Tax Working Group

The Spinoff asked for a few words on today's Tax Working Group report. They're here, and copied below.

The Tax Working Group’s proposed capital gains tax would exclude the family home, making for a more politically saleable tax but one which makes far less economic sense.

Not only would it provide incentives to invest in the family home instead of other assets, it also has the potential to encourage couples to ‘divorce’ for tax purposes to be able to exempt two houses rather than just one. If you’re laughing, note that family friends back in the United States would divorce and remarry semi-regularly for tax purposes. They’d have a small party each time they did. Good luck to IRD in policing that.

It would also provide a strong tax incentive to pass the family farm along to the kids rather than sell it, even if the kids aren’t all that interested in farming. Because passing it on rather than selling it allows any capital gains tax to be deferred. We can expect complicated tax arrangements to make selling to the kids to fund the retirement look a lot more like inheritance.

And it hardly applies only to homes. KiwiSaver and other investment portfolios will feel the pinch. While Sir Michael Cullen’s group is certainly right that those assets are disproportionately owned by those on higher incomes, the effect of the tax is far more complicated.

Because the tax would be assessed on nominal investment gains rather than inflation-adjusted gains, the real effective tax rate on investment portfolios could be very high indeed. And the effect of that on business access to capital for investment will have flow-on effects throughout the economy.

Since the group proposed exempting the New Zealand Superannuation Fund from capital gains taxes, the fund would be at a strong advantage over private investors when bidding for assets. One might wonder how long it would be until the Super Fund winds up owning much of the economy.

But I’m sure that others will write many more column inches on the real-world difficulties of trying to bolt a capital gains regime onto a tax system that has, for the past 30 years, evolved around the absence of one. There’s a reason prior tax working groups concluded that it is, on balance, too messy to be worth the effort and that there were strong dissenters within this latest group.

Let’s look instead at some of the less-expected features in the report.

The Tax Working Group recommends shifting towards environmental taxation. In principle, this has a lot of merit. Taxes that correct underlying distortions provide a double dividend. Not only do they raise revenue, but they also improve overall economic efficiency if they’re done well.

The group recommended strengthening the Emissions Trading Scheme and having it shift, in effect, to being more like a tax by having the government sell more of the permits over the longer term. That recommendation should be supported if implemented well.

So too should its recommendation to use congestion charging to help fund the roads – it makes a lot more sense, and is far more equitable, than measures like the Auckland petrol levy that fall very heavily on poorer families with less fuel-efficient cars.

The group also recommended using taxes to improve water quality if the government isn’t able to find better ways of dealing with the problem soon. It suggested water taxes and taxes on fertiliser as potential measures.

Making sure that water users face the cost of that use is important, but tax is a blunt instrument. A tonne of nitrogen fertiliser has very different effects depending on where it’s used. And water taxes have a hard time recognising regional differences in water scarcity. Water should surely be more expensive in Canterbury than on the West Coast, but the government would have a hard time finding the right prices. A cap-and-trade system like the Emissions Trading Scheme is more appropriate.

Other suggestions, like hunting for reasons to justify increasing existing waste levies, or giving tax preference to buildings constructed to tighter environmental standards, might give the appearance of doing good for the environment but seem destined to be a boondoggle if pursued.