Are the purported benefits of the Tax Working Group's proposed capital gains an illusion? So far, questions about the potential effectiveness of the tax are the biggest challenge to the proposal, as there are strong doubts about whether the new tax would really achieve its desired aims.

The best arguments in favour of introducing a capital gains tax centre around the need to fix problems of economic inequality in New Zealand. I outlined these yesterday in my column, The arguments in favour of a Capital Gains Tax.

But would the proposed CGT actually achieve much in this regard? At what cost? And are there better ways of dealing with some of the problems of economic inequality? They're some of the questions being asked by commentators across the political spectrum at the moment.

The biggest challenge to the Tax Working Group's proposal is whether it's "too little, too late". In the context of the huge problems of inequality, especially in terms of housing, the solutions do seem comparatively weak.

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This has been best expressed by Anna Connell in her Newsroom column yesterday, in which she says she has been underwhelmed by the proposal's lack of vision or ambition: "The recommendations just don't seem that radical or go far enough to address some of the enormous challenges we have looming on the horizon. There's a limit to what tax policy can achieve but when it's the main source of revenue for the entity in charge of which direction we travel and where we spend our money, it's pretty high up the list of things I'd like to see properly future-proofed" – see: Capital gains tax – should we care?.

Connell thinks that both the strong pro- and anti-CGT factions fail to appreciate the extent of the problems the tax is seeking to tackle, and have an exaggerated idea of how much impact the proposed tax would have: "when you live in a world where the odds seem increasingly staked in favour of the overtly wealthy, where tech companies pay little or no tax and the gap between rich and poor seems beyond closing, I don't necessarily view a CGT as any kind of real leveller. I just can't get that het up about it - as a blow for fairness or an assault on the individual's right to reward for hard work. I reserve most of my apathy for the politics of it all. Because I think it's past it's use-by date as a political lightening rod".

Economist and TOP leader Geoff Simmons believes something similar, lamenting that inequality problems will be barely touched by this proposal: "Our tax system should be the central tool in fixing these problems. Sadly the best we can hope for following the Tax Working Group's recommendations is that these problems will continue to get worse; only a bit more slowly" – see: The Tax Tweaking Group.

Simmons says that at the heart of worsening inequality lies housing, particularly with home ownership and renting becoming unaffordable: "The Tax Working Group was supposed to make our tax system fair. Sadly the Government tied their hands at the outset, ruling out the biggest tax loophole we have – the 'family home'."

What's more, according to Simmons, the effect of the CGT will be to drive more investment in family homes: "it reduces the incentive to invest in businesses (which produce jobs and incomes) rather than sticking all our money into housing. As a result, under a CGT Kiwis will probably end up sticking even more of their money into housing than ever before, particularly the family home. This is known in Aussie as 'the Mansion Effect'."

Simmons and Connell aren't the only ones wondering if the CGT will actually have any impact on inequality. An Otago Daily Times' editorial has a long list of good questions that need to be addressed when assessing if the tax is worth supporting – see: Jury must deliberate on tax reform.

The ODT's questions boil down to: Will it really fix inequality? Is there a better solution to inequality? Will the tax really be fiscally neutral? Will all the compliance and efficiency costs be worth it? Will there be too many exemptions and therefore possible loopholes? Will it reduce investment and rental housing?

Tax Working Group chairman Sir Michael Cullen. Photo / Mark Mitchell
Tax Working Group chairman Sir Michael Cullen. Photo / Mark Mitchell

Even a lot of CGT supporters are expressing reservations about the likely effectiveness of the proposal. For example, inequality researcher Max Rashbrooke says that it's a mistake to make the scheme revenue-neutral, given that the Government urgently needs to spend money to implement its kindness policies. He also says that greater egalitarianism would be achieved from a more radical inheritance tax: "Fairer still would be a tax on gifts received - to compensate those not fortunate enough to inherit wealth - and a more thorough wealth tax that acknowledged the benefits people derive from their assets every year, not just at sale" – see: Capital gains tax: A test of our national myths and Labour's mettle.

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Similarly, many on the left and right continue to question why the "family home" is being exempt from the CGT, suggesting that this creates all sorts of problems with the scheme as well as reducing its potential to fix inequality and unaffordable housing.

For example, at the pro-Government blogsite The Standard, Matthew Whitehead writes In defense of taxing the family home. Here's his main point: "National is right about one thing. The exemptions proposed by the Tax Working Group leave ridiculous holes. We should close them. It's wrong that a $5 million dollar home, whether it belongs to an accountant, a union-busting director, a politician, or a business owner, somehow doesn't get taxed because it's a family home. Let's tax it, and use that money to discount other taxes, or to nationalize the ambulance sector, or to partially fund NZ Super, or a million other things that will be worth the tradeoff. They're right that it's ridiculous that selling an art collection would be free from a capital gains tax. Let's tax it. Hell, let's set a reasonable threshold, and tax the real realized gain on every asset over it."

Others have criticised the political decision to exclude the "family home" from the CGT, including economist Cameron Bagrie who was reported yesterday as believing "a CGT should be implemented, but it should be across the board and include the family home" – see Jason Walls' Economist Cameron Bagrie is not convinced a CGT would do much to improve living standards.

According to Bagrie, "the impact of the CGT would be more negative than positive. This was mainly down to the way small businesses would be hit by the tax."

There is plenty of concern that economic investment will be discouraged by the CGT. This was one of the main problems raised by the three dissenting members of the Tax Working Group. And for a high quality and in-depth discussion of such concerns it's worth listening to Kathryn Ryan's 33-minute interview with former Inland Revenue deputy commissioner Robin Oliver: Could capital gains tax proposals encourage dis-investment?.

Similarly, Brian Gaynor argues that under the CGT there will be much more incentive for New Zealanders to invest overseas, because of inconsistencies in taxation rates – see: Tax plan likely to go the way of the Titanic. He points out that the new tax could also negatively impact on the non-wealthy in another area: "There is a widely held belief that capital gains tax only impacts the wealthy, but this is incorrect if we include the 2,926,821 KiwiSaver members. All KiwiSaver funds holding New Zealand and Australian equities, either listed or non-listed, will have lower investment returns if the proposed CGT is introduced."

For other arguments about who else will be negatively or inequitably impacted by the tax it's worth reading David Farrar's Who will be affected by the proposed CGT? and Liam Hehir's How the capital gains tax affects the average New Zealander.

Will house prices go up or down as a result of the CGT? There is no consensus on this question, but certainly there's no strong suggestion that the CGT will be any elixir for the problem. Likewise, with rental properties, it's hard to see that the tax will result in cheaper rent.

It is clear that there will be some headaches caused by the tax in terms of compliance costs, especially in terms of valuing the price of assets when the CGT is first introduced. For the best discussion of this, see Ben Leahy's Automated mass valuations could be used to value Kiwi properties ahead of a capital gains tax. As this article – and others – make clear, there will certainly be a bonanza for tax consultants and accountants, who will be advising the wealthy on how to structure their assets to avoid the CGT.

There will be many complicated situations that arise from the CGT and often there will be inequities as a result. This is dealt with well in David Snell's Implementing capital gains tax will be 'incredibly difficult'.

Finally, for humour on the tax proposals, see my blog post, Cartoons about the proposed capital gains tax.