By Kyle Maxwell

 

Introduction

While one third of New Zealanders struggle to sustain themselves,[1] New Zealand’s 311 wealthiest families raked in an economic income of $14.6 billion in 2021.[2] Unsurprisingly, a capital gains tax (CGT) is likely to be thrown into the electoral fray once again as a crucial election looms. A capital gains tax has been potentially the most consistently contested economic issue ever since the introduction of the Income Tax Act in 1842.

Few policies are able to draw as much support, and equally as much vitriol, as what is a simple tax at heart. Fundamentally, a CGT is simply a tax on the difference between the purchase price and sale price of an asset. For example, if you purchase a house for $1,000,000 and sell it for $1,200,000 you would pay tax on the $200,000 difference.

 

Vocal dissenters of a capital gains tax, such as ACT leader David Seymour, claim it would simply push the message that Aotearoa is a society that does not value success but rather “beats up and punishes people who save and invest”.[3] Meanwhile, support for a CGT is equally strong at the opposite end of the political spectrum, with Green MP Chloe Swarbrick putting it forward as a simple fix for inefficiencies in taxing the wealthiest New Zealanders.[4]

This article sets out to analyse what the reality is by pulling apart how fair, equitable and productive a CGT might actually be.

 

Overview of NZ Taxation

As it turns out, eating the most meat pies per capita is not the only unique thing about New Zealand.[5] We are also the only nation in the OECD without a comprehensive CGT.[6] Taxation in New Zealand is heavily reliant on income tax, goods and services tax (GST) and corporate tax, making up a huge 85% of tax revenue.[7]

 

In less-than-unique fashion, it also arises that New Zealand’s tax system is based on a principle about as old as Tane Mahuta:[8],[9] the trust law principle of res, that the object of the trust is preserved, so you can tax what falls from the tree but not the tree itself.[10]

 

As such, we take some of the apples that fall from the tree — income and net profits — but don’t lop any growth off the top of the tree itself — capital gains.

 

For example, if you rent out a house for $500 a week, this will be taxed as income. If you sold that house after a few years of renting it out for $100,000 more than you bought it for, you would not be taxed on any gain; this is capital gain.

 

However, there are many situations in which it becomes difficult to determine what the tree (capital) is and what has fallen from it (income or profit). For instance, car dealers profit by selling cars for more than what they bought them for. Technically, this is a capital gain — it is simply money earned from the difference between sale and purchase price.

 

To get around this technicality, subpart CB of the Income Tax Act 2007 treats certain capital gains as income. The purpose for which property is purchased is the primary determinant of whether any capital gain is treated as income.[11] So, if someone purchased a car with the purpose of profiting from it, any gain would likely be taxed as income.

 

The bright line test is a further legislative reclassification of capital gains. It treats the gain on the sale of any house within 10 years of its purchase date as income for tax purposes.[12] However, there are a myriad of exceptions to this, including that it does not apply to the family home.

 

Equity and Fairness

The recent headline that the wealthiest New Zealanders paid an effective tax rate of half that of the average Kiwi understandably had many people questioning what web of tax avoidance the uber-wealthy are exploiting. [13] However, the wealthiest people are simply able to pay much less tax as around seven dollars of every 10 dollars they ‘make’ is from capital gains.[14]

 

This apparent unfairness gives rise to the ‘a buck is a buck’ argument: why should anyone pay less tax on one dollar than another? Such is the question that must be answered when determining whether a CGT is right for Aotearoa.

 

House Prices

Whenever a CGT enters the policy bonfire, the effect on house prices tends to be the immediate afterthought. Considering that almost half of our wealth is stored in real estate, this is no surprise. [15]  

 

Those in favour of a capital gains tax argue that taxing gains from increases in house prices would decrease prices, making them more affordable for first home buyers.[16] Theoretically, adding a tax increases the cost to investors, which dissuades investment. Prices would then fall as investors sell off properties until a new price floor was established.

 

As housing is a key driver of inequality, allowing more people into home ownership should close the wealth chasm. [17] Specifically, home ownership has also been linked to safer communities, better performance in school, diminished behavioural issues and improved productivity.[18]

 

Somewhat counterintuitively, a CGT appears unlikely to materially affect house prices. Compared to neighbouring nations with a CGT, house prices here are not abnormally high. In 2020, New Zealand house prices were found to be the seventh most expensive in the world when comparing incomes to house prices.[19] While this is undeniably high, the UK was ranked eighth and Australia was only three percent more affordable.[20]

 

Furthermore, since the introduction of a CGT in Australia in 1985, house prices have increased at a very similar rate to New Zealand.[21],[22] Additionally, home ownership rates are nearly identical.[23],[24]

 

Several studies have attempted to model what might actually happen in Aotearoa. However, these studies do not lift the fog of uncertainty. One 2010 study doused the idea that a CGT is the key to dampening our housing market. In modelling four different scenarios and changing variables such as inflation, in only one of these scenarios did any type of housing decrease as a 0.5 per cent drop in the price of large houses was witnessed. In fact, price rises up to five per cent were witnessed in some of the models.[25]

