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Matthew Gilligan

Labour's proposal to ring-fence losses

Labour has targeted investors in its fresh housing policy released in the last week. Ring-fencing tax losses, five-year bright-line rules and a tax committee (to mask their desire to bring in capital gains tax) are all on their agenda.

Ring-fenced tax losses derived from negative gearing will mean you can't get tax refunds from negative cash flow investments. (This is poorly thought through policy in my view, for reasons discussed below.)
Labour will extend bright-line rules to five years, meaning if you sell residential property within five years, you will have to pay tax on gains unless it is your home. (I am a fan of this, as it will curtail speculators and encourage long-term investment.)
If they get in, Labour intend to convene a tax committee post-election to see what they think the fairest tax system is. (In other words, they don't want to admit that they intend to bring in capital gains tax because they lost the last election (partially) on this unpopular policy, so they are feigning a review to defer the decision to bring in CGT until after the election. Do they really think we are this gullible?)

Five-year bright-line rules
As said, I think they are on to something with this policy. I see lots of investors intending to keep property for two years and then sell. I think this policy will weed out the speculators and move the market towards genuine long-term investment, removing the inevitable grey area that IRD will face with investors that sell after two years. I think it is fair policy in a tax base that has no capital gains tax. So they get a tick from me here.

Ring-fenced losses
Ring-fencing losses is interesting, because one would think that Labour voters are well represented in property investment circles, carrying lots of debt (and investment property) with the Kiwi dream of making money through leveraged capital growth very alive in the lower socioeconomic population. Integral to this is the knowledge that if interest rates spike, they get some tax relief in a down market (driven by high interest rates) but conversely, they will pay tax when rents go up and their investments turn tax positive in the longer term.

Rich people don't care so much about spikes in interest rates because they carry less debt and often sit on cash, so they actually enjoy interest rate spikes. 

Denying tax credits to negative gearing therefore bites families regressively, in that it impacts on the middle to lower income earners much harder than the wealthy. Plainly if you are poorer and carry more debt, and have less wealth to insulate you from interest rate spikes, then you need the tax credits more to survive. So people with less wealth playing in property circles stand to have their cash flow affected much more (relatively speaking) than the wealthy. They just don't have the income surpluses to prop up their houses. 

I therefore found it odd that Mr Little was saying he was targeting the 'big investors'. The big investors are big for a reason. They are wealthy, get the funding because they have the income to support the debt, and therefore are less likely to be vulnerable to these tax changes. 

Impact dangerous to poorer people in downturn
But this policy's outcome is worse than just merely 'impacting' the poorer investors' cash flow. It can ruin them and make them victims of the wealthy they compete with in the housing market.

Say interest rates spike because Trump does something to trigger banking instability. For example, he starts a war. Under Labour's suggested policy, less affluent people with lots of debt won't be able to get cash flow relief through tax refunds. So, they'll go broke in the credit-driven downturn, be forced to sell at the bottom of the market, and see rich people buy all their assets at the worst time for them. A bunch of good honest Kiwis trying to get ahead get screwed by this new policy in a down market. Furthermore, often small businesses are funded by security over property, so they'll likely turn belly-up also. 

When will these rules bite?
The impact would really bite when interest rates rise, not at present where rates are at historically low levels and most investors are tax neutral or near to it as a result. 

You need to roll this forward a few years. If interest rates go up 3% and you owe $2 million, that's an extra $60,000 you need to find to fund your rental investments. Ring-fenced losses mean you don't get $20,000 (33%) tax relief to soften the blow. So this will make a lot of heavily geared investors more insolvent (if they get caught out without fixed-rate agreements) than otherwise would occur under current tax policy. 

With the increased risk to private investors, the impact is a potential decrease in activity in the market, which leads to less properties being built. This is bad for Auckland house supply, because we desperately require more housing stock. You have got to wonder if Labour see this link, or are they just looking at the current interest rates and tax policy at a given point in time?

Labour just don't understand money and finance. They are great at social policy, but they seem to let Envy Politics cloud their decision-making and produce unpopular tax policy in recent times. 

They are trying to tax the rich and look innovative and relevant. But actually, this is an ill-conceived policy that screws their constituents, despite the stated target being the 'big guys'. Time will tell as to whether mainstream New Zealanders share Mr Little's enthusiasm to punish property investors and favour first homeowners, but I for one think he is playing with fire in his voter base. As Labour found out in the last election in 2014, Kiwis don't like governments mucking around with the taxation of housing. It may be that we see a similar backlash in this election; certainly most property investors will not be voting Labour!

This blog has covered Labour's position, and as National's position emerges, we will cover that as well if there is anything of interest.

Matthew Gilligan
Matthew Gilligan
© Gilligan Rowe & Associates LP

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