A good feature of our tax system

Yesterday I commented regretfully on the absence of any sign of much in-depth thinking from the Labour Party about reversing New Zealand’s ongoing relative economic decline.  I noted then that they had plenty of company in that failure.  As one illustration, I saw a piece on The Treasury’s website this morning outlining Treasury’s work programme, which is apparently organized around seven “strategic intentions”.  Each of them is probably fine in their own way, but none bears directly on reversing New Zealand’s decades of relative economic decline.  The standards of the modern Treasury seem to be  reflected in this quote from a related document, trying to recruit a new Chief Economic Adviser:

we are facing up to the challenge that economic actors operate in complex ways and not according to straightforward and predictable scientific models.  Moreover the days when improvements in living standards were measured exclusively by the increase in total production – GDP – are on their way out.

I just shook my head in weary despair.    I no longer have my Stage 1 economics textbook, but I doubt that even there anyone assumed that “economic actors” (people?) are other than complex.  No Treasury in my 30 years of working alongside them ever did.  And perhaps the Treasury could point us to cases where anyone ever thought that “improvements in living standards were measured exclusively by the increase in total production –  GDP”.  We conscripted labour in World War Two –  forced people to work even when they didn’t want or need to, and forced them to work longer hours than they preferred.  That provided a big boost to GDP, but no one thought it boosted living standards – it was a means to an end, defeating our enemies.   If they are really reduced to arguing against such straw men, it would be a very brave, or slightly deluded, person who took on that Treasury role.

But this post is, in part, about praising the Labour Party (and on this one, I suspect Treasury probably agrees with them).  The Herald has an article this morning on turnover taxes on real estate transactions.  They draw on this piece from a UK accountancy firm which looked at turnover taxes (on US$1m houses) in 26 countries.  New Zealand has no turnover taxes on property taxes and so ranks top of the table –  just marginally ahead of Russia, which levies a fee of US$30.45 on such a transaction.  Belgium, by contrast, which has always been known for its high turnover taxes charges US$113131 on a purchase of a $1m house.

The Herald found a local economist, Shamubeel Eaqub, who (in the sub-editors’ words) “frets on tax ranking” and who thinks, in his own words, “it would be a very good thing for New Zealand to tax property purchases”.  To his credit, Labour’s housing spokesman Phil Twyford disagrees noting that “stamp duty is a relatively inefficient tax” and stating that Labour did not advocate stamp duty –   no if, no buts, no suggestions of referring it to a working group.  Stamp duties on property purchases are just bad policy.  In some places (eg Australian states) they have been used when revenue options aren’t available to that particularly authority, but from either tax policy or housing policy perspective, let alone fiscal or labour market considerations, they have almost no other redeeming features and we should be grateful that we are free of such taxes.

The UK accountancy firm that wrote the piece fretted that high turnover taxes might make it hard to recruit overseas senior executives or rich foreign investors.  I’m not sure that the latter concern in particular will really have much resonance among electorates anywhere.  We should worry much more about what turnover taxes mean for the functioning of the market for ordinary people.  Moving cities is expensive enough as it is, without slapping an additional heavy tax on people whose job opportunities mean it is necessary for them to move.  Stamp duties on property transactions bear no relationship to ability to pay or any of the other usual desirable features of a tax system.  At the margin, they impede labour mobility, undermining the effectiveness of the labour market.  And, almost certainly, they reduce housing turnover.  Some might see that as a good thing, since high housing turnover is often associated with rising prices –  but it isn’t the turnover that generates the higher prices, it is the underlying boost to demand that lifts turnover and prices together.   Structurally reducing the level of housing turnover would simply reduce the choices people face when they do come to the market.  And where it might make good practical sense, on account of changing family circumstances, to move house, such taxes will simply encourage more people to alter and extend an existing house instead.  There is no obvious welfare gain from that.

