Thursday 24 October 2013

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.


  1. see some response here.

    Viking2 (10,076) Says:
    October 24th, 2013 at 7:24 pm
    nickb (2,912) Says:

    October 24th, 2013 at 3:53 pm

    Nick – why on earth do you support a CGT?
    And for what?
    Dime – to clarify I don’t support it in the current environment where both main parties just tax and spend.

    But pointy headed tax geeks like me support a CGT because it catches
    gains which are basically income and should be taxed as such.

    I won’t bore you with all the details (unless you insist!) but the
    prime example is rental property which hundreds of billions of NZ
    household wealth is tied up in, yet produces a $500m net loss to the
    economy annually.

    This is because property investors get tax write offs for everything
    all in the name of producing capital gains which won’t be taxed on sale.
    There is a big mismatch there.


    Easy to fix that loss. up the rents. I could do with a lot more.
    Build less houses and have more population. Up the wages you pay to
    those that rent and get them to pass it on to us.

    There fixed your loss no problem.

    Oh and yes lower the overly hyped interest rates. One would suspect from
    experience that most of the loss isf because interest rates are too
    high,(as compared with any other major country). Grab you clever
    calculator and add up what the difference would be in interest claimed
    when the interest rates are 1. at 5% and 2. at 8.5% which is about the
    average here over time. Interest paid mostly too offshore banks and
    investors.speculators of currency.

    On suspects that loss will be way less this year with the lower interest
    rates of the last year. I know mine are well down. Might have to pay
    some tax. Bugger.

    Oh and while you are tinkering with this stuff from on high how about
    making the tenants pay the rates. We are allowed to deduct them as
    expenses and are forbidden by law from recovering them from the tenant.
    Its the residents of the town, i.e. the tenants that use the council
    amenities and services. Again get your dead brain calculator out and
    add up what rates cost landlords and see if that don’t negate the

    Of course the loss is climbing again this year. why ? Because stupid
    bloody govt.’s and others decided they should interfere in the market of
    insurance which resulted in now ever increasing insurance bills for the
    rental houses. I would estimate from my experience the insurance lift
    this year will be greater than the lowered interest rates of last year.

    So go fix some of that shit before you attack landlords providing a valuable service to those that need a house.

    There are few capital gains in long term rentals that are not hard earned. As you can see we prop up most of you socialists.

  2. You write as if there is currently no CGT. There is, but it applies somewhat subjectively. If you are singled out as a property "trader", you pay income tax on capital gains from selling residential properties. If you are a "long term investor", you do not. Share trading rules are similar. If you trade infrequently, you probably won't be liable for income tax on capital gains. But enforcement is subjective.
    Page 10 is scary. "who you're associated with."

    After reading that, I think Aaron Schiff's neighbour in this story is probably liable for tax on their gains from trading property:

    Schiff's story screams of tax evasion. Although who knows.

    So I don't see how the status quo makes sense. Personally I think there is a strong case for the CGT to be applied more broadly, but at a lower rate.

    I'm surprised that you focus your attention on who is not currently taxed, rather than who is currently taxed.

  3. Alfred. I think theorisation behind taxing the capital gains of frequent traders is that it is no CG per se that is being taxed but a payment for labour. In that spirit, Aaron's neighbour should also be taxed. The best argument for a CGT to my mind is that it is a way of including in the tax net income that is a return on labour being disguised as CG. But you have to balance that against all the distortion a a CGT would create. I agree that there are current inconsistencies. For example, There is also implicitly a CGT in the way income from mutual funds is defined. But I would argue that that is a reason to reduce the CGT to zero in those cases. I can't see a justification for having a broad CGT at a rate between zero and the rate applying to labour income.

  4. I kind of agree but still have more questions. As you say, these capital gains, especially on property, look like labour. Wouldn't taxing them at a rate of zero, while income taxes are significant, create quite a large wedge, and mess up firm creation in these sectors? (Hiring someone to do the "doing-up" would create an income tax wedge somewhat arbitrarily)

  5. Alfred. Doing up houses is a non-taxed, non-market activity. So is growing your own vegies rather than buying from the store, doing one's own cooking rather than going to a restaurant, lying on the beach rather than buying leisure from yourself, etc. All are, for administrative reasons tax free and so are favoured by the tax system. Now this particular non-market activity could be picked up by a CGT, but the others wouldn't. And a CGT would pick up other things that, in my view, would be adding to tax distortions. I guess it is an empirical question as to whether we have a serious problem with people doing up homes rather than other work, but my gut is that this is not a first-order problem in NZ.