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 .

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.

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.

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.

Addendum:
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.

/Henrik