Showdown over tax

The Greens’ Russel Norman on why the time for a capital gains tax has now come

by Gordon Campbell

The Buckle working party on tax reform delivers its findings later this month. This will give the Key government a golden opportunity to carry out sweeping and enduring reform of the entire structure of the New Zealand economy. All types and rates of tax are up for review and possible trade-offs. The challenge for the media will be to work out the real winners and losers not only from the policy road taken, but from the roads forsaken.

Finance Minister Bill English has said that any changes must be revenue neutral. Meaning, this will NOT be a revenue garnering exercise, and any tax cuts on one hand will have to be balanced by tax increases elsewhere.

The worst possible trade-off for most New Zealanders would be if there is merely a hike in GST to 15% ( which would hit the poor hardest, since they have little choice about spending or saving ) and a corresponding reduction to 30% of the top rates of income and corporate tax. That would result in a transfer of wealth upwards – and would increase gaps between rich and poor that are already socially unsustainable. On the current signs, GST now seems unlikely to rise. Pricewaterhouse tax expert Geoff Nightingale – who has been involved in the working party deliberations – has acknowledged that any revenue gained from raising GST would probably be lost out the other door in benefit payments, given the likely impact on the poor.

The Buckle review’s stated aim is to encourage productive investment and discourage housing bubbles. For decades, investment funds in New Zealand have flooded into housing and other capital assets, rather than into productive investment. Despite all its alleged boldness, the Lange government was too politically gunshy and ideologically fixated to change the tax system to address the problem – even though the more conservative Hawke government of the day in Australia introduced a capital gains tax in 1985.

The distortions in the New Zealand economy resulting from our lack of a capital gains tax – or any workable deterrent to our housing addiction – are now blatant, and the Buckle review has been grappling with the issue afresh. As its working papers have already reported, the rental housing market has $200 billion tied up in assets on which it currently pays no tax – and in fact, it can write off losses that qualify for $150 million in tax refunds. Currently, we tax income and spending quite heavily – while assets that continue to appreciate in value remain almost entirely beyond the reach of the IRD.

Hovering in the wings of the Buckle working papers are proposals for a capital gains tax, with or without exemptions for the family home, and with various methods of assessment. Another proposal is for a land tax levied at a rate of anything between .1% and 1%. A land tax has been the brainchild of at least one heavy hitter for some years – namely, the economist Arthur Grimes, who is now chairman of the board at the Reserve Bank. For almost as many years, a capital gains tax has been mooted by the Green Party. Werewolf editor Gordon Campbell spoke to Greens Co-Leader Russel Norman about a tax idea whose time may finally have come.

Campbell : The aim of the Buckle tax review is to encourage productive investment and discourage housing bubbles. Can a capital gains tax really bite hard enough to do both those things ?

Norman : I’m not sure that it can do it by itself. I see it as part of a suite of measures, so its one part of it.

How would it contribute ?

Our approach has been to have a capital gains excluding the family home. So it contributes by taking away some of the capital gains advantages from investing in property, given that our major asset bubble has been property. There may be other kinds of asset bubbles in future, and we don’t just want to make policy for the past. It basically means you get taxed for the capital gain, so that its not as attractive an investment as it currently is.

Since it is only one part of a suite of measures, would you agree to a “no exemptions’ form of capital gains tax, if you could also get a cut in GST ?

No. I mean, our policy is around exempting the family home.

The logic would be that you get a more progressive tax system. Wealthy people making capital gains finally begin to pay tax on them, while you ease the discretionary spending burden on the poor. Wouldn’t that be a win/win?

There certainly is a reasonable argument to be made around that point. But we’ve taken the view that in order to make progress on any kind of capital gains tax – which I think has economic and social gains – that having it exclude the private family home makes it that much more possible to progress.

What’s the argument that owner-occupied housing be exempt ? Is it a fairness argument ?

I think its a combination of a political reality argument and [ a desire] to be fair. For a lot of people, the family home is their only investment. So it is a form of saving, effectively. For many people, their prime and only form of saving is the family home. Though a lot of people don’t [own homes] of course

And even if [the exemption] means that the lawyer sitting on a lifestyle block would still get away scot free ?

Obviously it will depend on how you wrote the rules. But yeah, potentially you’re right.

Within the suite of measures, I wonder whether you could achieve much the same objective, while still leaving the family home within the capital gains net. You could allow say, for interest paid on the mortgage home to be tax deductible for those earning less than $100k a year.

