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Envy taxes also hurt the poor

A two-page feature in the Sunday Star-Times (Aug 3) says Labour’s promise to introduce a capital gains tax and raise the top rate of income tax has put “equality” back at the heart of economic and political debate.  

The only concept of equality the article considers is one where the ideal is that everyone gets the same income regardless of how hard or productively they work.  

In this grotesquely inequitable situation the favoured value for the Gini coefficient measure of equality is zero. New Zealand’s value was put at 0.32, fractionally less equal than the OECD average of 0.31.

Philosophy lecturer Cathy Buchanan and University of Texas economist Peter Hartley point out in Equity as a Social Goal (2004) that a concern with poverty is one thing, whereas a concern with equality all the way up the income scale, regardless of merit or effort, is another.  

The former can be attributed to compassion, the latter to envy. References to the Gini coefficient evoke the latter.

Another comment, also indicating envy, was that New Zealand’s tax system was less progressive than many others, had no tax-free threshold for people on low incomes, no inheritance tax, gift tax or general capital gains tax to redistribute wealth.  

Those making this case also argue that GST is regressive in that people who could not or did not save, paid a higher proportion of their income in GST.

Yet Buchanan and Hartley’s analysis show how a progressive tax structure allows those with middling incomes to gain at the expense of the rich and the poor. This is because a single rate of income tax with a tax-free threshold can always be designed to raise the same static tax revenue as any given progressive tax rate structure, while taxing the poor less. (Even more equitable and efficient would be to use welfare benefits to assist the poor rather than a tax-free threshold.) 

They conclude that progressive marginal tax rates are more equitable than a single tax rate only if one is motivated by envy toward those with higher incomes.

Furthermore, GST is actually a form of wealth tax. A 15% rate of GST reduces the purchasing power of everyone’s savings by 15%, compared to a no-tax situation. Increasing the rate of GST particularly hits retirement savings.

The two-page feature also considers arguments for a comprehensive capital gains tax (CGT). This debate is a misnomer because no country could hope to implement one given the practical difficulties of pricing every asset in every family and business annually.

What is being debated instead is a partially-developed proposal to imperfectly extend the scope of the existing CGT, particularly with respect to rental housing.  

From the point of view of envy, an extended CGT is a no-brainer. The difficult debate is over whether any implementable proposal would make the tax system more efficient. A joint Treasury and Inland Revenue background paper for a Victoria University of Wellington seminar in 2009 showed why it is not obvious that it would.

According to Deloitte, Labour’s proposed tax would exempt the family home, yachts, artworks, inheritances, returns from gambling and the first $250,000 of gain on the sale of a “small business.” Moreover, the tax would only be paid on realisation and losses would be quarantined. It appears there would be no allowance for inflation.  

Such provisions undermine the in principle efficiency rationale for the tax.

Exempting the family home could induce some people to invest in a larger family home rather than in rental housing. A smaller supply of rental housing could lead to higher rents.

Business productivity gains might be taxed twice; first, as at present, on the entire gain in pre-tax income and, second, on the capital value of the gain in remaining post-tax income.   

The exemption for gambling invites financial innovators to repackage futures and options market instruments so that they satisfy the definition of gambling. 

Some, including the Labour Party and an editorial writer for the New Zealand Herald variously argue that a capital gains tax on rental residential property would usefully reduce investment in housing, freeing up national capital and making houses more affordable.

This does not make sense. First, high prices indicate shortage – inadequate supply due to inadequate investment. Indeed, since 2000 New Zealand’s real investment in private residential housing has averaged only 4.6% of GDP. In all the major European countries it has averaged over 5.0%, despite their slower rates of population growth. Moreover, housing was much more affordable in New Zealand before 2000 when the average rate of investment was much higher.  

Second, taxing the supply of something is unlikely to make it cheaper. A capital gains tax on rental housing will probably drive rents up by diminishing the supply. Any envy tax can hurt the poor.

Third, Australia also has a serious housing affordability problem, despite its capital gains tax.

Fourth, any problem of inadequate investment outside housing cannot be attributed to a shortage of capital when there is a global glut of capital.

