Comment: The Labour Party has now confirmed the widely held suspicion that a capital gains tax is one of its new policies.
Simply put, a capital gains tax (CGT) is a tax on the increase in the value of an asset. So, if an asset doesn’t increase in value, there is no tax. The tax is only on the gain, rather than the total value of the asset. For example, if you buy a rental property for $1 million, make no changes to it, and sell it for $1.1 million, you pay tax on the $100,000 gain.
There is a lot to like (and not like) about the policy. Starting with the positive, it is an attempt to address inequality by extending the group of assets that are subject to tax. This is long overdue.
The policy settings appear relatively simple: a 28 percent tax on commercial and residential housing, excluding owner-occupied homes. Simple policy is likely to improve compliance.
Hypothecating (earmarking) the tax for a specific purpose—that is, health spending—is likely to improve its acceptability. Research has found hypothecation for health and education generates public support for tax increases.
Pragmatically, the policy excludes inherited property and other property eligible for rollover relief (e.g., property transferred under a relationship property agreement). These same exemptions apply under the existing bright-line rules. However, property that is not always used as an owner-occupied home may be subject to the CGT for the period that it falls within the scope of the CGT—for example, a family home rented out while the owner is seconded in an overseas role.
There are also some questions and issues. The tax system is usually symmetrical, i.e., where a gain is taxable, a loss is deductible. Someone who sells a property that is within the scope of the CGT for a loss, would have the loss ring-fenced to be used against future capital gains. If that person does not have future capital gains, it appears the loss would be forfeited.
Typically, annual profits on investment property are not high and many property investors are in the market for the current tax-free capital gains. Therefore, the CGT will change the attractiveness of residential property as an investment and we could expect to see downward pressure on the property market. At a time when property values are mostly declining or static, depending on where you live, the impact of the CGT may be felt outside the intended group.
The politics are problematic. The National Party does not support a CGT. To the extent that the tax, if implemented, could be reversed with a subsequent change of government, this may result in some property investors holding on to properties longer than intended with the aim of selling if/when the policy is reversed. This is similar to the ‘lock-in’ effect that is associated with capital gains taxes on property.
Also problematic is the ‘mansion effect’. Someone who can afford a $10 million owner-occupied home in, say, Remuera will pay no CGT. But someone who owns a $500,000 home in, say, Otaki and a $500,000 bach, will pay CGT when the bach is sold, despite having only 10 percent of the overall wealth of the illustrative Remuera homeowner.
Different effective tax rates (the average percent of total income paid in tax) would apply to those with capital gains. For someone with a low income, 28 percent on capital gains may be higher than their marginal income tax rate. For someone with a high income, 28 percent on capital gains will likely be lower than their marginal income tax rate. Labour leader Chris Hipkins claims the CGT proposal is “the most progressive tax change in a generation” but a progressive tax system taxes on ability to pay—and, for some, the proposed CGT may not do this.
The policy announcement came with several references to the Tax Working Group recommendations. But no explanations were provided for the different policy settings adopted to those it recommended.
For example, the group recommended including investment property, land, shares, business assets, and intangible property within a CGT. Labour is proposing only residential and commercial property is included. While this is simple, it cannot be considered fair or efficient. It could also distort investment, as other investment options—e.g., shares—are excluded. New Zealand would remain one of seven OECD countries that does not comprehensively tax capital gains on gains from share disposals.
Inland Revenue’s 2023 high-wealth individuals research project report observes that “capital gains are a significant source of untaxed income for high-wealth families” and most capital gains accrue to those in upper net-worth deciles. Yet many of the high-wealth household asset categories are outside the scope of the proposed CGT. For example, the report showed that some asset groups, such as financial assets, are more concentrated in “upper net-worth deciles” than other asset classes, such as owner-occupied property.
Could the policy have gone further? Yes. But as a first step, it is better than nothing. And, of course, the more radical the proposal is, the harder it will be to sell to middle New Zealand. The challenge now will be for the Labour Party to effectively communicate the policy to voters.
This article was originally published on Newsroom.
Lisa Marriott is a professor of Taxation at Te Herenga Waka—Victoria University of Wellington.