Why a capital gains tax would be a disaster

Press, 19 December 1989, Page 12

Why a capital gains tax would be a disaster

Pattrick Smellie, in Wellington reports

TV TEW ZEALAND needs a IVI; capital galas- takivlike it a'hole in the head. As the economy limps to-the end Xofjis third it is 'Be'tnmking about such a virulent new form oftaxation. With interest rates on the rise, .the? Sharemarket' kicking around post-crash ; lows, and the ’Reelingthat we’ve just had andawn, its ---of phristmas heeds. The Government, too, has nothing to gain promoting a ~ capital gains tax at the moment.

What possesses political strategists to think there is an ounce of mileage in raising the bogey of a tax on the family, home less than a year from an election defies comprehension. Even the Government’s insatiable hunger for more tax revenue would be unlikely to be satisfied quicky or well by even a well-implemented capital tax. Yet today, the Minister of Finance, Mr Caygill, will release a discussion document of more than 500 pages outlining the possible approaches to taxing capital income.

First up, it’s totally unfair for the Government to have proceeded with capital tax initiatives when it’s welched on the other half of the bargain. Capital gains tax only became part of Government policy when the flat tax package was introduced in 1987.

The then Minister of Finance, Mr Douglas, included capital gains mainly as a sop to the Left to gain support for the more radical things he wanted to do elsewhere. He hoped to justify new capital taxes with the rest of the community with company and personal tax rates lower than almost anywhere else in the world. The economic barriers imposed by capital gains tax would be offset by the incentives of a simple, low-rate tax system. That didn’t happen. And it was a con anyway. Despite lower rates, the tax take from individuals and companies has risen dramatically since Labour took office because most of the old loopholes have been closed. Many of the new rules are only just starting to bite now, and are contributing to the profit difficulties faced by many businesses. Indeed, some of these complex new rules contain elements of capital gains tax already. •

The new “accruals” tax regime taxes capital gains on the increased value of financial instruments, even before the profits from such increases are collected. In other words, unrealised capital gains are taxed.

Unrealised gains on investments owned overseas ar? also taxed under the new international tax regime. Shareholders in companies such as the Brierley offshoot industrial Equity Pacific Ltd — one of the biggest on the sharemarket — are just discovering this with a nasty shock.

In the year ahead, they will be paying tax on the increased value of their shares, even though they may not have sold them. In economic theory, this is the fairest and best way to tax capital gains, because it spreads the tax bill over several years and taxes the gains as they occur. One day, in the best of all possible tax systems, there would be an argument for taxing capital income in this way. But in practice, it means investors have to find money to pay tax bills from profits they have not yet even made. For some, it will impose financial hardship, and many will likely sell up. Unless you oppose foreign investment, this is bad news for New Zealand. Superannuation funds also now face tax on unrealised capital gains. In addition, parts of the existing Income Tax Act provide for capital gains to be taxed when investments were made for the specific purpose of capital gain. These rules have tended to be honoured in the breach, because proving that intent is terribly difficult. But the tax authorities have been hardening their approach, and will be emboldened by a recent Court of Appeal decision in their favour in this area.

Before including it in the flat tax package, Mr Douglas had always opposed capital gains tax. He believed it would “stop things happening.” People with assets would hold on to them rather than face a tax bill. At a time of restructuring, that was exactly the opposite of what was needed. The essence of economic change is the revaluing of assets which have got out of kilter with their earning power. Plummeting farm prices after the removal of subsidies is the classic example. That argument holds just as true today as two or three years ago.