That’s not our policy. Look, we decided that this was how we wanted to set the policy, and would exempt the family home.

Do you think capital gains should be assessed and taxed annually – minus the rate of inflation – or should the CGT be levied only when the property gets sold?

I think probably for the simplicity of the administration of the system it should be probably when the property gets sold. Otherwise, you’re just creating quite a lot of admin. And while I think there’s an economic argument that [annually] this is a more rational way to do it…considering the administration, it should probably be when it is sold. We haven’t yet made our policy on how we would administer it all, and we’re open to discussion but that’s the most logical way.

One of the consequences of doing it that way is that – as I’m sure you’re aware – Australia has had a capital gains tax since 1985, and some properties are still waiting to be sold, and the tax to be realized. In terms of being a weapon against housing price bubbles – and precisely because of this ‘lock in’ effect of people choosing to sit there rather than realize the asset and pay the tax – it can be a very long and very slow method of coping with the immediate problem of unproductive investment in the economy.

Firstly, that’s true. But eventually you’ll get there. It will eventually be sold at some time or other. Secondly, there are still administrative efficiencies around it. Thirdly, I think its also about expectations. If the expectation goes that you can make lots of tax free investment in property – because eventually someone is going to pay a capital gains tax – I think it will change those expectations. Again, its only one part of the suite. We can’t expect it to do all the lifting itself.

Yes, and while we’ve probably covered this…Andrew Coleman from Motu – who is one of the advisers to the Buckle working party – has concluded that a capital gains tax that excluded owner occupied housing would raise very little revenue – while a CGT without exemptions would raise enough revenue to cut GST and do a whole lot of other things with income and corporate tax. In other words, there could be parts of the Green Charter that could be met, if you were prepared to revisit your current stance. Fine, good things, seeing we are now in this ‘hundred flowers bloom’ stage of the government revisiting tax policy.

And I think its important that there be a debate where people can put up those perspectives. But currently, our policy is our policy.

Okay…and might that debate include the Greens possibly considering a registration fee on mortgages ? You know,,,as in the higher the mortgage, the larger the fee. Within a system that could be safely administered well away from the politicians by say, the Reserve Bank..

What do you mean by a registration fee?

Banks would have to provide mortgage registration data to the Reserve Bank. When they did – and this would be a way of getting at the banks’ readiness to lend money on a wing and a prayer – you attack that directly by imposing a registration fee on mortgages based on compliance with certain lending criteria. The further away from those criteria, the bigger the fee. Is that the kind of thing the Greens might consider ?

What we would consider is looking at the Reserve Bank having more ability to set the rules around how mortgages work. We haven’t given specific consideration to that particular policy instrument.

Should depreciation for rental buildings be allowed? The Buckle review seems to think there are $1.3 billion in deductions going that way when – under the UK tax codes – only industrial buildings qualify for that kind of write-off. Does this seem like a good idea – given that, had depreciation not been allowed at 2 % of capital value, the owners would reportedly have had to pay nearly $1400 million in tax to the IRD. That could get you a long way towards a 30% rate on income and corporate tax, all by itself.

Our approach to it so far has been about ring fencing the losses. So we haven’t said “No” to depreciation per se, but we have said you can’t use it to write against your other income. Which has a similar effect.

Let’s look at the political feasibility. Is there anyone else on the political spectrum who supports the CGT ?

A CGT excluding the family home ? I actually think the political spectrum is moving on it. When you look at National, some of the statements from John key and Bill English are nowhere as vehement as they once were, They’ve really softened on it. When you look at Labour during the banking inquiry – clearly, it isn’t their policy or anything – but they heard strong arguments around it. I think there are some openings.

Do you regard Bill English as being a possible ally on this ?

It may not exactly be a CGT. He is certainly an ally on addressing housing asset bubbles. He is sympathetic to that.

Presumably he also realizes that if he is going to cut on corporate and income tax, he has to get revenue from somewhere that doesn’t just involve raising GST. Is that the motivation?

That’s part of it. But I think he also just genuinely recognizes that it [housing fixation] is bad for the economy.

Is it a problem that quite a few politicians seem to be property investors as well ?

Obviously, one can’t help but wonder whether it doesn’t influence their thinking. But I don’t know, because I don’t have property I own.. (laughs) I only have property that I rent. But an awful lot do seem to do it [own property] The problem isn’t simply the politicians, Its that great chunks of middle class and and upper middle class income earners in New Zealand were advised by their tax advisers to invest in property as a way to reduce their tax. That’s the truth. When you look at the curve in income there’s a big spike just under $60k or whatever, because a whole bunch of people are writing off losses on investment property to reduce their taxable income, to just under the highest rate. That’s the real political problem.

