COMMENT:

If you have an income tax you should tax income — and capital gains are income.

Tentative and preliminary as the conclusions in its interim report are, the Tax Working Group chaired by Sir Michael Cullen at least recognises that.

It recognises that New Zealand's tax base is narrow by international standards.

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It is too reliant on taxing labour income, when earned and then when spent, and correspondingly lenient in the taxation of capital income, which will represent a growing share of national income as production becomes more capital-intensive and less labour-intensive.

It also contributes to inequality of income and wealth.

The group makes no recommendations at this stage about changes to rates or thresholds in the income tax scale. It is not allowed to recommend increases which is, as Cullen observes, constraining.

In theory, the broader the tax base, the lower rates can be. But the Cullen review also recognises that a realisation-based capital gains tax would take years to build up to significant revenue.

Very preliminary estimates have the yield growing from around $300 million in year one to $6 billion in year 10. That compares with a tax take currently running around $80b a year.

The working group is not contemplating a separate capital gains tax regime, but rather the expansion — potentially pretty comprehensive — of the range of capital transactions which would count as income for income tax purposes.

It would encompass gains on the sale of land (other than land under the family home) including all other residential property, commercial, industrial and leasehold interests not currently taxed.

It would encompass intangible property including goodwill and all other assets held by a business or for income-producing purposes that are not already taxed on sale (such as plant and equipment).

And it would encompass shares in companies and other equity interests.

Only the net gain (or loss) would be taxable, after acquisition and improvement costs are deducted (to the extent that they have not already been depreciated).

But then things start getting complicated. Really complicated. There is a 40-page appendix to the interim report which addresses, in a still tentative, high-level way the devil (and lesser imps and demons) liable to lurk in the detail.

They include how to define the tax-exempt family home, given trusts and a variety of familial arrangements.

And when should roll-over relief — which defers the point at which a capital gains tax bites — be appropriate?

The interim report also devotes some consideration — though it is hard to see why — to an alternative to expanding the frontiers of income for income tax purposes, namely the risk-free return method, where a deemed return on assets is taxed as it accrues.

This was recommended by a tax review chaired by Rob McLeod and immediately dismissed by Cullen, then Finance Minister.

Yesterday he suggested it might be applied to the equity in non-owner-occupied housing as an alternative to the existing tax treatment or a realisation-based capital gains tax.

But any accrual-based approach faces a lethal combination of problems. One is the issue of cashflow when, for example, the income is highly variable as it is for many farmers.

The other is the issue of valuation in the absence of a market transaction.

The Tax Working Group recommends no change to goods and services tax.

It rejects the idea of a progressive company tax regime and favours no change to the company tax rate of 28 per cent, or to the imputation scheme.

So one is left wondering how it fulfils that part of its brief which is about rebalancing the tax system to encourage more investment in productive enterprises and less in housing speculation.

The changes it proposes to the tax treatment of retirement savings vehicles are modest and targeted, it says, at low- and middle-income people on the grounds that those on higher incomes are likely to be saving adequately in any case.

It suggests removing the tax on employers' superannuation contributions for employees earning less than $48,000 a year, and cutting by 5 percentage points the lower PIE rates applying to savings in KiwiSaver accounts.

But it has almost nothing to say about the debilitating, doctrinaire and internationally peculiar tax treatment of retirement saving vehicles introduced by Sir Roger Douglas in the 1980s and later described by Cullen as the worst case of intergenerational theft he had seen.

The taxed-taxed-exempt regime means that the Inland Revenue makes off with its share of the income your savings generate as it accrues, even though you have to wait years to decades before accessing your share — thereby hobbling the extent to which compound interest can work its magic.

Compare that with the effect of leverage on housing equity in what is generally a rising market and it is not surprising we have capital-shallow businesses and unaffordable houses.

When asked about this yesterday, Cullen said the fiscal cost of switching to the more normal exempt-exempt-taxed regime for retirement savings would be high and it would pose difficult transition issues.

This is disappointing because the broader context to the tax review is that the economy has some entrenched and serious structural problems that the tax system exacerbates.

One is a chronic negative household saving rate.

For most of the past 25 years, New Zealand households have collectively spent more than their income, according to the national accounts.

And what we do with our meagre savings is heavily weighted to investing in property rather than productive enterprises.

It is not obvious that the tax working group's thinking takes us very far towards a solution to either of those structural weaknesses.

To be fair, its terms of reference were less capacious than they might have been.

And it is important to recognise that it has yet to arrive at any formal recommendations, that the Government might not accept them when it does, and that in any case, any changes to the tax system resulting from this process will not take effect until after the 2020 general election.