14-03-2013

OLLY NEWLAND: Capital gains tax is not the answer

Landlords.co.nz

By Olly Newland

No matter how often the argument against a Capital Gains Tax is put forward, the subject is still popular among those who, it seems, fail to realise that implementing such a tax will solve nothing. The suggestion comes up again and again, and it has almost become an article of faith for ‘the left’ some of whom seem to imbue a Capital Gains Tax (CGT) with mythic powers to right all social wrongs.

When the Labour Government of the 1970s brought in a version of the tax to curb rampant property speculation, the result was a further rapid rapid rise in property prices — on top of the 50% rise up until then! Sellers rather withdrew their properties from the market than pay the tax. It follows that Less stock = Higher prices. (This ain’t rocket science.)

The ’Property Speculation Tax’, as it was then called, was abolished a few years later by the Muldoon government, and I am proud to say that I was partly instrumental for that. It was in those days that I first organised public meetings, wrote newspaper articles, gave interviews on TV and radio to quietly and logically explain that that sort of tax would not work. (Well, OK, I argued and lobbied hard against the tax.)

A master stroke in the PR war was a stunt where I ‘sold’ a property to a near destitute Pacific Island family on $10 down and the balance interest free — with a condition of sale that no Property Speculation Tax was payable due to the transaction. If the tax was levied the needy family would be evicted immediately. (Yes, I said it was a stunt.)

This was all over the news, breathlessly, and culminated in a call to Wellington to meet a red-faced and embarrassed Minister of Finance, Bill Rowling. From that chilly meeting flowed changes over the next few months which saw some of the draconian aspects the tax modified. (I’ve written more about this episode in chapter 3 of Climbing the Property Ladder.)

Perception versus reality

There is no doubt that the idea of a Capital Gains Tax becomes at times popular, as the article below ‘Frustrated home buyers want investors to be discouraged’ and myriad others suggest. This is understandable.

Ordinary folk who find themselves locked out of the market by rising prices feel angry. They have a right to be angry. But if they believe the propaganda that a CGT will solve the problem, they’re wrong. It won’t.
It would make it worse. Here’s why:

What riles people is their belief in a fairy tale that there’s a widespread phenomenon of speculators buying properties, then quickly re-selling them, making tens of thousands of dollars of easy tax-free profit. In doing so (the story goes) the speculators are depriving genuine home owners of their start in the property market.

A Capital Gains Tax, they believe, will discourage the buying and re-selling for profit by taxing those profits (if any).

Let’s get the story straight:

The call for a CGT is a populist cry because it appeals to the masses and is promoted by those with a Socialist leaning (e.g. Labour and the Greens and those further to the left). Of course, sensible people know that these parties are using the issue as propaganda just to have a ‘point of difference’ with the ruling right wing National/ACT party government.
In my view, their cry demonstrates the usual envy and New Zealand’s ‘tall poppy’ syndrome at its worst or a loathing of the ‘rich pricks’ as expostulated by then Minister of Finance in the last Labour Government, Michael Cullen (now Sir Michael Cullen, excuse the smirks).
Profits made on the turnover of properties is already taxed. If someone buys and sells properties on a regular basis they are already liable for the maximum tax under the present legislation. End of story.
By far the biggest group of ‘speculators’ is the general public — buying and selling their own homes. If you live in your home then sell it for a huge profit it is almost certain you will pay no tax … even of you do so regularly.

I know of many people who buy and sell their own homes on a regular basis for the purpose of making a profit. They rarely, if ever, are bothered by the taxman (and rightly so).

To look at if from the other side for a moment: exempting the family home from Capital Gains Tax (as the Labour Party suggests?) would be a huge blunder if a CGT was ever introduced. It would mean that house price rises would continue unabated. Since the majority — by far — of home sales are made by home owners, any dampening effect would, I predict, go by totally unnoticed.

It is true that without a Capital Gains Tax of any sort New Zealand is an outlier or oddball in the OECD. But rather than just mimic other countries, we need to take a logical approach so that currently tax-free gains are taxed in the case of deliberate profit seeking — but without causing major problems to the market as a whole.

Tax on profits = credits on losses?

The same cries for tax on ‘super profits’ happened in New Zealand in the 1980s when the sharemarket was going through the roof. People were baying for blood because the share speculators were making huge day-to-day tax-free profits. Under mounting pressure, the Government insisted that gains on share trading would be taxed. The ‘joy’ of the masses was short-lived: Along came the sharemarket crash of ’87 and share traders ended up with huge tax credits, giving some of them a tax-free status on everything else they did for many years to come.

