Wednesday, November 23, 2005

Taxing To The Hilt: The Failed Socialist Experiment

The great mistake that Socialists make about the world is that individuals behaviour does not change by altering the tax system. This is their justification for not cutting taxes when tax cuts are affordable: that they refuse to acknowledge the overwhelming evidence that tax changes influence individual economic activities, which have a massive cumulative effect on the overall economy.

The most startling case in point is the current state of the property market. The principal reason that that the Auckland residential property market has been running so hot over the last few years has nothing to do with sound macroeconomics; even the most basic economist will tell you that housing is not a productive investment. It does not, of itself, create wealth. But it is a sensible individual choice, based in large part to the peculiarities of the tax system that Michael Cullen governs.

The reality is that while it is nonsensical that investment property attracts so much individual investment, compared to productive assets, it is very sensible at the individual level. The reason it makes sense is that for small, individual investors, capital gains on investment properties are not taxed.

Personal income is taxed. At sixty thousand dollars, an investor is paying twice the marginal tax than somebody earning thirty-eight thousand dollars a year. The Socialist mantra claims, for some reason, that this is a fair arrangement. The individual taxpayer, who is by no means wealthy, but is striving hard to earn sixty thousand a year, does not feel that same degree of fairness. Unfairness soon leads to resentment. And resentment leads to people looking at ways of behaving differently.

There are various, widely-known mechanisms and financial products in the market to deliver tax-free capital gains to off-set personal income tax. And there are many individual investors—principally those who are earning over $60,000 per year—who are taking advantage of their legal entitlements.

Gone are the days when investment in residential property was a time-consuming affair, associated with the pitfalls of finding a good tenant to a property. There are several companies in the market that provide an end-to-end property investment service, from development of the property, financing, provision of legal advice, valuation of the property, tenancy and maintenance management, and guarantees of rental returns. An ordinary investor can enter the residential property market, having expended no greater energy than he would if he had simply gone down to the bank and made a deposit.

These are not the rich fat cats of society. This is not a scandal of winebox proportions. This is not a story of a handful of high net-worth individuals exploiting cunningly-devised, and little-known tax legislation, to rip the tax base of a few million dollars here and there. Rather, it is a matter of ordinary, mum-and-dad investors making the use of basic investment vehicles to reduce their tax liabilities, to the tune of hundreds of millions, if not billions, of dollars a year. They are not even small business owners who can take advantage of this situation, but ordinary, average, middle-income salary and wage earners.

The average income for a university-educated, full-time worker in paid employment is morme than $60,000 per year. In Auckland, that person earns more. Consequently, there is a massive market for property-based financial products that are designed to reduce tax.

The property market in New Zealand is effectively a state-sanctioned, and profitable grand pyramid scheme. Demand for residential property investment, propelled by high marginal tax rates, is largely immune to incremental interest rate rises, as the higher the finance cost of a property, the greater that property losses can be attributed against personal income tax. High marginal tax rates at low threshholds, through the property market, have created a degree of structural inflation.

Michael Cullen argues that reducing tax across the board has inflationary effects. Roger Kerr has written extensively on this, pointing out that in an open, competitive, trading economy, the effect of increasing the money supply is less inflationary than in a protected market. The reason for this is that the price of most goods and services in New Zealand is directly related to international commodity prices: New Zealand is too small a market to effect an increase in international commodity prices.

And what Cullen's argument doesn't address is that high marginal tax rates are a key component in both structural inflation, and high interest rates: housing investment is normally financed by fixed-term interest rates that are immune to increases in the Reserve Bank's OCR. House price inflation, driven by increased demand for investment property, to off-set personal income tax, is the key player in the structural inflationary mix.

This, of course, constitutes on its own, a massive potential threat to the tax base. It is guided, for no other reason, than that individual investors feel resentful towards the Government for the amount of money they are paying in tax, for little service.

