The housing market ‘hodl’

The real tax burden on housing

Jun 10, 2021

It’s been a big week in tax, with the G7 progressing the OECD’s multilateral tax agenda, ProPublica chiming in on billionaire tax and Australia releasing its annual taxation statistics.

I wrote about the G7’s tax proposals here, noting that they risk redistributing revenue and capital to some of the world’s worst performing gvoernments and economies at the expense of reform-oriented, small open economies. Sadly, Australia’s tax burden on capital means that we have more in common with the former than the latter, so we potentially stand to benefit from a global minimum tax.

That assumes, of course, that the global minimum doesn’t become a targeted floor. Governments cut corporate taxes because it is good for investment, growth and jobs and those incentives don’t change just because some in the G7 want to change the distribution of taxing rights. Fighting over existing tax revenue is a poor substitute for competing over the tax base.

The G7 also signalled it wants to impute a corporate structure to Amazon it doesn’t have to increase its tax bill. Once we go down the path of designing bespoke taxes for individual corporates, the rule of law in relation to international taxation goes out the window.

As far as billionaire taxation goes, it is worth recalling Steve Landsburg’s The Man Who Can’t be Taxed. Yes, you can take their money, but that’s not the same thing as appropriating real resources.

The annual release of the ATO’s taxation statistics in Australia is tailor-made for media stories ranking postcodes by taxable income, as well as league tables of who benefits from tax ‘concessions’ like negative gearing and capital gains tax discounts. The Treasury’s estimates of tax expenditures also inform these stories, by purporting to put a dollar value on their cost to the revenue.

The problem with almost all of these stories is that their preoccupation with distributional questions loses sight of the more fundamental issue of the efficiency of the tax system. The intra- and inter-generational distributional politics of tax reform is a game everyone likes to play (looking at you Grattan), but it mostly makes for bad public policy.

Ideally, we want a tax system that raises revenue at the lowest possible cost in terms of economic efficiency. Obviously, the tax system departs from this ideal in important ways, mostly because we try to use tax system tweaks to achieve distributional outcomes which would be better and more transparently met on the expenditure side of the budget. If our normative benchmark is an expenditure tax under which we tax consumption and not saving, then many tax ‘concessions’ are anything but. They exist to alleviate economically costly distortions to saving and investment. Most taxes on capital, including capital gains tax, are distortionary in this way.

With the housing market running red hot, people are once again suggesting that either negative gearing and/or capital gains tax concessions should be wound-back to ‘cool’ the market. Here, it is useful to distinguish between the tax burden on the returns to housing and the tax burden on dwelling construction.

The yield and capital gains on housing are taxed differently depending on whether you are an owner-occupier or an investor. Winding back negative gearing and capital gains tax concessions might help induce substitution between investors/renters and owner-occupiers by changing the relative price of different tenure types, but by itself is not going to address an imbalance in overall housing supply and demand. The long-run equilibrium relationship between rents and dwelling prices implies that both are driven by the underlying user-cost of housing.

Then there are taxes on dwelling supply. Many of the inputs into dwelling construction are taxed directly, but housing is not exceptional in that regard. The bigger tax burden is the implicit tax imposed by planning and development controls.

The construction cost is a small part of the price of a new dwelling. We also have to pay for the right for that dwelling to exist. House prices are just the present value of the economic rents that accrue to the holders of those rights. There is nothing surprising about people paying high prices for a durable good rationed by the government. As Ant Breach has argued, the resulting shortages are perfectly analogous to those generated by Soviet central planning. In Australia, we don’t queue for food, but we sometimes spend our Saturday mornings queueing to buy or rent the housing stock.

Capital gains taxes are transaction taxes just like stamp duty and have similar effects on the housing market. Both taxes are easily avoided by ‘hodling,’ reducing market liquidity and leading to a less efficient allocation of the dwelling stock. Note the head scratching in both the US and Australia over people not selling in red hot market. Every homeowner currently owning less housing than they plan to consume is effectively short and has been burned by the increase in house prices. It’s a negative wealth effect analogous to that from an increase in consumption taxes.

Removing negative gearing and capital gains tax concessions will have distributional consequences some might find appealing, but it won’t make housing more affordable. New Zealand is currently running an experiment on both counts. Watch that space.

The New South Wales government’s intergenerational report found that by 2060-61, we will need an additional 1.7 million homes in the state, equivalent to one new home for every two existing homes or 42,000 new homes every year for the next 40 years. Every single one of them will be the subject of a discretionary permissioning process. Every one we reject represents a reduction in quantity and an increase in price. That’s the real tax on housing. The rest is just overlay.

ICYMI