It’s no exaggeration to say that there is a risk of serious damage to our property market and our economy in general if a Capital Gains tax is introduced across the board. Look what’s happened in Spain, Portugal, the USA. Greece etc — all of whom have had long standing and draconian CGT taxes. Despite their Capital Gains Tax they endured enormous booms and catastrophic busts … and the tax will no doubt turn into life time tax credits for many.

What we need (if we need anything at all)

So, what could be done?

Enforce more rigorously taxes on people who buy and sell homes (including their own) as a business. It’s far too slack at present.
On the sale of any property, if the total proceeds are re-invested into another home or investment property then that would be tax free. Any surplus retained would be taxed. There would need to be exemptions for extenuating circumstances such as marriage split ups or entering retirement villages and the like.
Some countries use a sliding tax system which applies to both private and investment properties. Simply put, tax would be applied in full if a property is sold for a profit within 12 months, but the tax would slide downwards over the next ten years to zero, encouraging long-term holding. The paperwork and record-keeping would be horrendous, but perhaps it’s an idea worth considering.
There is some debate on whether “Asian” buyers (i.e. Chinese) are ramping up the market, especially in Auckland, and suggestions that restrictions should be placed on foreign purchasers. I have real difficulty seeing what this will achieve other than scratch the xenophobic itch that many people seem to display.

As I explained on TV 3 News recently (3News: Investor adds to rising housing market predictions ) when a foreigner buys a NZ property, in most cases the money goes into the pockets of a Kiwi owner, who in turn can compete back in the same market.

The Australian model seems very xenophobic — banning foreign ownership of rental or speculative property unless it is a new build or it will be occupied for at least 12 months by the owner. (Hence hordes are buying property through friends and family to skirt the rules.) Any such ‘foreign buyer’ restrictions here in NZ will be for political reasons only, and in my opinion, will have little effect.

There was some suggestion that farm sales should be taxed if there are profits made, which I believe could hamper exports and turn the farming community into a major opposition force. It’s increasingly clear that like landlords, farmers operate only secondarily for the lifestyle and cashflow of the endeavour — capital gains is where real end game lies. Likewise with business sales, collectibles, shares and indeed any investment which produces a capital gain.

Any tax pushes price UP

Whichever way you put it, any form of tax imposed feeds into prices. I challenge my readers to name one item that’s gone down in price because its been taxed. There are no such examples as taxes always feed into higher prices.

A Capital Gains Tax would only encourage people not to sell — thereby reducing supply and creating a greater shortage than ever. The laws of economics are crystal clear:

Supply more of any item and it becomes cheaper.
Reduce the supply and it becomes dearer.

Maybe, cynically speaking, punitive taxes should be applied to those who don’t sell! (Now that would be interesting.) That would certainly bring down prices with a thump and probably ruin a lot of people in the process, so that scenario seems extremely unlikely as well.

As an example of other countries which have far reaching Capital Gains Taxes, we need to look no further than Australia
and read through a website which details how and when a CGT is applied. (Note the understandable similarities with the NZ proposals.)

http://www.capitalgainstax.com.au/what-is-a-cgt-event/

The UK has tougher rules on CGT and indeed tax includes much in the way of personal items not only homes:
http://www.hmrc.gov.uk/cgt/possessions/basics.htm#2

And on property:
http://www.hmrc.gov.uk/cgt/property/basics.htm#2

The subject gets murkier when you look see how the USA treats CGT:
http://www.irs.gov/uac/Ten-Important-Facts-About-Capital-Gains-and-Losses

Take a while to scroll through these websites and you’ll realise that if and when a CGT is introduced it won’t just stop at speculators doing up and flicking houses. It could well end up on your front door and touch much more than you think. Once such a tax is introduced, it becomes the thin edge of the wedge and can be built up more and more as time goes by.

Stamp duty

And just to add to the debate: Remember that Stamp Duty still exists (look at your cheque book) and can be introduced with little fanfare if any ruling party decides. Stamp duty is one if the easiest taxes to police as it will be based on the value of the item transacted. The appeal of Stamp Duty, to the socialists complaining about the unfair burden of GST on the poor, is that with Stamp Duty, the rich will pay more, the poor will pay less or next to nothing.

Don’t laugh. Stamp duty was common on all sorts of transactions, as well as property in the recent past. It remained on commercial property until the late 1990s – I know because I paid my fair share of it and felt the pain.

It was also charged on commercial premises leases, and many types other types of invoices. Changing the rate from 0% as it is currently, to a real number is relatively easy to do.

If this is what the people want – the politicians will surely oblige. That’s democracy for you.

Tags: olly newland - cgt

Source: Landlords.co.nz