NZ Herald 20 March 2010

ASetting a property purchase cutoff date would probably cause more problems and unfairness than it would prevent.

Grandfathering — applying a new rule or law to newcomers but not to those already involved — is seldom used, says Rob McLeod, managing partner of Ernst and Young and a member of the Tax Working Group that advised the government on tax changes.

“I think it unlikely that government would accept grandfathering in relation to restricting rental losses or depreciation in the fashion suggested by your writer,” says McLeod.

One obvious reason is that owners of rental properties exempt from the changes would be reluctant to sell when they otherwise would have sold — perhaps to buy elsewhere, or to invest in something else, or to relieve a cash flow crisis, or simply to spend the money.

They would not do what in normal circumstances would be best for them. Their behaviour would be distorted by the tax laws. And such distortion leaves the whole economy worse off than it would otherwise be.

What’s more, if many landlords keep their properties off the market, that would seriously reduce the supply of property for sale — probably pushing up prices even further out of the reach of first home buyers.

McLeod offers a second argument the government would probably make against grandfathering. “All tax changes have immediate wealth effects, and it’s only where there is palpable unfairness to a segment of taxpayers that grandfathering would be used,” he says.

While you might argue that banning depreciation claims would be unfair to current landlords, others would argue that grandfathering the change would be unfair to future landlords. Why should they be treated differently from those lucky enough to get in earlier?

And what about all those who haven’t invested in rentals and have no plans to do so? Sure, your investment is “perfectly lawful and economically sensible”, but not everyone is in a position to own rental property.

You agree that the tax relief for landlords is “ridiculous”. So perhaps you could acknowledge that you’ve had a good run so far, but the party’s over. Now it’s the non-landlords’ turn to benefit from income tax cuts partially funded by a reduction in your tax relief.

I suppose you’re right, that some property investors could be bankrupted by tax changes. But only those who have borrowed heavily, which is always a risky strategy. I don’t think it’s the government’s role to protect people who knowingly take big risks in the hope of making big returns. And it’s not as if they haven’t been warned that changes were likely.

Sorry, but if the tax laws are going to be changed without reducing total revenue, somebody has to lose. And I doubt if you would find widespread support for the protection of current landlords — most of whom have done very nicely thank you over the last decade.

Which leads me to what textbooks call ex ante compensation. This argument states that when people make risky investments the market takes all the risks into account in the returns it delivers — including the risk of tax changes. In other words, investors are compensated for taking the risks.

If there were no risk of tax changes, rental property returns would have been lower. You’ve received the higher rewards. Now, I’m afraid, it’s time to accept the downside.

There’s a practical problem here, too. If current landlords were exempt from tax changes, it would take a long time before the government started receiving revenue from the rental property sector, instead of sending many millions of dollars its way as it does now.

If we’re all going to get decent income tax cuts, we need you and your fellow landlords to chip in a bit.

AI’m with you. If taxes are raised on rental properties, they will become less attractive investments, so we would expect their value to fall — or at least not rise as much as it otherwise would have.

Some landlords may react by raising rents. Others will sell, perhaps at prices that are rather disappointing to them.

However, disappointing prices to sellers mean attractive prices to buyers. As you say, other landlords — including some new to the game — will buy some of the houses. At lower prices, they will still be a viable investment despite the new tax rules.

And the rather appealing bit, as you point out, is that some people currently renting will be able to afford to buy their own homes.

This will reduce the pool of tenants, which means landlords who raise rents might find it difficult to find somebody to rent to. I doubt if many will be able to keep their rents high for long.

I can understand why landlords feel angry about the likely changes. But — as stated in the Q&A above — I think they are going to have to swallow their change in fortune. Too many have been too arrogant in the past about their burgeoning wealth for non-landlords to feel much sympathy for them.

AI like the idea of holding people accountable if they talk somebody out of KiwiSaver when they clearly don’t understand what the scheme has to offer.

I was told recently that some accountants are telling their clients not to join KiwiSaver. I challenge any accountant to write and explain why she or he is doing that.

On your second point, I thought about going into that last week, but the Q&A was already too long. I also thought — given the young man’s mother’s attitude — that we should take things one step at a time, and at least get him on board.

But you’re quite right. It would also be great if his partner signs up. As a non-employee, she would need to contribute 2 per cent of the minimum wage for at least three years to qualify for the first home subsidy — provided the couple’s income is under $100,000 and they buy a cheaper home. Currently, $11 a week would cover her contribution.

When they buy the home, she could put her contributions and all the returns on her KiwiSaver account into the deposit — along with her husband’s KiwiSaver withdrawal, which we talked about last week. Add to that the couple’s first home subsidies, which would total $6000 after three years rising to $10,000 after five years. Not bad.

As far as their child is concerned, they could also sign up him or her, to get the $1000 kick-start. That wouldn’t have anything to do with buying a first home, but would give the kid a good start at saving.

AFirstly, it’s not all that big a group — somewhat more than 71,000, compared with more than half a million getting NZ Super. Secondly, the vast majority if not all of the 71,000 will also get NZ Super. So it’s not accurate to say they won’t get any compensation.

But clearly what you’re interested in is whether there will be compensation for the loss in purchasing power of the private pensions if GST goes up.

I put the question to Finance Minister Bill English, but didn’t get far. “It would be premature to comment further on the exact composition of the Government’s tax package and the effect this will have on individuals, when final decisions are yet to be made,” said a spokesman. “Those changes will be announced in the Budget in May 20.”

Pension experts tell me some pensions are adjusted for inflation. And given that a GST rise will boost inflation, pensioners in those schemes will be compensated through a bigger inflation adjustment.

Others might hope that the tax changes will end up boosting after-tax returns on pension schemes. This would give the trustees a bit more money to play with, and they might decide to increase pensions.

I suggest you wait to see what’s in the Budget. You might then want to write to your scheme’s trustees and ask “How about it?”