By Richard Meade*
In New Zealand, capital gains tax debates spring up like zombies. Each time they get killed off, back to life they come.
New Zealand already has some types of capital gains taxes – such as the bright-line test (which taxes residential land bought and sold within two years) and taxes on other various activities. So the debate is more about expanding taxes on capital gains, rather than introducing a new tax.
ANZ’s chief executive Antonia Watson triggered the latest furore this week when she argued since people invest in housing for the purpose of realising capital gains, those gains should be taxed.
This earned a sharp rebuke from the government. But there was also muted support from the Labour Party, which sees capital gains taxes as a potential issue for New Zealand’s next general election.
Despite the government’s position, Inland Revenue is consulting the public and experts on how to address long-term challenges like superannuation and healthcare funding. Capital gains taxes has been put forward as one option.
Supporters of capital gains taxes also argue it is needed to create a more fair tax system, rather than relying on taxing income and consumption via the goods and services tax (GST).
Taxing Jack and Jill
So is it more fair to tax income from all sources, including capital gains? Superficially the answer is a clear “yes”.
But mapping out the future for notional taxpayers – Jack and Jill – shows how it could be anything but.
Imagine Jack and Jill are each 21 years old, with the same qualifications, the same job and the same expected lifetime salary. They both plan to retire at age 65, and to simplify things, suppose neither has any existing savings and won’t have Kiwisaver accounts.
For whatever reason, neither of them marry or have children and they both rent the same type of apartment, with the same rent, all their lives.
What separates them is that Jack is a party animal, who spends every dollar he can, and saves nothing. Jill, by contrast, saves a quarter of her post-tax income, foregoing current consumption so she can consume more when she retires.
Some of her savings generate taxable cash returns such as interest, non-imputed dividends and rents. But they also accrue capital gains, which are treated as either being fully taxed like any other income (at Jill’s marginal tax rate), or not at all.
Assume Jack and Jill each have a pre-tax annual salary of NZ$50,000, which will stay constant in inflation-adjusted terms. Allowing for inflation only strengthens the contrasts discussed below.
For this illustration, New Zealand’s current personal tax brackets and rates apply for each year until Jack and Jill retire at age 65.
Jill’s savings are assumed to generate a taxable 2% annual cash income (distributed each year), and annual 4% capital gain (reinvested each year, taxable or not).
With these assumptions, Jill accumulates a retirement nest-egg of $1.5 million, while Jack has nothing to show for his working life when he retires.
Since Jill earns income from savings as well as her salary, she pays more lifetime income tax than Jack. It would work out to be over a third more even without capital gains taxes, but more than double with capital gains taxed.
Jill pays less lifetime GST than Jack, mainly due to her higher savings rate, but she still pays much more total tax than Jack over their working lives.
While many other scenarios and assumptions are possible, this simple illustration shows that even without a capital gains tax, Jill’s thrift is rewarded by her paying more overall tax than Jack while they are still working – and much more so if capital gains are taxed.
Plus Jill accumulates more savings to be used to pay for aged care if she needs it, whereas under current rules Jack qualifies for taxpayer subsidised aged care as soon as he needs it. Jack benefits despite paying less lifetime tax and having lived it up a lot more than Jill before retiring.
A question of fairness
This shows that taxing capital gains is not obviously fairer than leaving them untaxed. Different lifestyle and savings choices result in differing lifetime contributions to the tax system (Jill contributing more) and differing burdens on aged care subsidies (Jack imposing more).
So if we are going to have a debate about capital gains taxes, we might need a broader definition of “fair”. We also need to take a broader view of how we incentivise – or not – desirable activities like saving for retirement.
New Zealand might be out of step with other developed countries in terms of not more widely taxing capital gains. But we are also out of step in terms of how poorly our tax system incentivises retirement savings.
That many New Zealanders take the route of saving for their retirement through tax-free capital gains on residential property is no mistake, even if it is an accident of policy.
If we shut that route down by extending the reach of capital gains taxes, how else do we comparably encourage people to save for retirement and reduce any future burdens they might place on the tax system?
*Richard Meade, Senior Research Fellow in Economics and Social Sciences, Auckland University of Technology, and Adjunct Associate Professor, Centre for Applied Energy Economics and Policy Research, Griffith University.
This article is republished from The Conversation under a Creative Commons license. Read the original article.
27 Comments
Why should Jack be punished for living a little whilst he is young? Jill saving up just drives inequality, saving instead of spending is the core driver of inequality in New Zealand. Everyone should be encouraged to spend everything as soon as they earn it as this will drive GDP growth and lower inequality. There will always be foreign capital available for capital intensive projects that become necessary or the government could take over all capital intensive operations such as starting businesses (further reducing inequality)!
Spot on. This is the Squirrel and the Hare rewritten for grown-ups.
https://medium.com/@arkaotsu/the-wise-squirrels-secret-a-children-s-tal…
However, it usefully points to Andrew Coleman's just-completed 13-part series arguing for a limited form of compulsory superannuation saving to cover the decade from the ages of 65 till 75.
Jill's net savings permits net investment. Without positive net national saving there will be nothing to invest in the aggregate and the standard of living in the aggregate will not continue to increase.
It is also fair that Jill pays less consumption tax (gst) because she is taking fewer goods and services out of the pool, leaving them available for others. That said, if Jill ends up spending substantially all of her saved money to live on in her retirement, the assumption that she will pay less consumption tax does not seem valid.
Jack can spend whatever he likes. If he has equal access to information and opportunity, the outcome is on Jack. Jill will end up paying for Jack's lifestyle party one way or another.
