NZ Herald 20 May 2006

AI’ve spent a good chunk of the week wading through a huge number of letters about the proposed tax changes. But the above excerpt from one letter is what has stuck most in my mind.

What are we doing here, making law-abiding citizens sick with worry? The way the changes are proposed, it’s quite likely the woman won’t have to sell savings to pay the tax. But the whole thing is so complicated that she is certain to need an accountant — indeed so complicated that accountants will themselves often need guidance.

I started out, a few weeks ago, planning to answer readers’ questions about the proposed taxes with the help of the officials who drafted them. There’s logic behind their moves, and I thought if people understood it more, they would cope.

By now, though, even if I worked full-time on it and the Herald gave me a couple of whole pages, I couldn’t cover everything. There are too many questions.

And it’s not as if people can turn elsewhere for help. Because the changes are only proposals, the government is not offering much in the way of education yet. But in the meantime, people need to know how the changes would affect them so they can make submissions while there is still a chance to change things.

The situation is mad.

The heart of the problem, it seems to me, is that the officials are proposing changes within an already flawed tax system. They will remove some flaws but inevitably create others.

Let’s step back and look at the system. How do we raise money to pay for government? Mainly by taxing people’s incomes — wages and salaries, interest, dividends, rent and so on. In New Zealand, unlike most developed countries, we don’t have a capital gains tax. Those who pay tax on their gains do so because their gains are really income.

Why shouldn’t capital gains be taxed? Arguably, the gains that people are lucky or skilful enough to make merely by holding an appreciating asset should, in fact, be hit harder than the wages people make by working.

What we need is an inflation-adjusted tax on all capital gains, much the same as income tax. We shouldn’t be taxed when we sell shares, property, collectibles or whatever to buy other assets, only when we turn the money into cash for spending.

With such a regime, many of the current problems addressed by the proposed tax changes would disappear — as would many of the new problems likely to arise if the proposals become law. Simplicity would reign.

Before you all rush to write protest letters, please read the following at least twice: Just because you make some capital gains, that doesn’t mean a capital gains tax would hurt you. Other taxes could be cut, and many people would end up paying lower total taxes.

Everyone would also benefit from the removal of distortions in investment decisions. If we can all choose what’s best for us without having to weigh up tax consequences, total wealth will increase.

And while accountants and lawyers would get less tax work, we would free up some bright people to help solve other problems.

In total, many more people would be helped than hurt, especially those whose income comes mainly from work and/or interest payments. Only a relatively small number of people make frequent large capital gains.

That’s not to say I want to sock it to the rich. Many of them employ others and help the economy to grow. But those who are high salary earners would benefit from the lower income tax rates. And the more efficient economy over-all would attract many wealth creators.

In any case, I keep hearing that the current proposed tax changes will put off wealthy people from coming or returning to New Zealand, or encourage those already here to leave. “If this goes through,” writes one reader, “we’re leaving New Zealand, which saddens us. I just will not submit to this unfair tax.”

A simple tax on all income and capital gains, at lower rates than currently, might well be more palatable to such people.

There are, however, three concerns about my proposal:

• Would our own homes be taxed? Ideally, yes, to prevent people from putting more of their savings into their homes than they otherwise would. As I said above, distortion makes us all worse off.

  In reality, though, I might have to concede that New Zealanders would cough and splutter over being taxed on gains on their homes. An exemption on the main home, but not on baches or rental properties, would probably be necessary.

• Retired people who would pay the capital gains tax wouldn’t be able to offset that with lower taxes on wages and salaries.

  While many retirees would benefit from my plan — as their main sources of income are NZ Super and interest — some mainly wealthier retirees would be worse off.

  But is this so bad? Many would be compensated by the fact that their families are better off. Beyond that, is it too much to ask the wealthy retired — and for that matter other wealthy people — to accept higher taxes for the good of the country?

• People might steer away from investments that generate capital gains.

  Arguably, we are currently overly attracted to property. This helps push house prices beyond the means of lower-income families. So less property investment would be okay.

  What about shares? This worries me. New Zealanders are already too scared of shares, probably because people got so badly burnt in the 1987 Crash. The introduction of a capital gains tax wouldn’t help.

  Hopefully, though, with ongoing education about diversification, the need to invest for the long term, and the superior returns shares can bring, shares will end up playing the appropriate role in people’s portfolios. After all, Americans are taxed on capital gains, yet shares loom large in their long-term savings.

Over all, I reckon the pros of a capital gains tax easily outnumber the cons.

I’ve hesitated to write this. Apart from angering those currently favoured by our distorted tax system, I know I will also be dismissed as unrealistic.

Just the other day, Brian Fallow wrote in the Business Herald that a capital gains tax “is a politically poisonous proposition. At the height of the mid-1990s boom, then (Reserve Bank) governor Don Brash suggested a capital gains tax on investment property, but the MPs on the finance and expenditure select committee shrank back in their seats as if he was offering them plutonium lollipops.”

I reckon, though, that politicians underrate the rest of us. New Zealanders are not stupid. Introduce a new tax and of course we will hate it. But lump it in with other tax cuts and a simpler, fairer system and most of us would learn to love it.

In the next few weeks, when submissions are sought over the proposed tax changes, if enough of us ask the government to consider taxing all capital gains whilst cutting tax rates, who knows what might happen?

AFrankly, I can’t think of anything less enjoyable!

A reader made a similar suggestion to yours in a recent column, but I dismissed it because the Aussie tax would apparently be tough.

Your idea might be different enough to work, but let’s not go there until the final legislation is known.

I ran your letter, though, because it shows what people like you, a chartered accountant, will inevitably do if the proposals become law — find ways around them.

As one reader says, “Like most, I will avoid paying my hard earned money on taxes based on theoretical paper gains derived offshore. There is simply too much at stake not to spend some significant effort avoiding these taxes, taking resources from more productive tasks.”

Adds another, “This proposed change to overseas investment capital gains taxation gives every appearance of being a piece of spite legislation, poorly thought through, and positively inviting the law of unforeseen consequences to come into effect.”

I agree. Even the cleverest government officials can’t predict every possible way around new tax legislation, especially when it’s as complex at this lot. Which leads me back to my lovely simple capital gains tax idea.

AThat might be the ultimate unforeseen circumstance, a baby boom.