you are right, the key to borrowerd funds, was that under the pillow was the capital gain, if all else failed..., it is the last log to hollow...
by way of example:.... see getting out and back breaking work your self was what fixed the situation "producing an extra 30 odd ha..... 
http://www.stuff.co.nz/business/farming/dairy/10636551/Bennys-battle-through-tough-dairy-farm-conversion
and possibly no/little wage/share producing labour for a year or two would help.....
 

CO, this powder business is getting interesting.

After months of easing off the gas, China hit the brakes in September. Chinese imports of whole milk powder (WMP) fell to 20.7 million pounds, down 63% from August to the lowest monthly total in nearly three years. Combined imports of WMP and skim milk powder were 40% lower than in August and 54% lower than last year. 

 

China is by far the world’s largest consumer of WMP 

and the second largest producer, behind New Zealand. 

The decline in imports may signal a decline in demand, 

fostered by slowing growth in the formerly booming 

economy. Or China may simply need less foreign milk 

powder than previously thought. Chinese milk 

production is reportedly rebounding after a problematic 

2013, and milk powder inventories have burgeoned 

after record-shattering imports earlier this year. 

The decline in Chinese milk powder imports comes at 

an inopportune time for U.S. dairy producers. Milk 

production is on the rise and much of that milk will 

make its way to driers. Without China to sop up the 

excess, global milk powder inventories could grow considerably, leading to lower dairy product prices. 

 

http://www.milkproducerscouncil.org/updates/102414.pdf

 

I see China just bought 50 farms/90, 000 cows in Victoria for infant formula market.

http://theglobaldairy.com/noticias/chinese-snap-up-50-dairy-farms-41138/

Anyone who has ever been an entrant in, and participated in, the "Business Game" you will understand that this is "not good"
 
They are going in at the threshhold end of the business to cut out the middle man
 
This is State-owned capital in play
 
Does not augur well for New Zealand
 
Tactically, the astute, small scale dairy farmer, would be getting out now ......
 
While the going is good

 
One wonders if one hand knows what the other is up to.
 
Growing pains
For both formula and diapers, though, the China market will soon change. The country’s baby boom is set to subside thanks to the one-child policy’s decimation of the birth rate. With it, the core demographics for both products will face a shake-up.
Daxue Consulting’s Matthieu David told The Financial Times last year that the formula market is expected to stop growing soon, with a steep drop in the number of Chinese women in their 20s after 2017. Assuming China’s central government succeeds in altering the country’s economic engine from export-heavy manufacturing to a consumer-centric, middle-class-fostering marketplace, the future for both industries may lie upscale in premium goods. But the recent circling of domestic wagons in the formula industry – not to mention others – raises questions about how certain the future is here for international brands. Even Pampers may not be safe from regulators’ wrath.
Whoever ends up selling them, another boom in diapers may yet await. China’s economy, famously graying, may become a hotbed of incontinence as its elderly population skyrockets. Estimates currently peg China’s over-65 cohort reaching 26% of its total population by 2050. As the middle classes have turned to infant diapers for convenience recently, they may also eventually turn to adult diapers for the same reason. That’s particularly true in highly-developed cities like Shanghai, where disposable income is high and the birth rate is particularly low. Whether aged urbanites will be willing to risk losing face by wearing them, though, remains to be seen.
http://www.chinaeconomicreview.com/troubleddeliveries/page/0/2
 
 meanwhile Fonterra have the pedal to the floor
http://www.reuters.com/article/2014/10/23/fonterra-driers-idUSL3N0SI1NH2...
 

Powder inventories
The bureau forecast a continuing build in New Zealand's stocks of whole milk powder, its prime export product, thanks to the rising liquid milk production and China's retreat from imports.
Whole milk powder inventories as of the end of 2014 were forecast at a record 200,000 tonnes, up 27% year on year, rising more slowly to 220,000 tonnes by the close of next year as Chinese demand recovers.
For 2014, "trade sources indicate that there are considerable unsold stocks in China which is reducing Chinese demand for imports considerably.
"This is allowing the second-tier purchasers back into the market at significantly reduced prices, but it is thought that the increased purchasing by these countries won't be enough to counterbalance the Chinese reductions."
 
http://www.agrimoney.com/news/milk-producers-may-have-to-wait-for-price-...