The result is four-fold: that the Socialists’ attempt to punish the well-off doesn’t actually work, that the tax base is reduced, and that economic activity is distorted: that individuals will cumulatively invest in non-productive assets, rather than productive businesses. Further, low-income New Zealanders are priced out of owning their own homes, as structural inflation locks them out.

That is entirely the situation in the New Zealand economy today.

The Reserve Bank has responded that it is looking at the arrangements of Loss Attributing Qualifying Companies. Again, these are not intricate devices reserved only for the very wealthy who can afford complex legal advice; they can be set up by any one of many mortgage-brokers in New Zealand. They are the prime instrument for reducing an individual’s tax liability. These products are easily accessible, and inexpensive to set up.

Tens of thousands of LAQCs function to fuel and maintain the value of the property market. The effect of any changes to the tax system relating to LAQCs would have an immediate and catastrophic effect on the Auckland housing market, in particular. The consequence of that is a potential threat to the banking system as a whole. But before the Socialists suggest that such a correction would be a good thing, consider this: the working capital of most small businesses in New Zealand is financed by equity in residential property. Start pinging the housing market, and small companies--and therefore jobs--go down the drain.

The only means to safely amend this situation is not to look at a capital gains tax on property. Capital gains have come about because of the distortionary nature of the tax system, which is driving investors into property ahead of other asset classes.

A far more practical approach to encourage investors to move into productive assets is to reduce high marginal tax rates. It’s not something Michael Cullen would like to tell his voters—who believe that middle-income New Zealanders are actually being punished for working hard and earning more. The reality for many of them is that the punishment doesn’t exist. Instead, the tax system fuels higher housing prices, making it unaffordable for low-income New Zealanders to live in places like Auckland and Wellington. Yet again, the Socialist formula cheats low-income New Zealanders who aren’t paying sufficient tax to benefit from tax write-offs in order to leverage them into the property market.

By reducing marginal tax rates and increasing the threshholds to which those rates apply, the Government would remove this perverse incentive to over-invest in the property market. Residential property would still be a viable investment option, but it would no longer be the only investment option for many New Zealanders. House prices would rise at a slower rate, and the structural inflation, and higher interest rates to attempt to counter those price rises, would disappear.

This morning I was having breakfast with a mate, who earns around a hundred grand a year. He’s not wealthy, except in the eyes of the non-working poor, but he is comfortable. I asked him about his property investments. He responded that he had none. I said to him: “Are you fucking mad? Why not?”

He answers: “Because I’m not sure about where the market’s at, right now.”

So I give him a three-minute spiel around the fact the Auckland property market has doubled in value, every seven years, for the last hundred years. That a very simply-devised mechanism would provide him with an additional income stream of twenty thousand dollars a year, plus capital gains over the medium-term.

By the time we got to our second coffee, I had made a call to another mate to see him at lunchtime. By dinner this evening, my breakfast companion was the proud investor in two residential properties, and Dr Cullen was some twenty thousand dollars a year poorer.

New Zealanders don’t have to go off-shore to pay lower taxes. They can do that right here. Of course, it doesn’t make our economy as a whole more robust, and low-income New Zealanders don’t share in that wealth—but that is the necessary consequence of Socialism and rampant taxation.

The Labour Government has slowly, but surely, created this situation due to their dogmatic insistence that it is right and fair to punish middle-income New Zealanders. Over the last six years wage rises have pushed middle New Zealand into high marginal tax brackets. This has encouraged New Zealanders to seek alternative investment options to reduce that tax liability.


liberty through profit said...

