What is wrong with housing anyway? (Warning: wonkish)

This is a post I have been meaning to write for some time, but the current spur is the Treasury briefing for the incoming minister. It is mostly very good, but included in it is the canard about over-investment in housing. This is a refrain we hear repeatedly, usually in phrases like “New Zealanders love affair with housing”, but I think the theoretical and empirical basis for the assertion of overinvestment is weak at best.

The main issue is one of tax-induced distortions. With owner-occupied housing, the purchase of a house is an investment, which generates an inputed rent that the owner pays to himself. The payment of this imputed rent is not subject to GST, nor is the rental income subject to income tax. There is also the issue of whether the absence of a capital gains tax is a further distortion, but I have discussed that issue here, here, here, and here. In this post, I want to explain why I don’t find it obvious that there is a distortion due to the lack of tax on inputed payments of a homeowner to himself. In part, this is a response to comments by Phil Meguire in the first of the capital gains posts.

To start with, let’s get an obvious point out of the way. Housing is a good thing, and nicer housing is better than worse housing, holding all else the same: If non-neutral taxes induce more investment in housing and less in other forms of investment than a neutral system, there is a cost, but it is the difference between the value of the flow of goods that would have been produced and the value of the flow of services produced by the housing, a difference which is not necessarily significant. I suspect that some of those decrying our love affair with housing are making the mistake of thinking that just because the purchase of housing services is a non-market transaction it doesn’t contribute to economic well-being. Similarly, it is irrelevant if the alternative investment would increase labour productivity, increase exports, etc. productivity and exports are just means to increasing the value of the goods the economy can consume; so is building houses. (Surprisingly, Greg Mankiw appears to make this mistake here, but to be fair we can attribute this to the need for simplification in an op-ed article, and his basic point—that the U.S. should get rid of the crazy mortgage-interest deduction—is sound.)

The next point to note is that the optimal tax rate on owner-occupied housing has to be considered in the context of an existing distortion: With an income tax, saving is subject to double taxation. If I choose to work today in order to buy consumption goods today, there is a difference between the value of what I produce and the value of what I consume, because of an income tax. But if I choose to work today in order to buy consumption goods in the future, there is an even bigger distortion between the value of what I produce and the value of what I consume, because the value of my work is taxed twice, once on my labour income and again when the interest income is taxed. We then have a classic second-best Ramsey taxation problem. The theoretical optimal tax on the return from investing in owner occupied saving will be somewhere between having no taxation on the saving (so as not to distort the decision between consumption today and investment in housing), and the full double-taxation rate applying to other forms of saving (so as not to distort the decision between investment in housing and other investment). So if normal investment returns are taxed at, say, 33%, the optimal housing tax will be positive but less than 33%.

And finally, here is the point that is overlooked in all the commentary on housing investment that I have seen. The flow of services from owner-occupied housing is currently subject to a tax. In other words, this graph, taken from the Treasury’s briefing to the incoming-minister, is wrong.

To see why, consider how a value-added tax like the GST works. Businesses charge GST on their sales, but deduct from their net tax liability the GST they have paid on purchases of goods and services. Expenditure on investment therefore reduces their tax liability, which is what makes the GST ultimately a tax on consumption and not investment income. When consumers buys a new house, they are making an investment, the return for which is the flow of housing services they will receive over time. The inputed payments they make to themselves are not subject to the GST, but unlike other business investment, the initial house purchase is, which has the same effect. (And, as I noted in an earlier post, the existence of a GST pushes up the prices of second-hand goods by the rate of the tax, so the argument is no different for owners who purchase an existing rather than newly built house.)

