Lawyer and lecturer Patrick Flannery busts what he sees as some of the myths around a capital gains tax

If Labour wins the election next month it plans to introduce a capital gains tax. Even if enacted in a partial form with exemptions, this would amount to the biggest expansion to the tax base since the introduction of GST in 1986, and warrants some serious debate.

Unfortunately statements by the parties in favour of the proposed tax have so far been quite simplistic and based on broad assumptions about the perceived need for the tax and the revenue it will generate.

While there may be tax policy arguments in favour of a general capital gains tax, the claim that such a tax is now needed in New Zealand requires more scrutiny. Even allowing for a measure of electioneering hoop-la, it seems a capital gains tax is being touted as a panacea for a range of problems - from solving the 'housing crisis', to achieving a greater degree of fairness in the tax system and providing the revenue to fund social policy objectives. But would it actually achieve any of these aims?

Let's separate the fact from the fiction.


Myth 1: The effect of the tax would be limited

Even a partial capital gains tax, which is what Labour is advocating, would potentially affect a considerable portion of the population. Just how large depends on the number of exemptions allowed. Australia's capital gains tax regime is also a partial regime and provides for numerous exemptions, most of them on policy grounds in order to narrow the scope and reach of the tax. Presumably any tax regime introduced here would have similar exemptions, and for similar reasons.

A range of operational issues will need to be addressed. For example how is a gain to be measured - from a specific valuation date or from the original date of acquisition? How is inflation to be factored into asset valuations, what allowance will be made for capital losses, and so on?

A capital gains tax would also have to be compatible with our existing tax system, which already contains plenty of complex legislation. Compliance costs for taxpayers, particularly arising from the need to obtain valuations, could be high.

Myth 2: It's a big revenue generator

In addition to implementation and administration issues, the claims surrounding how much revenue a capital gains tax would generate should raise some eyebrows.

Capital gains tax regimes have typically been nowhere near as lucrative as income taxes or value-added taxes such as GST. For example, in the last decade in Australia the Federal Government has, on average, generated less than five per cent of its annual tax revenue from its capital gains tax.

The relatively low revenue derived from the tax is largely because capital gains tax regimes operate on a transactional or realised basis, which requires some form of 'event' in order to trigger a liability for the tax. An ideal system would operate on an unrealised or accrual basis that taxed movements in the value of assets without any need for an 'event', whether deemed or actual.


But this would give rise to a range of problems in practice, not least of which would be the cash-flow implications of being taxed on unrealised gains. In reality no capital gains tax regime operates on an unrealised basis, and the revenue raised from these regimes is relatively minor. It was largely these concerns that led the Victoria University Tax Working Group to decide against recommending the implementation of a capital gains tax in 2010.

Myth 3: It will "fix the housing crisis"

The other big question that needs to be asked is what evidence is there that a capital gains tax would encourage investment in 'productive' assets as opposed to a 'non-productive' over-investment in property? Related to this is the claim that our lack of a capital gains tax is contributing to a crisis in over-priced housing in the main centres, most notably in Auckland.

Two matters arise here. First, expensive housing, housing speculation and housing shortages are features of many major cities, including those in countries which have a capital gains tax. Melbourne and Sydney spring to mind as examples close to home.

Second, there are several provisions in the Income Tax Act that currently impose tax on gains from real property sales in a range of circumstances, including what would otherwise be capital gains. Evidence suggests that these rules may require more comprehensive enforcement to be fully effective in taxing gains from sales of 'investment' properties that were purchased with a view to a future sale.

The apparent anomaly that a person can purchase a rental property, obtain tax deductions for any interest expense incurred in funding the purchase (and possibly other deductible expenditure as well), but still claim that any gain resulting on a sale of the property is on capital account, could be addressed by further targeted reform in this area. This could include ring-fencing of the tax losses or a clawback mechanism on sale. It is not necessary to introduce a capital gains tax to deal with the issue.

So, for something that would potentially affect many New Zealanders and not achieve any of its stated objectives, there has been very little useful discussion of whether we really need a capital gains tax - and there needs to be. To adapt a saying: be careful what you vote for.

Patrick Flannery is a lawyer with over 20 years experience in the taxation field and a lecturer in taxation at Massey University.
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