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Tax ineptitude or tax independence, your choice

There are some important policies that simply can’t be left in the hands of politicians

There are some important policies that simply can’t be left in the hands of politicians

Watching the political debacle unfolding over housing is as excruciating as watching the Black Caps play at Lords. It’s a humbling experience, to say the least.

While I don’t know what is going on with the cricket I can tell you one thing that’s amiss with housing – in a nutshell, the issue of taxing housing is too political to be left to MPs.

There are some important policies that simply can’t be left in the hands of politicians and New Zealand was the first in the world to recognise that this applied to monetary policy, leading the way in creating an independent central bank in 1989.

While we may disagree from time to time over the merits of a particular central banker, overall the ‘experiment’ has worked well as is evidenced by the fact that most countries around the world now have independent central banks. If in doubt about the ineptitude of politicians with monetary policy, just witness the nonsense MPs have been spouting about prudential lending limits – they are clearly unfamiliar with the concept of ‘oxymoron’ because there is nothing ‘prudential’ about ‘carve outs’ for first home buyers.

I think the time has come to consider creating an independent tax authority, ‘under renewable contract’ to Parliament. The tax authority would be tasked with achieving revenue targets subject to operating within prescribed limits set by Parliament such as the balance of revenue to be collected between income, wealth and expenditure  taxes, goals relating to redistribution from rich to poor, and the parameters of some specific corrective taxes such as those currently on tobacco, booze and fuel. This is just like the ‘policy targets’ agreement the Reserve Bank has with Parliament.

Beyond that, the authority would be free to design the tax regime that would collect the revenue in the most efficient way. Assuming they chose the right chief, the tax authority would be governed by the widely accepted principles of a good tax system – fairness, efficiency and simplicity.

New Zealand’s current tax system doesn’t stack up as either fair or efficient because it doesn’t tax the full benefits provided by housing and other types of wealth which produce non-cash returns to their owners. The key example here is the rental equivalent of living in your own home – it’s a real benefit to you just like the interest coming from your term deposit that you also own, but it’s not taxed. Other examples are capital gains on property, shares and other investments.

The result of leaving vast amounts of wealth untaxed is that savings are incentivised to flow into housing in particular, creating huge distortions in the economy. There are a multitude of factors working on house prices in Auckland, but being tax-favoured is a major one.

In 1997 American economist Professor Alan Blinder suggested tax policy should be handed over to an independent tax authority. In building his case Blinder explained why independence was so essential and effective in monetary policy, and drew parallels between monetary and tax policy.

The usual defense of central bank independence is more pragmatic than philosophical: It works, and for three main reasons. First, and least important, monetary policy is a somewhat technical field where trained specialists can probably outperform amateurs from the political realm. Second, the effects of monetary policy take a long time to filter through the economy, so good policy decisions require patience and a long time horizon – two attributes not normally associated with politicians. Third, the pain of fighting inflation (high unemployment for a short while) comes well in advance of the benefits…So short-sighted politicians with their eyes on elections would be tempted to inflate too much…

Blinder, Alan (1997). Is Government Too Political? Foreign Affairs volume 76 No.6 Nov-Dec 1997

Blinder then went to consider whether the same risk factors of technical skill mismatch, political short-sightedness and vested interests plagued tax policy and concluded that they did.

Wealth is concentrated to a greater extent in property compared to most other OECD countries, leaving households and the banking system heavily exposed to a correction in land and housing markets. Supply rigidities and tax incentives that bias savings decisions towards property investment have amplified the increase in house prices, widening wealth inequalities in the form of larger homes for those who can afford them, but deteriorating affordability for the rest of the population. Substantial distortions via tax planning have been evident in rental property markets. Although the 2010-11 budget introduced measures to reduce some of these distortions, further reforms are needed to remove the significant tax bias favouring housing.

Blinder’s idea didn’t get much traction at the time, but then the US’s tax system and those of other countries have been more comprehensive than our own. The US has long taxed capital gains on housing for example, while Europe has had the more sensible practice of taxing wealth directly. The Netherlands even taxes the rental equivalent of owner-occupied housing.  While New Zealand’s monetary policy system was an inspiration to the rest of the world, our tax system is so inconceivably inappropriate that it summons forth derision, albeit often carefully veiled in policy speak. This example is from a 2011 OECD report titled “Policies to rebalance housing markets in New Zealand.”

Wealth is concentrated to a greater extent in property compared to most other OECD countries, leaving households and the banking system heavily exposed to a correction in land and housing markets. Supply rigidities and tax incentives that bias savings decisions towards property investment have amplified the increase in house prices, widening wealth inequalities in the form of larger homes for those who can afford them, but deteriorating affordability for the rest of the population. Substantial distortions via tax planning have been evident in rental property markets. Although the 2010-11 budget introduced measures to reduce some of these distortions, further reforms are needed to remove the significant tax bias favouring housing.

New Zealand has had a housing bubble for over a decade, the fizz went out during the global financial crisis, but it seems to be back. Not only is National pretending the world doesn’t know their dirty little secret (‘we won’t tax you even though we know we should’) the tax policies the Labour and the Greens propose – capital gains tax with exemptions for owner occupied housing – are too timid to be our ticket out of this mess. Not a capital gains tax but a wealth tax which includes owner occupied housing and is integrated with income tax would do a far better job of meeting those principles of good tax policy. See here for an explanation of the difference between a capital gains tax and a wealth tax.

