Capital gains tax: Let’s not do this

ANALYSIS: The first parliaments were formed to give the consent of the people who were to be taxed, to the people who were to tax them. Strip away all the pomp, ceremony, and procedure and that’s what the whole thing is about.

Before the advent of regular parliaments in 1688, it was possible not to call them if a monarch didn’t need revenue. King Charles I was so brassed off with parliament he went 11 years without calling one. He ran out of money, of course - then he got his head chopped off. 

Over the last 1000 years, parliaments have come to acquire many different roles, but at their heart, they exist for us, the taxed, to give our consent to government, which wishes to tax us. 

To transform means to change. The word comes from the Latin trans, which means across or the other side, and the verb formare, which means “to form”. It’s an important distinction, the Romans divided Gaul (France) into Cisalpine, and Transalpine portions. Cisalpine Gaul was on the Italian side of the alps, the Transalpine was on the “other” side. 

The point is that to transform, you’ve got to go somewhere. But on Wednesday, our Parliament stayed exactly the same. Capital gains tax, Labour’s keystone tax policy and once the heart of its plan to tackle the housing crisis, was swept off the table, possibly for a very long time. 

The Government’s transformational slogan now looks more like a Tui billboard than a guiding motto.

The dollar took note, spiking just a little on the news, which gives some clue as to who is happy with the move: capital. 

Which with CGT now firmly off the table for at least six years (because neither National nor Labour will implement it after the next election - Labour would have to lose and elect a new pro-CGT leader if they wanted to change anything), investors now have the confidence they haven’t had since the election. They can invest their money in New Zealand without any chance the Government will raid the kitty when they sell up.

That’s good news. Investment is what we want, it’s what we need. But it’s not the investment that’s the problem, it’s where we’re investing: residential property.

As we’ve reported on Newsroom before, the “dirty little secret” of the CGT debate is the $500 billion of untaxed and leveraged capital gains that have accumulated over the last 15 years. Slap a 33 percent CGT on those and you’ve got enough money to run the entire country for two years. 

The problem with this is that the tax incentives around property are so good that it deprives the rest of the economy — the important, productive part —of investment. This means there’s less money around for companies that want to invest money in plant and machinery to help them become more efficient and productive. 

The Productivity Commission has said the lack of capital for investment in the productive economy is a key constraint on productivity in New Zealand, and a major contributor to the toxically low wages we have in New Zealand. 

The Government’s economic strategy is looking increasingly like that of a retirement home: a nominally service-based industry, designed for the elderly, staffed by underpaid immigrants, and whose only real value proposition is the rising value of land. 

And incentivising investment in housing has other negative effects too. It makes housing unaffordable, and encourages land banking - literally holding onto land for capital gains, rather than building housing on it. 

Deloitte Tax Partner Patrick McCalman told Newsroom that if evening up distortion in the tax system was the policy problem CGT proposed, the CGT was never really going to work.

“Your fundamental question of whether unproductive to productive was hamstrung from day one,” he said.

“Doing a full capital gains tax was never on the table.”

The Prime Minister gestured from day one that a proper capital gains tax was never on the table. Owner-occupied housing was always exempt, and distortion would have persisted. We likely would have seen homeowners adding extra pools and helipads to their houses, rather than investing in businesses. 

McCalman said it was likely the Government would "continue identifying the bits that offend me the most and going after those”.

There were gestures to that today. Among the 99 recommendations of the working group, the Government was giving “high priority” to explore options for taxing vacant land. This is part of the Productivity Commission’s work into local government.

McCalman believes the Government could look at finding some of the right levers in this work to put that land to better use. Shifting the burden of local body rates onto unimproved, rather than improved, land which would encourage speculators to sell up or put their land to productive use. 

David Snell, EY NZ tax policy leader, agreed that the announcement was bad news for reforming the inconsistencies in the tax sector.

“Business will likely view this as a positive but it’s a missed opportunity for much-needed reform in the residential property investment area,” he said. 

“This has not been a wasted exercise - it has put this endless debate to bed for the foreseeable future. The Government already has a busy tax policy programme and it can now focus on delivering against that.”

He agreed that the battle was not totally lost on the issue of ensuring land was used productively. 

“The Government clearly has an ongoing interest in efficient land use, with a sting in the tail for land bankers through its direction to the Productivity Commission to consider vacant land taxes,” he said. 

Of course the Tax Working Group wasn’t just about the CGT - it was about the integrity of the tax system as a whole. And with none of the recommendations endorsed by the Government carrying any significant revenue-raising potential (some were as simple as recommending the Ombudsman look at enhancing tax expertise), this faces a severe threat. 

New Zealand’s finances face a cliff-edge. An ageing population (baby boomers who own a lot of housing, one might add) march towards retirement at 65 with generous Government superannuation and healthcare provisions.

... younger generations have every reason to wonder what solutions, if any, the Government has to shore them up against the coming demographic tidal wave.

It should also be added that, contrary to popular belief, this generation hasn’t pre-paid for this. Yes, they’ve paid taxes all their lives, but unlike most other countries, New Zealand does not have dedicated social security taxes or national insurance that might pre-fund these services. Today’s retirees paid for their parents’ retirement; the burden now rests on today’s children to pay for their parents.

The problem is that they can’t.

Not only do demographic changes mean the ratio of workers to retirees is shifting, the nature of work and the income derived from it is changing. The gig economy means fewer people will be working regular jobs, paying regular income tax. Those who are working conventional jobs are faced with poorer wages than previous generations, which flows through to a poorer tax receipt for Treasury. The only area that's booming is the capital gains on property - but these, as we’ve learnt today, are off limits. 

The Tax Working Group’s initial background paper noted that by 2030, expenses will be short of revenue by 1.2 percent, but by 2045 that deficit will have ballooned to 4.0 percent. 

The significance shouldn’t be lost on people. These are deficits that were seen on the shoulder years of the Great Financial Crisis, and they’ll whack Treasury every year, compounding as the Government takes on more and more debt. 

With capital gains tax now joining a hike in the retirement age in the “not on my watch” camp, younger generations have every reason to wonder what solutions, if any, the Government has to shore them up against the coming demographic tidal wave.

On these fiscal settings, the Government’s economic strategy is looking increasingly like that of a retirement home: a nominally service-based industry, designed for the elderly, staffed by underpaid immigrants, and whose only real value proposition is the rising value of land. 

It’s not that there wasn’t any transformation on display this week - but it was oft the political, rather than the economic, kind. And while the Government shies from transformation, the world is transforming all around them. The rate of change is so fast that vast transformation is needed just to stand still. 

One man who knew a thing or two about transformation was Ovid, whose Metamorphosis poems are a veritable bible on the subject.

His poem, Fasti, describes an old man who briefly and “by his art” — ille sua faciem transformis adulterat arte — transforms his face, and before, bound by ropes, he quickly transformed back.

There was plenty of transformation on display today, but it was parties, politicians, and “old men”, who transformed and transformed back again, not the economy. 

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