Analysis: What will really happen with property investment tax

NetProphet journalist Rob Hosking attended the Tax Working Group conference last week and predicts what will really happen with property investment tax.

It is one of the quirks of technical areas like tax policy that the most likely outcome of last week's tax conference actually got very little publicity.

The government's ruling out of a capital gains tax again received the initial headlines.

A capital gains tax is something governments have got into the habit of ruling out repeatedly. Michael Cullen did so, on a reasonably regular basis. Having appeared to fail to rule it out earlier in the year, Finance Minister Bill English now has to remind people, whenever the subject of tax comes up, he is not going to introduce one.

We will get a capital gains tax - from National, anyway - around the same time Osama Bin Laden turns up for the Christmas Day Service in the Church of the Holy Sepulchre.

Moving on...Maverick economist Gareth Morgan's ideas, which were presented to the conference as a sort of minority report, received quite a bit of media attention.

If you missed it, Morgan proposed a flat income tax at 25%; a comprehensive capital tax on all land, buildings, plant and machinery investment, and a $10,000 guaranteed minimum income which would replace all benefits. In effect, he told the conference, the first $40,000 - not far below the average annual wage - would be tax-free.

The chances of finding out if Morgan's proposals would work are not high; for all that, they were presented with his usual panache and made more than a few headlines.

Conversion of the nation's dairy farms to supply the world with cannabis is about as likely. From the floor of the conference, the ideas were treated almost as a bit of light relief.

The land tax idea also received quite a bit of attention and seems to have more than minimal traction. Economist (and Reserve Bank chairman) Arthur Grimes presented a full set of how a land tax could work.

Bits of it have some attractions: the economic modelling suggests such a tax would, firstly, widen the tax net because it would hit property investors and also offshore landowners who buy land in New Zealand but who don't pay any New Zealand tax, unless they buy something when they visit and contribute to the GST take.

Grimes' model also suggests exempting property priced lower than $50,000 a hectare: that would in effect exempt most farms, forestry, and Department of Conservation and Maori land.

The other aspect is the built-in assumption that land values are currently unrealistically high and that this means they not only should but will come down, and that a land tax will give them a nudge in that direction.

Land values could fall just under 17% if a 1% land tax is introduced, according to his calculations.

The other assumption is that when they do so, landlords will drop their rents to reflect the drop in property value.

Grimes was challenged on this from the floor of the conference by a representative of the local property investors, who told him bluntly that in the real world, landlords don't act like that.

New Zealand has of course had a land tax before. Brought in by the Liberal government in the 1890s as a tax on the "unearned increment" of land values, various exemptions were applied once the farmer-dominated Reform governments took over form 1912 and the tax was gradually whittled away with more and more exemptions.

When it was finally abolished in 1990 it was costing more to collect than it was actually collecting.

It also has the advantage that it moves the taxation system more towards taxing things which cannot run away - unlike things like capital and income. The Treasury is rather keen on this.

The downsides? They are more political than technical, and they are more to do with a possible opposite effect to what happened the last time we had such a tax.

That is, starting a land tax with exemptions may well see those exemptions wound back. It is not too difficult to see a future revenue-strapped Labour government extending a land tax to include farms - which are of course usually owned by people who tend not to be big Labour voters.

It is also not impossible to see a scenario where this could become a deal maker and breaker in any future governing arrangement with the Maori Party, which would want to see Maori land exempt.

So even any land tax which exempts farmers is still likely to make them jittery.

What does that leave us with? A risk free rate of return (RFRM) on property investment is actually looking far more likely - for all that, you would not have got this impression from the coverage of the conference.

Rob McLeod, who is a member of the Tax Working Group, and who is also on the Capital Markets Task Force, first put up the RFRM approach in his 2001 Tax Review.

It did not make the cut then but the idea has never quite gone away (and was resurrected, in bastardised form when the investment tax changes were implemented alongside KiwiSaver in 2007.

It would target property investors - the group the government is trying to target. The political downsides are relatively minimal. It would raise $500-900 million a year for the government - which is not as much revenue as the government is looking for but is at least a start.

Comments from our readers

On 9 December 2009 at 10:49 pm Mark Withers said:

If we are to believe that a main motivator to target property with new tax is to reduce the Kiwi apetite for debt funded property investment it doesn't seem likely that RFRM would achieve it. If you are taxed at a deemed rate of return on the amount of equity it is hard to see where the incentive to build this equity through debt reduction would lie. RFRM could in fact promote debt funded consumption as investors look to reduce their equity levels, this is exactly the behaviour the government wants to stop. It would also seem to be grossly unfair on those already struggling to cope with funding genuine losses regardless of their equity. Having equity is all very well but it's cash that you need to pay your tax, it's hard to see where this extra cash will come from given the high gearing that exists in the sector already and the stricter lending requirements banks are now imposing.

On 15 December 2009 at 3:19 am Kerry Drumm said:

Capital gain tax has been given most prominence by the media. Housing brings its own tax problems including a severe distortion of over investment in comparison with more growth-oriented investment. Having worked in a tax system with a capital gains tax I know the compliance cost to the taxpayer is very high. And it taxes success! Given the need for change to the tax base I propose an Investment Asset Tax. Taxing only investment assets, mainly investment properties (and maybe second homes), and equity or equity equivalent investments. Valuations at tax date are readily available for listed equities, unlisted equity valuations would come from financial statements. Properties would use Rateable Values or other external valuations. All investment assets will be taxed on the same basis removing the bias to select investments that give favourable tax savings. To the extent that the taxable amount would be calculated as a percentage of the capital value this looks very much like a revisit to the Foreign Investment Fund – Fair Dividend Rate tax, that tax needs revision. A broad based Investment Asset Tax will do that. An asset tax on equities will allow for the abolition of the Imputation Credit regime and a consequent lowering of the company tax rate. That will stimulate growth.

Analysis: What will really happen with property investment tax

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