By Robyn Walker
Tax is something that can be a divisive subject, with everyone seeming to have an opinion about the optimum level of tax collected, the mix of that tax, and who should be paying more or less tax.
There was a clear signal in Budget 2024 that we shouldn’t expect any new taxes (the Budget ‘revenue strategy’ states: “With prudent control of spending, the Government does not see the need to seek major additional sources of revenue"). Despite this, debate still seems to rage on about whether New Zealand needs to have a capital gains tax or a wealth tax. The flames of this debate are fuelled by speculation about deteriorating tax collections, an aging population, the desire for more spending and investment, and of course the views of international organisations such as the IMF and OECD who have both again suggested New Zealand needs a capital gains tax (CGT).
One of the first issues though, is do we actually need more taxes?
After the high-spending COVID years, we’re going through a period of major readjustment, with many people concerned at the idea of cutting government spending and what this means for public services.
A key part of Budget 2024 was having tighter control over government spending and focusing on high-priority areas. A lot of emphasis has gone on the fact that tax threshold changes are at least partially funded through spending reductions.
Using OECD data, the amount of tax New Zealand collects is 33.8% of Gross Domestic Product (GDP). The OECD average amount of tax collections is 34%, so despite calls for more tax, it’s difficult to say that New Zealanders, as a whole, are currently undertaxed.
That naturally leads to a view that perhaps the mix of tax should be changed so that higher (economic) income earners pay more, and lower earning people pay less.
As it stands however, research suggests to truly understand the imposition of tax on different groups, taxes imposed should also be compared to transfers received (for example Working For Families) in order to understand who is comparatively over or under taxed. It is this thinking that leads to the nomenclature “the squeezed middle”, being those middle earners with high taxes on their economic income and limited or no access to any social transfers.
If we want to reduce taxes on the “squeezed middle”, then rather than adjusting spending or borrowing, some might suggest we should find another group to be taxed more, which is where the calls for a capital gains tax or wealth tax come in.
The idea of these taxes are gaining popular momentum because of a perception that there is a subset of society not currently paying enough tax. Whether this is true or not, or fair or not is not the point of this article. Fairness, in particular, is in the eye of the beholder. If society wants to tax different things, there needs to be an awareness of the consequences and trade-offs.
Capital Gains Tax
The tyres on this topic were last thoroughly kicked in 2017 by the Cullen Tax Working Group (TWG).
The majority largely took a purist view and recommended a comprehensive CGT, which famously was almost immediately ruled out by the Prime Minister of the time.
The minority of the TWG rejected the idea of a comprehensive CGT and instead favoured focusing attention only on residential property where there was clearer evidence that there was under-taxation. Their view was that a comprehensive CGT could not be implemented in a way that the additional revenue collected increased perceptions of fairness and integrity, and where the benefit would exceed the efficiency, compliance and administrative costs imposed.
Additional arguments the Tax Working Group Minority made against a comprehensive CGT included:
- CGTs can impede innovation and distort investment decisions;
- Taxing gains from business assets, including goodwill, increases the need for roll-over reliefs and exceptions which are intended to reduce the lock-in impact of CGT and compliance costs, but can actually have the opposite effect;
- Taxing both business profits and share gains can cause double taxation;
- Rules applying to KiwiSaver and Portfolio Investment Entities would need to be redesigned;
- The extra revenue forecast was relatively low and when taxing gains, the Government is essentially assuming a portion of private sector risk in relation to losses arising.
In addition to the above, it would be remiss to ignore that many capital gains are already taxed under our income tax rules, with our financial arrangement rules and certain foreign equity rules even taxing unrealised capital gains.
The TWG forecast revenue to originally start at $400million per annum (0.4% of tax revenue) and gradually increase, with the largest forecast source of revenue being residential rental investment and second homes (hence the suggestion of the TWG Minority to focus here); which is consistent with having an extended bright-line test.
This level of revenue is typical, with a 2009 Australian report noting “[most OECD countries have capital gains taxes, but they typically yield less than five per cent of the revenues from the income tax and always less than one per cent of GDP.”
While a CGT has the prospect of gradually increasing tax collections and ultimately collecting a “not immaterial” level of tax, the administrative and compliance costs of collecting that tax would be significantly higher than the more efficient taxes that already exist, such that the argument pivots more to fairness rather than just revenue collection.
By way of comparison, it’s understood that the Australian CGT legislation is in excess of 890 pages (our GST Act, which collects over $25 billion is less than 300 pages). Australia has a comprehensive CGT regime, albeit with many politically driven exemptions.
The complexities associated with a comprehensive CGT regime generally relate to providing exemptions and concessions, and building complicated rules around them; for example, access to concessional rates (to reflect, and not tax, the inflation component of a gain), exemptions for family homes, roll over relief when assets are sold and replacements acquired etc.
The counter to this is that we already have a large number of complex rules and considerable time is already spent considering the capital/revenue boundary as a consequence of the lack of a comprehensive CGT. That said, a targeted regime consistent with the TWG minority view could collect the bulk of the revenue with the lowest compliance and administrative costs.
Wealth Tax
The fact that New Zealand was close to having a wealth tax introduced as part of Budget 2023 is something that has concerned virtually all involved in tax policy.
While there seems some popular appeal to the idea of applying a small tax to the wealth of a small number of people, it’s not necessarily as simple or logical as it seems.
The problems with wealth taxes are fairly well documented, but are perhaps best illustrated by the fact that only around 4 countries have one, and of those countries, wealth tax collects very small amounts of revenue (Switzerland – 3.9%; Norway – 1.1%; Spain – 0.5%).
One of the issues with wealth taxes is that it is a tax based on a moment in time. It requires valuations and/or proxy calculations and exemptions (which then distorts decisions). It is based on asset values and therefore does not take into account the ability to pay, which is an issue for people who may be asset rich, but cash-poor (for example, the elderly). A wealth tax also impacts on entrepreneurs – if a business has taken off and suddenly is highly valued with intellectual property and goodwill, owners actually end up with material tax bills that can’t be funded without selling at least part of the business.
Other issues can include the potential for double taxation, liquidity issues, requirements for annual valuations, underreporting of assets, and of course the risk of wealth flight (the simplest way to avoid the tax is to leave).
It is effectively an asset tax, like rates. The wealth aspect is simply to set a threshold from which it applies.
Conclusion
It is not costless to impose taxes. Any tax brings with it compliance and administration costs. It has previously been estimated that there is a cost to society of $120-$130 for every $100 of tax collected. As a whole, many New Zealanders have become accustomed to tax hiding in the background, with PAYE deducted from earnings at source and GST added into prices. These taxes collect the bulk of New Zealand’s revenue and do so almost invisibly and incredibly efficiently (although the businesses who act as unpaid tax collectors may view things differently). However, when you move into the territory of other taxes, you enter a minefield of complexities and the cost of calculating and collecting the tax rises exponentially. This raises the question, is the juice worth the squeeze?
While there are many clear reasons not to have a wealth tax, the arguments for and against capital gains taxes of some form are less clear-cut. The current concern is that with 3 political parties having a wealth tax either as a former or current policy, at some point the view of voters may be that they just want certain people squeezed regardless of the juice.
Despite the above, one thing is clear, we shouldn’t be seeing a capital gains tax or wealth tax on the table for the next couple of years.