Yes. And in terms of political feasibility why would anyone think a National-led government that won’t make farmers pay promptly and fully for their pollution, would make them swallow a land tax or a capital gains tax ?

I agree that its not that likely. But it is certainly not as unlikely as it was twelve months ago.

Federated Farmers aren’t screaming about being hit by a CGT or a land tax. Do you think they’ve been told by Key that neither’s a runner?

Probably. But I really don’t know. There’ some strong arguments for it from a farming perspective. One of the problems is that the speculation in rural land is bad or worse than the speculation in urban land. That’s also where the capital gains are all untaxed. One of the problems for farmers is the size of the mortgages they’re having to take out, because rural land has been becoming so expensive. So if you could actually drive down the price of rural land [ the RB’s Arthur Grimes has said a 1% land tax would cause an immediate 17% drop in land prices] by taking some of the speculation out of the system, in the long run, it could be very good for farmers.

The risk with the impact of all these tax measures on the rental housing sector is that landlords will pass on any new liabilities to their tenants, and raise their rents. If you do tax capital gains, how do you plan on protecting that vulnerable sector ?

Our perspective is to increase the supply of affordable housing. Primarily, state housing – but also all the community sector stuff. Our view is that you’ve always got to work on demand and supply It will take some of the demand out of the system by taking some of the speculative demand out of the system. And around rental properties you need to dramatically raise the level of supply. But I agree – otherwise, renters could wear it.

Surely it was loose monetary policy that created the easy credit that fed the speculation. As much as a CGT may be needed to deter speculation isn’t there a related need to attack the availability of credit as well ?

No question. And I think there’s some interesting stuff going on there. Whether it is [RB governor Alan] Bollard’s last statement when he released the Fiscal Stability report….I thought his position now is that he is going to use what we used to think of as prudential tools as adjuncts, basically, of monetary policy – around capital adequacy ratios, to try and take some of the heat out of the system, and in terms of the quantity of credit running round the system.

I think there is a lot of talk now internationally and even now here in New Zealand about how do you control the quantities and not just the price, of money. How do you control these big floods of foreign capital that come into New Zealand looking for somewhere to invest – and the banks pass it on, into speculative investment in housing.

Which is why its almost funny to see Gordon Brown – even though he probably expects his initiative to fail – is resurrecting the merits once again, of a Tobin tax on financial transactions.

Yes. And obviously a Tobin tax is an international tax. And it really has to be implemented internationally.

And since Brown knows the Americans won’t, so he is on pretty safe ground. It’s a gesture, not an intention.

Yeah. Obviously we support going further with all that. And a Tobin tax makes sense. But there are also some creative policy around controlling the quantities of foreign capital coming in.

Land Tax

Wouldn’t a land tax be more difficult to avoid, and we’ve already got the administrative machinery there in place, with the rating system ?

We don’t have any policy with respect to land tax. We’ve been having quite a discussion about it among ourselves. I don’t know if you saw Arthur Grimes’ (pictured) paper on it.

Yeah. It is something he’s been floating for a few years. As an interested observer, and to make it more politically acceptable, would you be in favour of restricting a land tax to residential land – or even only to urban land ? To put it the other way around, would a land tax encourage farmers to let marginal land degenerate further into bush ?

No. Because Grimes is talking about a tax on the unimproved value of the land. Actually, you would create an incentive to use the land as hard as possible because its [being levied] on the unimproved value. So you’d go wow, I can’t put a block aside to regenerate because I have to pay land tax. As we’ve discussed how a system might work, the policy question is – do you have exemptions for native bush set-asides – in order to discourage the overly intensive use of land, and to encourage bio-diversity.

Even so, in urban areas, I can’t see how a land tax is going to prevent or pop, housing bubbles. If the average price is residential land is, as Grimes says, about $215,000 – and even if you went up to the top end and imposed a 1% land tax, you’d still be only adding just over $2,000 to the price of the cost of a house. Surely, that’s not going to stop a housing bubble.

I don’t think any one of these instruments, by itself, will stop a housing bubble. I really do think you need to look at all the supply side and demand issues that are driving these things – monetary policy, tax policy around investment properties, capital gains tax, ring fencing, the supply of affordable housing. It all needs to be put together in a package.

