By Deborah Russell*
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.