Deborah Russell says that for all its technical attributes that make our tax system a model widely admired, it is not serving the broader economy or society well

This article was first published on AUT's Briefing Papers series. It is here with permission.

By Deborah Russell*

The New Zealand tax system is largely robust.

It taxes most forms of income and consumption at rates that are by and large perceived as fair.

The overall tax take sits at about 30% of GDP, a rate that compares well with other OECD nations.

Most people pay their taxes, mostly on time.

That’s an indicator that there is a high degree of trust in the tax system and in government in general.

Tax professionals also regard the tax system as robust and sensible. More than that, they work actively with Inland Revenue Department to maintain the system. While on occasion individual tax professionals lobby for the particular needs for their clients, for the most part they confine their lobbying to offering constructive solutions to particular problems in the tax system. There are of course matters on which the people imposing taxation, and the people being taxed, disagree profoundly. But by and large, most people working in taxation aim to get the system right.

But there are some ongoing issues in the system.

Unlike most other countries in the world, New Zealand does not have a thorough-going capital gains tax.  If a taxpayer buys an asset and holds it long term, then she or he is unlikely to ever pay tax on any gain in value. There are some limited circumstances in which capital gains can be taxed: if a person is engaged in the business of buying and selling assets, then any gains are taxed under the standard income tax scale; if a person buys an asset with the intention of resale, then gains are assessable income; if a someone buys a residential rental property and then sells it again within two years of purchase, any gain is assessable income. Various land transactions are also caught in the income tax net. But by and large, if someone holds an asset long-term, then they will not be caught by income tax on sale.

A capital gains tax excluding the family home would raise about $4 billion revenue a year. Raising more government revenue could in itself be a good reason for introducing a capital gains tax.  However, a better reason might lie in fairness.

There are comparatively few concessions in the New Zealand tax regime.

Virtually all income is taxed, at rates that are more-or-less consistent across different types of business entities and forms of incomes. This is an expression of horizontal fairness: people who earn the same amount of income are taxed at about the same rates, no matter what the source of their income is. But capital income is excluded. Income that is earned quickly, like salary and wages, is taxed, but income that is earned slowly, like capital gains on a house, is not. The failure to tax capital gains is a significant offence against horizontal fairness.

It is also an offence against vertical fairness, that is, the idea that people who earn more income should pay proportionally more tax. People who make capital gains are usually wealthier people. They are the people who have inherited wealth, or who have higher incomes so they have been able to set some money aside, or who have enjoyed fortunate life circumstances. Less well-off people, or poor people, tend to live from pay day to pay day. In New Zealand, we tax every penny that poor people earn, but we do not tax the capital gains enjoyed by wealthier people. Having no capital gains tax is a significant flaw in New Zealand’s tax system.

There are other concessions in the tax system. The tax rate on Portfolio Investment Entities, or PIEs, is set at 28% which is lower than the top tax rate of 33%. Write down rates for bloodstock are set at faster rates than is justified by their income earning life. Cash income earned by children is not taxed. And so on.  Until recently, foreigners could use New Zealand “foreign trusts” to hide assets and income from their own taxation authorities. However, most of these concessions are minor, and they come about for reasons of operational or political pragmatism. They are comparatively few, especially in comparison to other OECD nations.

Negative gearing is not allowed in many tax regimes, but the New Zealand tax system allows it. All income (barring capital gains) that an individual earns is added together and then taxed in total. So if a person earns say, $50,000 from their salary, and $20,000 from a rental property, then that person would pay tax on $70,000 of income. However, if that person makes a loss on her or his rental property, then they can set that loss off against their other income. So if they earned $50,000 from their salary, but made a loss of $20,000 on their rental property, then they would offset the loss from the rental property against their salary, and pay tax only on a net income of $30,000. This is negative gearing. In effect, because the person pays less tax overall, other taxpayers end up subsidising their investment in a rental property.

Perhaps negative gearing would not be such a problem if New Zealand had a capital gains tax. The investor would carry the short term losses in the expectation that in the longer term, she or he would make a capital gain to offset the losses. The tax authority could sustain the tax concession from the short term losses, knowing that in the longer term, they would be recouped against a tax on capital gains. However New Zealand both allows negative gearing, and does not tax capital gains. The effect is to offer a tax subsidy for investment, and then to offer a tax concession as well when the investment is realised. It is a double gain for those who have the wherewithal to invest in property in the first place.

From a market point of view, there is no problem. House prices and housing affordability are not a market failure: they are simply the result of markets working as markets do. The lack of affordable housing is however, a significant social failure. And our tax system is aiding in that failure. The lack of a capital gains tax and the permissive approach to negative gearing are adding to the conditions that create the social failure.

