Bernard Hickey: Land tax the fairest route

A 1% tax on the value of land would raise $460m a year and substantially cut land prices. Photo / Michael Craig

The Reserve Bank's suggestion to revisit tax incentives for landlords has highlighted how poisoned that debate has become after voters rejected the Labour/Green Capital Gains Tax at last year's election.

Watching Labour leader Andrew Little squirm over a policy he doesn't want is like watching a hospital-pass recipient a split second before Ma'a Nonu arrives.

Even its supporters acknowledge a Capital Gains Tax is slow, clunky, difficult to administer, hard to apply widely and may not raise that much revenue, at least in the short term.

It also applies to plenty of non-landlord activity that risks creating a swathe of collateral damage.

It was easy for Prime Minister John Key to destroy it in the eyes of the public, particularly when then Labour leader David Cunliffe appeared not to be on top of the detail.

With Capital Gains Tax off the table, what's the next idea boffins and politicians will turn to in the attempt to reduce tax incentives for rental property investors?

The 2010 Tax Working Group looked at a land tax. Arthur Grimes, a former Reserve Bank chairman, proposed it.

It is simple, clean, and he estimated a 1 per cent tax on the value of land would raise $460 million a year and cut land prices by 17 per cent if it was introduced up front.

It would prompt more intense development of land and also encourage land bankers to build, something the Reserve Bank and the Government say they want.

Farmers and iwi would not be thrilled, but it would be the sort of broad-based and low rate tax that works best.

A less simple, but cleaner and more targeted option is one proposed this week by former Treasury deputy secretary John Crawford. He suggested the IRD apply a deemed rate of return on a rental property then tax it at the usual income tax rates.

It would mean IRD would look at the council valuation of a property and assume it returned, say, 8 per cent a year, which reflected the likely capital gains and cash profits from renting.

A $500,000 rental property would be deemed to have a return of $40,000 and the landlord would have to pay tax on that income.

The actual income from the property would be tax exempt and so there would be no padding of accounts with expenses in any sort of negative-gearing sense. There would be no escape.

This is a model already applied by the IRD when working out the income earned by investors in overseas funds.

Crawford proposed it only apply to residential property investment and not to owner-occupied or commercial properties.

That would keep the tax nice and targeted and away from farms and other businesses. It would address the Reserve Bank's concerns about the tax incentives for landlords pumping up a housing bubble that could burst and damage the banking system.

It would also help solve the Government's fiscal problems and reduce the risks that over-valued property in Auckland turns into a rental boom that forces it to pay much higher accommodation supplements.

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