By Alison Pavlovich
“If we want a fair and prosperous future, we need a tax system that helps to redress market inequalities.”
ACT leader, David Seymour, and National Party leader, Judith Collins, have both labelled the extension of the bright-line test from five years to 10 years a capital gains tax by stealth.
Prime Minister, Jacinda Ardern, alongside her deputy leader and Minister of Finance, Grant Robertson, unveiled the extension of the bright-line test in a press release in March 2021. Gains on land (and the buildings upon it) acquired on or after 27 March 2021 will be subject to income tax if the property is disposed of within 10 years of having been acquired. The bright-line test does not (generally) apply to the main home.
The bright-line test, and many other provisions in tax law, tax the capital gain a person earns when they dispose of land and buildings. Taxation of many land transactions, beyond that of a land dealer, have been in existence in New Zealand tax law since 1973. In the mid-2000s, the IRD stepped up its audit activity in this area, ‘catching’ many transactions which had been overlooked by the taxpayer. Then in 2015, the bright-line test was introduced, taxing gains on land that is acquired and sold within two years, regardless of the reason. In 2018, this was extended to five years. And now it is extended to 10 years. While the bright-line test has been in existence since 2015, the extensions from two years to 10 years will capture more transactions within the income tax net.
Is it a capital gains tax? Yes, it is.
The tax is imposed upon gains made on the disposal of ‘capital’ – that is, the excess of the proceeds over any costs associated with acquisition and improvement of the asset. In tax law, ‘capital’ comprises the structural assets that form the basis for earning income. For some people, it might be education. For others, it might be plant and equipment. And it might also be land and buildings for many others. The bright-line test, and the other land provisions included in our tax law since 1973, all impose income tax upon the realised gain made on disposal of a capital asset – a capital gains tax.
The more pressing question is not whether this is a capital gains tax (which it is), but whether taxing gains on capital is good for society overall.
Traditional tax policy setting has mainly relied upon two criteria: equity and efficiency. Equity is a subjective concept that considers whether a tax or the tax system applies fairly across taxpayers. Modern conceptions of equity include the objective of redistribution. That is, those who have more wealth pay a greater proportion of tax than those who have less. Efficiency traditionally meant that tax should not inhibit the efficient running of the economy, nor should the cost of tax collection be unreasonably high when compared with the tax collected. However, more recently, efficiency has been expanded to accompany or include the objective that tax should not inhibit economic growth. And in some cases, tax policy has been set with the aim of promoting economic growth. So, how do these criteria fit regarding taxing capital gains on land?
The Tax Working Group’s final report, issued in 2019, finds that New Zealand’s tax system is not particularly progressive compared to other OECD countries. A more progressive tax system is more effective at redistribution. Redistribution aims in New Zealand rely upon the Working for Family’s transfers to compensate for market inequalities and a tax system that is not particularly progressive. The Group finds that the failure to tax capital gains contributes to the lack of progressivity. In fact, the outcomes can be regressive – putting more wealth into the hands of the owners of capital.
Failure to tax capital gains is also likely to distort economic decisions – leading to inefficiency in market behaviour. While this is difficult to prove or measure, it stands to reason that a rational investor, all things being equal, will choose to invest in an activity that has low or no tax over an activity that does have a tax cost. The only way to ensure neutrality of investment decisions is to ensure tax applies evenly, regardless of whether the income arises through sales of goods and services, or sales of ‘capital’ assets.
As mentioned, successive governments over the past few decades have included economic growth within their tax policy setting objectives. This has resulted in many tax policies that favour ‘mobile factors of production’ such as money and highly mobile individuals at the expense of immobile factors of production – less mobile labour, and land. Only land has been favoured as well – leaving less mobile labour bearing the brunt of New Zealand’s taxation. Our tax policies have developed to favour those who have wealth over those who don’t – supporting the growth in inequality. Not taxing capital gains is a prime example of this. Capital is inherently held by those with wealth and we have been reluctant to impose tax upon its gains.
Ironically, it is excessive inequality that is now suspected to be one of the biggest threats to future prosperity and economic growth. Excessive inequality is linked with poor outcomes in many areas of life such as mental health, physical health, education and skills development, and opportunities. Aside from human welfare concerns, having a large part of the population living in poverty decreases overall demand for goods and services, decreases the potential pool of talent for innovation and workforce skills, and increases the burden of social need. There is also evidence that more unequal societies invest less in public infrastructure.
For an income tax system to be fair and efficient, tax should not distinguish between revenue gains and capital gains. If we want a fair and prosperous future, we need a tax system that helps to redress market inequalities. If we have a capital gains tax by stealth, then this author says bring it on.
 Income Tax Act 2007, subpart CB contains many provisions that tax gains of disposal of land and buildings.
Alison Pavlovich is a Lecturer in Taxation at Massey University. She is an expert in taxation law.
Disclaimer: The views expressed in this article reflect the opinions of the author and not necessarily the views of The Big Q.