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.