What's behind BusinessNZ's claim CGT would cost $5 billion?

Friday, 5 April 2019

Business NZ chief executive Kirk Hope says he is not saying a CGT would be more expensive than income tax, dollar for dollar, though his intuition suggests it would be.

BusinessNZ has estimated a capital gains tax would cost $5 billion over five years in compliance costs, administrative costs and 'deadweight costs'.

If correct that would appear to make a CGT a very costly tax given that it is only expected to bring in a little over $8b in tax revenue over its first five years, although annual revenues would increase over time.

Chief executive Kirk Hope says there needs to be a public debate about the costs before the Government responds to the Tax Working Group's recommendations for a broad-based CGT later this month.

*** NZ First suggests capital gains tax would need to be kept simple

* Capital gains tax: Sir Michael Cullen recommends the type of tax he never dared try himself**

Is a CGT more expensive, all round, to pay and collect than, say, income tax?

That gets straight to the heart of the matter, especially given the Tax Working Group's (TWG's) recommendation that revenue from a CGT would largely be handed back through income tax cuts.

But, unfortunately, there appears to be less evidence about that than one might guess.

Hope says that while he believes 'intuitively' that a CGT would cost more per dollar of tax-revenue raised than income tax, he readily admits he doesn't have evidence to back that up.

'We are not saying a CGT would be more expensive to comply with than any other tax. It may be the case, but I'd prefer to only make a comment about that if I had actual evidence,' he says.

Sir Michael Cullen is dubious about the biggest component of BusinessNZ's cost calculation the 'deadweight cost' of taxation.

But there's a quote in BusinessNZ's report from TWG's own tax adviser saying the compliance costs were high?

Yes, professor Chris Evans is quoted by BusinessNZ in its CGT report as saying 'compliance costs are high and significant; compliance costs are regressive; and compliance costs are not reducing over time.'

But the quote appears to have been taken out of context from a part of a report where Evans was discussing all taxes in general, and not specifically a CGT.

Evans is an international research fellow at Oxford University and a former head of the Australian School of Taxation.

So what does Evans say about a CGT?

His report did say CGT compliance costs were 'usually high' – especially in the period soon after the tax was introduced – and would 'not be insignificant' however New Zealand's tax was designed.

But he also said the features of the TWG's proposed CGT regime suggested 'that the compliance costs would not be excessive' and would compare favourably with those in other countries, including Australia.

Just to muddy the waters further, he said it was not possible to predict compliance costs 'with any confidence'.

So how solid is BusinessNZ's $5b number?

It is hard have confidence about any of the components that BusinessNZ has used to build up the figure.

Although BusinessNZ released its report with the headline '$5 billion additional costs from a capital gains tax', the report itself goes on to say that its 'central scenario' is that the costs would be just under $3.5b over five years.

Business NZ reckons a CGT would cost Inland Revenue $210m to collect over five years, but that hangs off its assumption it would cost $1.6b in 'compliance costs'.

It then adds between $1.5b and $4.2b for something it calls 'deadweight costs'.

Dig deeper and the problems seem to mount.

Shall we start with the compliance costs?

It's a mixed bag here.

For example, BusinessNZ has estimated it would cost on average about $160 to value each rental property and 'second home' for the purposes of a CGT.

But Tax Working Group chairman Sir Michael Cullen responds those costs should largely disappear if Inland Revenue were to base its initial valuations on houses' 'QV' values which he assumes it would – a point Hope accepts.

BusinessNZ estimates ongoing compliance costs at 10 per cent of revenue collected. That appears based on an estimate that the figure in Australia in the 1990s was 16 per cent and that New Zealand probably deserves a discount because – as noted by Evans – its CGT would be less complicated.

As such, the 10 per cent figure doesn't seem ridiculous in the tax's early years, but appears to be just a guess.

What about those 'deadweight costs'?

This is where it gets murkier.

BusinessNZ describes deadweight costs as resulting from people switching from 'higher valued to lower valued economic activities' because of taxation.

It puts those costs at between $1.5b and $4.2b over five years, but its evidence is thin – appearing to be based on assumptions from three international reports, one dating back to 1993, that they could eat up either 18 per cent, 20 per cent or even 50 per cent of tax raised.

Only the Australian 1993 report and the US report putting deadweight costs at a massive 50 per cent of tax-raised based their calculations on a CGT, according to BusinessNZ.

The third report citing the 20 per cent figure that BusinessNZ used in its 'central scenario' was based on the costs of 'all taxes', spokeswoman Kathryn Asare said.

Unless a case can be made that substituting income tax for a CGT would lead to an overall loss of economic efficiency, it would seem by BusinessNZ's own logic that deadweight costs should come out of its sums entirely.

That is because the 20 per cent 'loss' in its central scenario is not specific to a CGT and the overall tax changes the Tax Working Group have proposed are, at the request of the Government, 'tax neutral'.

That means the deadweight loss it attributes to a CGT should be cancelled out by the corresponding tax cuts.

BusinessNZ itself accepts 'deadweight loss is notoriously hard to estimate'.

Cullen goes further, saying he is 'always suspicious' of deadweight costs.

'Deadweight costs can't be dismissed entirely but there is a tendency for those opposed to taxation to really lather them and you have got to think of what is 'foregone' if you don't have the [tax] revenue.'

So BusinessNZ's $5b – or $3.5b figure – is an overestimate?

It probably can't be taken at face value, but that doesn't mean a CGT won't have big costs.

Hope was a member of the Tax Working Group and sided against its consensus recommendation for a broad-based capital gains tax, so it would be natural to be suspicious about BusinessNZ's claim that the tax would be an expensive one to collect.

But BusinessNZ hasn't made any attempt to include the costs that small businesses might have to incur complying with a CGT in its calculations (although it does menton in its report that it thinks that could add another whopping $5.5b over five years).

So it is not a case of the organisation being one-sided in all regards.

The bottom line?

BusinessNZ is right that the costs of a collecting a CGT will be an important part of the debate when the Government releases its response to the Tax Working Group's report later this month.

Hope certainly won't be alone in his intuition that it might prove a relatively burdensome tax, at least for some.

BusinessNZ says it wants to start a debate, accepting its numbers aren't perfect.

But its figures may be better viewed as politicking dressed up as a study.

So what will the compliance-cost debate look like?

A lot may depend on whether the Government decides to exclude small business owners from paying tax on their capital gains or allows the 'grandparenting' of existing small businesses to avoid the headache of them facing a 'valuation day'.

NZ First leader Winston Peters has made it clear the party would not support an 'explosion' of the valuation and accounting industries, suggesting perhaps that one or other of those options may be in play.

Cullen says the taxation of 'active businesses' is at the 'furthest end of the spectrum' in terms of the trade off between revenues raised and costs imposed – which may provide small business owners with more encouragement they may be in line for a break.

But he also argues that many of the compliance costs of a CGT can arise as a result of investors using aggressive tax planning to try to minimise their tax liabilities, and that those costs should not perhaps be regarded in the same way as other compliance costs.

'If you choose to spend money to try to reduce your tax that is different to having to spend money to comply with the state's requirements,' he says.

That is an interesting though controversial point of view, and one Hope unsurprisingly gives short shrift.

It may also be worth noting that it can't be assumed the costs of collecting other taxes will remain constant.

GST used to be a fairly 'cheap and easy' tax to manage – until policy-makers had to grapple with the thorny issue of shoppers buying goods tax-free from overseas.

So few facts, and instead headaches all around.