Capital gains tax: An issue of structure, not boom and bust

So it seems that our Prime Minister is opposed to a capital gains tax on housing.  His reason for this isn’t political, it is because he believes that it wouldn’t help.  His reasoning is:

I’ve repeatedly said I’m quite happy to say today, I personally don’t like capital gains taxes. I don’t think that they work very effectively, they certainly don’t stop housing booms, I mean the United States, Australia and the UK, all have a form of capital gains tax on housing, and it hasn’t worked, they all had housing booms

I agree that a capital gains tax on housing wouldn’t have prevented the “boom and bust” cycle that has been experienced in the market.  Of course, this completely misses the point of why we would want a capital gains tax on housing.

Ultimately, by not taxing capital gains on housing while taxing capital gains on everything else we increase the relative attractiveness of housing as an investment.  By doing this we end up with a relative misallocation of resources towards housing instead of other assets – which is inefficient.

Now how does this balance with the belief that we have under-invested in housing?  Well we could say that, instead of building too many houses we have been over-investing in making the houses we have attractive.  Of course is this believeable?

However, there is another way to explain why we seem to have an undersupply in housing even though the capital gains tax is inefficient.  There are other inefficiencies on the other side of the ledger!  The RMA and the convoluted process of getting consents has limited the increase in the housing stock, even as the lack of a capital gains tax has made new properties more attractive.  In this case it would probably be best to fix all inefficiencies, including the CGT, rather than letting the odd one slide.

Furthermore, there is another way we can view the capital gains tax as an issue.  It influences the composition of savings.  We currently have a group of people in New Zealand who have primarily saved by buying a house partially because of the lack of a capital gains tax.  This makes these people vulnerable to sector specific shocks (such as a rapid decline in house prices), which is a concern.  However, this also makes the idea of introducing a CGT difficult – as this would be a sudden, unanticipated, shock to this groups lifetime wealth.

So in the medium term, we need a CGT on housing to ensure a (relatively) efficient allocation of resources methinks.  However, we also have to ask whether the short-term cost to current investors in residential property is “fair”.  If not we then need to ask if we could “compensate” them and still come out with a better outcome.

19 replies
  1. Matt Nolan
    Matt Nolan says:


    Depends in part on the relative size of the consumption and income taxes in society. Furthermore, it depends on whether we do have an effective capital gains tax anywhere else. At the moment some types of investment are subject to an effective capital gains tax (shares) while others are not (property) – this is the issue I am concerned with.

    I support having everything taxed equally so as to minimize the mis-allocation of resources associated with tax avoidance.

  2. Eric Crampton
    Eric Crampton says:

    I’d thought that the capital gains tax on shares only came in where the gains are effectively income, like if you’re a day-trader; buy and hold folks, or Kiwisaver accounts, don’t get a capital gains tax. Alternatively, if the company restructures dividend payments as share buy-backs to have an income stream turn into a capital gain, there’d then be tax on that.

    I’d also thought that housing was treated identically: if you make your living flipping houses rather than having longer-term investment properties, you’re taxes on the gains as income; if you have a few rental properties you’re taxed on the rental income and write off your expenses.

    Where am I wrong? I’m no tax expert.

  3. Matt Nolan
    Matt Nolan says:

    @Eric Crampton

    Indeedy that is my impression of how things function as well.

    However, the way I see it this implies that the CGT issue could exist in two ways:

    1) It is a non-issue as housing is virtually included, and as a result we don’t even have to think about it.

    2) For some reason housing is being excluded from the “base” of capital gains taxes in some manner – either through legislation or through enforcement. If this is the case, we should broaden the base of where the capital gains tax effectively falls – so it doesn’t screw around with the relative price of investment.

    My impression is that Treasury feels the second way – and I have been told by people that there is a significant “tax wedge” between property investment and other types of investment. If this is the case we should clean it up.

    Tax isn’t my area of technical expertise either (that is what my brother looks at) – but I’m all for trying to prevent issues with the allocation of resources 🙂 . Looking at how the tax system functions, and whether there is an effective and appropriate tax on capital gains through income, is an important part of this. And it is appropriate for STRUCTURAL reasons, not the random “bubble” reasons that John Key raised.