What this suggests is that the collegial focus of tax officials and tax professionals on getting the system right may be mistaken. New Zealand’s tax regime in itself may be internally perfect, it may be coherent, and it may exemplify a good tax system. It is not clear however, that for all its perfection, it is serving the broader New Zealand economy and society well.

We need to recast the tax system as a tool of the economy, and a tool that serves New Zealand more broadly. A coherent tax system with high integrity is very desirable, and it is something we should strive for. But more broadly than that, we should strive to meet New Zealand’s social goals. The tax system should be a tool for achieving those goals, rather than an end in itself, to be admired for its purity.


Deborah Russell is a lecturer in taxation at Massey University. She holds degrees in political philosophy, and accountancy. (She stood as the Labour candidate for Rangitikei in the 2014 general election.). This article was first published on AUT's Briefing Papers series. It is here with permission.

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43 Comments

Yes, and could we have more taxes please? Stupidity knows no bounds... Leave it to academics to champion it!!
A perfect tax system is simply oxymoronic! But some people believe in it. Go figure...

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That wasn't how I read it. She may correct me if wrong, but the issue Deborah raises is about a level playing field. If we had one, tax rates could actually fall. It's not about another tax, but a tax system that taxes all income, however earned. Because capital gains isn't taxed, and because we have negative gearing, people with sufficient income/assets, perfectly logically, prefer property investment. Not because property is a better investment than equities, bonds, gold, small business, etc, but because it has a massive tax advantage. The tax system therefore skews investment into property, rather than other investment classes.

Some of the results of that are increasingly obvious, including price inflation in that asset (Auckland house prices anyone?), and widening income inequality (the renting wage earner taxed on all they earn is left further behind by someone who happens to own a house and rental property, who is not only taxed on just some of what they earn, but can offset more, so they are taxed on less than just some of what they earn).

And because we allow anyone in the world to buy NZ property and enjoy many of the same skewed tax benefits, which most of them couldn't get in their own countries where capital gains are taxed, which in a low-yield world presumably attracts them even more, non-residents help push up property prices further.

And, again, if I understand Deborah's premise, it seems on my reading at least that she's asking whether our tax system really ought to be used in such a way as to instituionalise societal inequality? (To which some might add intergenerational inequality and resident/non-resident inequality)

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Exactly, Ron. I think you've expressed the whole problem in a very succinct way. Property owners are streaking ahead on the racetrack while those without property suffer significantly more 'taxational friction' as a proportion of their economic 'speed'.

Negative Gearing and Capital Gains have been embedded in our system for many decades, if not generations, without causing any problems. That is until now when the international wealthy elites saw NZ as a bolthole and began treating Auckland as a playground

What has been exposed is the pressure large scale migration (NZ inbound migration is largest in the world) puts on the existing tax system which then has to provide all the requisite services expected of it. What is then discovered is the flood of newcomers exert a pressure beyond the capacity of the existing system to cope with it

The best example is the inability of Auckland's roading and motorway system to cope.

Because newcomers tend to buy only existing houses they don't add to the stock of residences thus exerting a downward and outward pressure on those members of the local society who cannot compete with the level of inbound wealth that has never been seen before

Next best example is the inability of the "housing" industry (in all its facets) to meet the demands made of it when more newcomers arrive that exceeds the capacity of the housing industry. That in turn creates further social pressures such that have never been seen before in NZ

Is it really the taxation system?

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Re: Is it really the tax system?

Iconoclast -it is the whole bloody lot -taxation, immigration, foreign investment, planning, infrastructure provision, competition policy -the blind eye turned to the duopoly in construction materials ...... it is all a rort that benefits a few wealthy property owners plus their cronies and buggers it for everyone else.

See how National converted young New Zealanders kiwi-savings into another rorting policy that has given a $1/2 billion boost to property prices as another example about how government policies are all being directed to supported an inequality driving property-ponzi.
http://www.stuff.co.nz/business/84281136/the-halfbillion-kiwisaver-home-...

Can't have the nobility paying taxes.

https://en.wikipedia.org/wiki/French_Revolution

If the family cg savings are taxable then.....why not the family home? This too has just become an avenue of excessive speculation driven by this tax imbalance. It needs addressing immediately.
IRD have put forth a draft report proposing taxing precious metal bullion cg claiming it is a taxable "investment" , yet is this not what all property has become? Family home or not, people invest in that area for capital gain above everything else, otherwise the mortgage even at today's interest rates would be a poor " investment".
Even the playing field or tax none of it i say

Yes, the family home should also be included. Many individuals purchase an old run down "family home", throw a lick of paint on it, then flick it.

Buying the worst house in the street and renovating it has always been a good idea. I do wish you guys would stop thinking about taxing good folk all the time and keep your stinky paws out of our pockets! There are far more important things to think about like how to save Western civilization.

It's only a good idea because you are exploiting the lack of a CGT on what is a personal investment. It's hypocritical to then simultaneously complain that "evil foreigners" and "property speculators" whom are doing exactly the same, should be subject to a CGT.