AJ
 
I would imagine the incentive to buy up in Australia is the difference in restrictions on buying rural-agrucultural land
 
NZ: anything 5 hectares and above requires OIO approval and or have to demonstrate they can do it better than the locals or improve it
 
AU: Anything over $200 million requires FIRB approval
 
AU: anything under $200 million does not require approval - it's a free-for-all
 
NZ: Crafar Farms and Lochinver processes will not have gone un-noticed

they have form,
and some chancers are looking to repeat what happend with coal mines to Japan, Korea, China and India (USA & Rio BHPBill aside) over the last 30 years.
thing is unlike mineral resources, there is no royalty pmt made by OS owners on farm produce, so its not just like.......
note most J, K C and I owned mines run at large Aust tax loss, as product profits are invoice vehicled away to happier places (not to mentions fees, IP pmts parent bulk funding etc, etc.)...
On the other hand, some less than mega (but big) China dairy folk are suprised at how little to be made framing/trading wise in Oz, compared to their China 8,000+ hd herd farms..
 
and domestic market-wise its seems no surprise  dairy folk over there happy to look at land sales option $'s...
 
plus, as some observe, the way of the ARU have been shown over the past weeks, is really how a great deal of many things are done in Ozz...
 

Aj re the Studholme driers The proposed investment would bring a significant boost to milk processing in South Canterbury – one of New Zealand’s fastest growing dairy regions – http://www.fonterra.com/global/en/Hub+Sites/News+and+Media/Media+Release...
 
How many other dairy farmers are like the MOTH and I?  We won't have family succession on our farm as family have other dreams, and we see 10years max of holding the land (well past current retirement age by then) and employing sharemilkers. So:
Do we take a purely business decision and move to the competition now where others who supply them say cashflow is much better and final payout payment is received in August and not October (Fonterra).  
You don't have to put up with the politics of the co-op. e.g. Govt intervention with company to get what they want (TAF)
You don't have to put up with having only a 'Clayton's vote' on constitutional votes - Shareholder Council effectively has veto power on any constitutional voting by shareholders, due to vote not counting unless 50% of Shareholder Council also votes for it and you can be certain that it will never vote against the Board, regardless of what the shareholders want.
You don't have to own shares. Mmm...just think of what we could do with that money instead. ;-)
Don't have to attend meetings where your hear more and more from shareholders that they now see that the real value of Fonterra will be in the share value - for when they inevitably list.  Is that why we are farming?  Not in our case.
Perhaps the time has come to sell out to the highest bidder - whoever that may be and ride off in to the sunset.  Now where's that bottle of pinot noir? :-)

You should give Mr Watters a ring. Then the lifestyle of the rich and famous you have become accustomed to would contiue into your golden years., No rates,councils, workers, Fonterra,storms,  droughts.The feast or famine years would be behind you.

Mr Watters wouldn't be on my list to ring Aj. ;-)  As for the lifestyle of the rich and famous - couldn't think of anything worse.  :-)  What happens to farms like ours is an elephant in the room for dairy.  There will be many others out there like us - family farms with no family succession.
 
Our pinot noir is shaping up to be a pretty good brew. The MOTH seems to have transferrred his farming skills in to viticulture.  Bit like you Aj, except MOTH lives on site.  He had to get up at 3.30am the other morning to check on frost fighting, as did all the other vineyard managers. Riesling and Pinot Gris has come out well too. :-)

Frosts have been very light this year with us, but we have a few more weeks left in the frost season. If you can make money from grapes, can you let me into your secret?
 I worked in for years with a local apple grower, so we contacted each other if a frost event looked likely, I had so many late nights that grew into early mornings, I eventually spent money on automation and better water volumes, now I only worry about filters and reliability of pumps.
 I have struggled in the industry, perhaps Im better at sheep and beef, where the dung is on your feet.
 I too have no one to continue the farming line, so all we have needs to be sold one day. I do ponder on the problem but as long as I can enjoy the sun on my back and the pleasure of a job well done, I will keep ploding along.
 I do worry about what kind of future the next generation is in for, one where corporations and acountants rule the land, once centralisation, financialization and globalisation have done their worst.
 