And even within the Green Party there would be people who would be saying with respect of a land tax – Russel, don’t go there. We already have a land tax and its called rates. Why add to it ?

Well, we’re not going there, and it isn’t our policy. But the country is in the process of having a tax discussion, and I think it’s a good discussion to have.

The political argument against a land tax is that farmers hold more of the land, in the main productive sector of the economy. So do old people who won’t get much of the benefits from any balancing cuts in income tax. Given those realities, would a land tax do much more than guarantee the resurrection of Winston Peters ?

Its certainly true that it would be pretty unpopular among older people who own their property and who don’t have a lot of flexibility in increasing their income. So yeah, I think there are real political issues about it. Whereas the capital gains tax which is levied on the sale of the property, has less of those issues about it. …You couldn’t make it at all retrospective. That wouldn’t be fair.

Since this is a zero gain exercise – and you advocate a capital gains tax PLUS environmental taxes – where do you propose to make the balancing revenue cuts ? Initially, what eco-taxes do you have in mind ?

The things we have focused on particularly have been around carbon. If you recall, the original ETS did involve generating a tax revenue for the government, eventually. So there was a carbon tax effectively incorporated within the old ETS. The other one is water, fresh water. Because we think that is an obvious one where there should be a resource rental. We’ve tended to support resource rental rather than a trading scheme with private property rights.

Isn’t it kind of hard to justify taxing some-one on something that they don’t own ?

We have said that the public as a whole, own water. It belongs to everybody, and so if you want to use a public resource then you have to pay a rental. That’s been our approach to water pricing. As to what exactly what taxes you cut…our approach towards a green tax shift has been that we have been very focused on making the first chunk of income, tax free. We think that produces the most equitable outcomes. So whatever money you get from environmental taxes, [should] go into eliminating the tax on the first chunk of income.

Right. And the attractiveness of the land tax option is that it creates the potential for that income exemption to be higher. To where you’re almost in the Maori Party realm of exempting the first $20-30,000 of income that they were talking about last year.

Yeah, I’m not quite sure how they were going to pay for all that.

Well, Grimes is saying that slapping on a 1% land tax could be equivalent to 20% of the entire income tax take.

There is no question that there are real opportunities for some serious tax shifting if you went down the land tax route. Some of the other stuff could make a difference. Ring fencing the losses on investment property would make a real difference…we don’t know how much revenue it would generate because we don’t know much it would change behaviour, from the modeling. But we do know about the $2.3 billion in the rental housing went by the LAQCs [loss attributing qualifying company] alone, and that doesn’t cover everything, because not everyone sets up specific companies to do this, so the number is higher.

Even so, capital gains have been has been the elephant in the room that everyone has felt too politically timid to address. We live in interesting times if the rifles are now being trained on it.

I think there’s finally a recognition within the political Establishment that this housing asset bubble was a bad, bad thing. There’s now an across the board recognition of that, and that we can’t let this happen again. Whether they’re actually going to do the things that will actually deal to that, I don’t know. Labour I think are now very clear that they made a mistake in not addressing it. It was on their watch.

They did have the opportunity with the McLeod review. Which raises an obvious question. Given the current political climate, is the Buckle tax review likely to go the way of the McLeod review and just go onto the shelf as an interesting resource for academics in future?

I don’t think the politics around it are the same. Remember, the McLeod review was Labour trying to sideline and shaft the Alliance. Because it was the Alliance that had said we’ve got to have a tax review and it was the Alliance who had the [Tobin] transaction tax..and a whole lot of stuff that was really quite creative.

Labour, in order to stop them, got McLeod in – who was completely antithetical to the Alliance – to head up the tax review, and shaft the Alliance. That was the politics of it. So it was never going to be adopted because its whole purpose was a political one. Whereas this review _I think you have to say – isn’t being driven by that kind of politics. I actually think there is more genuine openness to look at tax policy. I mean..this isn’t National trying to shaft Act or the Maori Party. This is National saying well, tax policy is really tricky and difficult and it’s a political hot potato and so its great to have someone independent of us involved in giving advice. That’s the politics of it, I think…

Even so, there would be collateral damage to its core, whatever National does – if this is to be a genuine process of reform. Over the past 30 years though, National has been far more timid than Labour about attacking its own base, and ready only to attack the political base of other parties, as it did in the mother of all Budgets. Not so much the farmers and the old people. Yet the economic arguments emerging from the Buckle working party do seem to be lining up those groups, as among the possible prime casualties.

(laiughs) Time will tell.