I disagree that houses are non productive components of the economy.
Houses help people to be more productive: case in point, a bum under a bridge, and a factory worker in a unit, who is more poductive, and therefore valuable?
What is the key difference?
Also what value to the economy does a house represent?
Houses need maintenance, mortgage payments (therefore lender overhead), rates, insurance. I estimate that NZ's investor housing stock generates $2.5B per annum in this aspect of the business alone. Add to this some profit for the investor which they will spend on something, and you get a lot of jobs created (think cars, boats, holidays, better quality clothes/food/houses: multiple tickets clipped along the way, not to mention the govts 40% claim on it all).
You are right that the govt needs to make it more attractive to invest in other classes of assets, but punishing those already in trying to secure their retirement years in housing is not the way to do it. Taxing them to oblivion, so they have nothing left to invest is also the wrog thing to do.
tehy could do what a lot of the Asian tiger economies do, which is to make passive income sources subject to lower taxation rates, or have a flatter, and fairer tax structure. Although I don't agree with govt regulation and intrusion, compulsory superannuation in personal transferable accounts could be justified.

Insolent Prick said...

The point I was making, LCL, was precisely that: that the existence of high marginal tax rates on moderate incomes has diverted investment flows into the residential property sector, at the expense of more productive asset classes. It is a situation that has arisen out of tax distortions.

As you point out, the answer is not to create new tax distortions through a CGT, or limit the transfers between LAQCs and personal income. That will just create further economic distortions, and lead to a catastrophic collapse in the housing market generally, and provoke a massive loss of equity across the entire economy. Given the reliance on property investment at the moment, such a move would be tantamount to economic suicide.

The only viable solution to reducing the weighting of residential property investment over other asset classes is to reduce the tax incentive to do so: raise marginal tax threshholds, and flatten tax levels, so that people are less likely to favour property investment over other investment vehicles.

Anonymous said...

Change of subject: Don't you have some fuckwit theory about vegetarians?

Check this out:

liberty through profit said...

I agree with you IP. If housing is perceived (wrongly in my book) as a non-productive asset class, then Cullen needs to actually engage a brain cell, and start to look for alternative answers to problems. At the moment, his problem solving answer to everything is, "how can I increase the tax on this?".
There was some recognition in his last budget that allowed for increased rates of depreciation on some fixed assets, but it is too little, too slow. Economic reality has it that, for producers to stay competitive they need to up out to decrease unit cost. Retooling is key to this, especially given the low yeild of the workers availble in the unemployed currently.
As far as wealth goes, it would be interesting to compare the net results of the average funds in a managed funds account versus a similar amount in a property investment over say 15 years. From my own experience, the property has has pissed all over the managed funds (although I have only been in managed funds for 8 and property for 6)

liberty through profit said...

supposed to be "for producers to stay competitive they need to up output to decrease unit cost"

Anonymous said...

Tax breaks etc, though aren't the only reason people invest in property. They are seen (somewhat falsely) as reliable investments which are subject to market forces to a lesser extent. In order to dampen the property market, or to encourage people to invest elsewhere, it would require, not only tax incentives, but public education. Especially because people will be reluctant to move the funds they invested in property elsewhere.

Although, as you rightly pointed out, a mass exit from the property market would deflate it completely.

In order to force the public to reevaluate their investments in a balanced way, one must ensure that incentives are not so strong as to deflate the property market, yet strong enough to encourage those who can afford it, to reinvest. This can only be achieved through a combination of public education and revaluation of tax rates.

Cathy Odgers said...

Most NZers dont need LAQC's however as LAQC structures in the past have been set up for residential property that owners want to live in and create some kind of guise of separation. NZers now are buying rental properties in addition to their main homes.

You simply buy the rental property in your own name, rent it to someone else as a business proposition, prepare a profit and loss and whack the number into your personal tax return. Offsetting any PAYE against the rental loss. This has always been allowed.

The most simplistic way for a legitimate tax deduction on a house you actually live in is to get a friend (hard for Socialists as they never have any with any money) and buy into an apartment complex. Two identical apartments.

Rent them off each other. Prepare everything above board.

Bingo. Less tax for you both and you have a good tenant.

No need for LAQC, which is defeasible easily under one act of Socialist pen movement in Parliament.