Houses can be made more affordable by measures that increase the housing stock and household incomes. Freeing up the supply of land for housing and encouraging income growth by rewarding rather than penalising effort, merit and productivity growth would be promising options. Policies pandering to envy are unlikely to tick those boxes.

Bryce Wilkinson is senior research fellow at The New Zealand Initiative.

Comments and questions
31

Parts of this article make sense but parts are just plain misinformed. House prices here have nothing to do with a shortage and there is no way additional taxes could be passed on in rent. All the data points to no fundamental shortage of housing relative to demand for accommodation. Hence rents are, and always have been, rising at tepid c2%pa in line with wage growth amd inflation. If there was a shortage, renters would be price takers and rents would be rising rapidly.
Our currently bubble is entirely fuelled by the historic low interest rates that have been in place from 2010 until early 2014. There has been a flood of cheap money circulating around the world, and the portion seeking "safe" yielding assets that used to go into bonds, decided to go into real assets. They used to get 3-4% pa from government bonds, but this fell to 0% so they bid up property and infrastructure prices (either directly or via bank loan products) around the world as these were relatively "safe" and produced a cash yield; this ended up collapsing the yields to around 3-4%. It is all logical and all intended by the reserve banks, who wanted people to "feel" wealthy to encourage them to borrow and spend.
Now finance costs are rising everywhere and it will (and is in NZ now, look at the data) cause property prices to fall.
Historically Auckland prices grow around 5% per year on average (looking at data over 20+ years) Big rise years are associated with low mortgage rates (eg 15% per year in Ak in 2012 and 2013) You can then expect prices to fall as rates rise to get back to the average (already now happening in Auckland). It is just maths (but sometimes i despair at the lack of basic maths skills in this country).

I think you are confusing the residential housing market with its smaller subset the rental market. They are not the same thing. A tepid rise in rents or low rent yields by themselves imply nothing about the demand and supply of houses available within the residential housing market for home owners to buy. This is a common flaw made when relying on inductive reasoning to arrive at specific conclusions.

Sorry, but that's just plain wrong. A house is only worth what it can earn you, either in saved rent+cap gain, or earned rent+cap gain. Your sort of thinking is exactly the misinformed nonsense that a disturbing number of Nzers are guilty of because they lack basic maths skills. And it will lead to a lot of people losing a lot of money unnecessarily.

The capital gain game is over. The baby boomers rode a generational shift in the cost of finance, where the move to independent central banks and inflation control led to a structural reduction in the level and volatility of interest rates, from 15%+, to c8%. Incomes also grew massively in their working lifetime and as a consequence the vastly increased borrowing ability pumped up house prices here and in all western countries. Most of this was structural but to fund it, it was accompanied by huge household debt growth.
That got us to the early 2000s. Since then, and definitely in the past 3-4 years, people have interpreted the shift from 8% interest rates to 5% as a similar structural shift. But it never was. It was a temporary stimulus worldwide and is being reversed now. If you doubt any of this then i can't help you as that implies an inability to read (the news) as well as do maths.
Capital growth in Auckland is only driven in the medium and long term by income growth and population growth, which supports the historic average of c5%pa. Anything higher is just volatility driven by mortgage rate movements. We have overshot considerably based on temporary low rates. Now expect a price drop as rates drive up, and hey presto we already have this happening. Again, look at the underlying trends in the data and UNDERSTAND what is going on. Don't believe misinformed Herald articles or real estate spin. Volume collapses always lead price drops, and price drops have started-again read the full QV and Barfoot releases, not the "spin" headlines. I am not making this up, it is THEIR data. And importantly, look at the data over a time period and look at the trends.
On the rental portion, The article above talks about landlords passing on taxes to tenants as rent increases. With respect, in a market wih a surplus of available accommodation (lots of empty rental stock), landlords cant pass anything on as they have no pricing power. As a landlord over the past 3 years, i could choose to raise rents by 30-40% to match property price growth, but my house would stay empty. So I would be forced to eat any cost changes. Is is business 101, and it is called margin reduction driven by rising costs in a very competitive market.

Price drops, empty properties, and so on. Not the Auckland I deal in. The influx of chinese money, with soon to open floodgates, with drive property even harder. Traditionally your points would be valid but the world has changed.

