Kerr on Capital Gains Tax

Roger Kerr writes:

A gains tax on housing would not reduce inflation. Inflation is an ongoing increase in the general level of prices, not a one-off change in some prices.

The introduction of the Goods and Services tax resulted in a one-off increase in the consumer price index – it did not lead to ongoing inflation.

Similarly, a capital gains tax might reduce property prices initially but it would not affect longer-term inflation.

True, and any increase in GST would be a one off bump.

Moreover, if such a tax on housing were applied only to realised gains as is likely, house prices could even rise. This is because of the lock-in effect, with owners holding on to homes to defer the tax on gains. Anything that reduces supply is likely to lead to an increase, not a decrease, in price.

One could do it on unrealised gains, but that would be pretty draconian.

Evidence confirms what theory suggests: the inflation performance of countries with a capital gains tax doesn’t differ systematically from countries that don’t.

Australia, the US and Britain, which tax capital gains, have all had large and volatile house price movements this decade.

I always like a look at empirical evidence.

A second mistaken assumption is that investment in rental housing enjoys tax privileges.

As the deputy commissioner of Inland Revenue, Robin Oliver, told a select committee in 2007: “Rules about expenses for deducting costs such as interest, upkeep and maintenance, as well as paying tax on income, are the same for investments in shares or anything else. In fact under the housing case … there are tighter rules regarding what is a capital gain.”

People are misled into thinking that rental housing is tax-preferred since highly geared rental property may record tax losses. This is because the full economic income (including the change in the market value of the assets) earned on rental property is not taxed.

However, this is a quite general feature of the taxation of real assets, including plant and equipment and farms.

A real issue though is whether it is sensible to allow property owners to claim 3% depreciation on their property annually, when the empirical evidence is that almost no residential property depreciates in value – in fact it appreciates.