' />

A capital gains tax can help New Zealand's lagging economy, write Craig Elliffe and Chye-Ching Huang



Myths are circulating about a capital gains tax ahead of Labour's tax policy announcement tomorrow.

These myths appear to be the symptoms of a mild phobia - an irrational and unreasonable fear of a policy that has proved beneficial in most other developed countries.

Myth: Capital gains are fundamentally different to wages or salary.
Reality: Capital gains tax simply closes the largest single exemption from the income tax.

To economists, and to most people, a profit from buying and selling property is plainly income, just like salary or wages earned from labour.

There is no adequate answer to the question of why someone should pay no tax on a capital gain of $100,000 but $23,920 on their $100,000 salary.

The non-taxation of capital gains is an archaic exemption from the ordinary income tax, developed by 19th-century English lawyers and judges, with no basis in economic reality. It is a conspicuous departure from New Zealand's general approach to taxation which has been to eliminate loopholes and special exemptions that benefit just some taxpayers in favour of lowering rates across the board. A capital gains tax (CGT) would close the largest single loophole in the income tax system.

Myth: CGT would discourage savings and capital investment.
Reality: CGT could level the playing field for investment.

The present tax system encourages investment in inefficient and unproductive tax shelters: assets that would not be purchased if it were not for the tax-free capital gain. CGT would help level the investment playing field, directing investment to productive uses, including the most productive capital assets.

Myth: International investors will flee New Zealand and/or rich professionals will leave.
Reality: New Zealand should be trying to attract those who will invest and work in the productive economy, rather than using the country as a tax shelter.

Over time a CGT will improve efficiency and productivity, may forestall the need for tax increases on productive investment and wages to address the worrying long-term fiscal situation, and ultimately increase the attractiveness of New Zealand as a place to live and work.

New Zealand shouldn't be trying to compete with other countries on the basis of being a tax haven: that is unwise and unsustainable, as Ireland has discovered.

Myth: We already have CGT on some property and land transactions, so we don't need one.
Reality: CGT would plug gaps and simplify those rules.

The rules that effectively tax some limited types of capital gains are complex, and based on fuzzy concepts such as a purchaser's "intention" when they buy property.

There are still lots of gaps, and taxpayers spend lots of money trying to find gaps, the IRD lots of time and money trying to stop them, and policymakers time and money trying to close gaps that get too big. A CGT could allow those rules to be more simple and coherent.

Myth: The impact on the housing market would be disastrous.
Reality: The change to house prices will likely be modest, home ownership rates are likely to increase, and rental increases can be mitigated.

Some opponents say CGT will gut the housing market; others say house prices may skyrocket. Evidence suggests neither is true.

Modelling for the Tax Working Group indicates that with an exemption for owner-occupied housing, and even with CGT rates at 20 per cent (Labour is said to be promoting 15 per cent), house price increases would be negligible: less than 1 per cent.

Home ownership rates are estimated to increase under a CGT (with or without an exemption for primary residences).

Rents will likely go up under CGT, however, some renters will become home owners. If some revenues from CGT is used to cut income or other taxes, the impact on renters can be mitigated.

So, it is unlikely a CGT would either be a disaster or a boon for the housing market.

Myth: CGT makes accountants and lawyers gleeful.
Reality: accountants and lawyers may stand to lose from a CGT.

Some accountants and lawyers have been among the most vocal opponents of CGT. Commentators in countries with CGTs have speculated this is because accountants and lawyers have an interest in maintaining the status quo: the exemption for capital gains which has necessitated exceedingly complex rules to distinguish between "capital" and "ordinary" income thus protecting their advisory practices.

Accountants and lawyers may benefit from advising on the changes, but it is the same for any tax change.

Many objections to CGT appear to be based on misapprehensions about the tax. All we need do is to consider the 100 years of experience of CGT in the United States, 50 years in Britain, 30 years in Australia. We can also learn from South Africa: when it introduced CGT 10 years ago, policymakers looked to what other countries had done, and cherry-picked the best design and implementation ideas.

A sound and evidence-based consideration of the experience of other countries can ensure the debate becomes rational rather than phobic, and allow us to see through the self-interest that seems to be driving some objections.

* Craig Elliffe is the Professor of Taxation Law and Policy, University of Auckland Business School.

* Chye-Ching Huang is a senior lecturer, University of Auckland Business School.