Anyone who thinks a new Tax will reduce the price of anything they are simply delusional , its an oxymoron .

There is no way in hell that Capital Gains taxes ever made houses more affordable , its just counter-intuitive to even suggest that a new tax will miraculously reduce house prices .

Quite simply CGT can be avoided by NOT selling , but borrowing against the asset for further investment .

Work a job, earn some money, you pay tax.
Speculate on houses, earn some money, you pay no tax.
Job – commuting expenses not tax deductible
Housing speculation – expenses tax deductible.

It might have been OK when everybody was owner occupiers and property was not inflating in real value (pre 90’s), now it’s a glaring injustice in the tax system.

Bring in CGT, and lower income tax, and set them at the same rate.

You clearly don't know how CGT works , and I strongly suggest you read up on it .

CGT can NEVER be a substitute for Income Tax , it simply can never generate enough revenue to do so

CGT is ONLY due when any asset is sold for a profit ( and that includes your boat ) . If you realise a loss , you get a tax credit ( How about that for a sting in the tail ?)

Speculators are liable for income tax on property trades anyway , and have always been liable

With CGT , there is usually a small exempt amount , and the rest of the 'gain ' is either taxed at a fixed % or at your personal tax rate .

Your own home is usually exempt , so most Kiwis will never incur the tax .

CGT is a cumbersome and difficult tax to administer , and is too easily avoided by not selling your assets

Boatman, you say:
'Speculators are liable for income tax on property trades anyway , and have always been liable'

I've heard this said before, can you please specify where it is provided for in law?
Also when is someone a speculator and not a speculator? Surely there is wriggle room there? Would it be easier and more efficient just to tax the capital gain on any home which is not the family home?

It’s not a substitute; it’s about levelling out distortions.

Yes CGT would only be liable only when the asset is sold or transferred, allowance for inflation. No tax credits for losses (you paid too much for it or it depreciated).

There are too many loopholes for speculators to pass through; I don’t believe many people are paying tax on that income.

Most other countries can manage a CGT.

And once the houses stop inflating beyond general inflation there will be no CGT to pay.

'There are too many loopholes for speculators to pass through; I don’t believe many people are paying tax on that income.'

That answers my question.

Not only can CGT help disincentivise property speculation, it's also another valuable source of revenue. Some of our services are pushed to the limit, especially with an ageing population we will need more tax revenue.
My mother is in a dementia care facility and the wages some of those angels get paid is just criminal. The need for such angels will grow significantly. We'll need a lot more health workers, and we need to pay them more.

As pointed out there is significant injustice with our current system with regard to capital gains and negative gearing.
One option would be to give folk the option; claim interest deductibility and you pay capital gains tax on the sale of the asset OR no interest deductibility and no CG tax unless sold within 2 years or so. Would tend to dampen speculation and overleveraging but still leave the family home out of the tax net as well as allow significant tax reductions elsewhere. How about removing tax on bank interest below a certain threshold as well.

Good idea -as soon as a landlord claims interest deductions from their rental income tax then any future capital gains on the property should be taxed, even if it occurs after the 2 year bright line test period.

Thanks Brendon, it is really quite fair to apply the tax in this way. Interest payments are not an operating cost so much as a cost of capital therefore the capital gain component of the sale is like a recovery of that cost. I don't think it's fair to expect to have it both ways. People buying without leverage (cash buyers) would need to show they were buying to hold.

Another way might be if non owner occupied housing gives an investment return lower than the prevailing interest rate -then this is evidence that the owners intention is capital gain -then in the future -however distant -capital gains tax should apply.

Negative gearing and lack if Capital gains is known to all kiwi but now that has been highlighted world over spevially in China who have realiesdbthe bebefit of parking money in ssafevand tax free country like NZ and with head of the government openly comming out in protection of speculators - it is heaven.

Seriously does this government has any polivy or plan for local except long longbterm plan and that too options that may not be prefered by many that is to live in pigeon hole and see all joudes and good apartment being enjoyed by chinesse ( it is not racist but truth).

What about the corporates that charge their NZ companies royalties so that they have no taxable income?

In the example she gave she says the persons taxable income was only 30k, that means 40k went to servicing the house, so does she want that person to be taxed say an additional 20k so they are left with 10k, I am not a professor, but when you present a one sided argument like this no wonder the have-nots who by the way pay no tax start complaining

the inconvenient fact that is missing from this article is that up to 50% of NZ'rs actually pay no income tax after government hand outs, hence why we had to push up GST to 15% so we can collect a fair share from everybody, a fair comprehensive tax system would be CGT on all investments including primary homes and / or a stamp duty on home purchases on all homes, maybe the only exception being on new builds off plans , then you capture everybody fairly (including greedy property investors and suspicious foreigners (you know who you are))

How any body could claim that our tax system was a model to be admired is beyond me. Other countries must paid to say that!! It is cumbersome with so many loopholes you could drive a bus through. Negative gearing allowing any loss to be set off against total income is one of them and that was another of Labour's loopy ideas in the 1980s. Scrap the lot and start again I say. A FFT is the only one that is transparent and which would put everybody on the same level.

