Time to examine the sacred cow of capital gains tax

11 July 2014
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Professor Craig Elliffe.

By Craig Elliffe

It is time for New Zealand to consider the advantages and disadvantages of taxing capital income. That is why the University of Auckland have asked experts from the United States, United Kingdom, Canada, Australia and South Africa to a conference to learn about the features of their capital gains tax systems - good and bad.

New Zealand spent time and effort designing the world's leading indirect tax (GST). If we can learn from the experience of others in capital gains tax (CGT), then we don't need to make the same mistakes as they did but instead can try to replicate our GST experience.

South Africa introduced a capital gains tax in 2001 (the most recent common law country to do so). Professor Jennifer Roeleveld, who will be speaking at the conference on 18 July says this about her country's experience:

"On the face of it the CGT system works well. There have been no major lobbying, disputes or court decisions to date regarding CGT except for the Estate Duty and donations tax overlap. The fact it is a component of normal taxable income means that no separate or additional administration is required. Incorporation into the Income Tax Act ensures that all anti-avoidance rules, penalties and interest are applicable. It is a good system."

Tax reform requires people to look rationally at the whole tax system from the perspective of the country not their own vested interests. This public policy aspect suggests that we should listen, but not pay undue credence to, people who have their own agenda. It may be they are protecting a preference or advantage that they have over others.

One thing is for sure: an ageing population is going to create some unique tax reform needs. Expenditure on health care and superannuation is unlikely to be funded from increasing income tax on salary and wage earners particularly when this group has moved into retirement mode.

Let's face it: capital gains tax was a sacred cow in New Zealand. However, public perceptions about CGT do seem to be changing; people are thinking more deeply about the fairness of such a tax. For a long period any positive noises about CGT tax would have immediately ended the conversation with an embarrassing silence.

Mainstream banks are supporting the introduction of a capital gains tax, saying there are real benefits outside of revenue collection. The chief economist at Westpac believes it would:

• help right the current misallocation of resources to land (presumably into more productive investment sectors creating jobs and promoting growth); and

• lift the rate of home ownership whilst decreasing property prices (he calculates a 15 per cent CGT would reduce the value to an investor of a given property by 23 per cent).

Other possible implications include making the tax system more coherent and robust so it is less able to be manipulated. Overseas experience suggests that capital gains most often arise in the hands of the wealthy, making it more progressive in tax policy terms than the current complete exemption.

The major drawbacks raised by opponents are that it does not raise sufficient revenue to justify its inherent complexity. The curious thing is that while these two objections have been consistently raised by review committees and working groups over the last 50 years, there is a lack of evidence to support these claims.

But it is also completely anticipatory to say that these problems exist when the design of the CGT could reduce or overcome them.

Back in 1985, when New Zealand introduced GST, one of the principal concerns was how people would cope with the high cost of compliance. The Advisory Panel noted that "concern bordering on anger was very common." Over time people got used to filing two monthly returns and recognised that the broad base and lack of exemptions made things easier to comply with rather than more difficult.

Nearly 30 years later it is now widely accepted that New Zealand did the right thing with the introduction of GST. It is a tax that led to a much more balanced tax system and it is extremely efficient and effective in revenue raising. That success could be attributed in part to its design, the consultation process and the effectiveness of communication on implementation.

In summary the devil is in the detail. Designing a CGT which is fair, workable, practical and still worthwhile is no doubt extraordinarily hard. But we have an excellent policy of broad base and low rate (which our GST exemplifies). Not taxing capital gains is a huge hole in that policy.

Professor Craig Elliffe is a Professor of Taxation and Law at the University of Auckland Business School. Before taking a chair he was for 14 years a tax partner at KPMG and for eight years a tax partner at Chapman Tripp.