Big accounting firms will not set up LAQC's. Which is interesting. They are now being sold as a product to low end consumers alot of the time by wankers who do not have a clue about tax law. That is, like anything if it is not done properly (which in alot of those cases it won't be) then the entity can actually fail in its use andbe effectively void.

Mortgage brokers are in general, complete sharky retards. I mean pretty much everyone can do mortgage broking now, it is the new real estates salesperson. LAQC's are simply another product for them to flog to unsuspecting trash who will never get legal advice because they are too tight to do things properly.

And I bet in most cases the client never needed an LAQC as they could have got a deduction as I explained above on their personal return for a valid above board rental property.

sagenz said...

most interesting post IP. The other reason people invest in residential property is the fact private investors habitually lose a bundle in the stockmarket or kiwifruit/deer/apples/forests schemes set up by under regulated wide boys.

cathy - Unless the law has changed real estate costs must be ring fenced and cannot be offset against PAYE.

liberty through profit said...

cathy: when would an LAQC be advisable then?
I used one for a small syndicate, as I didn't want the complete liability that a partnership would have put me in.

Cathy Odgers said...


News to me. Are you thinking of the same thing?

All those returns I prepared at PwC for high net worth people with residential rental properties must have been wrong then :) Oh dear!!

Refer page 16.

Then mechanically on the form here at Question 21. Did you receive any rents?

This result at Question 21 flows from completion of an IR 3R summary for rental properties.

This reduces your taxable income from box 11 which relates to PAYE and flows through the form - if it is a loss - therefore rental losses ARE offset against PAYE, just as LAQC box 24. This net sum then has tax and credits applied to it.

The only thing I think you could be thinking of is people with many rental properties who are deemed to be "in the business of renting".

Or people who live in their own home, for which none of IP's post actually applied to.

Cathy Odgers said...


"when would an LAQC be advisable then?"

When you can find a tax lawyer/specialist accountant dumb enough to sign it off with an opinion in the case of residential property.

OR under advice from a tax lawyer/specialist accountant in any other commercial transaction involving a complete structure (your case).

Go google "LAQC". You will find hundreds of shonky little NZ operatives dealing in these things with special emphasis on property.

I refer you to this for example from

"But recent statements from IRD suggest that while the department will accept tax loss claims involving genuine rental properties, you won’t get away with setting up a LAQC just to claim a tax loss on your own home".

In other words - the IRD know that it is becoming more widespread, they don't necessary like it and will accept genuine rentals (as I explained above) but not what is happening here.

Like everything with the IRD the more the product is mass marketed the quicker down to the gutter level it is now with mortgage brokers, the more likely the IRD is going to suggest to Cullen to shut it down.


The best tax structures are not googleable and definitely cost more than $1000 to set up.

LAQC's are an old product that lack any tax planning imagination. Repackaging it with a gloss brochure and a salesperson and selling it to the masses only seeks to piss the IRD off.

Anonymous said...

About the only time you should use a LAQC for property is when you live in a debt free property and wish to rent this debt free home out move into a new home borrowing money for the new home to live in. The interest on money borrowed for the new home which you live in would be non deductible.

To claim the interest as an expense against PAYE the debt free home (to be rented) needs to be sold to an LAQC which for losses are is treated like a partnership ie the losses flow to the shareholders. The LAQC raises a loan on its new asset and pays the vendors ie the LAQC shareholders who then use this money to pay for their new home to live in.

This is about the only time you would need to use a LAQC for rental property. Otherwise a complete waste of time at best or very dumb if you sold the house you continue to live in to a LAQC to claim the interest as expense.

Bollard is a complete fuckup as his recent panty wetting episode has shown and Cullen has had to bring in Treasury to try and save his sorry arse. Problem is doctor brainy act is going to fuck it up as well. By time Cullen gets his landlord hate legalization through some time in 2006 /07 the property market will be going backwards anyway and interest rates will be in double figures. This third term government has got fuck up written all over it.

liberty through profit said...

