Practicalities & Politics

Practicalities and politics can reduce bright idea to nonsense, even when the economic theory underpinning it is exquisite.
The theory with goods and services tax could be demonstrated and the practicalities dealt with. Therefore the Lange government introduced GST, which this year will account for $9.3 billion of the total tax take of $37.7 billion.
No matter the attractiveness of the theory underpinning the idea that our houses be taxed, on the other hand, the practical problems are profound and the political willingness to talk about it, let alone introduce it, zero.
The idea jumped into the headlines when the McLeod tax review team published its interim discussion document. The McLeod team came up with formula for working out the theoretical income from owning house, based on what would have been earned with the money if it were invested in government bonds instead of being used to wipe off the house mortgage.
The OECD report on New Zealand’s economy last year identified “the capital-revenue boundary” as “perhaps the single most important issue facing the tax system”.
It grumbled that the preferential tax treatment of housing implies that investment is diverted from more productive uses “and possibly contributes to higher cost of equity capital”.
While preferential tax treatment of owner-occupied housing is widespread among OECD countries, “it could have more adverse effects in New Zealand than elsewhere, since private pension saving is not subsidised as in other countries”, the OECD report said.
This means we don’t have the same pool of pension assets to be invested in productive capital formation.
The McLeod discussion paper canvassed the matter in its examination of the country’s income tax base, which it described as “one of the cleanest in the OECD”. The lack of major gaps meant the income tax system “is generally both fair and efficient”.
The two most important gaps are capital gains and the taxation of housing.
Ruling against traditional capital gains tax, the committee said the cost of imposing it is likely to exceed the benefits. The status quo nevertheless could be improved.
The possibilities led the McLeod team to muse on taxing people’s net assets, proposal most obviously affecting shares and residential property.
The concern was that New Zealanders put more of their savings into owner-occupied housing than people in most other countries, partly because owning is more tax-effective than renting and the gains on sale of house are tax-free. This could be tackled by taxing the house value, minus its mortgage.
But so what, if the “income” from owner-occupied housing is not taxed? The McLeod report replied that the system is inefficient, because it induces over-investment in housing at the expense of the accumulation of financial assets. This is likely to result in less investment in assets that generate taxable returns, and more in housing, than would occur if there were no difference in tax treatment.
There’s an equitability argument, too. Two households with the same level of wealth and employment income will be subject to very different levels of tax, if one has its investment in housing and the other lives in rental accommodation and has bank savings.
Lower income households rely more heavily on rental accommodation. Thus more prosperous house-owners get tax break; less prosperous people who rent do not. “The theoretical case for taxing returns to owner-occupied housing is strong,” said the report.
It was an obvious issue for the review to address. It also appears to be impractical and most definitely is politically unpalatable, which means it is fatally flawed.
PricewaterhouseCoopers tax expert John Shewan says three fundamental requirements of successful tax are the ability to measure the value of the gain; liquidity, or the need to avoid cash-flow problems among taxpayers; and perception, or awareness that taxpayers won’t comply with tax they perceive to be unfair. The housing tax bombs on all counts.
While Shewan didn’t blame the committee for raising it, he wondered about its failure to better explain the theory and the trade-offs from introducing such tax.
Trade-offs? Yep. There was crucial condition in the McLeod report: “… we would only recommend such tax if the proceeds were used to reduce taxes elsewhere, restricting the net impact on most taxpayers.”
Trouble is, the trade-off assumes that politicians can be trusted. But let’s suppose government overcame the powerful political urge to steer well clear of the housing tax and took the McLeod report’s advice. Does anyone honestly think the taxes reduced elsewhere would stay reduced for long?

Bob Edlin is Wellington-based economic commentator and journalist.

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