 

However, a 2019 study by Westpac suggested that house prices may fall by 10 per cent.[26] The National Party lambasted the study for failing to adequately account for reduced supply due to developers facing lower prices and thus producing less. They contended that this would mitigate any price fall due to reduced demand.[27]

 

Rent Prices

Furthermore, there is the very real possibility that landlords would simply pass on the cost of the tax to tenants, increasing rental prices. Studies by Westpac,[28] the Inland Revenue Department (IRD) and Treasury,[29] and various academic studies[30] all reached the conclusion that rents could increase by up to five per cent. This is all the more likely in the short term before the effect of dampened investor demand can be felt.

 

Increased rents are particularly harmful in achieving a more equitable society. Since 2016, the lowest quarter of rents have increased by 34 per cent, increasing the number of people dependent on the government for housing up more than five times over.[31] For many, the risk of increased rents cannot be taken.

 

Overall, it is decidedly unclear as to what the real impact would be on Aotearoa house prices, but a CGT does not seem to be the silver bullet some propose it to be.[32]

 

Use of CGT Revenue

The impact of additional government revenue is perhaps the strongest argument in favour of a CGT. The Tax Working Group (TWG) recently found that a variant of a CGT (exempting things like the family home) could generate $8 billion over its first five years before levelling out to around $3 billion per year.[33]

 

According to the Green Party, $2.68 billion would be enough to introduce widespread welfare reforms, including: increasing net disability payments to 60% of the fulltime net minimum wage, setting a minimum of $325 per week for all core benefits, boost the “Sole Parent Support” payment to $410 per week and broaden who receives this. On top of this, it could remove stand-down periods for all benefit categories. Alternatively, for $1.2 billion every student could receive the full student allowance.[34]

 

Contrastingly, ACT believes that Kiwis know how to spend their money better than the Government, claiming that the Government should instead be focused on creating conditions for prosperity via incentivising investment.[35] David Seymour contends that the real root of failing health, education and infrastructure is that New Zealand is no longer a wealthy country. To fix this, he argues that regulation and red tape need to be cut, promoting economic growth.[36] The resultant higher incomes would generate more tax anyway, allowing the Government to target key areas.

 

Ageing Population

With the cost of NZ Super increasing by billions each year,[37] additional tax revenue may well become a necessity. The double-barrelled blows of an ageing population, decreased tax and increased expenditure cannot be deflected indefinitely. As it happens, those aged 65-74 are also Aotearoa’s wealthiest age group, with the vast majority of that wealth held in real estate.[38] In this case, two plus two seems to equal a CGT to protect Aotearoa’s ability to support those that need it into their twilight years.

 

Efficiency

While fairness arguments are the primary battlefield for CGT debate, arguments also rage as to whether a CGT would boost the economy by incentivising productive investment.

 

Productive Investment

A capital gains tax may shift the New Zealand bias away from investing in residential real estate and towards productive assets such as shares of businesses.[39] The TWG determined that the current tax landscape biases investors towards residential property rather than such productive assets.[40] This inefficient allocation of resources hampers the economy’s ability to grow.

 

However, it is dubious as to whether a CGT would shift investment. Despite a recent slew of regulations that include the 10-year bright line test extension, interest deductibility reversal and increased healthy homes standards, housing as an investment has not taken the slightest hit.[41] Whether this remains the case in the long run remains to be seen.

 

A CGT also ignores the fundamental advantage of investing in real estate — the ability to leverage debt to earn huge returns. When investors borrow money from the bank to invest in property, they keep 100 per cent of the gain on that money.

 

By way of example, take two investors: one puts down $200k on a $700k property (borrowing the rest) and the other invests that $200k into the share market. After 10 years, assuming an annual return of 6%[42] the property investor sells the property for $1.25m, netting $525k. On the other hand, if the shares investor returns 8%[43] per year, their shares would be worth $431k, netting $231k. Without factoring in mortgage and maintenance costs, this is nearly a $300k difference over just a decade. Over three decades, the difference expands to around $2 million.

 

Conclusion

Overall, the effect of a CGT is extremely unclear. While some view it as a silver bullet to the housing crisis, poverty and an ageing population, there are equally strong arguments that it would have no effect, or even a disastrous impact on those the proponents of a CGT seek to help. It remains to be seen whether a CGT would unlock the door to a fairer future.

[1] Stats NZ “Household income and housing-cost statistics: Year ended June 2022” (23 March 2023) <www.stats.govt.nz/information-releases/household-income-and-housing-cost-statistics-year-ended-june-2022>.

[2] Inland Revenue High Wealth Individuals Research Report (Policy and Regulatory Stewardship, Inland Revenue, April 2023) at 27.