And, of course, there is no sign that the presence or absence of a turnover tax plays any part in explaining cross-country variation in house prices, or price to income ratios.  Belgium’s houses certainly aren’t cheap, Australia and the UK both have quite material turnover taxes and house price problems as severe as ours, and in the US places fast-growing places with very affordable housing co-exist with highly unaffordable cities all in a regime with very low property turnover taxes

I’m also very uneasy about property taxes tied to turnover – whether stamp duties, or realisations-based capital gains taxes (which all real world CGTs) are –  because of the fiscal risks they create.  When times are good property turnover is higher than usual –  often quite a lot higher than usual.  Tax revenue floods in –  not just 10 per cent higher than GDP when GDP is 10 per cent higher, but multiplicatively so (housing turnover per capita might double or treble from bust to boom),  If the boom runs for several years, the fiscal authorities –  officials and politicians –  come to treat the higher level of revenue as normal, and perhaps even sustainable.  Even if some boffins in Treasury keep sounding the alarm, politicians have elections to win and abundant revenue encourages even-more abundant spending.  This is a problem even when tax systems draw almost entirely on income and consumption –  our own Treasury finally caved in in 2008 and conceded that the higher levels of revenue built up during the boom of the previous few years was sustainable,  just before the severe recession blew to pieces all those assumptions. It was much m0re of a problem in Ireland, where property-based revenue had hugely flattered the fiscal picture in the years leading up to the crisis.  It is fine to talk about clever schemes to limit these risks –  fiscal rules or separate funds –  but they rarely work well.  And there is no good tax policy or housing policy case for turnover taxes in the first place.

I’m not so keen on the rest of Labour’s housing tax policy –  extending the quasi capital gains tax for investment properties, or “axing” so-called negative gearing –  but credit to them for having no truck with pure turnover taxes.

(UPDATE: I noticed that Treasury recently released some material on the – rather limited –  work they had been doing on the possibility of a stamp duty –   turnover tax –  for residential property).

 

 

16 thoughts on “A good feature of our tax system

  1. What do you think of a land tax? To my mind, it seems like an easy way to collect revenue and encourage more efficiency in land use — as well as make people pay a chunk of the benefit they get from a high land value (which they can’t really contribute to on their own, at least not in residential areas). But would like to hear your thoughts.

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    • Here is a link to a 2015 land tax post
      https://croakingcassandra.com/2015/11/12/are-land-taxes-the-answer-to-house-prices/

      This was my summary then

      I’m not in principle opposed to a land tax, but I’m:
      •sceptical that it could be imposed, in an efficient way, on an enduring basis
      •sceptical that it would allow much effective tax system rebalancing
      •and doubtful that, on the scale at which it could be imposed, it would really make much sustained difference to urban land prices, and trends in them over time.

      Recall that in Auckland land prices make up such a large share of urban house prices that local authority rates already look quite a lot like a land tax.

      Since I wrote that post in November last year, real risk-free interest rates have fallen quite a lot further. I think they have to be taken into consideration in thinking about a feasible and efficient rate for any land tax.

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      • Indeed, on my small property investments I already pay $50k in rates a year so not too sure how much more is expected in additional taxes.

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  2. And thankfully, the trend in Australian states is to gradually replace those stamp duties with land tax (see the ACT and SA), but generally speaking it is a matter which is forced on a state Treasury against the will of the Premiers and the voters. Generally because the Treasury has a hard time forecasting (and responding to) very volatile stamp duty revenues as opposed to very stable land taxes.

    I think the attraction to stamp duties actually comes from its economically least desirable aspect: people think that it doesn’t really apply to them or that they can avoid it by deferring a sale of a house. People generally don’t think ahead that they will move and sell their house in the next seven years or so, even though on average that’s exactly what happens. And while they’ll complain about the stamp duty it is levied at the same time as what is usually a big windfall gain, it somehow seems more palatable to get a bill for $50k once rather than paying up $2k per annum.

    Note too that at least in Australia, the States have had land tax powers for a long time now – they have just generally found that it is politically easier to raise revenues via stamp duties and central government grants than levy land taxes.

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    • Interesting comments. If someone did start pushing the turnover tax argument here I could imagine them arguing for it just to apply to the dreaded “investors” – after all, “it won’t really apply to me”

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      • It might go that way – though in Australia the number of people who also happen to be investors is so high that running an argument against greedy investors might backfire badly. Not so sure where the truth falls in NZ though.

