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Capital Gains a Taxing Question Indeed

Whether or not our tax system is fair, there’s little doubt it needs to change. Unfortunately, a recent IRD report has simply added fuel to the fire, writes Ben Tutty.

6 June 2023

New Zealand used to have a reputation as an egalitarian country; a place where everyone gets a fair go. But rising income inequality, house prices and a cost of living crisis have called that reputation into question.

A recent report by the IRD is asking further questions by revealing how much tax (or rather how little) the ultra rich pay. It found that the median effective tax rate of the wealthiest 311 families in New Zealand was 8.9 per cent. That’s less than half the average Kiwi’s effective tax rate (20.2 per cent).

While those numbers are shocking some have claimed they’re based on false assumptions and that the report’s findings are questionable. Others say the report is sound proof that NZ and its tax system is fundamentally unfair. Who’s in the right?

A rather odd picture

Robin Oliver, director of private tax advisory firm OliverShaw and former deputy commissioner of policy at IRD, says some calculations in the report aren’t based on hard data.

“Yes the report produces a low effective tax rate [for the 311 families] but it’s not based on actual numbers. The income figure is based on assumptions about notional income from unrealised gains.”

In other words, the report includes the increasing values of property, businesses and other assets held by the wealthy families as economic income, and it works these values out using models and estimates because the assets haven’t been sold yet.

“That effective tax rate of 8.9 per cent is so low because these unrealised capital gains are included. But it’s a rather odd picture because no-one is suggesting we tax them,” Oliver said. “To my knowledge no country in the world has a comprehensive tax on unrealised capital gains.”

Another problem with the report, according to Oliver, is that it doesn’t take into account inflation and comes to questionable conclusions.

“It doesn’t paint an accurate picture of our tax system. The recent Treasury report is much clearer: it says the higher income you earn the higher tax you pay.”

The objective of our tax system is to raise money to fund government activities and Oliver says it does this very well. “It’s the world gold standard in terms of tax design. It makes a lot of money and it does so efficiently.”

And, most importantly, it’s easy to understand and makes sense to most people. “The amount people are taxed reflects their ability to pay. It’s also objective; your taxable income is based on hard numbers, not the whims of an official or a valuation of your business or property.”

Problem with unrealised capital gains

If we were to tax unrealised capital gains then unrealised capital losses would also have to be allowed as tax deductions in the name of fairness, according to Oliver, and this could raise a few issues.

“Most of the capital gains in the report were from one year during the Covid asset bubble. Half of those gains have reversed so all of a sudden [Grant] Robinson would look at his numbers and see tax revenue has collapsed.”

The next problem is that if you institute an unrealised capital gains tax, many of the super wealthy may simply choose to leave, which could minimise the gains from such a tax. That’s what happened in Norway when their government increased its wealth tax (which includes realised capital gains) from 1 per cent to 1.1 per cent. In fact, more than 30 Norwegian billionaires and multi-millionaires left in 2022, according to Dagens Næringsliv newspaper. Had they stayed they would have contributed $82 million to government taxes per year.

The report raises thorny issues and it’s got its problems, but the main question it’s asking still remains: is our tax system fair? Oliver says that’s a subjective, value-based question, but he thinks it is.

“A third of the population pays negative tax, meaning they get more in tax credits and benefits than they pay. What we could do to make it fairer is move the middle brackets from 17.5 per cent to 39 per cent upward because inflation has meant that more and more people are captured in these higher brackets.

“But the problem is when you move stuff around, there’s holes elsewhere. It’s like whack-a-mole. I’ve got sympathy for Grant Robertson, there’s no one solution and it’s not an easy job.”

Is our tax system really fair?

Shamubeel Eaqub is an economist, author and director at economics consultancy Sense Partners. His assessment is the polar opposite to Oliver’s.

“No, our tax system is not fair. We are not asking the wealthy to pay any tax on the largest source of their income. They are minimising the tax they pay with good accountants, but it’s not their fault, it’s the fault of our spineless tax policy,” he says.

“The report shows very clearly that the majority of tax is collected from people who are working. We have a tax system that’s less progressive than Australia. We want Nordic-style welfare and services but with low US-style taxes. New Zealand being egalitarian is just a pretty little lie that we tell ourselves.”

He adds that the calculations in the report are legitimate because unrealised capital gains are economic income and they do increase an individual’s ability to purchase goods and services. Eaqub claims that those who disagree are simply lying.

“There’s a small group of people who understand issues around tax. There’s so much self interest and so many conflicts of interest. Good public policy can’t be designed by people with self interest. The fox is in the hen house. The question of how these gains should be taxed is a distraction. The central issue is that they should be taxed.”

Running out of money

Whether or not our tax system is fair, there’s little doubt that it needs to change. The fact is, our government has a big problem. The population aged 65-plus is expected to go from 25 per cent to 40 per cent by 2050, causing the cost of superannuation and health care to skyrocket. Treasury estimates that our infrastructure deficit is sitting at $210 billion and climate change is expected to cost a fortune in the future.

These looming costs will demand higher expenditure, but where will the money come from?

Most (including Oliver and Eaqub) agree that squeezing the low and middle income earners for more tax is not a good option. Oliver argues that increasing economic growth is the way forward because more income equals more government revenue. Eaqub says capital gains is an obvious place to start, but he’s not holding his breath.

“We’re a very reactionary country, we make band aid changes but that’s not going to be possible with climate change. The problem is the way we approach public policy is not very sophisticated; there’s very little framing and narrative. There’s never a coherent, strategic vision of how to shape the country, just a laundry list of policies.”

With all that said it’s hard to imagine that significant change will come any time soon, whichever party is in power. But whatever happens Eaqub explains that the two pillars of economic policy should guide any change.

“The two pillars are equity and efficiency, but the equity is lacking. For example, one of our most powerful institutions [the Reserve Bank] doesn’t consider equity or distribution when making decisions. If you can’t do both, you shouldn’t be a regulator.”

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