Shake-up needed to alter obsession with tax losses

Just imagine if we taught business students in schools and universities that the aim for any business was to lose money. Surely that would be ludicrous.

How can any business or economy survive without profit? Eventually the cash flow runs out when creditors and shareholders stop pouring in good money after bad.

The value of the assets is eroded by time and new technology, and the business has to reinvest to be able to keep going.

Yet most New Zealand investors and many businesses are doing just that - deliberately losing money on at least $200 billion worth of assets.

They believe they will get their money back through untaxed capital gains and by offsetting these losses against their regular incomes.

A major sector of the New Zealand economy is genetically driven to lose money because our investment culture and business practice cares more about avoiding tax and making capital gains than about making a profit day in day out.

New Zealanders are simply responding to the tax settings, tax policies and financial policies in front of them that say that PAYE income is taxed, profits are taxed, consumption is taxed (a bit), but capital gains are not taxed.

This approach appeared to create more than $400 billion of wealth over the past six years because of the boom in house prices through untaxed and leveraged capital gains.

But the powers that be are determined to change the perverse incentives which mean the biggest chunks in our economy - property and farming - run their businesses to make losses.

Inland Revenue and Treasury revealed to the Tax Working Group advising the Government that property investors owned assets worth $200 billion, but were generating losses for tax purposes of $500 million to $700 million.

They also found 312 people who had traded properties and avoided $212 million in taxes because Inland Revenue did not have the resources to chase them.

They then proposed either a capital gains tax or a land tax. One forecast presented to the Tax Working Group suggested a 1 per cent land tax would raise $4.6 billion, equivalent to 20 per cent of income tax.

A full capital gains tax for all property and shares would raise more than $9 billion over time, although a capital gains tax for property that excluded owner-occupied property would raise just $1.5 billion.

However, this would be enough to pay for a move to a flat tax rate of 30 per cent across income, corporate and family trust tax.

An immediate 1 per cent land tax would reduce land prices by 17 per cent, the Tax Working Group was told.

Introduction over 20 years would cut land prices by 11.5 per cent. A capital gains tax would be hard to administer and could cause "lock in" - homeowners refusing to sell in a bid to avoid tax. A land tax would operate in the same way as rates for local councils, but mean foreigners were taxed and act as a brake on those owning properties to make tax losses.

The one-off drop in land values would also be a dampener on the capital gains-driven model of many of these investors. These changes are drastic for the economy and the way our investing psyche has developed.