Alan Blinder made a call to arms, we surely more than any other country, should be listening. We succeeded in weaning politicians away from monetary policy, now we must turn our eye to tax.

All societies tend to see their current governing institutions as immutable, as if they were the natural order of things. But they are not. What men and women have created, they can change – and change they should when these institutions grow dysfunctional…the time has come instead for a real national debate over a question that no-one seems to be discussing: Might policies be better, and …democracy stronger, if more public policy decisions were made on less political grounds. It is not an impossible dream.

  • Clive

    The so called housing problem of “New Zealand” should be seen for what it is, an Auckland situation and Auckland alone. There is slight shortage in Christchurch due to the rebuild and problems pertaining to that, but elsewhere in rural provincial and other cities in New Zealand there are beautiful affordable houses just waiting to be inhabited. Why would you live in Auckland’s chaos with its poor infrastructure, it’s lack of coherence etc, unless you were on huge money to afford it, the situation is ridiculous. The Govt should be encouraging young families and people to look elsewhere across the country for further opportunities instead of further compiling everything into Auckland. it is continuing to create two countries in this nation, one is called Auckland and the other is the rest of New Zealand.

    • cosmopolite

      Excuse me, but housing affordability is a grave problem in Tauranga, Christchurch and Wellington. I can also attest to the fact that housing quality in Christchurch often leaves much to be desired.

      When I go to Auckland and Wellington on business, I see bustling cities devoted to making money, like all large cities. The rest of New Zealand lives in a manner consistent with this country being the poorest English speaking country by a large margin. A country built on closely held family firms, producing and trading raw materials. Those who own resources do all right. The rest of us earn wages that are quite modest by international standards.

  • Paul King

    If you tax owner utilised assets, why stop at owner occupied housing? Why not tax clothing, books and anything else that could in theory be rented?

    If other people/society feel I should pay tax on the rental value of my house, would those others equally be willing to reimburse part of my mortgage if the payments exceed the market rental returns ?

    Why would anyone bother to own (or at least pay more than interest on a mortgage) at all?

    On capital gains, surely the fact that other people may elect to upwardly revise their opinion of the value of a thing after I have bought it should in no way impact me while I own it – otherwise what does ‘ownership’ mean? Those others had the same opportunity to buy that I did, and by not buying demonstrated that that thing was in fact NOT worth even the price I paid for it to them. What gives those who demonstrably disagreed with the value set by a willing buyer and willing seller the right to then dictate the ‘market value’ thereafter and to tax me on that?

  • jh

    We have had independent groups such as the Tax Working Group and Savings Working Group but the government didn’t listen. The Productivity Commission gets quoted a lot but the terms of the Productivity Commission were set up such that they were: “relatively uncontroversial given the desire to
    establish broad political support for the Commission”. So the solutions are out there but as Gareth points out the vested interests won’t let them through.

    In order to draw attention from themselves the vested interests have created this “land supply” meme. They are quiet on the fact that a low paid workforce has to fund the infrastructure for a growing population.

  • cosmopolite

    The only simple way to realise what Gareth is proposing is for the IRD to collect a second layer of rates. And collecting this tax from owner occupants and farmers will be as unpopular as it is administratively feasible. And it would be interesting to contemplate how landlords would push hard to shift this tax onto their tenants. I would expect ferocious and relentless resistance from Grey Power.

    I propose a flat tax of 35%, with the ACC levy credited in full against flat tax liabilities. Then pay every legal resident of New Zealand $100/week, with parents receiving what their children are entitled to. The IRD would deduct from this “demogrant” an annual amount equal to 0.5% of the GV on one’s house. This flat tax and the associated national rates could be levied at the source. A wealth tax would be far more difficult to administer, because wealth is easily hidden from the tax authorities. A tax on realised capital gains is enforceable by requiring that the proceeds of all sales of assets be reported to the tax authorities.

    Thank you for drawing attention to the writings of Alan Blinder advocating an independent taxing authority. Just as war is too important to be left to generals, tax policy is too important to be left to MPs. I also had no idea that the Netherlands taxes the rental equivalent of owner-occupied housing.

    The USA does tax realised capital gains on real property and financial assets. But here are four big loopholes.

    1. Realised capital gains are taxed at preferential rates. Households whose total taxable income (including realised capital gains) is under about 100K p.a. owe no tax on their realised capital. Hence the entire middle class is largely excused from paying tax on small sales of shares. Capital gains on households with taxable income between 100K and 450K p.a. are taxed at 15%. Capital gains on households with taxable income exceeding 450K p.a. are taxed at 20%.

    2. Realised capital gains on inherited assets are calculated using the value of the property at the time it was inherited.
    http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States#Inherited_property

    3. For a married couple, the first $500K of capital gains realised on the sale of one’s primary residence are exempt from tax. Hence the vast majority of house sales in the USA result in no taxable capital gains. Capital losses on the sale of one’s primary residence are not deductible.
    http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States#Primary_residence

    4. Capital losses offset capital gains without limit, if both are realised in the same year. Unused capital losses can offset realised capital gains for up to seven years in the future.