Gareth Morgan looks at how a proposed Comprehensive Capital Income Tax would affect individuals, and uses himself as one example

Who wins from the current tax system?

By Gareth Morgan*

In June I released a report detailing my idea for a Comprehensive Capital Income Tax (CCIT). This reform would close the loopholes in the New Zealand tax system, eliminate speculation in the housing market and importantly improve the capital available for business. It would also raise a lot of money, which could be used to reduce other taxes.

Here’s an example of how a CCIT might work insofar as persons are concerned. This is not example of how it would apply to a business.

Let’s say the tax rate is 30%, the deemed income is 5%, and the lower threshold at which the tax applies is $100,000 per person. A minimum threshold or exemption for CCIT isn’t necessary, but it greatly reduces the number of people who would be subject to CCIT (no exemption means all 3.5million adults would need to be assessed each year, a $100k minimum would reduce that to 2 million, a $200k exemption to 1.5 million).

Now if we take a couple with a $350k house and a $50k mortgage, then the CCIT applicable is as follows;

Equity in house = $350k – $50k = $300k

House is jointly owned so lower threshold = 2 * $100k = $200k

Value of asset to which CCIT applies = $300k – $200k = $100k

Deemed taxable income = 5% *$100k = $5,000

Tax on deemed income = 30% * $5,000 = $1,500 per annum

A lot of people ask if they can write off expenses such as depreciation upkeep or interest costs for a rented or owner-occupied dwelling. Under the CCIT this wouldn’t be allowable; the whole idea is that an investment should generate at least the risk free rate of return (5%) after expenses.

Now remember that CCIT expands the tax base only, it is not an increase in taxation overall. So it’s “matched” by a cut in tax rates – not one dollar of additional tax is being raised. The government of the day would decide how that is done, but for the purposes of illustration let’s assume it’s just a cut in tax rates across the board – so an equal cut in all tax rates.

My estimate is that a CCIT of this magnitude would reap about $6bn in additional tax on an income tax base that currently provides government with $30bn pa. So that’s enables a cut in all tax rates of 6/30 or 20%.

Back to the example above then. Let’s say the family above has one income of $70,000 per annum. The current tax on that is $14,000 or 20%. Now a 20% cut in tax rates would see that tax burden drop by $2,800 to $11,200.

So while the couple pays an additional tax of $1,500 on their owner occupied house, they save $2,800 on the rest of their income tax. They are ahead.

Now let’s look at the impact of this on some rich dude like me

I have a home worth say $4m with no mortgage. It’s jointly owned let’s say (it’s not but I’ll deal with Trusts elsewhere) with my wife.

Equity in house = $4,000,000

House is jointly owned so lower threshold = 2 * $100k = $200k

Value of asset to which CCIT applies = $4m – $200k = $3.8m

Deemed taxable income = 5% *$3.8m = $190,000

Tax on deemed income = 30% * $190,000 = $57,000 per annum

Our current taxable income (let’s say) is $230k, all earned by me. Tax on that currently is $67k or 29%. A 20% tax cut would reduce that tax by $13,400.

So we pay an additional tax of $57,000 pa on the house but save $13,400pa from the overall cut in tax rates. We are worse off by $43,600 pa.

The issue then comes down to whether the status quo is fair. That status quo sees me enjoying tax free the benefits of living in a $4m house whereas the tax free benefit the couple get is from their $350k house. Now this is not an argument about whether we should all be the same – it has nothing to do with that. The question is whether by virtue of having more money I should compound that financial advantage via the tax loophole on rental benefit. We get much more gain from the loophole than the other couple do.

Let’s put it another way – if their $300k was in a bank deposit and so was our $4m – we’d both get taxed on the interest from that. We’d still be better off, but the tax regime wouldn’t amplify that advantage. To the extent we all choose to buy houses (one or more, larger rather than smaller) rather than bank deposits because of the tax break is the anomaly that needs addressing. It is especially pertinent given that 90% of New Zealanders are closer to the situation above of the couple, than to the one I enjoy.

Finally, a note on trusts

The above example is for joint ownership with the owners using their personal exemption to minimise their CCIT liability. What if a trust owns the house or there are more than two owners? My approach would be to not allow the personal CCIT exemption (if indeed one was even favoured) to apply in those cases.

The reaction of many people to the idea of having their house taxed is one of incredulity. But they don’t realise that these tax loopholes are exploited by the rich far more than by the middle and working class. Therefore a Comprehensive Capital Income Tax – even levied at a flat rate – would be an incredibly progressive change to our income tax regime.

Gareth Morgan is a New Zealand economist and commentator on public policy who in previous lives has been in business as an economic consultant, funds manager, and professional company director.  This content was first published here and is used with permission.