I got an opinion from IRD regarding a company I own that IO wanted to rent to one the other directors to live in. They stated that as long as you could prove the director was paying market rent or above, you would not be liable for FBT, and the costs associated with ownership of the property would be deductable agaist it's income.
That was 4 years however, and things have changed somewhat (ie they are no longer accepting their own published material as a guideline for depreciation rates in relation to residential housing), so it is highly likely that despite OK-ing something, the rules have changed.

kisekiman said...

An erudite analysis of how taxation is the ultimate distorter and perverter of rational thought. Meanwhile, the productive sector of the New Zealand economy i.e agriculture has to bend over and take it in the ass twice via high interest rates and suppressed returns as a result of a soaring dollar driven by the worlds highest yield curves.
Wakey wakey and hand off snakey Dr Cullen.

Anonymous said...

Cathy and IP,

to my understanding, LAQC is quite beneficial if your income is much higher/lower than your partner.

So, instead of having the loss offset 50-50 against both income (say one on a 39% tax bracket, the other one is on 19%) you can offset it say 99% against the higher income and just 1% against the lower income.

For example, if your loss for the year is $10,000, in the first instance you will get 39% of $5000 and 19% of $5000 which equals to $2900.

If you have LAQC and you set it up right, then you will get 39% of $9900 and 19% of $100, which equals to $3880.

This way you can maximize your tax rebate.

I do work in the home loan/ mortgage industry and to my understanding this is one of the best reason why you would want to set up an LAQC.

And yes, you are right, some of us do not know about the tax law etc, and that is why we always refer them to their accountants for advice regarding tax structure on their investment property.

I would always refer my clients to solicitors and accountants to get the best advice.

-pucca (i'm struggling to get a blogger identity! can anyone help me? )

pink panda said...

you really do write boring shit dont you. even your commenters are fucking dim witted morons.

Zenskar said...

Very odd the way that the peculiarly New Zealand form of libertarianism combined with social conservatism (like IP's dogma) calls everything non-right "socialist". It's like the American label of "liberal" applied to everything that is not going Bush's way. It shows a personality type that sees only black and white, not subtle enough to pick up shades in between. There's a real provincialism about this type of analysis, a definite lack of worldliness and certainly no ability to see the value of pluralism in modern society.

Insolent Prick said...


What you have written has absolutely nothing to do with my post on how marginal tax rates have fuelled the residential property market.

If you're going to come up with commie propaganda, fuck off and start your own blog. Don't come filling up my blog with shit that has nothing to do with the discussions at hand.

And Panda: Piss off, you stupid bint. Go get some cock up your jacksie, and find a boyfriend who will beat you sufficiently for you to shut the fuck up. If you're not going to engage in debate, then I really don't care that you're bored. Go find some other shit to bore yourself with.

Anonymous said...

Did you really suggest that domestic violence was a good thing? That is the most offensive thing I have ever seen on a blog....

Anonymous said...

In addition to the benefits of using LAQC as stated by pucca, another one is that you can change the % of shareholding between shareholders easily, which makes much more flexible for claiming of losses. And when you're ready to sell your houses the depreciation clawback could be minimised by the same way... i.e. the partner that makes the least will have the most shares...

liberty through profit said...

interesting idea anon11.28, probably one of the very reasons that the Cullender is looking to close LAQC status down.

Anonymous said...

I doubt that LAQC could be closed down as it's used legitimately by many other kinds of business other than rental investments. A friend of mine has a software startup (which is setup as a LAQC) and all losses are claimed by his wife who has a high salary job via this LAQC for better cashflow during the early and difficult time.

gd said...

The other option is a Trust If the property has a positive income this can be distributed to beneficaries on the lowest tax rate.Also avoids problems with any future means testing of super etc and personal liability.And with most of the pollies having family trusts you can bet they will never dick with the rules to disadvantage themselves.