Richard, you should double down now then. I'm sure you could find a bank to lend you 6 or 7x your income and give you credit for potential rental income too, so you should quickly buy at least another 2 houses, 3 if you can stretch to it. Don't worry about rising interest rates. Chinese buyers (the most maths savvy people on the planet) will deliver you another 15 to 30% capital appreciation because rental properties should only yield 1 or 2% in a normal world right?

There were high price rises when interest rates were 18% peaking at 23% (I bought my current house at that time), so prices can rise during times of high interest rate. I am not sure why you say price has nothing to do with supply. Look at the small towns in the provinces (e.g. central North Island, Taranaki-New Plymouth and Otago-Southland. The house prices are small (less than $100k for a 3 bedroom house in small provincial settlements). This is below the cost price of building. There is low demand (hence more supply than demand) as the populations are decreasing and there are few jobs.

Don't despair. There's no shortage of maths skills, and even if there were there are plenty of $5 calculators to solve all sorts of things. Now economics - well that's quite a different matter. Otherwise fine.

Article needs some balance.
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Firstly, some in our community and overseas, make a living out of buying and selling houses in NZ, either individually or in buying groups. I actually heard a Chinese chap saying to an agent he was back buying for syndicates. These people target high demand areas.

Secondly, I can see no shortage at present. Listings exceed sales, but in popular areas demand is high, listings are low, property is tightly held and there is no way to increase supply in these areas as there is little or no land. the only way for prices to go is up.

Thirdly, there are huge tracts of land being developed, but the foreigners and some Kiwis are not to keen to buy in those areas, concentrating on the popular areas above, which creates the perception of a supply shortage.

Fourthly new builds are not low cost. Local body charges and hurdles have increased, not deceased, labour is costly due to demand, materials are costly as suppliers achieve good margins due to demand. The licensed building practitioner rule is one such impediment.

In regard to rents, the common thread for those with rental property, is not the rental income that makes the investment work, but the non taxable capital gains, the conversion of taxable rental income into non taxable gain. A property I know was purchased 12 years ago for 296k and is will sell now for 800k. It is rented presently for 520 pw which after rates, insurance and maintenance is a return of around 2.0%.

Finally if interest rates were normal or interest rates like capital gains were exempt fully or partially from tax, investment into property would not be so attractive.
This whole issue is complicated and a move in one direction will cause fall out in another. I Pity the next generation.

A house purchased 12 years ago at 296K, and currently collecting $520pw rent is generating a gross yeild (before rates, insurance and maintenance) of 9.13%. A far cry from your incorrectly calculated 2%. Kind of puts the skids under your equally incorrect argument that it's "not the rental income that makes the investment work, but the non taxable capital gains" doesn't it?

Evening Anonymous, That particular example is factual. the place has a CV of a touch over 800k. That's the capital value of the property, not 296k which was the CV 12 years back.

The return on investment must be calculated on todays value, as commercial sites are calculated..

if the property was sold for 800k in cash, one would expect interest on 800 not 296. If a landlord calculates returns on investment as you describe, they are kidding themselves.

The point of the story is residential rents do not reflect a fair return capital value, landlords seem to accept that because the true profit is non taxable capital growth, about 500k in the above example.

Cheers

Arty.

You can cut it whichever way you like, but a house purchased for 296K 12 years ago that is now earning rent of $520pw is generating a gross return of 9.13%pa on the original investment. And I would suggest that there are many astute landlords who have owned rental properties in the long term who are now earning yields of this amount and much greater on their initial investments, and have invested largely with that intention in mind. Any capital gain is just regarded as the cream on the top. In my experience it is these investors who are making the serious money in the rental housing market and growing their wealth, rather those who are focused on flipping and short term trades upon which a CGT must be paid. The long term investor doesn't pay CGT, and no CGT is paid on properties that are not sold. So while a capital gain is the cream on top of rental property investments, to argue as some do that it is the only real reason for investing in one is not correct.

That is a much more coherent argument than the article above.

Mr Wilkinson seems to confuse the term "investment" throughout, alongside mentions of productivity, value and risk. Housing speculators bidding up the price of existing stock with cheap credit with little consideration for yields but a focus on capital gains are always going to inflate a bubble and aren't "investors" in any true sense of the word.