This is another example of the beauty of pure value-added taxes. By shifting in part from an income tax to a value-added tax, the rate of double taxation on delayed consumption is reduced. At the same time, the effective rate of taxation on the consumption of owner-occupied housing is increased from zero. We end up with a system where the tax rate on owner occupied housing is somewhere between 0 and the rate applying to other investment, just as Ramsey tax theory would stipulate. Whether it is higher or lower than the optimal rate is a difficult empirical question to which I don’t know the answer. But I have not seen any of “New Zealander’s love-affair with housing” commentators seek to address it. Furthermore, given that there are no simple methods of increasing the tax rate on owner-occupied housing that don’t bring their own problems (we have no mortgage-interest deduction to get rid of, for instance), I find it hard to believe that we have an over-investment problem that is worth solving.

Should Capital Gains be Taxed

This was the headline on an article in the Press on Saturday (no on-line version that I can find). The sub- head says that the article reports on both sides of the debate. This is a bit of an obsession of mine (see my earlier posts, here, here, and here), as most of the arguments I have seen on this seem to be making incorrect partial-equilibrium arguments.

So I was keen to see what arguments would be put forward by the expert economists interviewed for this article. In a telling, but perhaps not surprising, commentary on the relevance of our profession for public policy, the number of economists cited in the article on either side of the issue was zero.

There was a quote from an Auckland professor of taxation law and policy to the effect that the absence of a capital gains tax causes "over-investment in property", but as I noted in the second of the posts linked to above, the chain of reasoning needed to get this conclusion is a lot more complicated than one might think, and the combined assumptions needed are somewhat heroic.

I continue to search for a coherent economist rationale for a CGT.

The impossible trifecta

Kevin Milligan says a Guaranteed Annual Income cannot simultaneously satisfy three goals. Instead, you have to pick two among the following:

1. low tax rate
2. high benefit
3. balanced budget

Treasury here in New Zealand modelled a GAI for New Zealand on the request of the Welfare Working Group (HT: Lindsay Mitchell). What did they find? A GMI paying $300 per week - the mean benefit income among those on benefits - would cost $44.5 billion, or $52.6 billion if we extended it to superannuitants as a replacement for NZ Super. The former could be covered by a flat personal income tax rate of 45.4%; the latter, 48.6%. But full fiscal neutrality would require tax rates of 50.6% and 54.4% - the lower tax rates would be just enough to cover the transfers, but income tax revenues are currently also used to fund more than just transfers.

If we recognize that most parents are beneficiaries via Working for Families and compensate them for the loss of our version of EITC with a $86 per child per week payment, we get a $57.1 billion fiscal cost and a personal tax rate of 50% (or 55.7% for fiscal neutrality).

And, even this rather expensive system leaves the worst off worse off, as it kinda has to. Treasury notes:

Although the Gini coefficient improves under all models, many beneficiaries (including the disabled, carers and sole parents) currently receive more than $300 per week and would be made financially worse off under a GMI scheme. Therefore the GMIs considered could distribute money away from those most in need of government assistance and toward those who have choices and opportunities but choose not to work.

Treasury also warned about potential adverse labour supply responses to the necessary personal tax rates. And, the induced gap between company and personal tax rates would increase IRD's enforcement costs.

Treasury concludes by reiterating Milligan's impossibility:

From the international examples it is apparent that the more equal a society is in the beginning, the lower the returns to a GMI scheme. That is, a New Zealand specific GMI would either be at a level of income too low to reduce poverty, or a level of income that is high enough to reduce poverty but is therefore expensive and hence distortionary through higher tax rates. 

I don't think Gareth Morgan's Big Kahuna scheme is able to escape the trifecta by imposing new taxes on capital or land. Why? Because those aren't free lunches either. If it's worth having a land tax, it's worth doing it regardless of whether we have a GAI. So in the first stage we set the optimal tax structure - and I'm completely unconvinced that a capital gains tax is all that hot an idea anyway (see Seamus's posts here here and here.) But whatever the optimal tax structure, we implement it in stage one. Then, we still have to increase all the tax rates by enough to pay for a GAI if we're going to have a GAI. And the impossibility reasserts itself.