 Your Reisling has potential. Have a good vintage.

My girls have got pretty good at grapes, not bad at sheep and cattle, smart on a horse, wise on a tractor. Not a bad inheritance looking back.
 On top of that they can all read music and play the piano. Gods knows what they will do with their lives.

The grapes were on the block when we bought it,  but we didn't buy it for the grapes.  Seemed a pity to pull it all out so MOTH decided that with the help of a viticulturalist he would 'have a go'.  Were never interested in trying to make it a business - couldn't see how that would ever work with the number of vines we have and have seen quite a few with more than we have struggle.  So long as we cover costs we are happy. It was a bit of a fun 'filler' while we worked out 'where to next'.   We have interest from a young boutique winemaker to take the fruit for their own label that they are developing.  We're always keen to give young folk who are motivated a handup where we can. Got plans for automation in a couple of years.  So MOTH, while still involved, won't be involved to the same degree as in the past. Timing is great as we now have a 'project' we want to take on.  You have a good harvest too Aj.
 
Adaptability to change and resilience are going to be important traits for the next generation going forward.  The World may be different to what we know now but that doesn't mean it will be all bad.

This is an interesting idea. My questions are where does the cash come from to pay for tax on a capital item that does not produce any income?
And what about assets owned overseas?
 

You couldn't be more wrong. New Zealand households have assets of about NZ$1 tln, and almost three quarters of those are houses. 
http://rbnz.govt.nz/statistics/tables/c18/
 
Almost all assets in one undiversified asset class is madness. And then to give the gains tax-free status is an enormous distortion that reinforces the madness. And that is especially true for 'investors' who rely on very high leverage. No normal business leverages their assets like property investors. They only do it to chase the tax-free income that other businesses are barred from.

Tax free 'income' is actually unproductive capital gain. It is a racket that transfers wealth/income to land based vested interests from productive labour (who pay higher living costs) and productive capital (who have to pay higher wages and have fewer sales). The solution is not to tax the unproductive capital gain but to eliminate it so it doesn't exist.
 
This is analogous to the 1840s Corn Laws. The campaigners which included the new industrialists like Cobden and new workers like the Shefield unions knew the solution was cheaper food through more competition not some tax or tariff on food imports. Those campaigners knew they were asking for regulations that favoured the new productive capitalists and labourers not the old land based vested interests. It was more than a liberal free trade story. It was about class, aspiration, spreading opportunities etc.
 
I think we are in a similar situation today.

3/4 of wealth in houses and averaging a 7 magnitude earthquake/decade. A bit more diversification - especially offshore - is in order.

An example of an small economy, more diversified than ours, taking a hit:

"I guess one could say that the iPhone killed Nokia and the iPad killed the Finnish paper industry, but we'll make a comeback." His comments followed S&P downgrading the Finnish economy last week. The ratings agency cited the country's ageing population, shrinking workforce and slowing exports."

Shelter is what it should be, that and HOME, anything else should be severey disincentivised.

How come you people NEVER complain about the tax disincentive where if you run a PROFITABLE business you PAY tax. The LESS profit your business makes the LESS tax you pay and all the other crap that goes with it.
 
All businesses are incentivesed to spend time and money trying to look un-profitable so they dont have to pay tax. What about closing that loop hole? Have you looked at how much tax Google, Apple and Facebook pay and why? Obviously not.
 
If i buy a house TO LIVE IN i am evil and avoiding paying taxes. Naughty, naughty me.
 

Capitalism and its constant grow, grow, grow, accumulate, accumulate mantra and this idea that we have to get "better" at doing whatever. Has anyone thought "get better at what" and the real question, what for, what exactly on earth for? It will have to go soon, if we are to survive with some sort of meaningful purpose to life, and guess what, that purpose is not going to be, to own the latest smart phone or re-do the house in the latest, must have colour, you know, the house with the $1m mortgage on it. Blah blah blah. 
There is a push back coming and all this stufff will not matter that much any more.