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Capital gains debate’s dirty little secrets

The Tax Working Group is tip-toeing around the third rail of New Zealand's political economy. Bernard Hickey explains why the politics and the personal finances of taxing capital gains are so gnarly.

The dirty little secret of the whole debate is that property-owning voters are almost completely dependent for their retirement security and their small business survival on over $500 billion of untaxed and leveraged capital gains from their land over the last 15 years.

Even though the limited forms of taxing capital gains being discussed would not touch those gains, many property owners see unending land price inflation as the only way for them, their kids and other people like them to get ahead. The vested interests in our economy from banks on down to the local dairy owner are dependent on land prices continuing to rise, or at least not falling, for their financial and social wellbeing.

It is the exact opposite for renters. They are poorer in relative wealth terms in the last 15 years and their rental costs are brutally high relative to their disposable incomes.

The tragedy in this debate is that real wage inflation growth has stalled in tandem with productivity growth in the last decade due to a lack of investment in productive assets, skills and infrastructure. That's because it has gone into land values, and investors see leveraged land investment as more attractive because it has vastly outperformed every other asset over that time.

It's the classic Catch 22 in our political economy. Not taxing capital gains created the productivity problem. Taxing capital gains might solve it, but those who decide loved the land value wealth captured because of not having a capital gains tax, among other factors such as record high migration and record-low house building rates relative to population growth.

Solving the problem would require voters and investors to ignore or forget those astonishing capital gains, or for renters to overwhelm those vested interests at the ballot box.

The political calculations for the coalition Government are difficult in this term because older provincial and suburban property owners vote at much higher rates than young, urban renters. The voting rate imbalance is especially wide between older Pākehā property owners and young renters that are Māori, Pacifika or new migrants.

These dirty little secrets in New Zealand's underlying economic and electoral structure are the reasons why the capital gains tax has been the lightning rod issue of New Zealand politics since at least the 2011 election when Labour adopted its capital gains tax policy. It was a major factor in Labour's 2014 loss and almost cost Labour the win in 2017. The 1999-2008 Labour Government led by Helen Clark and Tax Working Group Chair Michael Cullen knew also it was the third rail of New Zealand politics. It's why Cullen regularly recommended against such a policy.

Jacinda Ardern and Grant Robertson will be hoping the electoral mathematics of the low voting rate of young urban renters can be changed just enough to swing the balance. It will also depend on the attitude and electoral success of New Zealand First and the cohort of voters who lifted Winston Peters into the kingmaker position in 2017. It will also depend on the turnout rates among young, urban renters at the next election. A small rise would be enough to tip the balance in the Labour-Green direction, but it will depend on Ardern retaining the popularity that swept her to (just) winning in 2017 and on New Zealand First and any new parties remaining below the five percent threshold.

If Peters chooses to back whatever version of the capital gains tax that Labour and National adopt, then his support base may desert him, especially given his lack of action on reducing migration. The polls already show New Zealand First below the five percent threshold. That decision in large part depends on Peters' health and his ambitions beyond 2020, both for his future and his personal legacy.

National hopes to regather those New Zealand First voters at the 2020 election and hang on to enough of middle New Zealand to get over the line and pip the combined Labour-Green vote at the post in 2020.

The wild card is whether another provincial party or another young, urban party is formed to upset those calculation. These are the reasons why Ardern and Robertson are being so cautious.

Today's report is not the final word. Labour and the Greens will have to consider how hard they push the capital gains tax barrow. That will depend in large parts on the relative popularity of their support in polls versus National, and whether they are ruthless enough to try to jettison New Zealand First and confident enough they can make up the difference by increasing the turnout rate of young, urban renters.

Labour is due to respond to the tax working group within a few months. We'll know then how ruthless and confident Ardern and Robertson are feeling relative to National's support under an unpopular Simon Bridges.

Read more: Capital gains tax - a vested interest