Property Bubble

Towards an orderly and long term solution of the property bubble in Auckland

Gareth MorganEconomics12 Comments

Auckland’s revised Unitary Plan looks good – realistically up and out is the only way the supply bottleneck can be addressed. But supply failing to keep up with demand is not the underlying cause of the property bubble in Auckland. It is a periodically a source of ultra-stress but not the chronic, decades-long problem that has driven the house price-to-income ratio to giddy heights. That issue remains – it is over-stimulated demand.

Unitary Plan aims to fix supply

The general thrust of the Unitary Plan is right – building far more houses than the Council originally planned, 2/3 by building ‘up’ in existing suburbs, 1/3 by sprawling out. This is a good result, particularly compared to the original Council plan; we’ve previously discussed how sprawl is a false economy. The plan isn’t perfect – there are some concerns about the removal of rules governing energy efficiency, cultural sites and affordable housing provisions. Still, on balance the plan is progress, so now the Council needs to just get on and pass it.

Now that there is a concerted effort afoot to increase supply of housing, this is a good time to also bring in policy that addresses the cause rather than the effect of this permanent excess demand. Through changes to zoning, the Unitary Plan should simultaneously reduce the price of new houses but also add a lot of value to existing land values, as they can be redeveloped for more intensive housing. The new houses that emerge are no longer houses with a quarter acre section, they are infill housing – and they will be cheaper, albeit only for a while. The temporary relief only underscores the need to address what keeps pushing house prices up relative to income – not just in Auckland but across the country, not just when there a population burst but decade after decade.

It’s about taxing housing and land appropriately.

The demand side

The demand for property remains higher than it need be, decade after decade because of regulatory bias and tax breaks that keep it that way. The political conundrum of course is how to correct this without (a) causing a property price crash and (b) alienating the property-owning class who are thriving from the wealth transfer this phenomenon bestows on them.

The Reserve Bank is slowly but surely addressing the regulatory bias than underlies its culpability for the housing bubble. The belated rise of deposit to value and loan to income ratios are a somewhat clumsy response, but better than the nothing the Bank has done since the financial deregulation of the 1980’s kindled the bushfire that is our property market.

Tax reform

However, equally responsible for this phenomenon has been the tax break that is conferred to property owners by not taxing the benefit they enjoy from ownership of the asset. And I don’t mean capital gains. The fact that $100k in the bank attracts tax on the interest income, while $100k in a property doesn’t do the same to the benefit an owner-occupier enjoys, is a distortion in our income tax regime. That distortion has long been recognised by economists and tax experts but is in the ‘too hard’ box for political leaders.

In other countries there are imperfect methods used to address the benefit of this ‘imputed income’. They include wealth taxes, stamp duty, inheritance duties, capital gains tax, and so on. None of them work properly, primarily because of the exemptions that are made.

Yet there are ways to solve this problem if the political will can be found. An income tax reform that included in the definition of taxable income, the implicit income that asset owners enjoy from merely owning assets would remove the incentive to buy assets in order to minimise tax. And the closing of this loophole need not result in one single dollar of additional tax being collected – because it could be offset by cutting tax rates.

It looks like there’s about $750bn of non-financial (so excluding deposits, shares or superannuation) assets owned by people in New Zealand, net of debt. So at a tax rate of say 30%, levied on a deemed income of say 5% on those assets, this is $11bn of potential income tax per annum that should be being collected. This is roughly 30% of the income tax collect so such a windfall could be totally applied to cutting income tax rates by 30% say.

Such a policy would neutralise the tax system when it comes to property investment, meaning that demand for property would be more akin to demand for accommodation, rather than as it is now, driven by the demand to exploit the tax loophole. So that makes it fair but it also makes it far more economically efficient – we wouldn’t have the bias in capital investment we do now, businesses would compete for capital on a level playing field.

Transition

Of course there are the transition issues to address. Where does the cashflow come from for those who are over-invested in low income assets to pay the tax? What about older folk who are the most grossly over-invested in property – how might they rebalance?

Neither of these transition issues should be show stoppers and certainly do not outweigh the benefits to the economy from fixing this problem. In time people will rebalance their investment portfolios so that they can bear the tax load on their imputed (or deemed) rental benefit. As they adjust to that position their tax could be deferred or alternatively the switch to the new regime could be graduated over a few years to allow portfolios to be adjusted – i.e.; the tax rate on this income could step up over time to the full rate.

As for the impact on older folk already over-weighted in property, they could either be grandfathered out or at least given a longer period than the rest of us to adjust, have the annual tax simply accumulate as a charge against their property without compromising their right to occupy (like a reverse mortgage) – or a combination of all three transition policies.

The main point though is that closing this loophole in the income tax regime is essential to aligning property prices with the demand for accommodation and finishing this orgy of entrenched capital gains that are nothing more than a redistribution of wealth to the property-owning class, exacerbating inequality and affordable housing.

Nobody wants a property crash. But the serious issue of removing the tax-driven, artificial stimulant of demand for assets is yet to be addressed. Now is the time to do that, as a construction initiative temporarily takes the heat off the market.

Towards an orderly and long term solution of the property bubble in Auckland was last modified: August 15th, 2016 by Gareth Morgan
About the Author

Gareth Morgan

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Gareth Morgan is a New Zealand economist and commentator on public policy who in previous lives has been in business as an economic consultant, funds manager, and professional company director. He is also a motorcycle adventurer and philanthropist. Gareth and his wife Joanne have a charitable foundation, the Morgan Foundation, which has three main stands of philanthropic endeavour – public interest research, conservation and social investment.