Morgan squares things with a cheaper GAI paying $11k instead of Treasury's $15k. But I have a hard time believing that's a stable political equilibrium. Could NZ politicos really avoid the temptation of adding targeted benefits for the many folks currently on benefits totalling well over $15k? If not, how quickly do we wind up having a GAI on top of a targeted benefit system?

Capital Gains Taxes Redux

A couple of comments on my previous posts have suggested two possible efficiency motivations for having capital gains taxes. Both are theoretically correct, but neither makes a convincing case for a real-world CGT, in my opinion.

First, Bill Kaye-Blake suggests they can be a way of capturing otherwise untaxable non-market activity. The idea here is that DIY work does not involve a market exchange and so is taken out of the tax net. The whole optimal tax literature from Ramsey on is predicated on how to minimise the inefficiency arising from this inability to tax some goods. As an example, I had an uncle who was a keen DIYer. He liked buying houses in need of repair and then doing them up. Once finished, he would sell and move on to a new fixer-upper. For him it was just a hobby, but an unintended consequence was that he was able to move into better and better houses through the untaxed return on his DIY labour that manifested itself as a capital gain. The argument here is perfectly valid, but as a reason or having a CGT, it would be like giving yourself acupuncture with a fork (Ron Jones’ expression). For the very small amount of non-market income-generating activity that would be captured indirectly by a CGT (not my uncle, if first houses are exempt), one would have to bear the other costs of the tax. Even if the net efficiency and equity benefits of the tax for all other reasons were zero and not negative, it is pretty hard to see that this benefit would outweigh the enforcement and compliance costs.

Second, Michael Reddell cites the 1990 consultative committee on the taxation of capital income as stating that capital-gains taxes can be efficiency enhancing when the changes in gains or losses in asset values are not windfall changes. I have not been able to track this document down, but I am guessing that the idea here is related to a 1964 paper by Samuleson, which Andrew Coleman has pointed me to. Samuelson’s paper is very elegant, but it isn’t an easy read, so let me try to illustrate his result with a simple model. Those who don't like models expressed without equations just jump two paragraphs at this point.

Consider a world in which there is a perfectly elastic demand for domestic saving in international markets at an interest rate of 5%. This means that, in the absence of taxes, there is an opportunity cost to both a saver and the country of investing in the creation of a local physical asset in the form of an ongoing return of 5%. It will therefore only be efficient for the country to invest in the asset if the present value of the future payments from the asset exceed the cost of the creating the asset, when the future is discounted at 5%. If we now put on a 40% tax on interest income, then local savers will use the after-tax interest rate of 3% to discount payments, which will lead to a higher present value of a given flow of payments from an asset. If, however, the 40% tax is also levied on the payments from the asset, there will be an offsetting reduction in the present value. In the special case where there is a constant flow of payments, these two effects will exactly offset. In this case, private incentives will lead to the efficient level of investment in local assets—namely invest only if the social rate of return is in excess of 5%.

Now consider an asset which will produce a constant payment in perpetuity but starting in one year’s time, with zero payment before then. The price of the asset in one year will be unaffected by the tax, but the private saver will discount this value back one year at a rate of 3% rather than the socially optimal 5%. As a result, the present value will be overstated and there may well be overinvestment. The reverse situation applied for assets whose payments fall over time. The problem arises because of the compounding of interest, which means that taxes on interest imply a larger proportionate reduction in the rate at which values are discounted at longer time horizons than in the near term.

The bottom line of this is that the tax system creates a distortion in which there is an incentive to invest too much for long-term gain, and not enough for shorter term gain.

Now, if payments from an asset are going to predictably increase over time, then so will the market value of the asset—that is, there will be capital gains. Similarly, predictable decreasing payments will lead to predictable capital losses. Samuelson’s very neat mathematics shows that if you tax capital gains and subsidise capital losses at the same rate of tax as is applied to interest and payments from the asset, then the distortion in favour of long-term returns over short-term returns is removed.