  4. Eric Crampton
    Eric Crampton says:

    Yes, if the government were to implement a broad CGT, excluding housing would be distortionary. So, should we tax on an accrual basis and throw old folks with low income out of their houses, or tax on a realized basis an induce inefficient holding onto housing when a move would be efficient and thereby increase unemployment rates? Or, only consider investment properties?

    There was a LOT of focus at the NZAEs on property or land taxes: Grimes and Coleman. It’s in the wind….

  5. Dave
    Dave says:

    @Eric Crampton, NZ also has a CGT on unrealised capital gains for foreign sharemarket investments, making the treatment of shares vs property even more inequitable.

    The IMF reviewed NZ’s tax treatment of property investment ( against other western tax regimes and found it had the most favourable treatment of all of them for investors: mortgage deductibility, no CGT, limited property tax, negative gearing allowed, depreciation allowed. It is this toxic combination that needs to be looked at, not just CGT.

  6. Bill Bennett
    Bill Bennett says:

    I think Australia has this about right. CGT, but not on the family home. That does a great job of equalising the tax on different forms of investment without penalising people needlessly. But I’d also like to see a brake on negative gearing — which strikes me as just plain wrong.

  7. Andrew Coleman
    Andrew Coleman says:

    There are a lot of issues here. To tackle one, Matt, I think you are correct that the difference in the taxation of different types of capital income is a major problem. In particular, the government taxes the inflation component of interest income, but in general does not tax the capital gains caused by inflation. This creates a bias against interest earning assets, even when the inflation rate is at moderate 2 – 3 levels. But it is not clear that a capital gains tax is needed to solve this problem. If the government exempted the inflation component of interest income from tax (and only allowed the real component of interest payments to be deducted against tax), there would be a much more equal taxation of different classes of assets. This suggestion would also mean that the simplest asset class in the economy – interest earning assets – one favoured by the elderly and by those who are least financially sophisticated, would not be subject to the highest real tax rates. (For this reason the current situation where the Government taxes the inflation component of interest income is morally repugnant, as well as distortionary. It disproportionately falls on widows, and should be called what it is : a widow’s tax.)

    Modelling work done at Motu in the last year suggest that a capital gains tax (with or without an exemption for owner-occupied housing)will raise rents and home-ownership rates in the long run, although the effects on welfare are ambiguous. A similar result would occur if you were to exempt the inflation component of interest from income tax. So why add an extra tax if you could achieve a similar result by getting rid of one?

  8. rainman
    rainman says:

    @Land and others:
    Instinctively, I favour CGT on investment properties only – and I can see more sense of the arguments in favour of this approach rather tha on al properties. But then I’m a) not an economist, and b) a cash-strapped homeowner with no investment properties. So I’m keen to hear a wider debate 🙂

  9. chris
    chris says:

    interesting read on the capital gains tax and housing, i would agree that it as well should have a CGT of about the equivalent of other investing areas.

  10. Mark
    Mark says:

    The CGT with an exception would allow for taxing real income gained through buying and selling property but protect the old folks who spent decades putting all their equity in their home. There could be a provision for a single “windfall profit” built into the new system to protect people who were not income generating investors. I favour the CGT on property so as not to make it a special investment opportunity.

  11. Henrik
    Henrik says:

    Interesting view on the capital gains tax and housing, I agree more or less on all the points pointed out.


  12. Robbie
    Robbie says:

    Given that we have a dividend imputation system, I don’t think that we need a capital gains tax in order to create an even market for capital.

    Firstly, I want to exclude professional traders. If you flip houses, you are in part being paid for your work as a handyman, just that it gets capitalised into the house. Naturally these products that you sell should be taxed like everything else (and are under the current system).

    When you sell an item, you also sell the future tax liabilities
    Suppose a person were to realise capital gain on a house. For rental housing this gain results due to the increase in the PV of expected future cash flows from the house. Say this increase is $10,000. However this stream of cash flows can only be sold for $7,000, as tax is payable on the income stream. When the investor sells the house (the future cash flows) they also sell the tax liability.

    2. A capital gains tax tilts the playing field.
    Under existing tax policy, the investor is indifferent between trading the property or holding on to it – the expected profit is the same under both circumstances. However if we had a capital gains tax, then the investor would be taxed twice on the income if he trades the property, however only once if he holds it to maturity. The same applies to an equity holding. If an investor believes Infratil is undervalued, he buys and the rest of the market agrees, at present he is indifferent between trading for other securities that he believes have better potential, or to holding on to maturity.