        I think it happened rather organically in Australia via bracket creep on inflating house prices. Old statutes which were originally written to target trades on rich peoples homes eventually started hitting ordinary homes more frequently and at much higher effective tax rates, and State governments were relatively happy to let the trend keep going to improve their finances. And people making lots of money trading inflated houses probably didn’t mind that much – in fact one might think they were more concerned about improving the quality of health care and education systems. (Ie; increased incomes led to increased demand for government services)

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      • I think the number of investors is even larger here (share of population) and if anything they are increasingly scapegoated by policy. This afternoon I added a link to the post to some material Treasury had recently done on the option of a stamp duty – including the possibility of various carve-outs/exclusions.

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  3. I am just completing a 3 site subdivision from a 2 site cross lease which I have held for 10 years now. As the potential tax via the Bright Line tax is a hefty 33% tax and could amount to $600k in tax payable as 3 new titles would be issued. I have decided that it is probably wiser to just sit on these properties for the next 2 years and just rent out and save $600k in taxes. If the Bright line tax is extended to 5 years, it still makes sense to just sit for 5 years and still save $600k in taxes perhaps even more as the chronic shortage drives prices higher as supply is crimped even further.

    Not too sure where economics 101 re efficient markets need to have barriers removed to achieve fair and lower market prices. Put barriers up and prices rise. RBNZ economists pushing for taxes(which resulted in the Bright Line Tax after Wheeler put the government under pressure to respond) seem to have forgotten their basics. Again a sign of the RB making glib and unresearched comments. Just no clue and dangerous incompetence.

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  4. The 40% LVR rules seem to be already having unintended consequences. Where previously when a property investor would buy a property off the plans, wait for completion before buying a 2nd property, they are now under tremendous pressure to buy 2 or 3 properties off the plan straight away.

    The reason is that if you buy brand new off the plans, the 40% LVR rule does not apply to new build. But on completion, if a investor wants to buy a 2nd investment property he would then be subject to the 40% LVR on his first property as it is now considered 2nd hand.

    Therefore instead of buying 1 and wait and watch and assess, he now has to buy 2 or 3 straight away in order not to trigger the 40% LVR rule. Smart move RBNZ.

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  5. And I think the RB would respond that the behaviour you describe is desirable, to the extent that it encouraged effective demand for new construction.

    (of course, overseas experience is that financing new builds is typically much risker than financing existing properties, and the regulations are supposed to be driven by financial stability/efficiency considerations, but….that is probably what they would say)

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  6. I agree it is good to see Labour not drinking the Kool-aid of stamp duty… You can’t tax your way to prosperity no matter how hard Mr Twyford’s colleagues wish it and knocking that bozo idea on the head is a good move…

    We have high house prices now because the supply in the secondary market is still nowhere near the level if was before the GFC on the back of a rising population. Some of that lack of supply may be because NZers are not leaving in the numbers they were for Australia – ran some stats and the R2 is about 0.25, which is not that strong, but maybe a partial explanation for the very low levels of properties coming to market.

    I also agree that the RB sees that increasing supply via new builds is a good medium term strategy – so putting a tax in the way of that is just a dumb idea… and yes, every time the RB intervenes there will be unintended consequences…

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  7. You’re absolutely right about Ireland. The situation was worsened by the fact that the Irish government knew the revenues were cyclically abnormally high, but spent them anyway, and not just on one-offs (roads or the like) but on longer-term commitments like public service salaries.
    That UK article on property transaction taxes misses the impact of avoidance. Don’t know about the top 3, but in #4, France, I understand there’s a practice that when a house is sold, the notary will briefly leave the room, the purchaser slips the vendor the amount needed to pay the real price, the notary returns, and the deal is booked at a lower ‘official’ price for duty purposes. And with a 5% tax rate I’m not that surprised

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  8. Yes, I had wondered about avoidance techniques – and now you mention it, had also heard that French story.

    The real problem for politiicians in huge revenue booms is that even if they know the revenues are temporary, virtue (typically) isn’t rewarded. Instead, it leaves a money pot for opposition parties to promise to spend their way – one could see interest-free student loans in the 2005 election in this light. Don Brash’s Nats were promising to spend the surpluses their way, and Labour felt obliged to match that, responsibly or not, to stay in office. And it worked.

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