12 Comments on “Towards an orderly and long term solution of the property bubble in Auckland”

  1. ‘imputed income’

    ‘implicit income’

    ‘deemed income’

    But you can only pay a tax bill from your ACTUAL income. That’s why all such schemes are bad and wrong and will fail. The issues aren’t ‘transitional’; they’re **fundamental**. It’s a matter of fairness.

    You won’t persuade people that deeming or implying or imputing an income which **doesn’t actually exist** and then taxing that **hypothetical** income in **real dollars** is fair. You HAVE to relate it to ability to pay.

    1. “You HAVE to relate it to ability to pay.” Um no. If I’m mortgaged up to the hilt and can’t pay my tax, I don’t get much sympathy from the IRD.

      1. You HAVE to have phasing in of a major tax change like this one. In the long term, people will take the tax into account and readjust being “mortgaged up to the hilt” to take the tax into account.

        One thing I would suggest is that, along with introducing the tax and in preparation for a house price crash, the government sets up a “bank” to bail out people who are about to lose their homes. I prefer such an approach to the government bailing out banks if we get a real house price crash. Perhaps the government would take over partial equity in the home to allow the occupants to continue to live there. I’m not sure of the details and I’m sure there are plenty of objections to this idea. Banks would, of course, start to factor it into their risk assessments. It does seem to me the right thing to do, by some measure.

        Then, too, I’m also very much in favour of drastic financial, monetary and banking reform, but that’s another story.

    2. Excuse me. You say “It’s a matter of fairness” but fairness is exactly what a Comprehensive Capital Income Tax is all about.

      What’s not fair is the bizarre situation where earned income is taxed but certain preferred unearned income is not taxed. Not only is it not fair but it is damaging to the economy, and damaging to society and each and every one of us. And it’s been all of these things for a long time.

      In fact, as far as I can see, you don’t have to pay this tax out of “ACTUAL income” at all. You can use a home loan to pay it or add it an existing home loan. In a scenario of increasing house prices at the present rates (say 10%) and low interest rates that could work very well indeed because starting from freehold you would only be borrowing about 1% of the home’s value which would have increased by 10%.

      You can even use a reverse mortgage: https://www.consumer.org.nz/articles/reverse-mortgages

      It entirely makes sense, it seems to me, to pay the tax out of a loan when the house is your home and a priority. You can also take the opportunity from time to time to move to a different priced home to pay off any borrowing incurred for tax purposes.

      When you are a highly geared investor, on the other hand, the tax will mount up on all the properties in your portfolio and it will really seem like other investments might be a better strategy. That’s exactly the point of the tax.

      1. Why on earth would any sane person take out a loan to pay a tax on a hypothetical income that *doesn’t actually exist*? Why would any decent human being seek to impose such a tax?

        Why not just relate the tax to income – or pay a benefit to those too poor to afford the tax? Why not do that??? You cannot say with a straight face that you expect poor people to take out loans to pay their tax bills and expect to be taken seriously! The very notion is risible.

        1. The sane person would probably rather take out a loan to pay tax than have their house sold from under them to do so.

          If someone puts their money into a bank savings account they pay tax on the interest they get and they have no potential capital gains. Neither, any longer, are they assured that their capital is “safe as houses” since they may very possibly take a “haircut” if the bank gets into trouble. On the other hand, put the same amount into property, and you pay no tax on the benefit obtained from ownership, AND make a tax free capital gain.

          The risible notion is that this is fair.

  2. Agree – fundamental change is required. The issue is too big and has such dire intergenerational consequences (sucking billions from the pockets of future generations in mortgage interest is not going to help saving for retirement or education or health or anything else of real importance) that it cannot be left up to party politics to manage. Like health and education, housing is a societal necessity and investment in national well being. Needs to be managed independently by people who have a broader perspective than getting reelected in 3 years.

  3. The biggest problem is Auckland
    We need to encourage people to settle in the “provinces”

    Either a “JAFA” tax
    Or some type of subsidy for the rest of us

  4. The main impediment to the idea of a comprehensive capitals gains or weath tax is in people’s minds; it will require quite a bit of readjustment to many because of the way we’ve always done things in this country regarding property. Sure, those sitting on valuable properties but cash-poor will need to be exempted but not their inheritors. That means any debt built up will come from the sale of the property. I can hear some screaming already that it is their right to inherit their parent’s assets tax-free but it wasn’t always that way. The reality is that for may reaching the age of 70, they will have never paid sufficient tax that covers their pension nor their health costs. Something has to give. Income taxes will need to be adjusted so for most the net result is neutral but some will benefit more and some less. My only issue is to come up with a system that isn’t over-bureaucratic to police or circumvent. Never underestimate the determination of the wealthy to avoid paying their fair share while lecturing the rest of us on our profligacy.

  5. Your argument on this subject Gareth has gone from a well thought through exercise in fairness, although politically impossible, to this latest version which is a very well thought through and economically commonsense proposal which is an exercise in fairness and is surely politically plausible as well. Now show me a political party with the balls.

    1. I wonder on what grounds David Seymour would reject this tax (if it were replacing other taxes and rebalancing the tax system)? Perhaps because it was somehow perceived as coming from “the left”. It would seem to meet the requirements of a party founded on “traditional classical liberal principles which are the basis of a free and prosperous community” which is committed to “fairness across generations” and has a vision of “law applied equally to all citizens”. http://www.act.org.nz/principles-0 Mr Seymour could hardly argue that access to home ownership was fair across the generations or that tax was being collected equally from the income (including property income) of all citizens.

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