    3. As a result, a CGT impedes the price discovery mechanism.
    Any tax is going to create a wedge of deadweight loss. However a tax on realised gains like this creates a transaction cost and warps the incentives to allocate capital among different alternatives – ostensibly the reason that we have capital markets in the first place.

    If we want to discourage property investment, CGT a good way to do this. However we should realise that we aren’t doing so for reasons of fairness or in order to restore even incentives in the market, we actually distort the market.

    This logic only applies to a dividend imputation juristiction. Where you have double taxation of dividends (e.g., the USA) then a capital gains tax is in keeping with the overall structure of the system.

  13. Matt Nolan
    Matt Nolan says:


    Hi Robbie,

    I think the wedge that is discussed could be captured in current law – so it is more an issue of implementation.

    Currently, a number of people hold property as they do not expect any capital gain to get taxed (unlike other income) – so you buy a house, sell it for $50k more, and as long as you say you didn’t do it in order to get the capital gain you roll off with $50k untaxed. This creates a wedge between effective residential property investment and other forms of earning income.

    Now, if we made it explicit that any capital gain on property would be taxed for anyone this wedge (and misallocation towards housing) would not exist.

  14. Matt Nolan
    Matt Nolan says:

    @Andrew Coleman

    Indeed, very interesting.

    I agree, we shouldn’t tax nominal income changes – hell our income tax brackets should adjust for inflation as well.

    Hopefully this is the sort of thing that gets pushed in the coming months.

  15. Ken Shock
    Ken Shock says:

    (already posted @

    I suspect that you have not ever been subjected to a ‘capital gains’ tax?? As a US and NZ taxpayer, I can tell you that the capital gains tax I have experienced for most of my life is onerous.

    1. it is expensive in terms of time and money with respect to the record keeing and professional services required. Example, you have held a property for 30 years. When you sell this you must have kept track of every capital improvement over this time. You must be prepared to defend against the IRD where they will say that your ‘capital improvement’ is actually a repair or maintanence expense.

    2. Where you have shares, and you have added to the position over time – and you have held the position for a very long time, you must have all records. Any lost record leads to being unable to demonstrate the ‘basis’ of your investment – you are faced with a capital gains tax that is well above the actual gain. Also, you must account on the basis of first in, first out – if you sell out portions.

    3. No nation that has got capital gains taxes discounts these for inflation, inflation created by the government itself. So, for example, you sell a house you purchased for $50K 20 years back – for $300K. The inflation may have averaged 4% over that time (which raises the issue of whose inflation number is correct) – over $60K of the ‘capital gain’ they will assess is NOT A GAIN. So, capital gains taxes confiscate capital!!!

    The practice of flipping houses that you wish to discourage can be addressed by tightening current tax law in simple ways.
    1. Reduce the amount of rental property ‘losses’ that can be deduced from other forms of income (tax shelter)

    2. Reduce the depreciation rate allowed on rental properties (tax shelter)

    3. Strengthen regulation that would consign ‘flipping’ houses to trading. Persons who are deemed traders do NOT fall into the capital gain category of taxation – thier ‘flipping’ income is regular income under current IRD regs – but enforcement should be tightened if flipping is to be stopped!

    Capital gains tax slows investmet in productive enterprise, and may well cause a flight of capital to Singapore ect… (including mine)

    More problems with capital gains taxes.

    1. they distort the economy by causing decision makers to delay transactions beyond the ideal economc timing – in order to defer taxes into the next tax year.

    2. once the capital gains tax is in place, tax hungry politicians start complicating the tax structure further – causing more economc distortions! In the US there are: short term capital gains tax (higher rates), long term capital gains taxes, various extreme distortionary rules – such as taxing gains into infinity, but only allowing $3,000 in capital losses against regular income etc etc ad nauseum. These are time consuming and require professional accountancy, often.

    3. New Zealanders have not had these time and money wasting complications in their lives, therefore – and this is a huge isssue – they have not retained the necessary records of their lifetimes of investments. They will therefore have no means of proving the capital basis of their real property to the IRD – a catch 22 .

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