Why a Capital Gains Tax won’t stop the housing bubble

Geoff SimmonsTax and Welfare22 Comments

Capital gains tax is often put forward as a potential solution to the housing crisis. However, recent evidence shows that our de facto capital gains tax – the ‘bright line test’ – is not quenching the market. This accords with overseas evidence that capital gains taxes have little impact on housing speculation, and can even be economically damaging. This is particularly the case when owner occupied housing is exempt from a capital gains tax. For these reasons the Morgan Foundation has proposed a Comprehensive Capital Income Tax (CCIT) instead. A CCIT would be more effective at both stemming speculation and making sure that as a nation we invested in the most productive assets.

Bright Line Test not deterring speculation 

Last weekend’s Q&A revealed that the most common length of time for an Aucklander to hold a property at the moment is less than one year, followed by 2-3 years, then 1-2 years. Under the ‘bright line test’ the Government passed last year, anyone holding a property for less than 2 years has to pay capital gains tax when they sell, though owner-occupiers are exempt. As was discussed on Q&A this shows that investors are willing to pay tax on their gains instead of waiting for 2 years to cash in. In other words, the bright line test is not deterring speculation in the Auckland housing market. Investors are happy to pay the tax on the stellar capital gains they are seeing.

Capital gains taxes don’t stop speculation

This insight puts pay to the idea that a capital gains tax would end speculation in our housing market. It might make a small dent, but it certainly won’t stop it in its tracks.

This accords well with overseas experience. A capital gains tax has done little to prevent housing bubbles overseas. At best it slows the bubble or prevents it getting bigger than it would. There are three reasons for this; capital gains taxes can be easily avoided, they usually exempt owner-occupiers, and a capital gains tax is just one of the many tax loopholes associated with housing.

Avoiding capital gains

There is one easy way to avoid paying a capital gains tax – or in fact any other tax based on a financial transaction – simply don’t sell. It is well documented overseas that capital gains taxes distort the market by encouraging people not to sell their houses. In other words if you don’t make the sale, you don’t pay the tax. The trouble is that selling is sometimes the best option – anything that discourages selling means that expensive assets can end up being used in a less than ideal way. Economists have long singled out capital gains taxes and stamp duties as a handbrake to ensuring assets end up in the right hands.

A Comprehensive Capital Income Tax on the other hand doesn’t discourage assets from changing hands. In fact, they encourage all investments to be used in the most efficient way possible, rather than as a way to minimise a tax bill.

Owner-occupier exemption 

Most proponents of a capital gains tax want to exclude the family home; an approach that is commonplace overseas. The trouble is that this hugely reduces the effectiveness of a capital gains tax. 

Even with the growth in interest from investors in the Auckland housing market, they are still only purchasing 45% of homes. Nationwide some 65% of households own their own home, still the majority of the market. While some people might consider owner occupiers as more ‘worthy’ owners of a property than investors, any tax is going to be far less effective if it excludes the majority of the market. Owner-occupiers – whether buying their first home or moving – are adding to the speculative bubble like every other buyer. When someone makes a capital gain on the family home that is income like any other.

As we have seen overseas, any exemption in a tax makes it far less effective, particularly an exemption this large. Rich people can afford accountants, so they are far better at exploiting exemptions than the average taxpayer. To be effective, a tax system has to be kept simple.

There are other loopholes

Capital gains is just one of the many loopholes associated with land and housing. The ability for owners to write off expenses – even to the extent of making tax losses that reduce their taxable income – is another. However the big tax loophole is imputed rental – the benefit you get from living in a house. This concept is well accepted in economics and is even included in our national GDP accounts. Imputed rental is at least partially taxed in some countries.

To explain the concept try this little mind experiment. Imagine you have $1m and need a place to live. You have a choice – buy a house in Auckland or put the money in the bank and use the interest to pay your rent. If you buy a house you get the shelter and you pay no tax. If you put the money in the bank you pay tax on your interest before you pay your rent.

These other loopholes are important drivers of the demand for housing, both here and around the world. How we deal with them is at least as important as how we deal with capital gains. Our proposal of a Comprehensive Capital Income Tax closes all these loopholes at the same time, putting housing on an equal footing with other investments.

Ultimately what we want to see is stable house prices. Housing should be seen as a place to live rather than a speculative investment. Instead of getting rich by buying houses off each other, our money should be invested in things that are actually going to earn us a real return in the world. A CCIT is the most effective way to achieve all that.


Why a Capital Gains Tax won’t stop the housing bubble was last modified: June 14th, 2016 by Geoff Simmons
About the Author

Geoff Simmons

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Geoff Simmons is an economist working for the Morgan Foundation. Geoff has an Honours degree from Auckland University and over ten years experience working for NZ Treasury and as a manager in the UK civil service. Geoff has co-authored three books alongside Gareth.

22 Comments on “Why a Capital Gains Tax won’t stop the housing bubble”

  1. I agree that ccit is a fabulous idea, and will get house prices under control. However, I feel that the difficulty of dodging it is a bit overstated. For example, I could stash cash overseas, and just bring it to NZ as I use it. My capital here would be basically zero, allowing me to lead a comfortable lifestyle without paying tax. How would the big kahuna handle something like this?

