The Tax Working Group’s proposed capital gains tax would constitute one of the most penal regimes in the world if implemented.

A comprehensive CGT regime would also tarnish the simplicity and competitiveness of New Zealand’s internationally praised tax system.

Worse, the new tax would raise minuscule revenue, be easy to evade and be too volatile to fund any tax relief compensation.

In essence, much pain and little gain – and unlikely to succeed in the proposed format.

As recommended by the (majority of) the Tax Working Group, the new tax would involve a realisation-based impost that is applied to gains on a broad range of assets. The gains would be taxed at full rates, with no discount and no allowance for inflation.

In theory, this is the closest to a pure capital gains tax regime. In practice, it is an unworkable Trojan horse that is neither fair nor popular. The government should have been more careful about what it wished for.

Taxing at full rates with no discount means a 33% tax rate kicking at every dollar above $70,000 earned income. This headline rate would immediately push New Zealand to the top of the international CGT rankings among industrialised economies, just behind Denmark and Finland.

Such a top-ranking CGT would without a doubt harm our ability to promote growth-inducing investments. European countries and the continental US might get away with it but, for a small island economy like ours, taxing capital gains would not go without chastisement. Singapore and Hong Kong, for instance, do not have such a tax.

Hitting middle-income earners

And given New Zealand’s recognisably low income tax threshold, a new CGT would disproportionally hit middle-income earners already struggling to invest for retirement. So, despite all the talk of fairness and “tax the rich!” motivations, capital gains tax would still hit the wider population too.

True, the wealthy might hold up to four-fifths of net private assets and be accountable for the bulk of CGT dues. But that fact will not make it less painful for the average New Zealander who would have to surrender a third of their capital gains on retirement savings, investment bach or inherited property.

The fairness appeal would also be tainted by the recommended no inflation adjustment.

To illustrate, say a half-a-million-dollar investment property appreciates below the line of inflation and sells for $550,000 a decade later. Under an inflation-adjusted regime, no capital gains are due; under the Tax Working Group proposal, a tax bill should be paid based on the $50,000 nominal return, even with property prices falling in real terms.

These features should be enough to shut down any attempted fairness and popular aspirations that a CGT might carry. Yet the uglier bits emerge when looking at the significant inefficiency costs and compliance quagmire that new tax would entail.

The choice of a realisation-based CGT instead of accrual accounting is a pragmatic one. Yet it does not come without significant drawbacks – the main one being undesirable lock-in effects.

Taxing capital gains only when a realisation event happens (for example, sale of a property) means CGT is nothing more than a turnover tax. And, as with all turnover taxes, it creates perverse incentives to defer a realisation event at the expense of economic efficiency.

In addition, the recommendation of taxing capital gains on a broad range of assets (with the notable exemption of the family home) creates a whole set of problems on its own.

First, taxing capital gains on corporate shares constitutes double taxation: Share prices are a function of the company’s stream of profits that already are subject to income taxes, which means capital gains tax would be a double hit on the same taxable event.

The double taxation issue is so prominent that our international agreements would forbid us to tax overseas investors on capital gains in our share market.

Compliance complexity

Second, expanding capital gain taxes on corporate groups, unlisted shares and business goodwill would too add greater compliance complexity. And surely become a windfall for lawyers and accountants.

For this reason, all previous government-mandated reviews – from the 1987 Consultative Committee to the 1998 Committee of Experts to the 2001 McLeod Tax Review to the 2009 Victoria University of Wellington Tax Working Group – have either refrained from recommending all-embracing capital gains taxes or expressed serious concerns regarding their practical challenges.

Ironically, despite all these drawbacks, the new tax would still raise little revenue.

According to the Tax Working Group’s own numbers, the new tax would raise a mere 1.2% of GDP after 10 years of introduction. And that is based on optimistic forecast assumptions, such as taxing capital gains for all types of land and domestic shares, consistent annual asset appreciation across the board, and no behavioural changes among taxpayers.

International experience also shows CGT is too volatile to give away tax breaks elsewhere or to fund steady expenses. In Australia, for instance, CGT revenues as a percentage of GDP more than tripled between 2002 and 2008, then crashed toward late 1990s levels from 2009 to 2013.

Plus, on fairness grounds, the tax report recommended allowing taxpayers to offset capital losses against ordinary taxable income (that is, not just against capital gains). This would dramatically increase the fiscal management challenges – and are very much unlikely to be welcomed by the government.

Every complex tax system invites complex tax avoidance strategies. But a simple one is already easy to guess: Overinvest in your family home and buy foreign shares. (And if you have some cash left, why not invest in the latest Damien Hirst or Ai Weiwei creations as art would also be an exempted asset?)

There is no economic case for implementing a comprehensive CGT in New Zealand. The sooner the government realises it, the better its odds to win the next election – and the greater our chances to advance our economy.

Dr Carvalho is a research fellow at the New Zealand Initiative and the author of the Initiative’s recent policy note ‘The Pitfalls of CGT’ on the Tax Working Group’s report.