Taxing QuestionsKeith Rankin, 5 July 2001
I have received some feedback after last-week presenting an argument in favour of a home equity tax. One responder cannot understand the difference between a home equity tax and a capital gains tax. Another sees the idea of offsetting a tax with a tax credit as a barmy form of bureaucratese. He also notes, quite appropriately, that there is no real difference between equity in a home and equity in some other asset such as a car or jewellery. Another notes that the value of home-equity is really quite subjective.
I'll tackle the tax-credit question first. I have spent the last 6 days in Australia. There, they are commemorating the first anniversary of GST. Indeed, once taxi-drivers, shopkeepers, or fellow airline passengers found out that I was from New Zealand, the first thing they wanted to know was how we managed our GST. (My main answer was that, in the late 1980s, we had plenty of other things to worry about other than GST. My second answer was that the simplicity of the New Zealand version did ensure its smoothness of transition. My third answer was, yes, it was one of several factors that made New Zealand a more unequal society.) The greatest amount of angst in Australia appears to relate to the compliance costs, which are higher than in New Zealand on account of the many exemptions.
Another story was aired in the Aussie media during the weekend. It was about the huge (approximately 75%) subsidies paid on politicians' meals. The chap who was called upon to account for paying such perks to people who are already paid well above the average wage noted that at least the politicians paid GST on the portion of their meals that they did pay for.
Whatever the social reasons for subsidising (ie paying tax credits on) politicians' meals, it would have been both more inefficient and more inequitable if their meals had been GST exempt.
An obvious solution is embodied in both these stories. The Australian GST could easily be applied to everything. Those products with social benefits would then be subsidised instead of being GST-exempt. Putting GST on everything, and subsidising just a few things is much less of an Inland Revenue horror story than the Australian system of GST exemptions and political subsidies.
An explicit tax credit to protect existing home-owners from a home-equity tax (which would, in effect, be for them a retrospective tax) falls into the same category. It would simplify present arrangements, while making them more transparent. The tax-exemption on income deriving from home equity is much like the Australian GST exemptions. There is a better way than the present way to subsidise particular social groups, be they poor families or people who own their own homes.
A home equity tax (ie a tax without an offsetting subsidy) would generate more revenue when property values increase. But that does not make it a capital gains tax. One of the key advantages of owning one's home has been that when real estate values have become inflated, the additional value (whether real or due to inflation) all falls to the mortgagor (ie the home- owner or landlord) and none of it falls to the mortgagee (ie the creditor). So, in the past, inflation arbitrarily created rapidly expanding non-taxable implicit revenue streams; the revenue streams addressed by a home-equity tax.
Yet a tax on home-equity, had it applied in the past, would have generated tax revenue in the deflationary 1930s (when nominal capital losses were the norm) as well in inflationary periods such as the 1970s and 1980s. It's just that, in the 1980s, disproportionately large increases in the home-equity tax would have offset the disproportionately small increases in tax levied on mortgagees' interest income.
The problem that I do have with the home-equity tax is that it is based on a number of contestable assumptions that underpin both the economics-oriented national accounting system [SNA] (which produces, among other things, our gross domestic product [GDP] statistics) and the various accounting assumptions that underpin our taxation system (which I will call Public Revenue Accounting [PRA]).
In the SNA anyone who benefits from the ownership of land is treated as a landlord supplying land to the market economy. This includes home owner- occupiers. Structures erected upon land are 'capital' which, like 'land' and 'labour', is a resource that is supplied to the market economy. Residential housing is treated exactly the same as a freehold dairy farmer's milking shed.
The PRA, however, generally defines income in accounting rather than economic terms. For taxation purposes, income usually involves an explicit payment. Income tax therefore is levied on explicit payments for labour, capital and land. Implicit (but equally real) payments are typically tax- exempt.
For the SNA, a private house is treated very differently to a private car. A house is capital; a car is a consumption good.
For the PRA, a private house is identical to a private car. A mortgaged car is taxed just as a mortgaged house is taxed. A rented car is taxed much like a rented house. Owner-equity on cars is untaxed just as owner-equity on houses is untaxed.
If we take the SNA approach of the economists to its logical conclusion, interest on money lent to businesses and to home-owners would be taxed (as would equity income arising from businesses and residential property), while interest on money lent on consumption goods would be tax-exempt. The accountants would have confirmation of what they have always thought; namely that economists really are crazy.
One way to try to get around the impasse would be for the economists to redefine residential property as a final consumption good; ie like a car. But part of the problem remains. Interest on a loan used to acquire a used-car, or a used-house would still be subject to taxation.
There is a solution. It is to tax production directly, instead of indirectly by taxing profits, wages and interest. If production was taxed directly, all 'factor payments' - wages, salaries, interest, dividends, rent - would be net of tax. In effect, all income tax would be an expanded 'company tax'; a business tax.
With respect to new housing, builders would remit tax much as they do at present. They would account for it all as company tax, instead of calling some of it employees' income tax. Employees would stop pretending that they pay tax when it is really their employers who pay it.
With respect to purchases of used houses, the only tax payable would be on the services of banks, lawyers, real estate agents, valuers, property managers etc. Landlords would only be regarded as producers when they add real value to their properties. Under this approach, the IRD would never need to know the subjective market value of used houses or used cars.
The SNA and PRA could become one. Economists would give up the idea that home-owners are equivalent to productive businesses. The Inland Revenue would simply calculate the value-added by firms in much the same way as Statistics New Zealand does, and collect its share of that value. For businesses, the Inland Revenue would function much as a private landlord. Except that, whereas landlords receive income on the basis of their private property rights, the Inland Revenue would receive its income on the basis of public property rights.
Finally, by adopting this approach, we get a clearer idea about whether total taxation should fall or rise in the long run. This argument has been dominated for two decades now by those who believe that public revenues should be falling as a proportion of nations' incomes. But, if in future the contribution of public inputs into production outstrips the contribution of private inputs (as was most certainly true over the last two centuries) then the growth of public property rights should outstrip the growth of private property rights, and public revenues should increase accordingly.