Still room for changes to tax mix to disincentivise property investment bias, TWG chair says; Asset bubble notion a 'completely different argument'

By Alex Tarrant

Some concerns about the integrity of the tax system have been addressed through changes made by the government, although there is still room for more work to be done to iron out investment biases created by the current tax mix, the head of the government's 2009 Tax Working Group (TWG) says.

Meanwhile, the notion that a capital gains tax could help stop asset price bubbles from forming was a "completely different argument" to why the TWG looked at capital gains taxes, with there being little evidence to support that notion.

TWG chair Professor Bob Buckle, from Victoria University's faculty of Commerce and Administration, told interest.co.nz the TWG looked at capital gains taxes from the perspective that biases in the tax system meant certain investment options were more favourable than others.

'About integrity of the tax system'

Talking about the Tax Working Group's work and report to the government, Buckle said the group looked at the option of a capital gains tax alongside other options for broadening the tax base and providing a more comprehensive taxation of income. A capital gains tax could bring into the tax net income generated by changes in asset values that was not currently captured.

“Given the tax system that we were looking at at that time, we felt it could potentially enhance the integrity of the tax system. In other words, there were at the time strong incentives to shift your income into property and other assets which weren’t captured by a capital gains tax," Buckle said.

"Secondly, the current capital gains tax regime we had applied to specific types of activities – some property dealings, some financial assets, foreign shares through the fair dividend regime, some intellectual property – but it wasn’t comprehensive, and it depended on intentions," he said.

Whether or not a capital gains tax addressed the TWG's concerns about the integrity of the tax system would depend on how comprehensive it was, and how the tax was designed.

The more comprehensive and well designed a tax was, the less opportunities there were for arbitrage. However it would potentially become more complicated to administer as well.

There were situations that could arise depending on how comprehensive the tax was. For example, if a capital gains tax excluded a person’s primary residence, there was always the risk of the ‘mansion effect’, where instead of investing in other property, a person just invested more and more into their primary residence.

It would take time for revenues to build up from a capital gains tax, with the Australian experience showing a period of up to 15 years for revenues to peak.

"I understand from the Australian tax revenue figures they are collecting about 4% of their tax revenue from their capital gains tax," Buckle said.

'Changes have helped'

Some of the integrity concerns the TWG had were being generated by the height of marginal tax rates people were facing, such as the top personal tax rate.

There was less concern now given changes to the tax mix had been made.

“By pushing up the GST rate, and reducing the top personal tax rate, some of these concerns have been ameliorated somewhat,” Buckle said.

Changes to depreciation rules had also helped.

Ability to tackle bubbles a different argument

Whether a capital gains tax was going to overcome asset price bubbles was unclear.

“The New Zealand tax system was favouring investment into residential property. And that’s what I meant by the integrity concerns – it’s biasing investment decisions. So in that respect, I think it warrants serious consideration," Buckle said.

"Whether or not that would help overcome asset price bubbles, the evidence on that – it’s unclear, because countries with capital gains taxes have had asset price bubbles. They’re generated, I think, by other factors that dominate these tax effects,” he said.

More importantly was the resource allocation effects of a tax system which encouraged biases in investment decisions.

In tackling the bias toward property investment, an argument could be made that instead of taxing property more, one could tax other forms of investment less. An example would be indexation of the inflation component of interest payments in order to make investment in bank deposits more attractive.

“There’s no doubt that should be considered as well in weighing up which is the best way to overcome these biases in the tax system, and broadening the tax base," Buckle said.

“That why I said the changes last year have gone some way to ameliorate those concerns. Not all the way, but it’s gone a good distance,” he said.