So why is this not a strong argument in favour of capital gains taxes: I can see three reasons:

1. Samuelson’s result requires symmetric treatment of capital losses and capital gains, and no distinction between realised and unrealised gains. If this is not going to be the system implemented (which real-world capital-gains-taxation regimes ever are), the result does not apply.
2. The result is partial equilibrium, dealing only with the distortion across time horizons. But the excess discounting that arises from the magic of compounding is exactly the reason that capital taxation is found to have greater efficiency costs than labour taxation. A regime without capital-gains taxation, may lead to some inefficiency in the time horizon of investments, while enhancing efficiency in the margin between consumption and saving.
3. With a 5% before-tax interest rate and a 40% tax rate, it takes a horizon of 25 years before the future is excessively discounted. Do we really need a complicated tax regime to dampen the amount of saving going into investments with payoffs beyond 25 years? Can any proponent of capital gains taxes state with a straight face that this is the problem they are seeking to solve?

I am definitely not an expert in capital taxation, and so am open to being convinced by counter-arguments. My problem with much of what I have read in public discussions, however, is that the putative benefits are couched in vague terms (like “productive investment”), which I have a hard time converting into a model that lays bare the underlying assumptions. I would love to see the models made explicit.

A Diatribe Against Capital Gains Taxes-Part II.

I noted yesterday that the main argument put by proponents of capital gains taxes is that they are needed to encourage savings into productive investments rather than into chasing capital gains. This sounds plausible on the surface, but I’m not sure that those making that argument have fully stated their implicit assumptions.

The first thing to note that “investment for capital gains” is not unproductive investment, it isn’t investment at all, at least not in the economics sense of the word investment—the creation of capital goods for the purpose of producing a flow of newly produced goods and services in the future. One can imagine government policy designed to improve the quality of investment, such as by creating a legal environment under which investors have confidence that they will be able to retain the returns on that investment, or more simply by removing policies that subsidise uneconomic uses of resources. But when a saver “invests” (in the household sense of the word) for capital gains by purchasing an existing physical or financial asset expected to increase in value, he is not diverting resources into the production of an unproductive asset, he is simply changing ownership of the existing stock. The best that can be said about a link to real investment is that if real investment in New Zealand is an increasing function of New Zealand savings (i.e. that firms here do not face a perfectly elastic international supply of lending) and if the pursuit of capital gains results in a reduction in the New Zealand savings rate, then the quantity not quality of real investment could be reduced by the absence of a capital gains tax.

But how reasonable is that assumption that the pursuit of capital gains results in a reduction in savings? For savings to have been reduced it must be the case that consumption has increased. How does that happen? Consider a saver who has to choose between lending to an investor or purchasing an existing asset. Whichever he chooses, he has devoted the same amount of his income to the savings, and so his consumption is not affected. If, however, he chooses to purchase an existing asset, he will need to induce its current owner to sell. What that owner does with the income from selling (i.e. whether he consumes or saves) is what determines whether the transaction has led to an overall increase in consumption. Now typically, when someone sells an asset, it is because they are seeking to earn the true return (consumption) from a previous decision to save, but that doesn’t mean that the pursuit of capital gains has induced an increase in consumption. We need to ask why the marginal asset seller was induced to sell as a result of a saver’s decision to seek capital gains rather than lend directly to investors. Presumably, the marginal seller was induced to sell because the additional demand increased the asset’s price, which would mean that the change in the observed price has changed his assessment of the asset’s value.

