Stealth tax on savers and families
It seems all but certain that, early next year, the Tax Working Group will advise the Government to adopt a capital gains tax. The idea is that you should pay tax on the wealth you gain as your property and investments become more valuable. At face value, it’s a simple, compelling idea.
Unfortunately, there are spanners in the works – perhaps the gnarliest being the question of inflation.
Each year we get richer on paper, even when in real terms our buying power remains the same. The paper value of an asset tends to increase by about 2 per cent each year, regardless of any real increase in value.
Should we be taxed for these paper gains? The Tax Working Group’s chairman, Sir Michael Cullen, thinks so. At a recent public symposium, he appealed to a sense of consistency, pointing out that we don’t inflation-adjust other parts of our tax system. Why break the trend with a capital gains tax?
Here’s why: to levy this tax on inflationary gains would be to stealthily devastate the finances of New Zealanders who are not actually getting richer. The effect of inflation on capital gains is striking for assets held long-term. Consider a family bach in remote coastal New Zealand, worth $400,000 when the capital gains tax is introduced. After one year, we can expect the property to see a paper capital gain of about $8000. After 10 years of compounding 2 per cent inflation, this gain becomes $87,000. After 20 years, the bach is worth an extra $194,000, merely in inflationary gains.
Now imagine the owner of the bach sells up – or they die, passing the bach on to a relative. Either event triggers the capital gains tax, meaning the seller – or inheritor – is faced with a tax bill from Inland Revenue of $64,000.
That’s based on the Working Group’s suggestion that the tax would apply at the marginal rate of 33 per cent, one of the highest capital gains tax rates in the world. So our bach seller (or penniless inheritor) loses $64,000 in tax on a completely illusory capital gain. This tax bill is, of course, in addition to the tax on any real increases in the bach’s value.
It’s not just residential property that faces such inflationary distortion. Consider retirement portfolios – assets held by savers for 20, 40, or even 50 years. Over this period, an initial nest egg can easily double its paper value. If savings are not exempted from the new tax, this paper gain would be taxed by one-third.
It would be the worst kind of tax: imposed by stealth, robbing savers who might not even realise they’re being robbed.
We are told to accept such a punitive flaw in the new tax because we already accept inflation’s distortionary effects in other parts of our tax system. For example, the nonadjustment of income tax brackets forces us to pay more each year in income tax, despite our real, or relative, income being unchanged.
But why can’t the Tax Working Group address those policy flaws at the same time? Surely, to unpick such issues was exactly why it was set up. More than half of the reply submissions to the group called for the inflationadjustment of tax brackets. Despite previously calling for the public to ‘‘have their say’’, Cullen has simply ignored them.
The group’s plan to enable the stealth taxation of our assets and income based on paper gains looks like a contemptuous revenue grab, and undermines the promise that tax reforms would focus on ‘‘fairness’’.
If the Tax Working Group recommends a capital gains tax on inflation, the Government should declare the proposal dead on arrival.