Just under 2 weeks ago the final Tax Working Group report was finally released. The report contained a large number of recommendations regarding tax changes that should be considered by the Labour led government. Naturally the focus has been on the groups recommendation that New Zealand should implement a capital gains tax, so that is what I will focus on today. The group also made a number of interesting recommendations regarding extension of environmental taxes, which I will cover another day.
The Tax Working Group final report lays out a strong case for taxing capital gains. The introductory chapters of the report layout the high level reasoning. Central to the argument is the following point:
“The inconsistent taxation of capital gains is unfair. It means that people earning the same amount of income can face quite different tax obligations, depending on whether their income is earned as capital gains or, say, as wages.”
Similarly the group argues that New Zealand’s lack of a capital gains tax leads to gaming of the system, because people are incentivised to earn their income through capital gains and not through personal or business income.
“The current approach reduces the integrity of the tax system because it creates opportunities and incentives for tax minimisation and avoidance. Taxpayers have a strong incentive, for example, to argue that their gains are on capital account and are therefore not taxable.”
The lack of a capital gains also impacts investment decision making:
“Since capital gains are untaxed, there is a tax incentive to invest in those industries that have a high proportion of untaxed realised gains. To put
it more bluntly, the tax system is subsidising the activities of these industries.”
The figure below highlights that several key industries in NZ earn nearly half of their income through untaxed capital gains,
Chapter 5 goes into further details regarding the design of a capital gains tax, including alternative designs that are not recommended.
While the opening chapters made a strong case for the idea of a capital gains tax in theory, the practicalities of taxing capital gains is much more complex than taxing personal of business income or goods and services. The group tasked themselves with answering this question, to confirm that a capital gains tax would deliver broad benefits in practice:
“In broad terms, will the fairness, integrity, revenue and efficiency benefits from reform outweigh the administrative complexity, compliance costs and efficiency costs arising from the extension of capital gains taxation?”
In terms of equity and fairness:
“International experience indicates, however, that capital gains taxes are highly progressive and primarily affect the wealthiest members of society.”
The group used a number of figures to indicate the distributional impacts of capital gains tax. The following figure outlines that while the top 10% of income earning households earn 36% of the income, the top 10% of asset rich households own 70% of the assets. This provides a strong case that capital gains tax would overwhelming impact the wealthy.
In terms of rents and house prices the results were more uncertain. There was a range of conflicting evidence from models used and from overseas jurisdictions.
“On balance, the Group expects that an extension of capital gains taxation would lead to some small upward pressure on rents and downward pressure on house prices.”
The report estimates the revenue that a capital gains tax would bring in, which is shown in the figure below.
This graphs raises a number of interesting points.
- Firstly extending the taxation of residential investment property brings in a significant proportion of the income, around 42% by year 10. Of note bringing this asset class is unanimously supported by the Tax Working Group
- Secondly, the revenue steadily increases over time. This causes issues in terms of revenue neutrality. For example any tax cuts offered up as a sweetener can not come fully into force until several years after the capital gains tax does.
The group notes that the capital gains tax would have a positive impact of productivity.
“The current treatment of capital gains may reduce productivity to the extent that it distorts investment into less productive – but tax favoured – sectors and industries. A more comprehensive approach to taxing capital gains would enhance productivity by greatly reducing this distortion.”
In summary the Tax Working Group makes a compelling case for the introduction of a capital gains tax. A tax would reduce the distortions in the economy caused by our current lack of a capital gains tax, ensure all income earners are treated fairly and reduce inequality buy ensuring NZ’s wealthiest citizens pay their fare share.
So why wouldn’t a government do it? Well, primarily the politics are very difficult and exploring that will be the subject of my next blog.