Not much can be done about housing affordability, but something could be done about fairness in property tax.
Labor cannot make much out of housing affordability, even though the Government said this week it intended to do nothing.
The Government was responding to the report by the Productivity Commission that it commissioned in August last year.
It rejected changes to capital gains tax and negative gearing that, combined with high marginal income tax rates, the commission pointed to as major drivers of the surge in house prices since 1996.
Labor cannot do much about this because it, too, has rejected changes to those taxes for fear of a backlash by aspirational voters. Further, the commission got stuck into state and territory governments over stamp duty and all of those governments are Labor and all have presided over increases in those duties.
Any attempt by Labor to appeal to people shut out of the housing market will be met with the obvious response that Labor presided over hideously high interest rates in the 1980s and is therefore not in a position to talk.
In all, it is not a bad result: both sides of politics agreeing to do nothing about a so-called crisis. It is not a bad result because when governments do something they almost invariably make it worse or cause a whole range of other unforeseen adverse consequences.
The commission itself recognised that danger. It said, “There is no ‘quick fix’ to address affordability concerns. Indeed, governments cannot prevent most of what happens to house prices and should not try.”
But the commission was keen on suggesting that changing the tax system could help a bit. In that it was right, but perhaps it missed some critical points.
Interestingly, the conflicts-of-interests section at the beginning of the report stated that none of the commissioners had any investment property. I have, so I’ll declare that interest now.
You can take two views on general (as distinct from specific) conflicts of interest. On one hand, you could say that the commissioners bring objective minds to the question. On the other hand, you could say they have no experience in the area and so do not know what they are talking about.
The commission is right in saying tax is central to the property boom. Why pay a top marginal income tax of 48.5 per cent when you can borrow large sums to money, buy a property, claim a big tax deduction on the interest, wait for the capital gains and sell at a big profit which is taxed at only 25 per cent?
If the marginal income-tax rate were lower, fewer would take the risk, the commission correctly pointed out.
But it missed a more salient point. When investors keep a property for a while, the potential capital-gains-tax liability grows. An investor might buy a place, say, in 1995 for $300,000. By 2004 it is worth $600,000. That would result in a capital-gains tax liability of $75,000, assuming the investor was on the top marginal rate. Forget it. The investor will not sell. What would the investor to do with the money? Reinvest at the lower base of $525,000? No way; it is better to keep the original property investment ticking over until one of two events: someone makes a hugely high irresistible offer, or the investor leaves the workforce and takes a year off so that the capital gains is the only income for that year and so the tax is bearable.
In short, we have a whole lot of baby boomers who have invested in the housing market and are refusing to sell. Small wonder supply is lower than demand.
This began in 1985 when the Keating Government tightened capital gains tax to include investment properties. Property was still a good investment then (given the share market uncertainties). Incidentally, investors holding houses bought before 1985 are clinging to them even more closely because as time goes on, their capital-gain-free asset becomes even more valuable to them – again reducing supply. The 1999 reduction of capital gains tax made little difference.
So you will just have to wait for the baby boomers to retire before many of these investment houses are returned to the market.
The other point missed by the commission is that the lower affordability and the shutting out of many from home ownership is not such a bad thing. Renters are getting a better deal these days. With investors assured of high capital gains, the investors are not so concerned about squeezing out more income in rent. Typically, renters are getting the use of capital at 3 or 4 per cent. They rent a $400,000 house at $300 a week (If you ask a bank for the use of $400,000 it costs nearly $600 a week.)
Further, renters are getting more security of tenure these days because the typical rented house is one where the landlord is not likely to be selling real soon (given the capital gains tax).
So we should accept the good bits and accept that we might just have to live with high property prices simply because land is finite and governments keep insisting on importing more people into the country.
But Governments can do something about the fairness of the tax system. Governments could abolish stamp duty for owner occupiers (which would remove a reason for people not moving to more suitable housing as families grow and shrink). Then they could bring the whole of the investment property market into the GST regime. In effect, stamp duty would be replaced by a 10 per cent GST on purchase of an investment property. The states would get the money via the feds. Rent would attract the GST. My guess is that rents would not go up by 10 per cent. Landlords would ultimately cop that (and so they should given their investment is primarily an income-tax reduction scheme). The GST on inputs would be rebated.
It was a mistake to leave investment property out of the GST regime. It was left out because it would have been seen as a tax on poor renters. But that is not the way the market works. We have a glut of rental properties; there is only so much tenants can and will pay. Landlords can only charge so much (irrespective of the GST) to attract and keep a tenant. So the landlord ultimately pays the GST. Overall, the GST will come out of the property-investment sector which at the moment is under-taxed.
It would marginally help housing affordability because stamp duty would be abolished. House prices may not plummet and the affordability problem would not be fixed, but at least the tax system would be slightly fairer.