Legacy investments versus speculative investments.

datePosted on 14:01, February 22nd, 2019 by Pablo

Among the arguments about instituting a capital gains tax in NZ (common in many parts of the developed world) is the claim that much property is family residence or inheritance in nature. The argument goes that it is unfair to not differentiate between the sale of a family home, granny flat or holiday residence by middle and working class people and the sale of properties bought by developers and speculators with the intention of “flipping” them for a profit. The first category are long-term, emotionally laden investments whereas the second is simply about making money.

I see merit in the argument for differentiation of property investment categories. In particular, I see a difference between legacy investments and speculative investments. Legacy investments are those where property is bought for family use over time. These can be the main family home but more often are second, smaller flats or holiday homes that are passed on between the generations (think of the archetypical bach or a crib). The emotional as well as financial investment in such places is not based on eventually securing returns but on preserving collective experiences and traditions from generation to generation and giving off-spring the chance to acquire a property stake without the exorbitant financial costs associated with the contemporary real estate market (for example, an equity share in a family bach may help towards securing a first time mortgage loan). It specifically excludes using family members as fronts for speculative purchases (say, of a family farm).

Speculative investments are just that: property investments that are designed to be on-sold in a relatively short period of time in order to secure a positive financial return. Here the intention is to make short-term money off of the buy/sell transaction.

I would suggest that a capital gains tax is appropriate for all speculative investments. They become another cost of playing the real estate flipping game and will eventually be incorporated into the real estate price architecture. On the other hand, I do not think that capital gains tax is appropriate for legacy investments. If a family property is on-sold within blood lines or divided into part ownerships to children and grandchildren, it seems to me that the less financial burden imposed the better for all. People get to keep their properties within the family and share in the collective benefits over time and generational change. That includes rental income from family owned property subject to the requirement that the property must be used by family members for given periods within a specified time frame (this would allow seasonal rentals and other short-term lease arrangements to non-family).

The system would work if there is a legacy declaration made on a property at the time of purchase. Again, this may be less appropriate for a main family home that could likely be on-sold to strangers as the family demographic shifts. There a capital gains tax would apply. But it very much should not apply to properties that families hope to preserve within the bloodlines for posterity. Here on-selling to relatives should not incur capital gains taxes.

On-selling under the legacy clause will require verification of family lineage, and any sale to non-family voids the legacy declaration and makes the sale subject to capital gains tax. Those who try to cheat the system and are caught will be subject to heavy financial penalties in excess of the tax otherwise to be paid.

I am not an economist much less a taxation expert but it seems to me that distinguishing between legacy and speculative investments in the property market strikes a good balance between profiteering and homesteading. I admit to not having thought through all of the implications inherent in this proposed scheme so if any readers want to illuminate me please feel free to do so.

I have no doubt that clever devils will immediately try to game the system and seek out ways to turn legacy homesteading into profit-driven speculation. But with a detailed code of compliance and robust enforcement regime in place, it is possible for this approach to split the fair difference between an all or nothing capital gains tax on property and one that reflects the nuances in property buying preferences. Or perhaps that is simply too much to ask in an ideological climate where the very idea of taxing something other than salaried income, business earnings and consumer purchases and services is considered sacrilegious by the Right.

PS: I have been informed by the smarter adult in my house that this is a silly idea and unworkable. She also points out that trusts already allow for inter-generational transfers of wealth/assets without being subject to tax on the transfer. I am not familiar with trust law and am not going to risk savaging by pointing out that family trusts are something more likely to be created by the well-to-do rather than the middle class, so must accept the scolding and move on. If anyone is familiar with the intricacies of trusts, please feel free to explain.

14 Responses to “Legacy investments versus speculative investments.”

  1. Görkem on February 23rd, 2019 at 09:56

    I’m generally a fan of capital gains tax but with three caveats:

    1) It is not a silver bullet against housing inaffordability, as you say, Pablo, most western countries have capital gains taxes but they have similar issues with the price of housing rising faster than the average wage (we need only look across the Tasman to see a market where capital gains taxes coexist with ridiculously inflated housing markets – naysayers will claim that Sydney and Melbourne are too large to be compared to even the largest NZ city, but Adelaide is broadly comparable to Auckland in both population size and economic size, and yet it’s just as unaffordable).

    2) The general idea of separating out legacy sales and speculative sales is a good one, but the devil will be in the details. Houses bought for speculation may want to be converted to legacy use due to unexpected demand from family, and government inflexibility around the distinction will cause angst, which will be ginger for conservative politicos (assuming it’s a Labour government that passes it)

    3) Similarly, permission to pass on legacy homes to family members will cause disagreement around precisely what constitutes a family member, with those who feel the government’s definition doesn’t meet their family’s experience feeling shafted by an uncaring bureaucracy and, again, generating angst. So, in other words, this distinction would be a recipe for semi-monthly fifth page newspaper stories about “The government wouldn’t let us pass the family home to our dead uncle’s ex-boyfriend without a whacking great tax” with photographs of said ex-boyfriend looking sad outside the gates of said property, and lots of juicy quotes about out-of-touch ministry officials and government that doesn’t care about people’s needs.