The notion that these people are contributing to new housing stock in any significant way or providing accommodation that wouldn't otherwise be supplied is laughable. They are participating in a ponzi scheme that they will hope to short at the right moment. Or simply hold for the very long-term as their asset re inflates.

To argue otherwise is to ignore the price of rents which is a much more accurate indicator of demand for accommodation than house prices which in Auckland in particular are simply some kind of modern day tulip-mania...

We need much more considered thinking in this debate than that offered in the article above.

When will people accept that you can't make the poor rich, by making the rich poor?

If the rich earn 80% of the income, they should pay for 80% of the expenses, and that includes taxes. As long as their business provides a surplus, they get there fair share.

This is not the case at present, where the middle earn 15% of the income and are expected to pay for 80% of the expenses, including taxes. The middle move backwards into the poor, and we all know the poor can not afford to pay any tax on income due to the low minimum wage.

Tell me how this is sustainable in the future, because its not!!

Where do you get the idea that 'the middle' earns 15% of the income? Since when did 'the middle' pay 80% of expenses including taxes, whatever that means? That has got to be the worst case of plucking figures out of nowhere I've seen for many a day. You really should learn basic mathematics; and a couple of lessons in spelling and apostrophe use wouldn't go astray either.

This government has shown however that you cyan make the rich richer by making the poor poorer

The rich make themselves rich. The govt. certainly do not make the poor poorer. Quite the opposite.

Really? Try an increase in GST, petrol taxes, increased ACC levies, and so for a start in making the poor poorer...

You forgot to mention low taxes on initial incomes, working for families, community service benefits, and various other subsidies to assist the lower paid. They are extremely well supported through a generous social welfare system.

Of which, the gnats are responsible for?
The tax cuts; more than offset by gst increase for low income workers.

A capital gains tax wont solve the relatively high prices themselves.

If people havent worked it out already, we are in for an extended period of low growth. When you have a combination of historically low interest rates and wage growth which is less than inflation, the masses can not fund anymore debt; unless you pool resources. While this is a possibility, this is not likely to be wide spread, and therefore have any impact.

Owning houses in the next 2 to 3 decades is likely to yield very poor returns, which could actually lead to a reduction to real prices. This may take some time for the relatively unsophiscated residential property investors to work out. Have a long at Japan to see what I mean.

As such taxing capital gains on housing is not likely to be the earner it once was. Notwithstanding this, a capital gains tax on all forms of investment will not be a bad think. Sophiscated investors have used company ownership vehicles to get around not paying tax, and its time this stopped.

If governments want to encourage more home ownership, a land tax on non resident ownership would encourage this. It would provide a compulsory tax for those who manipulate the system to avoid paying any tax. It is also easy to administer.

Back to the article. Fundamentally misinforming:
"… Even more equitable and efficient would be to use welfare benefits to assist the poor rather than a tax-free threshold."

Welfare benefits are neither efficient nor equitable. The administration overhead is huge, they encourage both manipulation and "welfare mentality". SOme people miss out due to pride or ignorance.

"no country could hope to implement one given the practical difficulties of pricing every asset in every family and business annually"

What? Most capital gains taxes work on realisation. Australia has had a workable CGT for years.

"Business productivity gains might be taxed twice; first, as at present, on the entire gain in pre-tax income and, second, on the capital value of the gain in remaining post-tax income"

Ok, Invest for yield and you get taxed on 100% of your income. Invest for asset value increase and lo your gain is 100% tax free. The Income Tax Act requires the gain on any asset purchased for resale to be declared as income. Including your family home if it was really a spec. Something most Kiwis love to ignore. So investors play the game of pretending to invest for the long term only to 'change their mind" and flick an asset for a tax free "capital gain".

How many IPO stags declare their short term gain as income?

"Furthermore, GST is actually a form of wealth tax. A 15% rate of GST reduces the purchasing power of everyone’s savings by 15%, compared to a no-tax situation. Increasing the rate of GST particularly hits retirement savings."
Bryce appears to not understand how GST works. It is a consumption tax. The reason it is considered regressive is because those who are better off are able to save and avoid having to pay GST, whereas those less well off have to spend most of their income. That statement alone means I will be less inclined to waste time reading Bryce's view in the future.

