Sir Michael Cullen has revealed the Tax Working Group's capital gains tax hand. The Group has laid down detailed plans for a capital gains "big bang" reform.
The group was well-resourced, powerful, given a clear mandate and circumstances are as much in favour of reform as they ever will be. Even so, the "big bang" reform is not a given.
Sir Michael couldn't carry his whole group with him. A minority (three out of 11 members) see the pathway to a full capital gains tax as too hard to implement and the gains as too small by comparison. That shows implementation of a full capital gains tax is going to be incredibly difficult with associated revenue and efficiency gains uncertain.
A narrow approach centred on residential property is, in the minds of the three no-voters, preferable to wholesale and rushed reform.
It's hard not to agree with both camps: the majority is right that there is an issue to address for a fairness-driven government, the minority is correct that any solution will be imperfect and challenging to implement.
In terms of implementation, the Government first needs to win the fairness argument.
Tax systems perceived to be "unfair" are resented, avoided and generate less revenue. They have higher administrative costs, than tax systems that are perceived to be "fair".
They are harder to police because people will make more efforts to get around them.
I'm not opposed to a capital gains tax in principle. A well-designed, comprehensive, capital gains tax targeted at gains over and above inflation has much to recommend it as part of a fair, broad-based tax system.
The quality of income in the hands of the recipient should not determine its tax treatment. My concern is that in moving from a no capital gains tax world to one in which all gains are taxed at full tax rates with no allowance for inflation is moving from arguable under-taxation to clear over-taxation.
Allowing for inflation is tricky. Many countries have tried, by way of lower tax rates on capital gains, exemption thresholds or calculating an inflation allowance based on the time an asset is held. In failing to take any of these options, Sir Michael's group have left themselves open to views that the pendulum would swing too far against investors.
Any capital gains tax also faces artificial boundaries. As an example of unfairness, take the "family home". Qualifying "family homes" will be exempt: the exact same house falling on the wrong side of the "family home" definition will be subject to tax on disposal.
Any tax will need to have rules to cater for relationship breakdowns, inheritances, home-offices, short-term rentals, use of the family trust, short-term absences and the like. Families with the exact same home, but a slightly different life story, will face markedly different tax bills.
The same boundary problem applies when selling the family business. The group suggests a $5 million dollar average turnover threshold for "rollover relief".
Turnover of less than that and tax can be deferred when business assets are sold and reinvested. Turnover of a dollar more, and tax is due on sale.
The other imponderable is the amount of revenue the tax could potentially raise. The Group assumes around $400 million in the first year (2021/22), rising to $5.9 billion after 10 years.
That compares to a total tax take forecast to be $100 billion in that first year. A capital gains tax on that scale isn't big enough to allow truly ground-breaking personal or business tax cuts elsewhere.
David Snell is an EY New Zealand tax policy leader. Photo / Supplied
It starts as less than 0.5 per cent of total tax revenues, gradually building to around 5 per cent of total taxes. Compensating tax cuts will appear small as demonstrated by the illustrative packages provided by the group.
But will that revenue eventuate? The group's been forced to make assumptions about our future economy and asset values in its underlying model.
That's absolutely the right approach: in their place I would have done the same. And I have no reason to doubt the sources used are the best available.
The problem is, though, that reality never matches forecasts. Revenue will be higher or lower than projected, with a high margin of error.
Capital gains taxes are inherently volatile. When the economy is growing strongly, asset values rise and revenue increases. But in a recession, when the money is most needed, asset prices fall and revenue dries up almost entirely.
None of these points are fatal in themselves. In tax technical terms, a capital gains tax is hard but – as many countries have demonstrated – feasible.