What is FFT?

A typo I expect, as well you know.

I don't, that's why I ask?

FTT - financial transaction tax

A lot of the issues in NZ's tax system and other countries are the exemptions and the capital/revenue distinction. Thankfully, our GST is rather light on the exemptions and our income tax is also limited in tax breaks etc. However, as noted in the article when it comes to property it seems all sense and rationality goes out the window. The simplest solution that would avoid a CGT and the issue of negative gearing is to abolish the capital/revenue distinction. All in-goings are taxable all out-going deductible (excluding employment for administrative reasons). This would close loopholes and acknowledge that if a person is in a business then he or she is trying to make a profit - what does it matter how?

If Deborah has been a recent Labour candidate, she needs to work on her Party. I held my nose & voted Labour at the last two elections because they proposed a rational tax system including a (relatively comprehensive) CGT (and also raising the retirement age). However her current leader Andrew Little said "we're not having that nonsense of taxing the wealthy thank you very much" and ditched it. So only minor parties such as the Greens are supporting it. Great.

Isn't the Labour party a minor party? One that has constantly been losing support over the last few elections at that! As far as I'm aware the left is currently represented by the Greens who have been growing at roughly the rate that Labour has been declining.
I'd generally group Labour, Act & internet mana into the wasted votes category.

My 5 point plan of action.
It is becoming increasingly apparent that negative gearing as well as interest only loans and low deposit rates fuel the investment property fire.

1. Remove the tax advantage of negative gearing and interest only loans on investment properties– as promoted on banks, such as ANZ website http://www.anz.co.nz/personal/home-loans-mortgages/property-investment/i.... Here is the text promoting this
"Negative gearing on property investments
Negative gearing is when your expenses and outgoings (such as interest repayments on your home loan) are higher than the rental income, which often happens in the early years of owning an investment property. In effect you are making a loss on your investment, but you can offset that loss against your income tax. This tax advantage is one of the key benefits of negative gearing.
Investors following a negative gearing strategy often choose interest-only loans, because they increase the tax-deductible expenses on your investment property (as you’re not repaying any principal). You should seek professional advice when following a negative gearing strategy."
2. Banks to require 75% deposit on investment properties
3. Councils to impose a non-development levy on bare land
4. Migrants (first 5 years of residency) and foreigners to buy new homes only
5. Follow up on how the Government has addressed building industry as highlighted by Michael Morrah http://www.newshub.co.nz/tvshows/3d/are-kiwis-paying-too-much-to-build-o...

Tut Tut , you are crazy Mate . How can you deny migrants ( who have been invited by the Government to apply to come and live and work and pay tax here ) deny them the right to buy a home here ?

Instead , if anything , we need to reduce the number we invite in here .

I''d go further Boatman. Only citizens can buy New Zealand property.

Okay KH , fair enough , but then the Government must cease a desist inviting migrants to apply to live and work here .

You simply cant invite people to come and live in New Zealand and then deny them the fundamental right to acquire a roof over their heads .

Its just ludicrous

Forget about property investors " streaking ahead " we are going to know very soon who has been streaking and who has been swimming naked , when the tide goes out

It's pretty simple about negative gearing. The rule should be if you ever claim a loss eg negative gearing - then by definition you are trading or speculating, therefore capital gains tax should always apply.

one big rort in our tax system is the international corps and transfer pricing. Our big four banks and also the likes of Apple. Not only are the taxpayers of Ireland getting nothing out of Apple, an essential part of that scheme is New Zealand is robbed as well.
Trying to control these thieves is a challenge. You can't administer a response to these people. But a 15 % surcharge on every (yes every) transfer of cash out of the country. (yep including that credit card purchase you did.)

Sorry KH are you saying the Ausise banks aren't paying much tax ? Can you please advise us how much they have paid thanks since you seem to know

Grant A. Sometimes the banks employ people to police comments on the media.

I think the last paragraph of the article hits the nail on the head. Lacking in NZ is a coherent set of social goals that our nation is aiming for. Just what do we want our society of the future to be ? The government is focussed on economy, economy, economy. What use a bunch of fine economic statistics if the social fabric of the nation is falling to bits? Do we want to end up a nation like Sth Africa where the wealthy live in their private luxury prisons, sleeping with guns under their pillows for fear that the "underclass" will rob them in the night ? With regard to taxation, I urge you to look hard at what a Financial Transactions Tax can do in place of the current complex and unbalanced plethora of taxes.