This is getting complicated, but when you put it all together, this is what it seems to me must be the story you have to tell if you believe that the absence of a capital gains tax is harming productive investment:

1. there are some canny savers out there who know which assets are going to appreciate in value; 
2. some of the owners of those assets are not so canny and believe that their assets are worth less than they actually are based on the current price;
3. in the process of bidding for those assets, the canny investors push up their price, inducing some of the non-canny owners to save;
4. when the non-canny owners sell at higher prices, they discover that their portfolios are more valueable than they thought;
5. as a result of this higher perceived permanent income, they increase their consumption;
6. as a result, the total flow of savings in the economy is reduced;
7. investing firms are not able to replace this reduced flow of savings from off shore;
8. even though the increased consumption in point 5. is the result of non-canny asset owners receiving better information about their true wealth, this change of behaviour is a bad thing;
9. somehow a capital gains tax will act to prevent this better information getting through to uncanny asset holders, even though anything less than a 100% capital gains tax would provide an incentive for canny investors to exploit undervalued assets! 

There has got to be a better justification for capital gains taxes than this. Is there an economist advocate for such taxes out there who can enlighten me?

A Diatribe Against Capital Gains Taxes-Part I.

(Warning: this is a large and somewhat geeky post).
I noted in my post on Labour’s tax policy here that there were arguments on both sides for capital gains taxes. This was a euphimistic way of saying that there are economists who I respect who are in favour of capital gains taxes, so I wouldn’t want to dismiss the idea out of hand, but I have a hard time understanding how they could come to that conclusion. So I am going to lay out the case against in a couple of posts. Most of the points below are standard fare but a couple of them I haven’t seen before.

One thing to note in the discussion of any tax is that all taxes created bad effects, and so it is not sufficient to show that a particular tax has bad effects: those effects have to be compared to the alternative source of revenue. Capital gains taxes are taxes on assets, and so part of the general taxation of capital income. Most studies of tax systems have concluded that the long-term distortionary costs from taxing capital income are greater than those from taxing labour income, so that, from the standpoint of efficiency the optimal tax system would have lower tax rates on capital than on labour income. Equity considerations might lead one to favour eschew this result and favour income and labour income being treated identically. It would be difficult, however, to make a case for higher tax rates on capital income than on labour. Note, however, that in an unindexed tax system, this is what we see. Because it is the nominal interest rate that is taxed, not the real rate that subtracts off the rate of inflation, the effective tax rate on capital income is greater than the headline rate in the presence of inflation. In particular, consider a tax system with a 40% tax rate on all labour and capital income and a real interest rate of 5%. Every percentage point of inflation increases the effective tax on capital income by 8 percentage points, so that if inflation were at 2%, the effective tax rate on capital would be 56%. It is against this backdrop that capital gains taxes need to be considered.
First, let’s start with an incorrect, but not necessarily misleading, example given by Rodney Hide showing how we implicitly already do have a CGT. His example was a variant on the following. Imagine that a no-tax world in which the risk-free rate of interest is 5% and you have an asset expected to pay $100 per year in perpetuity. The asset price would be $2,000. Now let there be a surprise increase in the payment of the asset to an expected on-going $200 per year. This will result in the asset price increasing to $4,000, a capital gain of $2,000. Now consider a world with a 40% tax rate on interest income. In Hide’s example, the asset would pay after-tax returns of $70 and $140 before and after the productivity gain, giving before and after asset prices of $1,400 and $2,800. In this example, the tax on the assets income results in the capital gain being only $1,400, and so has effectively been taxed at the 40% tax rate.
The error in this example, as pointed out here by Bill Kaye-Blake, is that it ignores the effect that taxes have on the risk-free interest rate. If the 40% tax rate applies to interest income as well as the flow of earnings from the asset, then the after-tax risk free rate of interest would be 3%, and the before and after prices of the asset would be $2,000 and $4,000, exactly the same as in the no-tax case.

But this doesn’t mean that Hide’s analysis is wrong. It is true that taxes applied equally to fixed interest and asset earnings would not change the capital value of an asset, but it does change the implied income from the an asset of a given value. Consider someone who owns the above asset and will continue to own it. They are earning $100 per year of which $40 per year is paid in taxes. After the increase in earnings, they pay $80 per year in taxes. What is the fairness justification for also taxing them on the capital gain, which is simply capitalises the future earnings, which are going to be taxed anyway? To draw an analogy, consider a tradesman living in Christchurch who suddenly finds that, due to the post-earthquake rebuild, his future wage income deriving from his human capital will increase. As he earns more he will pay more in income taxes; should he also be taxed on the increase in the value of his human capital?

