The recent clamour for capital gains tax, like so many cries from the mob throughout history, stems from envy and ignorance. But first, let me (totally wasting my time in doing so) say that as a permanent investor, I’m not talking my own book. These taxes don’t affect me.
Frank O’Flynn, QC, a Lange Government minister, put it well when he once said to me, “Tax the tree or tax the fruit, but don’t do both.” This was a reference to income and capital taxes and the desirability of incentivising economic entrepreneurial activit
Roger Douglas had a wise guiding maxim on taxation, namely, in the interests of economic efficiency do nothing that makes commerce behave differently than it otherwise rationally would – which capital taxes certainly do. Roger was the greatest reformer in our political history, among other things scrubbing a labyrinth of hugely inefficient and distortionary taxes, thereby making commerce immensely more productive.
Here’s an example of that distortionary effect. In the 1970s I owned an industrial building company jointly with Brierley Investments Ltd in Sydney. Back then, most companies owned their premises. A successful manufacturer, having outgrown its building, would sell it and construct a larger one. If the price, location and key physical features were okay, we would buy their building, restore it to pristine condition, re-lease and retain it.
But the introduction of capital gains taxes in 1985 by the Hawke Government wiped this niche exercise out. Unlike other commercial property categories, which have a host of value-affecting factors, industrial buildings’ value increases correspond strictly with construction costs. Those were highly inflationary days, so manufacturers found that selling meant losing a sizeable portion of their equity to capital gains tax on an effectively illusionary gain and were now unable to build a new building. So they were forced to reduce their efficiency by renting another supplementary building elsewhere, and locating part of their operation there. It was a key factor in why most businesses, large and small, now lease their premises.
Take our major industry, farming. In 1977, then Labour Party leader Bill Rowling aptly described it as capital-gains farming. He was right in financial terms. But farmers are motivated by lifestyle and as demand to be farmers exceeds the supply of farms, their irrationally expensive market values make them lousy investments. Farmers tolerate that so long as they can keep their heads above water, which, for a sizeable number, is a continuing struggle. But they console themselves with the lifestyle satisfaction and the prospect of leaving something valuable to their heirs, thanks to inflation plus their life-long enhancement efforts.
I reminded my friend Stuart Nash of that three years ago after, as shadow revenue minister, he telephoned me triumphantly about gaining the front page of Wellington’s Dominion Post newspaper. His plaint: farmers pay little or no tax.
“There’s a bloody good reason for that,” I told him. “They don’t make any money.” Their constant reinvestment of their income in productivity enhancement to stay up with the play, be it fertilisers or whatever, benefits us all.
Much of the current clamour arises from the false perception that residential investors are creaming it, buying and selling houses and paying no tax on profits. If they’re doing that, namely trading, then their gains are taxable. Permanent investors, however, are akin to farmers, constantly reinvesting in their properties and achieving lousy net returns but looking to long-term security. Show me a rich residential investor and I’ll eat my arms uncooked. As with farmers, be grateful for residential investors, for if they didn’t exist we’d all be paying to meet the cost of the state filling the ensuing rental housing gap.
Other countries have capital gains tax is another cry. That’s excellent news for New Zealand in giving us an advantage in the competitive quest by all nations for foreign investment. But it’s also a fallacious argument. Other countries have capital punishment, compulsory military training, public floggings, bullfighting, military dictatorships, compulsory prayers; I could go on but since when is what others do our guide? And with taxes, well, other countries have inheritance taxes, stamp duty on every transaction, payroll taxes, tariffs on imports, land tax, and so on ad infinitum. They’re certainly no example in their implicit inefficiencies and inherent costs to society.
Labour’s promise to introduce capital gains taxes reeks of hypocrisy and the negative envy politics of yesteryear, which kept them out of office so long. My first column last year was on taxation.
I observed that my life-long study of tax reform proposals from diverse factions, always without exception, amounted to tax the other fellow. So too with Labour when it inconsistently says it won’t tax the family home. It didn’t say why but I can tell you. It’s totally self-serving as it wouldn’t be elected.