By Ranjana Gupta*
The tax system plays multiple roles.
In addition to being a fundamental instrument to raise revenues that finances government expenditure, it also acts as an instrument to achieve the economic and social aims of government, and redistributes income on a socially acceptable basis.
Classical economist Adam Smith developed the principles of a ‘good’ tax system back in 1776. These include equality (fairness in the distribution of tax burden), certainty (the tax system should be easy to understand), convenience of payment (the tax system should be easy to comply with) and efficiency (the lowest possible cost of tax collection)1.
Smith’s principles have been expanded by subsequent economists and writers, who have added concepts such as adequacy (raising sufficient revenue) and sustainability (the ability to meet changing needs of governments).
The New Zealand tax system is generally well-designed and has served the country over decades, but it relies heavily on income tax and the Goods and Services Tax. A narrow tax base is inefficient because there is the tendency to avoid participation in the taxed activity, which forces the tax rate up on that activity; by taxing different activities or new sources of revenue, tax rates can be kept comparatively low. Land tax – recommended by the Victoria University of Wellington Tax Working Group (TWG) in 2010 to replace a number of existing taxes – is one of the biggest holes in New Zealand tax regime.
One of the most famous advocates for a tax on land was Henry George, who in his 1879 work Progress and Poverty argued that the value of land was largely created by the community’s economic activities. The proximity of a piece of land to other activities and infrastructure (population concentrations, main transport links and the like) is what gives land much of its monetary value: the land owner makes unearned income because of the activities and investments of others in the community.
Land tax is a tax levied on the unimproved or rental value of land (but there are some variations that include improvements to land). A land tax is a cost of owning land, and taxes an immobile factor. Unless exemptions are made, a land tax will have an impact on all land owners including non-residents, charities, local authorities, non-state schools, hospitals and others owning land in New Zealand at the time the tax is announced. Land values are the rising element in real estate prices and a land tax may help reduce speculation in land and property sales. While the government did not act on the recommendation to implement a land tax as part of the reforms undertaken in 2010, in April this year it hinted at imposing a land tax targeting foreign buyers of residential real estate.
There are different kinds of land or property tax valuation methods used overseas. These include: annual rental value, a tax on estimated (not actual) income earned from the property; land value or site value tax, a one-off tax on the existing wealth in the form of property that only targets land owners; and capital improved value, a tax on the total value of land, buildings and improvements.
In New Zealand, local authority rates – which can be based on land, capital or rental values of properties – have been the major source of revenue for local government. Central government, on the other hand, earns only an estimated 5% of its total tax revenue from property. This is well below the OECD average, which is not surprising given New Zealand remains one of the last countries within the OECD which does not have a comprehensive capital gains tax (CGT). A partial CGT exists but its application is rather limited. The current bright-line test for residential land (effective from 1 October 2015) and residential land withholding tax (RLWT) regime (proposed to take effect from 1 July 2016) are also designed to remove certain capital gains and bring them within the tax net.
Depending on how it was designed, implementing a land tax in New Zealand could hit two groups particularly hard: Māori Authorities, and farmers.
Māori Authorities are trustees administering communally-owned Māori property – often in the form of land following Treaty of Waitangi settlements – on behalf of individual owners. The imposition of a land value tax would adversely affect the negotiated settlements. Māori freehold land is underdeveloped relative to general land, even after taking into account differences in land quality and location and could have important equity implications on land value tax. Māori land is culturally sensitive, possessingMana (spiritual power) with some land being Tapu (sacred) and therefore while held by Māori Authorities will never be developed for commercial or residential purposes. If land is taxed on a basis of unimproved land value (highest and best use of the land) it will not reflect the fact that some land is culturally sensitive and therefore will not be used in an economic manner. Imposing a tax on an unrealistic value of land, given in settlement of past wrongs and in recognition of the cultural value of land, would be contrary to the underlying principles of the Treaty settlements.
In New Zealand an estimated 55% of all land is put to agricultural use and the impact of a land value tax would be felt severely by the farming and forestry industries. While a land value tax is an ad valorem tax, meaning that the urban areas, on a per hectare rate, will face substantially larger taxes, the land intensive uses in rural areas result in a higher tax burden on individuals and small companies. Considering that the average plot size in suburbia is around 700m² the incidence of tax per owner will be significantly less than farmers who own many hectares of land. Thus the effect of a land value tax is inconsistent with current policy measures that protect farming in recognition of its importance to the New Zealand economy.
Implementation of a land tax in New Zealand would broaden the tax base and depress land speculation. It could reduce the burden of tax on income, and shift taxation more to wealth. A one percent tax on all non-government land, using 2006 land values, was estimated to raise $4.6b annually. The precise form of land tax and its design – for example, any exemptions – would determine whether the principles of a ‘good’ tax were met, including its acceptance by most New Zealanders.
1. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, (first published 1776) in Edwin Cannan (ed), (Chicago, 1977, Book V, Chapter II, Part II).
Dr Ranjana Gupta is a senior lecturer in taxation at Auckland University of Technology (AUT) and had been teaching range of taxation courses to undergraduate and postgraduate students. . This article was first published on AUT's Briefing Papers series. It is here with permission.