At this point, the riposte might be that capital gains taxes are typically only applied to realised gains, so that the above asset holder would not be taxed unless he sold his assets just as the tradesman is not taxed on the unrealised value of his human capital. So, now imagine that the asset holder were to sell the assets whose value has appreciated in order to purchase an alternative portfolio of assets. He will still in expectation be earning $200 per year paying $80 per year in taxes, up from the $40 per year in taxes before the gain. There is still no compelling argument for taxing that increased earnings twice. Of course, he might choose to consume the gain rather than reinvest, but that is just the distortion introduced whenever capital income is taxed.

Furthermore, taxing just realised but not unrealised gains introduces other distortions: it creates an incentive for investors to hold on to assets rather than adjusting their portfolio mix to suit changing circumstances; if capital gains are taxed but capital losses are not subject to an offsetting negative tax, it implies a higher overall tax on savings, but if capital losses are treated symmetrically, canny investors can structure their investments to ensure a mix of capital gains and losses, and then realise their capital losses while retaining assets that have made a gain.

For these reasons, economists often express a preference for a capital gains taxes that tax both realised and unrealised capital gains. This is one area, however, where the politicians have it right and the economists wrong, in my view. Taxing both realised and unrealised gains is the more efficient policy, but such a tax has nasty implications for basic property rights when it creates situations where asset owners are forced to divest themselves of assets that might have high personal utility value (family holiday homes, businesses that one started, etc.) simply to meet a tax liability. Furthermore, there are the implementation and compliance costs from measuring unrealised capital gains.

So what are the arguments in favour of a capital gains tax? Let’s consider it against the criteria of efficiency (including enforcement and compliance costs), equity (vertical and horizontal), and respect for rights. Working backwards, I noted above why, respect for property rights leads real-world tax systems to only tax realised capital gains. But this creates its own problems with definitions, and potential for tax avoidance. An accountant friend of mine recently described a court case taken by the IRD against a group of accountants, in which the issue to be determined by the court was not what actions the group had taken, but whether their actions did, in fact, constitute a violation of the law. Legal processes where one can be hanged on a comma, are not ideal for a society based on the rule of law.

On equity grounds, since the income stream from assets will be taxed when they occur, at the same marginal rate as labour income, there is no obvious vertical equity imperative for capital gains taxes. It is true that the nature of having traded assets sold in competitive markets is that the benefits of future expected gains and the costs of future expected downturns in value are always captured or borne by the current owners of the assets, so that a comprehensive system of taxing capital gains with negative taxes on capital losses might serve a social insurance role, but there is no clear equity benefit.
Finally, on efficiency grounds, the complications that arise from trying to solve other problems give rise to a tax system with higher compliance and enforcement costs per dollar raised than other taxes, and also introduce other efficiency-reducing distortions.

Against all these arguments is the only serious argument I have seen in favour of capital gains taxes: that they are needed on efficiency grounds to make sure that savings is directed into productive investment rather than into chasing capital gains. This is a complicated issue that merits a separate post. More on that tomorrow.
In the meantime, let me propose a simple alternative to a normal capital gains tax that maximises benefits with none of the above costs. Take a tax system with a 40% tax on labour income and nominal capital income. Introduce a 13% tax that will apply to realised capital gains but also give a negative 13% tax on realised capital losses, and will only apply if the gains (losses) result in an increase (reduction) in consumption rather than being reinvested. (This removes the incentive to cash the losses and run the gains.) Finally, reduce the overall tax rate on nominal capital income so that the effective tax on capital income with an interest of 5% and an inflation rate of 2% is only 43% not the 56% it would otherwise be. And do all of this with a simple tax system with very low transactions and compliance costs. It seems too good to be true, but it can be achieved simply by reducing the tax rate on all income from 40% to 31% and replacing it with a 15%, no-exemption GST! Put another way, we already have a very good capital gains tax in New Zealand without any of the downside costs.

