COMMENT:

If the average person is to become better off, wages need to increase.

In order for wages to increase we need higher labour productivity – increased goods and services produced per hour worked.

To get higher labour productivity we need more investment.

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As the New Zealand Productivity Commission has shown in many reports New Zealand has low labour productivity and thus low wages relative to Australia. Will a capital gains tax (CGT) help increase wages?

The Government's Tax Working Group is to report in January.

Based on the interim report released in September, the key features of a capital gains tax will be to tax realised capital gains on land, shares and business assets with the key exemption being the family home.

Increasing tax on productive investment when the family home becomes the only tax haven to invest in does not seem the best way to increase productive investment.

In this article I outline a number of key investment decision distortions that will arise with the proposed CGT.

Most governments want more investment in "productive" assets without defining what "productive assets" are.

One possible definition of productive assets is all investment other than the taxpayer's family (or second) home. This leads to the most significant distortion that will arise from the Group's CGT regime, the family home exemption.

If you want more investment in any asset category, you will not get that investment by raising taxes on it. Conversely, more investment will flow into the areas that have least tax. Under the likely comprehensive CGT regime, expect further investment in family homes.

The Group did not get the option to consider a CGT which includes the family home, it was excluded in the terms of reference set down by the government.

The Group correctly concluded "excluding gains realised on the family home encourages people to invest more capital in their family home, where it can generate untaxed income (both in the form of the benefit of living in the home, and in the form of the gain on sale)."

They did dip their toes in the water and suggested that if a person's family home exceeded $5 million, then it to could be subject to CGT. The government sent a letter to the Group following the release of the interim report where the Ministers reaffirmed that the exemption for the family home was without any cap.

What message does a comprehensive CGT send to New Zealand? Everything will be taxed, compliance costs will increase, tax returns will need to be filed, unless you invest in the family home. Are we better off for this?

The other key investment decisions will be how our equity markets are taxed. This is a very important and delicate issue, get it wrong and money will shift overseas or worse still, New Zealand corporates shift overseas. In the abovementioned letter, the Ministers acknowledged this issue and requested the Group to consider "measures that will promote a more balanced savings culture and deeper capital markets."

Having deep and vibrant capital markets is important, possibly critical, in providing access to capital for many businesses to grow and increase productivity.

So what will be the effect of the capital gains tax on the capital markets? Under a comprehensive CGT, realised share gains (and losses) will be subject to tax. This will likely apply to New Zealand shares and (most) Australian shares.

This is an added tax that we currently do not have, albeit it will only apply to New Zealand shareholders. Foreign shareholders will likely be exempt from CGT on New Zealand shares.

Foreign shares (excluding the Australian shares noted above) owned by New Zealanders are currently subject to the fair dividend regime. This effectively means that they are taxed on a deemed 5 per cent return on their total value unless their return was below 5 per cent (in which case they pay tax on their actual return). The Group recommended this continues.

So in summary, under a comprehensive CGT, New Zealand investors face no additional tax on foreign shares but they will be have an additional layer of tax if they invest in New Zealand shares. Foreign shareholders investing in New Zealand shares will likely see no change.

It will be interesting how the Group promotes deeper capital markets by increasing the tax on New Zealand shareholders in New Zealand companies but leaves other settings constant.

If the tax settings are currently in equilibrium, this proposed new tax will mean that New Zealand shareholders are less likely to invest in New Zealand shares and invest more in overseas shares.

Further, as New Zealand shareholders re-weight their portfolios, the logical buyer is foreign shareholders.

If we are not currently in equilibrium, why has this not been addressed by successive governments since Sir Michael introduced the fair dividend regime on foreign shares.

We now wait for the Group to finalise its report, the likely winner will be the family home and the loser, New Zealand investment in New Zealand companies. Will this increase productivity and wages?

- Mike Shaw is a director at Olivershaw.