NZIER on Fiscal Sustainability and Capital Gains Taxes

Bill at Groping Towards Bethlehem posted today on the NZIER report on New Zealand's fiscal sustainability. This is mostly about short-run and long-run projections for debt and whether we have room to raise additional revenue by increasing tax rates without hitting Laffer curve effects. Bill takes issue with a comment in the press release by one of the report's co-authors, Kirdan Lees, saying that we need to take action now to avoid reaching a U.S. like situation. I agree with Bill that major differences in political systems between the U.S. and New Zealand mean that the U.S. is not a good comparison. But that is because our system (probably) leaves us better positioned to respond to unpleasant projections before the situation becomes dire, and therefore doesn't negate the value of making those projections.

But what really caught my eye, via David Farrar's comment on the same report (here and here) is that it called for taxes on land or capital gains as a way to broaden the tax base. Now capital gains taxes (or at least gaps in the arguments in favour of them) are a bit of a hobby horse of mine (various posts archived here), so I went to the report to see what the justification was. After reading it through (and then searching for "capital gains" to see if I'd missed anything), the best I can see for the justification is as follows:

1. if we continue with the current path, growth in government expenditure as a result of an ageing population will exceed growth in tax revenue pushing out the debt to GDP ratio;
2. this will necessitate either tax increases or expenditure reductions;
3. we have room to increase tax revenue by increasing tax rates (that is, we are on the right side of the Laffer curve);
4. taxes, however, do have disincentive effects;
5. ????;
6. a tax on capital gains or land would be a good option to explore. 

Now Kirdan is a very good economist, so I am sure he has something in mind for step 5. I wish it had been included in the report, however. Based on the rest of the report, it seems that the argument is not about reducing tax distortions between capital gains and other sources of income, but rather about a general broadening of the tax base. This only makes sense if a capital gains tax is expected to raise positive revenue, in which case it would represent an increase in the effective tax rate on capital which is already triple taxed relative to labour income (by being taxed once when the original money saved was earned, again as it accrues interest, and a third time when the portion of the nominal return that just represents adjustment for inflation is also taxed). Maybe this effect is outweighed by other benefits of a capital-gains tax, but I would really like to see what these benefits are believed to be.

Postscript: While writing this post, I have come across a news story saying that Treasury are now recommending a capital gains tax and or land tax as an alternative to or supplement to (I'm not sure, I need to check the source documents) the Reserve Bank's loan-value-ratio policy. I will be interested to see what Treasury's justification for a CGT is.