Why a capital gains tax is fairer
Accountant Terry Baucher argues a capital gains tax on investment properties would be fairer and ease inter-generational tensions
Is it fair to tax money earned from a bank deposit, but not from capital gains on a house?
At present, interest from term deposits is taxed, but the capital gain on the sale of an investment property is not. But should this differing treatment exist?
Not according to Inland Revenue. In a policy report, Benefits and drawbacks of a capital gains tax prepared in February 2014 for then Minister of Revenue Todd McClay.
Inland Revenue noted: “There is no obvious reason why a person who derives $100,000 in interest income should be taxed differently to a person who derives $100,000 in capital gains.”
So if that’s Inland Revenue’s view how did the current situation arise? It’s a long story but it traces back to the 1984-90 Labour government which in a flurry of activity swept away the pre-1984 tax system with its maze of special preferences and exemptions.
One of the key drivers of the reforms was broadening the scope of ‘income’ to encompass the wider economic definition of accretion in value. This would mean the end of the so-called capital-revenue distinction as all gains would be taxed. As part of this the financial arrangements regime was introduced in 1986, followed by a foreign investment fund regime in 1989. Both regimes sought to tax the overall economic return from investments rather than the ‘income’ in the traditional sense of interest and dividends.
The logical conclusion of the 1980s tax reforms was the introduction of a capital gains tax (CGT). Although a consultative document was released in December 1989 proposing a broadly based, realisation-based CGT (including the sale of principal private residences), this proposal was first side-lined in March 1990 and then abandoned by the National government elected in October 1990. Since then, despite introducing changes such as the bright-line test in October 2015, no government has proposed introducing a comprehensive CGT.
Although neither the McLeod Tax Review in 2001 nor the Tax Working Group in 2009 recommended introducing a CGT, Treasury does support the tax. A joint Treasury and Inland Revenue report in 2012 on the taxation of savings and investment income commented:
“Treasury continues to see merit in a general capital gains tax or a land tax as possible revenue-raising reforms, and considers that a capital gains tax offers the best way of improving allocative efficiency by reducing economic distortions caused by gaps in the tax base.”
Inland Revenue on the other hand was not so keen: “…it considers that a land tax would impose an unacceptable loss on those who hold wealth in land. Especially for capital gains taxes, all the devil is in the detail. Working through the full details of how best to design a capital gains tax in practice and evaluating whether the pros of the best possible capital gains tax would outweigh the cons would be a very substantial exercise.”
Overall, the department gave the impression it seemed to view the prospect of giving detailed advice on CGT design as too hard.
But the ‘It’s complicated’ argument views the introduction of a CGT in isolation and doesn’t seem to take into account the changes that would follow. A paper for the 2009 Tax Working Group acknowledged that a CGT would be "relatively challenging to administer" but then asked the question "compared to what?’"
For many transactions a realisation-based CGT would be conceptually clearer than the current law. This is particularly true of land transactions, where the question of whether or not a sale or subdivision is taxable relies on such factors as defining a person’s intent or what represents work of a minor nature. Tax advice in these instances is little more than a variation of ‘It depends’. The introduction of the ‘bright-line test’ in 2015 highlighted how unsustainable the existing approach to taxing land transactions based on intent at the time of purchase had become.
A realisation-based CGT is far more comprehensible to the layperson. Critically, it would also be more enforceable, as intent would no longer need to be determined. It would also be fairer: given the subjectivity of measuring ‘intent’, taxpayers in identical circumstances could currently finish up with differing tax bills. (What may be acceptable proof of intent to one Inland Revenue auditor may be insufficient for another.)
The experience of other countries is the most relevant counter-argument about complexity and administration. Most other OECD members – including major trading partners like Australia, the USA and the UK – tax capital gains on a realisation basis. The Americans have done so since 1913, Britain since 1965, Canada since 1972 and Australia since 1985. There are literally decades of experience available from overseas about the practical aspects of designing and implementing a CGT. There is probably not an aspect of it that hasn’t already been encountered by another jurisdiction. Inland Revenue therefore isn’t being asked to re-invent the wheel: it’s more a question of installing an off-the-shelf model.
So yes, we think it is unfair that capital gains from investment property are currently untaxed. It undermines the overall fairness of the tax system by creating a tax-preferred class of assets. Furthermore, it is a key factor in the current housing crisis, creating inter-generational tensions between older baby-boomer property-owners and younger millennials struggling to get a foothold on the property ladder. Sooner, rather than later, the taxation of property capital gains has to be addressed in order to preserve the integrity of the tax system.
*Terry Baucher is an accountant and has written a book with former tax lecturer Deborah Russell called Tax and Fairness, which is published by Bridget Williams Books May 2017.