Even a ‘pure’ tax has real costs

Last week Businessnz released estimates of costs relating to a capital gains tax. These estimates were done independently, based on the tax as recommended by the Tax Working Group.

This debate is one of the largest tax discussions we’ve had for some time and it’s important that it considers both the revenue the tax would raise, and also the costs it would incur. To date the discussion has been around the revenue, but there are always costs – compliance, administrative, and economic – with new taxes.

At this stage there haven’t been any other cost estimates provided as far as I’m aware, and it’s worthwhile to understand what the costs might look like. What we provided are estimates, within a range for each type of cost, from low to high. Our estimate of total

costs for five years range from $2.7 billion at the low end to $6.81b at the high end.

Our proposed capital gains tax has a number of features that differ from other jurisdictions. For example, there are no exempt amounts or other exemptions, and there is very little rollover relief (where you sell an asset but the tax is delayed until a future trigger threshold or event).

The rate is high by OECD standards, applying at the taxpayer’s top marginal rate. Some features mean it is difficult to compare general costs of a capital gains tax here with other jurisdictions, although there is that inevitable temptation.

There are some key differences incorporated in the Tax Working Group’s capital gains tax.

First, it is described as relatively ‘‘pure’’ with few exemptions and little rollover to muddy the waters for taxpayers, and therefore should reduce compliance costs.

However, the tax does apply to a wide range of assets so pushing against the simplicity is the breadth of assets to be valued.

We broke the costs into three categories: compliance costs (predominantly obtaining valuations), administration costs (IRD’S costs of collecting the tax), and deadweight costs (essentially the opportunity cost of complying). Compliance and administration costs are probably well understood, but deadweight costs less so.

Deadweight costs are incredibly important. Treasury guidelines explain that most of the costs of a project typically arise from the consumption of resources, such as labour and materials.

But additional costs arise where the funds for the project come from taxation. Taxes encourage people to move away from things that are taxed and toward things that are not taxed or more lightly taxed.

The change in the mix of consumption has an adverse welfare effect which is additional to the loss of welfare resulting directly from the loss of money that is taken away in the form of tax. This welfare loss is referred to as the deadweight cost of taxation.

Attempts have been made at estimating these effects, with estimates varying from 14 per cent to more than 50 per cent of the revenue collected. This guide suggests a rate of 20 per cent as a default deadweight loss value in the absence of an alternative evidence-based value.

Businessnz’s analysis provided a range for deadweight costs: 18 per cent at the lower end, 20 per cent at the Treasury guidance level, and 50 per cent at the upper end.

We acknowledge that these are an estimate, but in the absence of anyone else doing the work we thought it important to have an independent estimate of the costs of the policy.

We encourage the Government to carry out a similar process and provide a robust assessment of the costs of the proposed CGT policy.