As to spending everything as you earn it? Are you serious? How do you ever achieve anything that requires a major financial commitment? Maybe we all live in state housing? We are not all "equal" thank goodness. As much as socialism demands coffee coloured clones of each other serving the state, that would get boring very quickly as people grow up.
So how do you propose we control the flood of the worlds poorest flocking to NZ in this scenario? Surely this is a recipe for reducing the collective standard of living in this country, where our best and brightest leave the country as well- by default those are individuals who aspire to be above average.
Yes taxing all capital gain would obviously be fairer. The problem is that we have the "tax them not me mentality" so many are asking for exceptions. The outcome is that no CGT is ever implemented. CGT needs to be applied to ALL properties, shares etc... for it to work. But the rate of CGT does not have to be the same as income tax, (30 or 33%), it can be lower.
Taxing increases in capital wealth is all well and good as a strategy in secular bull markets, but these things tend to move in lots of three or four decades. A secular dropping market doesn't create much capital gain to be taxed - and taxing increases in asset prices that are the result of monetary policy distortions (QE, low interest rates, etc.) not true productivity gains, just redistributes wealth (ie taxes capital not real capital gains).
We are also talking about it because many of our children cannot see any benefit to staying in NZ.
We are talking about it because our birth rate is declining and our demographics are becoming worse as a couple struggle to afford a family.
We are talking about is because many young people see no future and commit suicide.
Its all in the same pot and to think it’s all just fine shows a massive lack of awareness.
That's a post hoc view. The social issues you raise are all valid but can largely be sheeted home to declining productivity and inflated asset prices, chiefly houses, making it harder for young families. The need for tax increases is a direct result of government spending. Which is in turn the direct result of a state sector that is disproportionately large. And continuing that philosophy will continue to depress productivity.
That many New Zealanders take the route of saving for their retirement through tax-free capital gains on residential property is no mistake, even if it is an accident of policy.
If we shut that route down by extending the reach of capital gains taxes, how else do we comparably encourage people to save for retirement and reduce any future burdens they might place on the tax system?
This is a bizarre statement, is the author implying that without tax-free capital gains on residential property (with all it’s negative consequences for the economy, societal cohesion, etc), people won’t feel the need to save for their retirement? Is making easy money on the back of future generations so ingrained in Kiwi culture that we can’t see alternatives to wealth creation anymore?
The bright line test , is a capital gains tax. Everyone who buys a property into a company structure pays tax on any capital gains, and there are a fair few of those out there now, to enable deduction of interest.
All the time spent on debating capital gains would be better spent debating our current subsidies and where they end up. I believe that accomodation supplements push up rents and are a bigger wealth transfer mechanism that any capital gains will ever be, especially now the horse had bolted.
I think that taxing the churches (and them paying rates) should rank ahead of this discussion on CGT.
CGT is going to be very messy and those with sufficient funds will find a way around it.
We do need to broaden the tax base to encourage those that contribute/invest rather than simply hoard assets. For example, with shares, if the shares where purchased and those funds went to the company = not taxable, simply trading shares with no capital going to the company = taxable.
This would be a lot simpler if successive governments' behaviour hadn't painted us in to a corner. The nuts and bolts of tax reform itself are likely a smaller problem than our political behaviour and consequently diminishing public belief in the state's competence.
To get public consent to broaden the tax base, the citizens need to be convinced that the money will be spent intelligently, effectively and efficiently by government. The roster of failed, failing or vastly over budget public projects, as well as the public service's previously huge growth, don't give evidence of that. There may be a lot of resistance until that trust in probity can be established and where it is believed government is up to the task of managing our money.
The idea of redistribution of wealth via the state also struggles for the same reasons. Belief in competence, issue politicisation for other ends, reflexive adversarialism, our addiction to 'strong' leadership, the inability to compromise and negotiate like grown-ups... It all demonstrates that we are in no way a mature country.
Some of the specific problems -
Property capital gains are what a lot of people are relying upon for their retirement savings and have calculated return on the current regime. Taxing them suddenly is potentially going to leave a fair number of older people short on their retirement, meaning there's going to be a greater reliance on a state that can't afford it.
People have mortgaged themselves to the eyes for an asset that while it has tax advantages is also concrete and can't be lost via theft or negligence: there is a lack of trust in state and financial institutions that would encourage investment rather than speculation on property.
Financial education has never been promoted: it's like there's been a conspiracy of silence to make sure the majority of people don't have even a basic understanding of money. It's cast by education as though knowing about money is a bit distasteful - an arrangement that works well for the cognoscenti in government, banks and financial services industry.
Our investment environment is a mess: there is little capital for productive enterprises as it's largely been hoovered up by the property market and our amateurish investment management is expensive and under-performing. We have a long way to go to building up a mature investment environment to replace buying and selling houses.
Some of the proposals for CGT from some give the appearance of wanting to double-tax investments: at source and then on draw-down or as part of personal wealth if you invest well and save hard. There needs to be a lot more clarity and consensus to give stability and avoid the perception of disincentivising thrift and other useful behaviour like investing in the country's enterprises. Given the reflexively adversarial nature of our politics that is likely the biggest stumbling block to tax reform.
Firstly , someone get a large fish and slap Antonia Watson across the face with it ... how can anyone on $ 12 million per year be so thick ! ... CGT is a stupid idea , the dumbest of dumb taxes ... its extraordinarily complicated & raises bugger all revenue ...
... secondly , if we strip away WFF , the accomodation supplement , and charities tax free status ... 3 things .... and suddenly we're flush with cash .... Solved ! You're welcome ...
( stop blubbing , Antonia ... fish is good for you )
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