Q+A on CGT

I interview myself on Capital Gains Tax.

Can a capital gains tax be good for the economy?

Yes. Most tax experts say that the best tax system is one with a broad base and low rates. A Capital Gains Tax which broadens the base and leads to lower rates can make the economy more productive.

Is a CGT fairer?

To some degree, yes. In some cases not taxing capital gains is unfair. However it can also be seen to be unfair taxing such gains, when they are incidental – such as selling the family bach when the kids are older.

Aren’t capital gains already taxed?

Only when the person making them is deemed to be investing for the purpose of making the capital gain. It is then treated as income for them.

So how do you judge if a capital gain was incidential or deliberate?

With difficulty and a degree of subjectivity. This is one of the advantages of a CGT.

Would it be better to just enforce the current law more rigorously, than have a catch all CGT?

Reasonable people can agree to disagree on this. National has allocated $100 million to target tax avoidance, including those who should be paying income tax on their capital gains. This might be more effective than a comprehensive CGT. Tax experts disagree on this one.

Could some people pay less with a CGT?

In theory yes. Labour’s proposed CGT is thought at be a 15% rate. Most of those who currently have their capital gains taxed will pay 33% tax on their gains. Presumably Labour will want those people to still pay income tax on their gains, not CGT. But I foresee good times for tax accountants if a CGT is introduced.

Is a CGT necessary to stop over-investment in residential property?

Not really. The Government’s 2010 budget changes have made residential property investment significantly less attractive anyway, by stopping depreciation tax write-offs and other changes. Plus those countries with a CGT got hit by the property bubble just as much as NZ.

So should a CGT target residential property investors only?

No. The most economically efficient CGT should be as broad as possible. It should include capital gains on shares, futures markets (even iPredict), business sales, farm sales and even the holiday bach. One could even argue a case for including the family home, even though politically that is not viable.

So farmers might have to pay CGT when they sell their farm?

Unless exempted, yes. And this could disrupt the way many farmers structure their affairs. Outside the lucrative dairy sector, many farmers have a relatively modest income, especially as a return on the hours they work. Many of their profits are ploughed back into the farm, meaning there is relatively little ability to save for retirement.

The sale of the farm as they get older, is often how they generate their retirement income. A CGT on any increase in value over the last 20 years could significantly affect them.

How can a CGT be good for the economy if it is an extra tax? I thought higher taxes were generally bad for the economy.

Great question. This is key. The best tax system is broad base and low rate. If the extra income from a CGT is used to lower income tax rates across the board, then that can improve the economy, as we are reducing disincentives to work and earn.

If the CGT is used to fund extra spending, and hence increase the overall tax burden, then it is not a good thing in my opinion.

So will Labour be announcing lower income tax rates?

Sadly it seems not. To the contrary they seem determined to reimpose an envy tax on higher income earners, as well as a CGT.

They have also said they want to exempt the first $5,000 of income (which is not a bad thing) but at this stage we don’t know if their proposed CGT will allow them to do that, or will raise more money than  needed to do that. We need to see the details.

So what is most important with tax?

The key thing I will be looking for is whether Labour’s changes will increase or decrease the overall level of taxation in NZ. There is a mass of emperical evidence that countries with a lower rate of overall taxation grow significantly faster than those with higher overall taxation.

This does not mean every low tax country in every year out-performs every high tax country. But a study done of around 30+ OECD countries over around 40 years found very significant correlations.

So why not just abolish tax, to maximise economic growth?

Because then we would not be able to afford the services that most people want the Govt to provide. It is a balancing act between low enough to enhance economic growth and high enough to fund certain services.

Of course over time faster economic growth, even with lower tax rates, will lead to greater tax revenues and hence a greater ability to fund more services.

This is why the key thing for me is not increasing our overall tax take. I want economic growth to fund future services, not new taxes.

So how good or bad is Labour’s proposed CGT?

Ask me again after it is out. If it is a pure tax swap, reducing income taxes in return for a CGT, I’ll be favourably inclined towards it. Of course I will want to verify if it is a pure tax swap – I won’t accept their press release on it.

But if the reports are right that they will be increasing the top tax rate to 39%, then that partly spoils any benefits from it. If anything they should be reducing the top tax rate, due to a CGT, not increasing it. This is the politics of envy, not economic efficiency if they bring back a 39% tax rate.

The top income earners already fund a massive proportion of our tax system. More on that later today.