Response to Analyst: "Welfare benefits are neither efficient nor equitable".

Relative to what alternative? Buchanan and Hartley page 171 are explicit that they are arguably more efficient and equitable than a tax-free threshold. Perhaps you have a different counterfactual in mind? If so you are not addressing the point. See also pp 183-184 for a fuller explanation of the reasoning. Downloadable as pdf at http://nzinitiative.org.nz/shop/Library+by+type/Equity+as+a+Social+Goal.html

Response to Aaron GST a form of wealth tax.

Your comment does not address the point that saving is deferred consumption. People save today so they can spend more in retirement. GST taxes future consumption. Raise the rate of GST and the purchasing power of all retirement savings (and bequested wealth) falls. GST is thereby a form of wealth tax.

Not if you pass your wealth onto your kids. They may consume it eventually or you may use your savings to build an investment portfolio from which you only spend the investment income.
GST is a consumption tax and a regressive tax. Pretty weak argument Bryce.

Response to Wakey Wakey
"House prices here have nothing to do with a shortage and there is no way additional taxes could be passed on in rent".

If you believe that the extraordinarily high median house price in Auckland relative to median income is not due to shortage, what do you attribute it too? (Keep in mind that your explanation needs to account for this finding in a NZ Productivity Commission Research Note March 2013 that observed that "Pressure on land prices has been particularly acute in Auckland and land now accounts for around 60% of the cost of an Auckland house, compared to 40% in the rest of the country".)

Another puzzle is how you reconcile your mainstream proposition that rents are determined by supply and demand with your bald assertion that a capital gains tax, being part of the cost of supply, would have no affect on the market for rents.

Response to So dismal is the dismal science

"Mr Wilkinson seems to confuse the term "investment" throughout, alongside mentions of productivity, value and risk."

For the avoidance of doubt, the word "investment" appears 5 times in my article, and on every occasion it takes the same meaning as in the national income accounts. Expressed differently, it refers to additions to the capital stock (as distinct from the purchase of an existing capital asset).

Response to Aron "Not if you pass your wealth onto your kids and GST is a regressive tax"

I take it that we have concurred at this point that GST reduces the purchasing power, in terms of consumption goods and services, of retirement savings and bequests. We also concur that it does not tax savings that don't take the form of deferred consumption, ie deferred consumption today that never induces higher future consumption. In the article, I sought to make the point that GST is a form of wealth tax rather than opine on whether it was regressive, taking this and other points into account. If you want to engage in that debate, one way to enter it would be to ask Google "Is GST regressive? look at the interesting and diverse contributions there and respond to them. You might find that it is more complex and technical than you think. But, if you can strike a decisive blow, it would be great to see it.

I don't think GST is a wealth tax it is a consumption tax. Your argument that it is somehow a wealth tax because it leaves you with less to save would apply to all taxes making income tax a wealth tax as well. Not something I could agree with. Here is a simple example how GST works as a regressive tax, get back to me if you can't follow anything in the explanation.

For simplicities sake assume it costs $23,000 to afford the basics in life. A guy earning $23,000 is paying GST at 15% currently. Even if a guy earning $115,000 spends twice as much($46,000) and saves $69,000 he is paying twice as much GST as the guy on $23,000 but as a proportion of his income he is paying GST of roughly 7.8%. The more he saves the less GST he pays as a percentage of his income. Assuming everyone needs to spend on the basics such as food etc poor people have less choice as to whether they want to pay GST or not and end up paying GST at a higher proportion to their income.

Response to Aaron
Aaron, is this not exactly the (partial) argument that I acknowledged in the article with these words: "Those making this case also argue that GST is regressive in that people who could not or did not save, paid a higher proportion of their income in GST"?
If so, it does not dispose of the point that the issue is more complicated than this because a rise in GST reduces the purchasing power of the capital value of accumulated wealth. Your comment that an income tax hike hits retirement savings is not correct in respect of the capital sum of accumulated retirement savings, but it is correct in respect of the income from those accumulated savings. I don't understand why you write "Not something I could agree with". Can you clarify why not, perhaps again with an illustrative example?