“I know an old lady who swallowed a fly” is a nonsensical story that has delighted children for decades. Its tale of an old woman, who swallowed increasingly large animals, each to catch the previous one, is as humorous as it is absurd.

Yet like all good nursery rhymes, its meaning extends beyond entertaining the young. It serves as a warning about misdirected "solutions" to pressing problems. Sometimes the "cure" can be worse than the symptoms.

It is a warning the Labour-led government’s Tax Working Group would do well to heed.

Chaired by former finance minister Sir Michael Cullen, the group released its first discussion paper last week. Grandly titled the Future of Tax, the report poses five questions.

Four of them are reasonable inquiries: What is the purpose of tax? Does our tax system need to change to be ready for the future? Are we taxing the right things? What tax issues matter most to you?

These are all sensible, general questions. And the answers to them could well help identify whether changes are needed to the tax system.

But tucked in among these questions is a specific inquiry: Can tax make housing more affordable? It does not require a Mensa-level IQ to work out that this question is the odd one out. Indeed, the premise behind the question itself is inconsistent with the likely answers to the Working Group’s first question.

No one with the slightest knowledge of tax policy is likely to suggest that “the purpose of tax” is to reduce the value of a specific asset class.

Housing affordability

It is true, though, that tax policy can affect housing affordability – but not in the way Sir Michael and his group may anticipate. Indeed, it is almost as if the group believes tax policy is the cause of the housing affordability crisis.

It is not. The housing problem stems from planning laws that tie developers up in knots. Planning laws limit the supply of land for development, impose restrictions on densification and front-load infrastructure costs on new developments.

In combination, these factors have dramatically inflated property values. They have turned one of New Zealand’s most abundant resources – developable land for housing – into a scarce commodity, driving its price beyond the reach of many ordinary New Zealanders.

Why that has happened is a combination of the misguided approach of the Resource Management Act and the way local government is funded. The former problem is well-known. The latter less so.

The funding problem arises because councils bear the burden of facilitating local growth. The new roads and municipal facilities that come with rapidly increasing populations must be funded. And most councils have only two sources of finance: ratepayers or borrowing.

Councils, like Auckland, that have hit their debt ceilings, find themselves with over-burdened infrastructure and over-burdened ratepayers. Little wonder councils are resistant to encouraging the development their growing populations need.

Complex solution

Finding a solution is complex. But when the spoils of population growth enrich central government – with extra income tax, company tax, and GST – it is clear enough where the solution lies. We need to find a way to use that extra income to incentivise cash-strapped local councils to make pro-growth decisions.

The New Zealand Initiative presented one such solution in its 2013 publication, Free to Build. This recommended that central government share the GST on every new house built with the relevant local council. This would provide an alternative funding source for the infrastructure needed to facilitate new development. And it would provide an incentive to local government to encourage new development.

Of course, this type of solution has nothing to do with the policy behind the taxes raised by central government. Rather, it has to do with how those taxes are spent.

Indeed, if the solution to the housing crisis were as simple as introducing a capital gains tax (or for that matter a land tax), then Australia, which has a capital gains tax, would not be in the grip of its own housing crisis.

It is true that some landowners have become wealthy because of New Zealand’s restrictive planning framework. And it is also true that the scarcity of housing has attracted investors to take advantage of rapidly rising property prices.

But that is a consequence of the housing problem, not the cause of it.

If either the government or its Working Group wants to make the case for a tax on capital assets it should make that case openly and honestly. But it should not be dressed up as a solution to a broken housing market – especially when introducing capital gains or land taxes on investment properties may actually make housing less affordable, as landlords pass on the increased tax expense to tenants.

The lesson for the government and its Working Group is clear. Misdirected solutions will only complicate an already difficult problem. And we all know what happened to the old lady after swallowing a horse.