[3] Dan Satherley “Accountants the winners out of capital gains tax - David Seymour” Newshub (New Zealand, 21 February 2019).

[4] Interview with Chloe Swarbrick, Green MP (Lisa Owen, Checkpoint, RNZ, 26 April 2023).

[5] “Meat Pies” (January 2017) Foodstandards Australia <www.foodstandards.gov.au/consumer/generalissues/meatpie>.

[6] Andrew Maples and Sue Young “The Tax Working Group and Capital Gains in New Zealand - A Missed Opportunity?” (2019) 21 JAT 66.

[7] OECD Centre for Tax Policy and Administration Revenue Statistics: Key Findings for New Zealand (OECD, 2022).

[8] UpNorthNZ “TĀNE MAHUTA – THE BIGGEST KAURI TREE” (n.d.) Up North New Zealand <https://upnorth.co.nz/tane-mahuta>.

[9] Melinda Jacomb “A History of Taxing Capital Gains in New Zealand: Why Don't We?” (2014) 20 AULR 124 at 128.

[10] At 128.

[11] Income Tax Act 2007, s CB 4.

[12] Income Act, s CB 6A.

[13] Inland Revenue, above n 2, at 15.

[14] At 26.

[15] Stats NZ “Household net worth statistics: Year ended June 2021” (03 March 2022) <www.stats.govt.nz/information-releases/household-net-worth-statistics-year-ended-june-2021>.

[16] Andrew Maples and Sue Young, above n 6, at 73.

[17] Luke Symes The Wealth Ladder: House Prices and Wealth Inequality in New Zealand (Treasury, Analytical Note 21/01, November 2021).

[18] Shelter, or Burden?', The Economist (16 April 2009) <http://www.economist.com/node/13491933>.

[19] Daria Kuprienko “NZ house prices - how do they compare to the rest of the world?” (24 November 2020) OneRoof <https://www.oneroof.co.nz/news/kiwi-house-prices-how-do-they-compare-to-the-rest-of-the-world-38726>.

[20] Daria Kuprienko, above n 19.

[21] Ed McKnight “Does New Zealand have a Capital Gains Tax?” (2 February 2023) OPES Partners <https://www.opespartners.co.nz/tax/capital-gains-tax-nz>.

[22] Andrew Maples and Sue Young, above n 6, at 75.

[23] Stats NZ “Homeownership rate lowest in almost 70 years” (8 December 2020) <www.stats.govt.nz/news/homeownership-rate-lowest-in-almost-70-years>.

[24] Australian Institute of Health and Welfare “Home ownership and housing tenure” (5 April 2023) AIHW <https://www.aihw.gov.au/reports/australias-welfare/home-ownership-and-housing-tenure>.

[25] Andrew Coleman “The long-term effects of capital gains taxes in New Zealand” (2010) 44 NZEP 159.

[26]Westpac NZ “2018 Economic Update” (2018) Westpac NZ <https://www.westpac.co.nz/assets/Business/Economic-Updates/2018/Bulletins-2018/Tax-and-House-Prices-June-2018.pdf>.

[27]Brent Edwards “National rejects Westpac's capital gains tax assumptions” The National Business Review (New Zealand, 19 June 2018).

[28] Westpac NZ, above n 26.

[29]Andrew Maples and Sue Young, above n 6.

[30] Andrew Coleman, above n 25.

[31] Brad Olsen “Rental crisis: Poorest getting squeezed the hardest” (21 March 2022) OneRoof <https://www.oneroof.co.nz/news/nzs-rental-crisis-countrys-poorest-are-getting-squeezed-the-hardest-40853>.

[32] Interview with Chloe Swarbrick, above n 4.

[33] Andrew Maples and Sue Young, above n 6, at 83.

[34] Green Party “Poverty Action Plan” (Green Party Aotearoa).

[35] ACT Party NZ “No ifs, no buts - wealth tax would be gone under ACT” ACT NZ <https://www.act.org.nz/no_ifs_no_buts_wealth_tax_would_be_gone_under_act>.

[36]David Seymour “You can’t tax your way to prosperity” (26 April 2023) Voxy NZ<http://www.voxy.co.nz/politics/5/415804>.

[37] The Treasury New Zealand Superannuation Fund Contribution Rate Model (Treasury, HYEFU 2022, 14 December 2022).

[38] Stats NZ, above n 15.

[39] Melinda Jacomb, above n 9, at 126.

[40] Tax Working Group Future of Tax: Final Report (Tax Working Group, Final Report, 21 February 2019).

[41] Andrew Maples and Sue Young, above n 6, at 84.

[42] Ed McKnight “New Zealand property market | House prices 2023” (29 June 2023) OPES Partners <https://www.opespartners.co.nz/property-markets>.

[43] Tim Kroller “Looking back: What does the ‘long term’ really mean?” (29 September 2022) McKinsey & Company <https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/looking-back-what-does-the-long-term-really-mean>.

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