    None of this is to say it isn’t a good idea, if we refused to implement policies because they weren’t total solutions and they would generate bureaucratic tension, we might as well give up on the whole concept of policy formulation.

    But it’s good to be open about these costs up front. Many commentators (not you, of course, Pablo – you’ve always been very clear eyed, without ever veering into cynicism, which I admire) get so caught up in the proposed benefits of a policy that they develop or inherit an ontological blind spot to the reality of its implementation, which conversely means they either abandon the policy or start actively advocating it be ditched when it hits fairly expected roadbumps (Kiwibuild is probably the current epitome of this dynamic).

  2. Pablo on February 23rd, 2019 at 12:59

    Gorkem:

    I see your point. As I was writing the post I thought about two things: 1) definition of “family;” and 2) implementation (including enforcement). Both are considerable obstacles to be overcome but with some degree of nuance layered into legislation they can be fairly addressed. For example, family can be defined to include non-traditional groupings, with lineage determined by the nature of partnerships, unions and the like. In any case it will take input from people far more versed in tax law and family dynamics than I am to turn this into a workable reality.

  3. James Green on February 23rd, 2019 at 17:36

    I think CGT should be on everything and taxed at the same rate as salaried income. On the other hand corporate tax should be removed entirely.

    The idea is that land should become completely useless as an investment, with overall prices stabilising permanently (i.e. with only local fluctuations). A comprehensive CGT is maybe only 5% of the solution to achieving this, but every little part is needed (nationalising zoning and a land tax are more important).

    In my own highly detailed system I’d have an exception on taxed income that is received as a gift. There would be a threshold exemption of how much you could receive as a gift per year without paying tax on it. By using this you could transfer a property over many years through a family trust type arrangement (e.g. parents give 5% ownership of their house to their each of their two kids over a period of 10 years.) In this way legacy transfer could occur without triggering any tax on it.

    There should never be carve outs on a tax, it should be always all or nothing. (The exception is short term tax breaks in order to kickstart something.) Capital and wage income should be taxed the same. Fairness needs to be the rule.

    Speculative investment of commodities (including land) needs to be ruthlessly crushed for the good of society as a whole. Some people will get unlucky and lose out, but in order to have a system that functions equally well for everyone that is the price that has to be paid.

  4. Görkem on February 23rd, 2019 at 22:24

    It would be possible to cast the definition of “family” very broadly, but the broader it is, the less impact the policy will have, and the easier it will be for people to game the system. For example in Japan, there are very strict laws about passing on corporate holdings to non-family after death, which leads to a practice (I guess we could now say a tradition) of CEOs legally adopting their corporate successors as their sons in order to ensure a low-cost transition.

    “Family” is innately a vague, ill-defined idea, and trying to set a legal ring around it, especially a legal ring with financial consequences, is always going to result in either some people being excluded who think they should be included, or some people being included who the policy intended to exclude (or, most likely, both).

  5. Edward Main on February 24th, 2019 at 10:40

    Hi all

    The proposed CGT (and taxes in general ) are just one part of how a government funds it’s spending

    The greater game is to understand the relationship between
    Central Banks, the monetary system and taxes.

    Case in point: Up until the early 1900’s the USA did not have an income tax. There was no need.
    It was brought in after the creation of the Federal Reserve in order to pay for the interest on loans from the Fed to the Government

    Recommended reading: The creature from Jekyll Island by
    Edward Griffin, The web of Debt by Ellen Brown and
    The lost science of money by Stephen Zarlenga
    ( I have yet to read this but it is on my to do list )

  6. KJT on February 24th, 2019 at 19:23

    Taxes need to be broad based, fair and simple.
    Tax accountants spend their whole lives, learning how to drive a bus through anything else.
    A CGT is essential to capture the increasing amount of income that is gained through speculation, capital gains, rather than working for a living.
    We can’t continue to mostly tax, wage and salary earners. While speculators income is not taxed.
    If we are going to have a CGT, let’s have all income taxed equally, including capital gains, as income taxes.
    The only carve outs I would consider is a rollover provision for swapping family homes, and going concern businesses, of the same value. And an exemption for homes you are living in, under a certain value. Key making 10 million, on his Auckland “family home” untaxed, is an obvious unfair hole in the tax system.
    If a family never sells their Bach, if there is such a thing left. Then, they will not be taxed on it.
    Carve outs for economic and political purposes, should be acknowledged as subsidies, separate from the tax system.
    On the other hand, local business taxes can be set to zero, as all their income is taxed personally. Not too much different from now, with imputation credits.

  7. Redbaiter on February 24th, 2019 at 20:29

    The thing about tax, is that you just can’t take say $10 out of any economy and say “there you are, the govt has $10 to spend & nothing else has changed”.

    There are costs, compliance, transaction, bureaucracy, and a dampening effect on investment. Let’s say the economy has a value of $100.

    Taking $10 out and transferring it to govt does not mean the economy is still worth $100. (as GDP implies)

    The $10 actually becomes less, and by what rate is the subject of thousands of studies, but generally, its accepted that the govt spends $3 to get $1 back into the economy. So in this case, there is only a little over $3 going back, reducing the value of the economy to $93.

