Residential property investors face a double-whammy under proposals unveiled today by the Tax Working Group which could raise $2 billion from a sector currently costing taxpayers $150 million a year.
While the TWG recommends against a comprehensive capital gains tax, it proposes axing depreciation deductions for buildings where evidence shows they don't decline in value, and a new risk-free rate of return method for imputing income from rental housing.
The TWG estimates that axing depreciation on buildings that don't depreciate would produce $1.3 billion in new tax revenue every year, while a risk-free rate of return approach to rental income would raise around $850 million, wiping out the $150 million of tax losses currently recorded and adding $700 million to the national bottom line.
However, fears that the TWG would target loss attributing qualifying companies, through which many investors put their rental income and expenses, were unfounded.
"LAQC's are a red herring," said PricewaterhouseCoopers country chair and TWG member John Shewan.
However, the report is cautious on the complexity of applying RFRM to rental property, and group members acknowledged that rental properties were being singled out for special treatment against other classes of assets because the area was perceived as problematic for both the efficiency of the tax system and the skewing of investment towards non-productive activity.
"Instead of taxing the owner on gross rents and allowing a deduction for expenses (including interest and depreciation), imputed income would be calculated by applying a risk free rate to the equity that the owner holds in theb property each year and thaxing the result at the taxpayer's marginal tax rate," the TWG report says.
"In theory, an RFRM tax has the same allocative efficiency benefits of a comprehensive income tax, but it may overcome some of the disadvantages of a realisation-based capital gains tax, such as lock-in and revenue volatility."
To work well, an RFRM system would need to be based on the market value of the underlying investment, a risk-free deemed return rate; and "all returns in excess of the risk-free rate should solely be due to risk premium or risk volality (no economic rents or returns to labour could be bundled into the return)".
Key factors to consider before implementing an RFRM method included the extent to which it might shift investment to more productive parts of the economy, the accuracy of the risk-free rate, how equitable it would be "if applied only to rental property". This would include assessing the likely impact on rents for low income households if landlords pass the additional tax cost on, as recent Treasury modelling suggests would happen. There would also be tax integrity issues where assets had mixed uses or borrowing was for various purposes, not just rental property ownership.
On land tax, the TWG says it may be easy to introduce and administer, and that it is an "efficient tax by not imposing any distortions on economic behaviour, provided the tax is imposed at a single rate across all types of land".
However, a land tax would not address the residential rental tax advantage, and it was unclear how it would affect the fairness of the tax system.
"Firstly, it taxes only one component of wealth and therefore mainly impacts those people and organsiations holding their wealth in that form," the report says. "Retirees, Maori authorities and farmers could be particularly affected."
Taxpayers could face cashflow difficulties if they were asset-rich but cash-poor, although this could be solved if land taxes could be repaid from an owner's estate.
Setting the land tax at a very low rate - a 0.5% rate of land tax would raise an estimated $2.3 billion - would be one way to reduce such issues.
However, the temptation to cave in to pressure groups "may lead to pressure for exemptions which raises concerns about the sustainability of such a tax".
One option to deal with a land tax hitting large landholders harder than others would be to apply a value-per-hectgare threshold below which no land tax is payable.
"This would tend to shield land-extensive activities such as farming and forestry," the TWG says.