Why A Capital Gains Tax Will Have A Minimal Impact
For years people have asked me, as a financial advisor and co-director of Erskine + Owen, if I thought a capital gains tax would come in at any point. I’ve always said it’s possible, but it would have zero to minimal impact on house prices, certainly in the medium to long term.
Here we are on the eve of a possible announcement of a Capital Gains Tax. Will my theory hold true?
Is it the end of property investment?
Tax and death, the two certainties. We like talking about one and not the other. One day we’ll all die and if the research is right, many of us will look back and wish we’d taken more risk. In my line of business, every day we see ridiculously smart people use fabulously crafted technical questions to mask their fear of taking the bold step of investing.
We’ve all just about forgotten that several years ago the government announced it would rule out deducting depreciation on rental properties for tax purposes. When announced, there was a lot of press and commentary about the impact on property prices. Some decided to sell – I bet they wish they hadn’t now. That tax change has had zero impact on property price growth. It’s all but forgotten. And look at other countries that have a CGT. Has the CGT had any material impact? No. We’ve been researching and commenting on the property market for years, looking closely at the drivers. It’s simple. Population growth, interest rates, ease of access to credit and supply are always the big ones.
If there is a CGT, so what? If it is just on property, so what? What are you going to do? Not invest? The answer depends on what returns you will get from property in comparison to ‘under the mattress’, equities or business.
On a sensibly leveraged portfolio with conservative growth variables, property will out-perform a medium risk portfolio of equities over the long term, according to my calculations. So, then we have to run the calculation including a Capital Gains Tax. When you retire you need an income, and you need money invested to generate that income. While you might sell some of your property to relieve debt, you probably won’t divest everything. And in that scenario, you’ll only have tax on a portion of your equity gains. I can’t give the final calculation until we know if there will be a Capital Gains Tax, and what the rate will be. However, if the plethora of commentary in the media is right, we’re likely to see it greatly watered down from the working group’s recommendations.
Money needs to be invested wisely
I am an Authorised Financial Advisor. I have a high duty of care towards my clients and a big part of any portfolio advice is assessing risk. Let’s say a client asked me to advise what to invest in. I’d need to take account of a lot of things, for example their age, their alternative income sources etc. Equities are more liquid than property, but I would argue that property, especially in New Zealand, is less risky than equities. So my recommendation would be to invest in various asset classes, including property. Will a Capital Gains Tax change that recommendation? Will a Capital Gains Tax make property riskier? Property investors are long term investors – so the answer, in my opinion, is no.
Will a Capital Gains Tax achieve its aims?
Those in favour of a CGT argue that by creating a fairer tax environment across different types of investment classes it will discourage so much heavy investment in property, and encourage more investment in savings and equities. Really? Where is the evidence for that? I don’t invest in property because of tax-free capital gains. I invest in property because I can sensibly leverage my equity, and as a result get dollar gains superior to other forms of investment. So I doubt very much there’ll be a sudden flight to savings. That strategy simply won’t get you to where you need to be for retirement.
And will it create greater ‘fairness’? Define fairness. Sure, it may result in all asset classes being treated the same. But will it result in fairness? What if a family lives rurally but works in the city, and has an apartment in the city. Will that second home be taxed? Is that fair?
What about affordability? Will it suddenly make housing affordable so that younger generations can miraculously afford a home? Absolutely not. It’s wrong to use the important issue of affordability as a tool to garner general acceptance of this tax. If the government or the Tax Working Group were serious about using the CGT to make a difference to affordability, then they’d promise to use every cent of the CGT to pay for infrastructure, so that developers don’t have to pay for water mains, waste water upgrades and public roading. That would make housing more affordable.