Fallow on Tax

Brian Fallow writes:

“We need to stop the tax system creating the wrong incentives,” said Treasury Secretary John Whitehead in a speech last week.

Citing Inland Revenue data, Whitehead said 1996 was the last year that more people made profits than losses from rental properties, yet the number of such properties had increased significantly since then.

I wonder what the total amount of tax losses claimed in those 15 years has been.

“Now why would increasing numbers of people – rational New Zealanders – invest billions of dollars collectively in an area that is unprofitable?” he said.

“It’s hard to believe it’s not because of the tax advantages. People can claim depreciation against their investment properties – even when most real estate was significantly increasing in value. They can deduct tax losses on property against their other income.

“And if they sell a rental property the capital gain they make is usually untaxed.”

The depreciation is reversed at sale, but you may have had interest free use of that money for a decade or more.

A widely quoted passage of the Tax Working Group’s report in January said that in 2008 the $200 billion invested in rental housing yielded net rental losses totalling $500 million.

That meant that collectively landlords not only paid no tax on their rental income, they were able to escape paying around $150 millon of tax on other sources of income they had.

However, Michael Littlewood, of Auckland University’s Retirement Policy and Research Centre, has cast a lot of doubt on the robustness of the $200 billion figure. …

But if he is right to conclude that the true combined value of residential investment properties could well be less than half the $200 billion stated, how much ice is that likely to cut with policymakers?

I doubt it will change decisions, but it will change estimates of how much revenue the Crown may gain from any changes.

It depends what they are most worried about. If their concern is that New Zealanders are over-invested in property and that that is for tax reasons rather than, say, a shortage of other investment opportunities, then Littlewood’s results are highly relevant.

But if the concern is purely fiscal – how to fund the gap between the $2 billion and change that a GST increase would yield and the cost of comprehensive income tax cuts and compensating adjustments to superannuation, benefits and family tax credits – then the focus would be not on how much is invested in rental properties but on the aggregate $500 million of net tax losses.

A bit of both I’d say, with priority on the latter.

The IRD data charted by the tax working group shows a clear downward trend in net rental income for the past decade, and it was 10 years ago that the Labour Government raised the top marginal tax rate from 33 to 39 per cent, increasing the incentive to shelter income through highly geared property investment.

I sometimes wonder if anyone actually pays the (now) 38% tax rate? Much better to reverse Cullen’s envy tax, and clamp down on loopholes.