Is a capital gains tax right for New Zealand?
By Patrick McCalman
Unsurprisingly, a big portion of the Tax Working Group’s (TWG’s) final report is focused on the question of whether New Zealand should adopt a capital gains tax (CGT). This much hyped, long awaited, recommendation from the TWG has generated a tsunami of news stories in anticipation of today’s release, with all manner of pundits having weighed in over recent weeks.
So do today’s final recommendations put the questions around a CGT to bed once and for all? And the answer is…no. It’s really now just the start.
Shortly, the debate will be further heightened by the ultimate design chosen for any extension of the taxation of capital; whether it is a comprehensive CGT or a less radical reform of existing tax rules. For their part, the Government has committed to issuing their response to the report in April which will be tested with the electorate in the 2020 election.
In the Interim Report, the TWG set out a guide by which any CGT should be evaluated: “In broad terms, will the fairness, integrity, revenue, and efficiency benefits from reform outweigh the administrative complexity, compliance costs, and efficiency costs arising from the extension of capital gains taxation?”
Also worth noting is that the TWG’s members are themselves not fully united on whether a CGT satisfies the above statement, with a minority view rejecting it because of the efficiency and compliance cost impacts that such a tax could introduce. For the majority, however, the recommendation for a CGT seems to be firmly bedded in the notion that it would increase the fairness of the tax system.
At one level there is an attractiveness in the argument that a “buck is a buck” and everyone should therefore bear the same tax burden on every dollar earned. However, when one delves into the detail, other issues of fairness emerge including new tax exemptions which would distort where investments are made – in effect, in seeking to create fairness, the proposal creates a number of layers of unfairness. For example:
- With a CGT applying at full rates with no inflation indexation, is it fair that someone who buys an asset is taxed on the full amount of any gain when part of that gain is simply inflation? How will they be able to re-invest in a new asset if the inflation element is taxed?
- Is it fair that the family home and artwork are excluded but most other property is not? Consider a plumber who has a $500,000 house and a $500,000 commercial building who would be taxed on the disposal of the commercial building. Should they have instead bought a $1,000,000 house, rented a business premise and enjoyed a tax free capital gain?
- Is it fair that that investors in New Zealand shares would pay tax on capital gains but investors in foreign shares would continue to be subject (as they are presently) to the 5% FDR rate (even if gains are less or more)?
- Is it fair that small business (turnover less than $5 million) could sell assets and defer the CGT bill if they reinvest the proceeds, while medium and larger size business cannot?
- Is it fair that property could pass on death without an immediate CGT cost but gifts made to children during one’s life would be taxed?
- Is it fair that there are proposed tax reductions for KiwiSaver to compensate for CGT but not for other forms of investment?
At one level, true fairness can only exist if all asset classes and forms of remuneration are subject to the same tax rate. But even then, anomalies will always arise.
Maybe the way that CGT will be projected is that what’s ultimately proposed is not fair per se, but just less unfair. It doesn’t remove all distortions, but reduces them.
Of course, like any cost benefit analysis, everyone will have their own perspectives on the overall implications of what’s proposed. The only certainty being that the political difficulties of the debate far outweigh the policy deliberations.
Setting aside the question of fairness, there are a number of difficult policy issues – unintended or otherwise – that a CGT raises for consideration:
- In simple terms, it is recommended that a CGT apply to any gains on New Zealand shares. However, the report recommends that the current level of taxation on foreign shares remains unchanged. The potential negative impacts for New Zealand capital markets of raising the tax on this asset class need to be carefully thought through. The concern being that such an uneven tax burden may dissuade investment in New Zealand businesses. We need to ensure that New Zealand businesses have access to the capital they need to grow. If the tax on capital increases, how would that impact the cost and availability of capital here?
- How would a CGT impact business investment decisions? If selling a low performing asset will result in a CGT bill, then a business may not be able to afford to reinvest in a higher yielding asset. This risk has in part been recognised with a recommendation to provide roll over relief where such funds are reinvested, however that recommendation only applies to businesses with turnover of up to $5million.
- Having a CGT not apply to disposals arising from a death but apply to gifts also raises efficiency issues. Why should the transfer of assets from one generation to the next have to wait for death to occur? Surely it would be more productive for family businesses to be able to pass assets from generation to generation before then, without crystallising a tax liability?
- Is the Government itself taking a large fiscal risk? In the event of an economic downturn, capital losses will be able to be offset against other income sources. This has the potential to add unpredictability into the Government’s accounts.
The above are just some of the wider questions that a CGT raises. The question of whether a CGT is right for New Zealand is far from black and white. Instead there is a whole spectrum of choice, all with their own consequences, which will need to be taken into account and ultimately sold to a voting public.