Bach idea a wealth tax in disguise
The Government has a habit of coming up with creative new taxes and giving them names to hide what they really are. Buried in the Tax Working Group (TWG) report to the Government is a concerning and ill-considered idea: deemed income.
It can only be described as a wealth tax on families who own a bach or a second home.
The proposal would introduce an annual tax, paid regardless of whether the owner has earned any income from the property or whether it increased in value. It is only one proposal that is being considered, but the mere fact it has been put forward is worrying.
This new tax would not be a capital gains tax, since it would be assessed every year regardless of whether the bach has gone up in value, or not.
It is not an income tax, since it would be assessed regardless of whether the bach is rented out or used only for family holidays.
A tax that applies only to the value of an asset regardless of the income the asset generates – or whether it is sold at a gain, loss or break even – is a wealth tax.
If this new tax makes its way into legislation, it will apply to the ‘‘deemed income’’ on all baches and second homes assessed, using a made-up formulae called a ‘‘risk free rate of return method’’.
What that means is that every year, owners of a bach or second home would include in their personal tax return a percentage of the value of the equity in the property. The percentage will be determined by Inland Revenue using the 10-year government bond rate or some other measure.
Let me give you an example using an ordinary Kiwi family. Tony (an electrician) and Janet (a teacher) are hard-working Kiwis, with two children, earning $130,000 a year between them.
In 1980, Janet’s father bought a bach for $100,000 and the family holidayed at it for years, but later transferred ownership to Tony and Janet to enjoy with the children. Given the bach is now worth $500,000 and the government bond rate is around 2.5 per cent, under the proposal being considered by the TWG, Tony or Janet would have to include another $12,500 of ‘‘income’’ in their annual return.
If the bond rate rose to 5 per cent, which is certainly possible, they would be taxed on an extra $25,000 a year. But Tony and Janet do not rent this bach out, so they haven’t earned the $12,500 they are being taxed on. The bach may not have gone up in value at all.
After paying rates, insurance and maintenance costs on their home and bach, Tony and Janet cannot afford this extra tax, so are forced to sell the bach. The $500,000, when adjusted for inflation since 1980, means they sell at less than the sum Janet’s father paid for it.
So they’ve made a capital loss, and are being forced to pay tax without earning any extra income. This is clearly a ludicrous outcome. How can this proposal be considered remotely viable by the TWG?
It is not the first time Michael Cullen, the TWG chair, has considered this ridiculous wealth tax, but last time his advisers had more sense. In 2001, the McLeod Review conducted a review of our tax system and rejected both a capital gains tax and a wealth tax on second homes.
When it reported to Cullen, then the finance minister, it concluded: ‘‘We raised the possibility of applying the risk free return method to tax the net equity component of owner occupied and rental houses . . . That approach met with such widespread opposition that no government is likely to implement it.’’
There are a range of issues with this tax that offend the fundamental principles of good tax policy. Tax policy needs to be seen by many as fair. That is a subjective judgment, but we know what it is when we see it.
It should be consistently applied so that tax is collected from individuals and entities that have earned income or generated wealth and doesn’t produce silly outcomes.
It should also be simple to collect and ideally progressive, meaning it hits harder the more we can earn or afford.
This new wealth tax proposed on baches has none of those qualities and should never have made its way into the TWG report. If implemented, it could rob future Kiwis of that dream. It should be thrown in the bin.