July 2001

The news from New Zealand this week stunned me.

There is, probably at tax-payer's expense, a study being undertaken to advise the government on changes to the taxation system that should be entertained.

This week they released their interim report. Known as the McLeod tax review, the most startling suggestion is that too many New Zealanders have money tied up in property, and that to discourage this, we need to tax the equity in those people's homes (be they owner-occupied or investment properties).

In other words, if you bought a $100,000 property using a $100,000 mortgage, then you would not pay this tax. But if the value of the property increased over time to $500,000, and the mortgage was still at $100,000, then you would be taxed on the equity of $400,000.

Long-term readers of my columns will recall that back in November of 1997, I wrote about the absurdity of rent controls. Rent controls are put in place to protect innocent tenants from the claws of rapacious landlords, usually by left-leaning do-good governments. In reality, however, rent controls have proven, time and time again, to work against the very group that the government is trying to help. Rental controls do not just stop landlords from raising rents. They discourage investors from providing housing stock, making the pool of rental stock smaller and driving up prices even further and creating an acute shortage. The best current example of this is San Francisco, where rent controls have been in place for some time and where rentals are among the highest in the United States.

In a similar vein, the idea behind this absurd property tax is simple enough: tax people on the equity in their property, and it will (a) generate a lot of income (which governments need to reward the people who voted them in) and (b) encourage people to invest in things other than property.

To all of that I say "Nonsense!". New taxes never generate as much income as predicted when they are proposed, for the simple reason that people change what they do to not pay the tax. Therefore, I do not believe that the tax would generate the $750 million a year that the review predicts.

Property has always been the bane of the government, not because it isn't a lucrative investment vehicle for investors (it is) or because the government does not collect income tax from rental incomes (they do), but because they see all this wealth in the nation's properties and no effective way (as yet, thank God) to tax us on it even more than they already do.

After all, we earn money, pay tax on it, start accumulating funds in the bank, pay tax on any interest earned, and then use what the government hasn't taken for a deposit on a property, borrowing the rest from a bank. We then pay rates (property taxes), and income tax on any net rental income.

The notion of taxing any equity in the property is absurd for the simple reason that at other times the government has expressed dismay at the amount of money New Zealanders borrow to buy houses. There have even been claims that this has kept the New Zealand dollar so low!

If you own a $200,000 property with a $100,000 mortgage, and you face the prospect of having to pay tax on your equity of $100,000, then people will do one of two things. The poor will say: "Ouch, we had better sell this property to avoid the equity tax". So far, the government is happy, as they have discouraged one more family from "unproductive" investment in real estate.

Well wake up! The family still has to live somewhere. And they will be renting. From property investors, who when faced with the same prospect of being taxed on their $100,000 equity, decided to borrow more against their existing property to buy the one that the poor family was bullied into selling.

Those who can afford higher gearing will not pay any more tax (the tax-deductibility of the increased mortgage interest will wipe out the equity tax), and those forced to sell their homes will not pay any less tax. In this way, the rich get richer and the poor get poorer.

To that extent, I should be in favour of the concept. However, there is more to happiness than living off the misfortune of others, even if it is inspired by a good-intentioned but misguided bunch of policymakers who have probably been civil servants all their lives.

The report claims that "the present concessionary treatment of housing was one reason New Zealanders held an unusually high proportion of their savings in bricks and mortar."

Are they saying that if you have equity in a stock portfolio, you will be taxed on that equity? Or that if you have equity in paintings, antiques, gold, platinum, bonds and CDs you will be taxed on that equity? Of course not. That would amount to a wealth tax.

Perhaps the government is "testing the market" to see who can be skimmed for money after the next elections. After all, anyone can be elected if you promise enough. All you have to do is promise money to a greater number of people than the number of people from whom you have to extract the loot to give away.

Fortunately, because so many people own properties in New Zealand, the government will find it difficult to convince "the masses" of the merits of an equity tax for property.

Successful investing!

Dolf de Roos.