Restructuring is still far from complete. While many of those who are going to sell or go bust have now done so, the uptake of new opportunities by the entrepreneurs of the future is painfully slow. Why throw another log in the road at this stage? Sure, capital taxes worldwide are not big money-spinners. In logic, no-one should fear one too much for that reason. But logic does not drive responses to capital gains tax. Its ability to generate screaming headlines is almost unrivalled by any other area of economic news. More important, capital taxes are universally complex and

unwieldly. They distort the playing field as much as they level it by including all kinds of exemptions, thresholds and special cases. And most important, in the current New Zealand climate, a capital gains tax has massive ability to produce negative attitudes to wealth creation and selfbetterment. This is the chief gripe of the Committee Against Capital Taxes — a big business lobby group masquerading as the voice of the “little guy” and formed specially to oppose the capital tax thrust. Its main tactic so fat has been to prime up fears that people will face a tax on the improved value of their homes. “It’s a tax on leisure,” claims CoACT’s director and former chief executive of IBM in New Zaeland, Mr Basil Logan, on the basis that people’s homes become more valuable through amateur renovations. The fact that the Government has more or less ruled out taxing homes has not stopped CoACT whipping up fear about it in seminars up and down the country. The organisation is less forthcoming about its funding, although Brierley Investment, Ltd, admits to being a sponsor and big business interests in Auckland are planning some sort of assault in the New Year. Participants freely refer to CoACT as a “Brierley front,” although it is understood to have wider moral if not major financial support, with even some trade union interests understood to be involved. The group has also paid for a rather dubious poll asking people whether they like the ideal of capital gains tax, and reached the unstartling conclusion that no-one likes the idea of a tax if it might be applied to them. It did go some way to dispelling any belief the Government may have had that a tax on the rich would be a big vote grabber. But the idea of a tax on sharetrading profits and property investment was strongly supported, relative to the findings of the rest of the poll. But whatever its tactics may be, it can only be hoped that CoACT will find success in its primary aim of helping stop a capital gains tax going ahead at present.

CoACT’s strongest argument is that New Zealand’s sayings habits are bad enough anywhay without penalising those who do save with such a highly visible tax. But its proposed solution to the New Zealand savings dilemma is even sillier than having a capital gains tax. CoACT suggests the abolition of personal and company tax and its replacement by a higher rate of GST. For big-ticket items, it suggests GST could be at a higher rate, since the rich would then pay more tax.

This makes the mistake of thinking the\ poor never buy fridges, TVs, or cars, and reintroduces the distortions of the sales tax system GSl\ replaced. Moreover, GSi\ was introduced to broaden the 'courses of tax revenue, not replace all others. A tax system based -solely on GST would be aS leaky and distorting as the old over-reli-ance oh income tax. \ CoACT’s second strongest argument is that the tax system is too complicated already. Indeed, the widespread opposition to capital gains tax in the business community reflects an overload of new tax law in the last four years. The Government has recognised that with the recently announced tax simplification task force.

To make a capital gains tax more palatable, the capital tax document may contain options including the long overdue rewrite of the Income Tax Act. If it took this route, the Government may hope to offset the introduction of a wider capital tax against the improvements which would result for the tax system as a whole. The document is likely to include an option which would include taxing the family home. But it would be suicidal for the Government to endorse it. The Associate Minister of Finance, Mr Neilson, has already hinted at allowing privately owned assets below a certain value to be exempt from any capital tax. Such a threshold would presumably be set high enough to let most people own a house, a bach, and superannuation savings without facing capital gains tax. CoACT argues this would be distortionary, political, and hypocritical since the tax is supposed to be making the tax system fairer and treat all taxpayers the same.

CoACT’s greatest fear is that the Government will announce no tax on family homes, that everyone will breathe a sigh of relief, and business will be socked with the new tax. By tomorrow, we will know that Government’s thinking on capital gains is. There are likely to be several options for different approaches with diferent winners and losers from each. At the very least, reform to existing tax rules are urgently needed to clear up confusion and complexity surrounding such capital taxes as we have. There are also likely to be escape clauses for the Government. The most obvious will be a long, drawn-out consultation process which could mean no final decisions before the election. Yet this in itself is sufficient to damage business confidence and investment intentions, which are haemhorraging badly enough as it is. Putting decisions on hold will also help put economic recovery on hold. Embarrasing as it would be, the Government would be sensible to ditch all thoughts of capital gains tax at least until the economy is stronger.