I’m a bit pushed for time today, so just a fairly quick post on the latest housing “patent remedy”.
I was quite critical last week of the Reserve Bank’s latest proposed regulatory intervention in the housing finance market. I noted that
The Auckland housing situation (a social and political scandal, as I’ve said before) calls for careful diagnosis, informed by experience and insights from the rest of the country, and remedies that deal effectively with the underlying issues and causes.
The Government’s proposed new tax measure – a brightline test in which gains on (almost) any sale of a non-owner-occupied house held for less than two years will be liable for income tax at the seller’s usual marginal tax rate- doesn’t seem to fit the bill much better than the Reserve Bank’s new intervention. It is also unrelated to the basic causes of the problem – laws and regulatory practices that impede the responsiveness of new supply, while at the same time other policy instruments actively drive rapid population growth in Auckland. (Taking a medium-term perspective, almost anything else is largely irrelevant.) It will be interesting to see what Treasury’s advice on the proposal was – they have long-favoured a capital gains tax, but it would be surprising if they thought this was either good tax policy, or something well-targeted at the housing market issues.
Last week’s Reserve Bank announcement drew editorials praising the fact that someone, anyone, was doing something, anything. There doesn’t seem to be anything similar this morning, but perhaps that is the nature of politics.
In fact, relative to the Reserve Bank’s announcement, there are some things to be said for the government’s announcement.
- Neither announcement has an electoral mandate – and it is only eight months since the General Election – but at least the latest announcement was made by Ministers, who are elected members of Parliament. The public can oust MPs, and as Australia illustrates leaders (and ministers) serve only at the pleasure of governing party caucuses.
- Whereas it is virtually impossible to mount a credible argument that not a cent can safely be lent, at any interest rate, to Auckland investor property purchasers at LVRs over 70 per cent, at least the two year bright-line test can defended as reducing the weight the tax system places on establishing intent. Taxes should be levied based on actions (or even assets), not on highly intrusive bureaucratic assessments of intent.
- The government’s announcement yesterday will require legislation, and media report that there will be Select Committee scrutiny. Elected representatives will scrutinise the proposal, and the media will report on the process. Contrast that with the Reserve Bank’s proposal, which will be shoehorned in under legislative provisions that were never intended for the purpose. Submissions will be invited, but (unlike Select Committee submissions) we will see those submissions only after the final decisions have been made, and the unelected Governor will be judge and jury in his own case. Yes, it is probably lawful, but it lacks some legitimacy.
But in addition to being ill-targeted, yesterday’s announcement looks as though it will add to the pro-cyclicality of government revenue. In other words, more revenue will flow into the government’s coffer at the peaks of booms (when it shouldn’t need extra revenue) only for that source to dry up when downturns happen. Pro-cyclical discretionary fiscal policy is something to avoid as far as possible – see, for example, Anne-Marie Brook’s work – and this change will only (slightly) worsen the problem. On a much larger scale, this issue was a major problem in Ireland.
I’m not close enough to tax administration to know quite how this will work if house prices ever fall sharply, but if people can offset losses on a house sale against other income, it would be quite an incentive to realise one’s loss quickly (inside the two year window when one can avoid the intent test), potentially exacerbating the speed of a correction. So in a severe housing downturn, will the government be writing cheques to housing investors who’ve punted and lost? Even if losses can only be carried forward to be offset against any future gains, the procyclicality of revenue will increase and the risk of more procylical discretionary policy will rise.
Capital income is generally overtaxed. That said, I’m not resolutely opposed to a theoretically pure capital gains tax. With efficient asset market pricing, there are no rationally expected real capital gains. Any actual gains and losses (of which there will be many) are then just windfalls. One can treat them as taxable income/losses or not, and it is mostly just a distributional issue with no very material efficiency implications. But that assumes:
- All assets are subject to tax (not some assets, held by some types of people)
- Gains and losses are treated symmetrically
- Only inflation-adjusted capital gains (losses) are taxed
- The CGT applies based on changes in market values, not realisations
I’m not aware of a single capital gains tax anywhere, ever, that has met those tests. Real world CGTs are distortionary in a whole variety of ways, including discouraging turnover and encouraging assets to be held not by those who can most efficiently hold and manage them, but by those who are at least risk of having to trigger a transaction. Big investment funds might never need to trade a property, but an individual small business operator (eg a family with a single investment property) can face many possible changes in life circumstances which could compel a sale – including, but not limited to, redundancy or job relocation. The PIE regime already started to skew the ground against individual holders of investment properties, and this measure will skew it a bit further.
In the end, yesterday’s announcement looks a lot like political theatre. As ministers, and the Reserve Bank, have rightly noted previously, CGTs don’t change the character of house price cycles, and attenuated ones like this are even less likely to. Some will feel better that “something is being done”, but it will just divert attention, and policy and legislative time, away from measures that grapple with the real issues. My first reaction yesterday when I heard the announcement was to think of the Third Labour Government’s Property Speculation Tax in 1973, introduced at the height of an earlier house price boom. We had a look at it when we did the Supplementary Stabilisation Instruments Report in 2005/06. It also made good political theatre, distracting from the real issues. Every asset price boom is a little bit different. But like this proposal the Property Speculation Tax attacked symptoms and was largely irrelevant to ending the 1970s house price boom (which was followed by a multi-year very deep fall in real house prices). Marked changes in immigration policy, and a collapse in the terms of trade which helped prompt an exodus of New Zealanders to Australia, had much more to do with that. House prices are influenced by a whole variety of factors, but Auckland prices are only likely to fall very much very sustainably if there is some combination of a far-reaching freeing up of restrictions that impede supply and an end to the policy-fuelled population pressures.
UPDATE: This article is interesting in light of the Reserve Bank’s response to my OIA last week in which the Bank confirmed that it had done no substantive analysis of capital gains taxes, and had provided no advice on such issues to a variety of ministers or agencies. Since I inadvertently omitted the Prime Minister from the list, it is possible they may have given such advice directly to him, but it would be surprising then that nothing had been provided to Treasury (or IRD).
 The brightline test idea has been around for a while. I found that it was referred to in the Supplementary Stabilisation Instruments Report the Reserve Bank and Treasury prepared at the request of the then Minister of Finance in 2006.