Budget 2018: Tax
By Alex Mitchell
Budget 2018 won’t be remembered as a memorable one from a tax perspective. Initiatives were few and far between, including:
- The introduction of the R&D tax incentive – at an estimated cost of $1.0 billion over four years
- Additional funding for Inland Revenue over the next four years to ensure outstanding company tax returns are filed and analyse the potential to improve tax compliance
- Changes to bloodstock tax rules for the New Zealand racing industry
This isn’t a surprise, given the Government’s decision to effectively outsource deliberations on any structural changes to the tax system to the Tax Working Group (TWG), who won’t be reporting back until early 2019.
The TWG has been tasked by the Government with considering “the future of tax”. That’s no small task as we enter the fourth industrial revolution – the age of digital.
The many and varied tax issues that are to be considered are ultimately to be simmered down to a suite of recommendations “that would improve the fairness, balance and structure of the tax system over the next ten years”.
It’s no secret that the introduction of a comprehensive capital gains tax is in the mix and being debated by the TWG. Those in favour will argue that an extension of the current more limited taxes on capital tick all of the three boxes above – fairness, balance and structure. It’s also no secret that the Labour members of the Labour-NZ First Government are sympathetic to this, and in particular that a capital gains tax is, at its heart, all about fairness.
Those against point to the additional complexity that a capital gains tax would introduce into the tax system, and the design issues that will need to be very carefully considered.
At a more holistic level, it’s also important to step back and ensure that a capital gains tax is not simply a solution looking for a problem. Yes capital is under-taxed, and in particular property. But the Government is already taking steps to curb tax preferences towards property investment, including:
- Extending the existing bright-line test for residential property investment, so that if a property is acquired and sold within five years and is not the taxpayers' residence, any gain made is subject to tax. This is intended to bring property speculators within the tax net more than may have previously been occurring.
- Ring-fencing rental property tax losses so that they are unable to be offset against other taxable income (i.e. to reduce net tax paid).
Also likely to be relevant, at least politically, is that the Auckland property market - which was at least part of the catalyst for the Labour Party calling for a review of the tax system to include a capital gains tax - has slowed considerably in recent times.
From a “design” perspective, there are also likely to be exemptions from any capital gains tax regime that limit its application and arguably further undermine the problem that it is seeking to solve – that is the tax bias towards capital investment. The Government has already categorically ruled out the application of any capital gains tax regime applying to owner-occupied housing. There is a real probability that, in order to be politically acceptable, other exemptions would similarly need to be introduced.
The risk is that any capital gains tax regime ends up introducing material complexity into the tax system in an environment where capital assets are at best plateauing, whilst also carving out certain asset classes for political purposes that materially undermine its original purpose.
Of course, if you subscribe to the view that a capital gains tax is just about bringing fairness, balance and structure to the tax system – which is a credible perspective to take – then from a principled perspective the points noted above are unlikely to alter your underlying support for a capital gains tax. This is likely to be true of the government, given the not so subtle messages from the Prime Minister and Minister of Finance. What is less clear is how NZ First will deal with support for reform when it inevitably arises.
The TWG is therefore, to some extent, dancing on the head of a pin trying to balance the above, and a myriad of far more complex policy and design issues. This is not a job to be envied, particularly because no matter what other good work they do, their work on a capital gains tax will likely be the group’s defining legacy.
In September 2018, the TWG will release an interim report. The overall direction of our tax system is set to become clearer with its release, as they move towards a final set of recommendations in early 2019. Watch this space.