    1. Easy & it’s already covered – you have to declare any income that you are the beneficial receiver of from abroad. So you simply pay tax on the interest on your cash to the foreign government, Under the CCIT you have to make a statutory declaration on all your worldwide wealth if you’re a NZ taxpayer. You already have to make that declaration on your worldwide beneficial income

  2. Could a more simple solution be to apply the rates system that the council does on a national level?

  3. Geoff, how would the imputed rental value be set? In another essay on here I read that it would be 5% of the capital value, as that equated to the return you could get on the money in the bank – please tell me where I could get that much!!

    1. 5% rental return is nothing. It’s also the rate the govt already deems as income on overseas shares investors hold under the FDR regime. So the tax on that (at say 30%) is 1.5%.

      1. I must have misunderstood your comment on the other post that the 5% had some relation to what you can earn on bank deposit. They’re all under 4% at present. If a retired person sold their house and invested the money, they’d put it on term deposit, not into rental property or overseas shares.

        1. Sure but you know it’s all cyclical – we either vary the deemed income with the cycle – so it ranges from say 3% to 15% or we cyclically smooth it at some constant which is far more predictable. Also remember that 5% is only part of the effective return, so even with CCIT we’re not taxing the whole return risk takers receive. Cheers

  4. Next question, where would be the countervailing tax break? I’m sure you don’t plan simply to increase our taxes by this amount. How will you reimburse people whose incomes are too low for their present income tax to be higher than the tax on their imputed rental benefit?

      1. UBI – I’ve heard it said that that will be $11,000 or something in that vicinity. Single National Super is around $23,000. Will superannuitants get the UBI as well, or will there be a trade-off between UBI and super / benefits? This question relates to compensation for the tax on imputed retail benefit.

        1. UBI is not a substitute for benefits, its a part substitute only. So $11k would be too high for a UBI. The main point with UBI is that it recognises that all adults contribute to society – those currently unpaid as well. So child rearers, elder carer, community volunteers would get it as recognition of their contribution. I’m sure you realise that without that unpaid work society would collapse. In other words their is more, far more to GDP than paid work.

          1. I found Geoff Simmons’ talk about UBI, where he was saying that UBI will be paid regardless of other income. Is that correct? In terms of compensating for tax on imputed rental benefit, for some people UBI might not be sufficient.

          2. No the idea is not to compensate for CCIT for every individual asset owner, that would be a pointless exercise right? The idea is to fill in the tax loophole on imputed rental by imposing a CCIT so that now everybody is on a level playing field – those of us who forever have enjoyed the tax break on asset ownership no longer do. Then the next step is to redistribute the excess tax back so that overall there is no additional tax taken. Now you can either do that through tax cuts or via a UBI. It all depends what your objective is. That’s the really interesting part. But for sure under whatever approach you take some will be better off some worse off. In other words the privilege of the tax break some of us have been enjoying for decades will at last have been removed. Sound fair?

  5. “investors in the Auckland housing market [ ] are still only purchasing 45% of homes”

    Agree with much of the article but “only”45%?!! In a housing market 45% of assets being purchased by speculators is a clear sign of an emergency.

    Time to divest some NZD.

  6. I agree investments should be for social good rather than on one of the basic needs of people like shelter. Whilst a CCIT may do something to quell the veracious increase in house prices. The underlying cause is the structure of the banking system that is, fractional reserve banking itself, credit creation by private banks injected into mortgages. This new credit creation could have been injected into investments debt free. Spent rather than lent. This is the arguments of positive money. I would be interested into learning your take on it. http://positivemoney.org/2016/04/affordibility-of-uk-housing/

  7. Geoff this is a well reasoned, logical and compelling argument, an idea that will transform NZ and should have been put in place yesterday.
    But that is why it fails.
    The Government will make some smarmy comment like “I cant see the average New Zealander wanting to pay tax on their family home.” Its a nonsense comment that doesn’t stand up to any scrutiny. But in an environment where hearts and minds are won with 5 second sound bites, wham they’ve won the PR battle and CCIT is dead before a reasoned debate can even begin.

  8. So have you done the numbers on your CCIT? I would like to know what projections are in tax take terms especially in how it relates to a possible drop in personal income tax that could be allowed. Are you hoping Labour/Greens will adopt this new tax regime as I cant see National voters flocking to kill their tax free income?

  9. And saying that the existence of a CGT is clearly not working….that’s because people are not paying it!!!! I know heaps of people that have bought and sold….and they don’t pay CGT because “I intended to live in the house”.Maybe its enforcement that is the issue.

    Bit disappointed with this article, you can drive a truck through the holes in it. not up to usual gm standard.

  10. As I keep saying we don’t have a housing bubble – we have an Auckland housing bubble
    The way to fix that is to encourage people – especially new immigrants to settle in the rest of New Zealand and not in Auckland

    Tax everybody who chooses to damage the NZ economy by living in Auckland
    Say a 10% extra income tax on incomes in Auckland over $70,000??

  11. Good article. I think the other point you missed, explaining why a CGT wouldn’t work is that it is a tax at such a low level. The uplift in house prices is actually an uplift in land price. Land prices rise because of community activity and so rightly the ‘landowner’ should take none of it. An examination of the various CGTs that exist will show it is only a tiny percentage of the uplift that is repaid to the community.

  12. he brightline tax test only came in for houses purchased after 1 October 2015 so people holding for 1 year will only be taxed after October 2016 ie 2017 year. I predict the average time for holding property will rise from 1 year to 2 years Ha ha.. The government isnt interested in taxing profits profits on property.

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