    Then you have the dampening effect, which also lessens the value, but all up, you’ve probably got far less of an economy than the $100 one you started off with.

    So why do we do this? Because govt has core services that we want it to carry out. Keep records, run defence forces, and then the add on services that come with socialism and socialist voters which are often far from core.

    Socialists also want the govt to “smooth” the economy and (always) to make the tax take “fairer”.

    So we have in NZ the prospect of a CGT, which will increase compliance & transaction costs & have a huge braking or dampening effect.

    The fairness of course is to be debated, but the general idea is that people are escaping tax by investing in land and buildings, real estate. And that they are, and as a result, the industry is booming.

    Its also booming because every other industry is too hard. When I see these surveys touting NZ as one of the easiest places to run a business I have to think “Man, it must be so hard in other places”.

    A recent project I worked on had a budget of $100 million, and I’d estimate probably $30 million went on compliance. The $100 mil was part of a $400 mil windfall from another global project, and the rest was spent in other countries. The consensus among management was that they’d be reluctant to bother with NZ again, and this was before the proposed CGT.

    So using reason, the path to making things more “fairer”, without the dampening, compliance and transaction costs would be to reduce the taxes in other areas to the kind of level that finds current favour in the real estate industry.

    It will never happen of course. The last thing socialists ever do is use reason, or they wouldn’t be socialists in the first place.

    The thought that others might be making a buck, easy or hard, sends them into apoplectic fits of envy. That’s what’s driving the call for a CGT. You only have to remember past utterances of that dull old commie Cullen to know that is true.

  8. Görkem on February 25th, 2019 at 07:53

    @Redbaiter: Why is keeping records a core government service? Don’t you think private enterprise can perform record keeping far more efficiently and effectively than time-serving government bureaucrats?

  9. Redbaiter on February 25th, 2019 at 19:08

    In the scheme of things, its no biggy, but I think Venezuelan style collapses aside, there’s probably more longevity in the govt doing it. Births & deaths, marriages, land transfers, etc.

    That said, Maori land is a real boondoggle, and probably should be privatised. Its by choice so complex the taxpayer shouldn’t have to fund it.

    The real issue is just cutting spending overall. IMHO the govt budget could be halved tomorrow with no loss of quality of life. In fact, things would probably be far better.

    Have you ever watched the Australian TV series “Utopia”? By the brilliant Rob Sitch. Such an accurate portrayal of govt bureaucracies its frightening.

    Closing down the MBIE would be one of the first things I’d do.

  10. Görkem on February 26th, 2019 at 07:03

    “there’s probably more longevity in the govt doing it. Births & deaths, marriages, land transfers, etc.”

    Why? In every other area of the economy the private sector is more efficient, right? So, why is this particular one an exception? What is it about the task of record keeping that means all the usual dynamics of private sector inefficiency don’t apply? What do you mean by “longevity”? Longevity of what, exactly?

  11. Redbaiter on February 26th, 2019 at 08:35

    @Gorkem

    “No big deal”- If someone in govt thinks its better to privatise it then fine, but in the scheme of things, costwise, its a drop in the ocean. Don’t understand why your fixated on this small item, (and don’t care to understand, so don’t explain). Its not an issue you can use as a pattern for more consequential matters.

    “Longevity”- long lasting, a longer life. If some dopey or corrupt bureaucrat lets a contract for the work to ABC Record Keeping Ltd, because they’re cheaper, or because he was bribed, or whatever and then they go broke soon after, the records could easily go astray in the confusion. Smaller self contained govt is always better than contracting out big govt, which just grows cronyism & corruption.

    “Efficiency”- once again, its no damn biggy. Again, (sigh) keeping these records is a drop in the ocean costwise. If it costs twice or even three times as much because of inefficiency then it still only a minor cost compared to the massive wastage occurring elsewhere.

    (BTW, an endless series of lame questions is an infantile argumentative strategy. Its far better to make a reasoned solutions focused statement. Please though, don’t bother. Not really that interested in your thoughts on anything, including those responding to my infrequent comments here. Nothing personal, its just that the few comments I have read by you have been IMHO uninspired, predictable, ponderous & self focused. If you were speaking at a board meeting, it would lead to a fit of phone fidgeting and/ or stifled yawns.)

  12. Pablo on February 26th, 2019 at 09:06

    Red:

    If you are uninterested in a reply to your long answer to Gorkem’s question, then why answer at all (especially when you end with a series of ad hominems)? Just let things be. That way we can proceed to the next matter and not get diverted into side-tracks.

  13. Redbaiter on February 26th, 2019 at 09:28

    Fine. Feel free to delete the comment (and subsequent comments including this one) if you choose Pablo. I’m not that fussed, really.

  14. Görkem on February 26th, 2019 at 10:24

    It’s OK Pablo. Redbaiter has called me far worse than “uninspired”, “predictable” and “self-focused” in the past. In the context of our interactions, this has been an absolute festivity of civility.

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