Labour’s Tax Policy:

There were few surprises in the policy announced Thursday, as much of it had already been announced or clearly foreshadowed. The key policies are

• zero income tax on the first $5,000 of income;
• an increase in the top marginal tax rate to 39% for incomes over $150,000;
• exempting fresh fruit and vegetables from the GST (technically, zero rating them);
• a 15% capital gains tax.

I would stand to benefit quite nicely from these changes, but I still don’t like the policy. Let’s take each item in turn.

 

In principle, I don't mind the $5,000 tax-free policy. There are fixed costs to working compared to not working, which are not recognised when one has to pay tax from the first dollar earned. I could see a tax-free bracket having a non-trivial effect on decisions on whether to enter the workforce part time or not at all, particularly if the tax-free threshold could be lifted over time. A tax-free bracket is also a much more moral way of ensuring that workers receive a living wage than would be an increase in the minimum wage. I find it difficult to believe, however, that the other policies in the package could make up for the cost of exempting the first $5,000 of income from tax for every taxpayer. This is the unpleasant arithmetic of tax policy: Tax cuts at a particular income level only have an efficiency-relevant impact on the behaviour of those taxpayers whose marginal income is at that level, but they give a tax reduction to anyone whose income is at that level of higher; cuts in tax rates at the lower end, therefore come at a large fiscal cost for a only a small change in reduced disincentives.

 

The proposed increase in the top rate is silly. There is such a small proportion of the country’s income earned at those levels that the policy can hardly be expected to bring in a significant amount of revenue, but will surely lead to the usual tax avoidance games. It is hard to escape the conclusion that this is a purely symbolic policy designed to make people with incomes less than $150,000 feel good that those with more income are being taxed more. If so, it is appealing to a rather ugly side of human nature.

 

The zero-rating of fresh fruit and veg might just about be the most appallingly cynical election bribe the country has ever seen. I am not saying that it would be the most costly election-bribe policy enacted; that mantle would have to go to either National Superannuation or interest-free student loans. Rather, I suspect that this policy would have the highest cost relative to benefits, with benefits defined according to a policy’s proponents’ underlying preferences. Consider first the costs of the exemption: of relatively small importance is the lost revenue that will need to be made up elsewhere. More important, is the additional transactions costs in compliance, enforcement, and definitions that the policy would introduce. Much worse, is the erasing of the line in the sand that currently stands between a clean GST and one with messy exceptions; once we start on this slippery slope, there will be no clear line left to defend against creeping exemptions and tweaking of the GST system likely to be proposed in the future. Against this, are two putative benefits. First is the idea that the exemption will make the GST more progressive. I haven’t seen any data on this, but I would extremely surprised if taxing fresh fruit and were not a progressive tax; if one wanted to use the tax system to redistribute from poor to rich, I suspect the proposed exemption would rank second only to high cigarette taxes as a method for achieving that objective. The second supposed benefit is the health benefits from eating more fresh fruit and veg. The trouble is that nutritionists tell us there is no nutritional advantage to fresh over frozen or canned, so unless someone can show some convincing data giving a significant elasticity of demand for fresh fruit and veg that does not result from a substitution away from preserved fruit and veg, we would need to dismiss this benefit as well.

 

Finally, there is the proposed capital gains tax. I have never been a fan of taxing capital gains, but this is a complicated area that needs its own post. There are certainly good economic arguments on both sides. I do hope, however, that media commentators are careful to check the devil in the details. Just because famous economist X is in favour of a capital gains tax, calibrated in a particular way, does not mean that he or she is in favour of any capital gains tax. Neither statements like (“Treasury is in favour”) or government responses made before the details are known (“dagger through the heart of growth”) will move the debate along very far here.