Tax changes ‘essential' to remove investment property bias - SWG

In its report to Government on how to boost New Zealand's savings, the SWG also said steps need to be taken to prevent a repeat of the unsustainable boom of the last decade, which saw a large increase in the country's debt, "much of which went into housing and a 'bubble' in house prices."

Resolving tax distortions is one of the key recommendations of the report.

"The SWG estimates that the tax system bias in favour of housing caused about half the increase in house prices, with serious implications for affordability," the SWG said.

"Moreover, the boom boosted investment in housing rather than investment in more productive assets that would have lifted productivity and potentially lifted exports."

The SWG highlighted the tax treatments of capital gains, owner-occupied housing and rental housing against the over taxation of interest income and over-deduction of interest expenses because of inflation as one factor behind the bias.

"Overall, an incongruous and distorting outcome of current tax policy is that simple savings products, such as a fixed-term bank deposit, which produce no capital gains or opportunities to write off expenses against taxable income, end up having the highest effective tax rate, by a substantial margin over, for example, housing."

The SWG call for tax changes was echoed in the ASB report to the group.

The bank revealed more than a quarter of its home loans were for rental property (72% owner-occupiers, 28% investment property) and that work was required to reduce tax distortions "that encourage ‘non-productive' property investment."

The SWG report recommends that in the absence of a capital gains tax, a measure already ruled out by the Government, reduced taxes on financial assets - the main investment alternative to property - would be one way to address the imbalance.

"In short, a lower rate of tax on the returns from (especially) long-term savings would provide a higher after-tax return and thus a more attractive alternative to property investment," the report said.

"This would be likely to restrain house prices and therefore aggregate mortgage debt."

The report also argues for indexation as a means to leveling the investment playing field between property and other long-term savings vehicles.

While acknowledging that indexation is not common overseas, and would add complexity and additional cost to the tax system, the SWG argues non-indexation may be one factor behind the recent house price boom, which as a result, lowered home ownership rates.

Also, "the failure to index the tax system increases the tax incentives for New Zealanders to invest in owner-occupied housing rather than other forms of savings products, and for investors to invest in property rather than other classes of assets."

Finance Minister Bill English said the Government would carefully consider the reports findings, with any immediate policy decisions likely to be included in the Budget later this year.

However, any broad taxation of capital gains or a land tax have already been ruled out.

English said that while those measures, along with changes to NZ Superannuation, were off the table, "otherwise, we are not ruling anything in or out at this stage."

"Ministers will carefully look at the Working Group's report over coming weeks with a view to picking up practical ideas that can feed into the Government's economic programme and Budget 2011."