Scattered thoughts on tax and fiscal policy

It has been a quite remarkable rookie error by the Labour Party that allowed the mere possibility of specific tax increases to become such a major part of the election campaign, in a climate where the government’s debt is very low, and where official forecasts show surpluses projected for years to come.   If government finances were showing large deficits, and there was a desperate need to close them, that political pressure might have been unavoidable.  Closing big deficits involves governments taking money off people who currently have it –  by whatever mix of spending cuts or tax increases – and doing so in large amounts.   But the PREFU had growing surpluses, and Labour’s fiscal plan had almost identical surpluses for the next few years –  without relying on any further tax changes that might have flowed from the recommendations of the proposed Tax Working Group.

These are the surplus projections

labour surplus

Of course, Treasury GDP forecasts can’t always be counted on – and it is seven years now since the last recession – but there is quite a large buffer in those numbers even if the economic outlook changes.  But the other side of politics wasn’t disputing the (Treasury) GDP assumptions.  And it seems to have been lost sight of that in a growing economy, with low and stable debt levels, modest deficits (on average) are the steady-state outcome (consistent with low stable debt).     That might involve decent surpluses in boom years, and perhaps quite big deficits in recession years (as the automatic stabilisers work on both sides) –  but again the Treasury numbers, which both sides are basing their numbers on, say that at present we are in the middle (estimated output gap around zero, unemployment still a bit above a NAIRU, and on the other hand the terms of trade above average).

I guess it was always the sort of risk Labour faced in changing their leader so close to the election (things move fast and something –  who knew what specifically –  was almost bound to not work out well), but it was all so easily avoidable.  They could have:

  • stuck with the Andrew Little policy (now reverted to) of no changes flowing out of the TWG process to come into effect before the 2020 election,
  • they could have reverted to the 2014 policy (a specific detailed capital gains tax proposal, perhaps including revenue estimates), or
  • they could have committed to any package of TWG-inspired changes implemented before the next election being at least revenue neutral (if not revenue negative).   This latter sort of commitment would have been easy to make precisely because of the large surpluses in the projections both sides are using (see chart above).

After weeks of contention and uncertainty –  some reasonable, some just fear-mongering – they’ve finally adopted the first option.

But you have to wonder what the proposed Tax Working Group will be left to do?  In practice, it looks as though it might most usefully be described as a capital gains tax advisory group –  to advise on the practical options and details on how to make a capital gains tax work, as well perhaps as to review the evidence and arguments for (and against) such an extension to our tax system (my reflections on the CGT option are here).

They’ve ruled out increases in personal or company tax rates, they’ve ruled out GST increases, and they’ve ruled out a land tax affecting the land under “the family home” (which is most of the value of land in New Zealand).    They apparently haven’t ruled out revenue-neutral packages that involve a reduction in income tax rates, but this looks like a pretty empty suggestion.  Why?

The first reason is that they claim that their suite of policies are going to solve the housing crisis.   I’m a bit sceptical about their claims (and those of the government), but if they are right, how much revenue do they suppose there is likely to be from a capital gains tax anytime in (say) the next 20 years?  Treasury once produced some rather large revenue estimates, but (from memory) they involved some sort of muted extrapolation of the experience of the previous 20 years.       Both sides of politics seem to think they can stabilise nominal house prices, and then let income growth and inflation reduce real prices and price to income ratios.   If so, there are no systematic capital gains on housing  –  and idiosyncratic ones (particular cities or specific locations that do well) won’t add to much revenue at all.    Of course, it might be different if the housing measures fail, but Grant Robertson yesterday seemed pretty adamant.

“What we are signalling is, the Labour Party’s policy is that our focus is on fixing the housing crisis. That is our focus.

A capital gains tax might (or might not) be a sensible addition to the tax system, but it shouldn’t raise much money.

What else is there?  I’m sure tax experts have various small things they’d like the working group to look at, but it is hard to believe there is anything that could raise much revenue.    For some, a land tax looked promising –  my own scepticism is here.  But Labour has now ruled out a tax on the land under “the family home”, which effectively nullifies any possibility of a sensible, credible, and enduring land tax.

It is one thing to rule the family home out of a capital gains tax net.  Even for most of those left liable for capital gains tax (CGT), the effective liability can be deferred for many years (reducing the present value) simply by not realising the gain (not selling the asset).  That is even more true with the sort of institutional holders than many seem keen to encourage into the rental market.  And, of course, there is only a liability if prices actually go up.    Those are among the reasons why the overseas literature tends to find little evidence that a CGT would make much useful difference to the housing market.

A land tax would be different.  It is a liability year in, year out.  Owner-occupiers (and associated trusts etc) wouldn’t pay it, but everyone else would.  It would be a huge change in the effective cost of (say) providing rental services.

New Zealand real interest rates are the highest in the advanced world.   A very long-term real government bond rate is around 2.5 per cent at present (the real OCR is currently zero or slightly negative).  So suppose a government imposed a 1 per cent per annum land tax on land not under owner-occupied dwellings.     Relative to a risk-free rate of, at most, 2.5 per cent that would be a huge impost (40 per cent of the implied safe earnings of the asset –  the appropriate benchmark since the tax itself isn’t risk-dependent.)   It would dramatically lower how much any bidder who wasn’t planning to live on the land could afford to pay for the land –  by perhaps as much as 40 per cent.

That might sound quite appealing.   Rental property owners (actual and potential) drop out of the market and land (and house+land) prices plummet.    But wait.   Wasn’t the political promise that they weren’t trying to cut existing house prices?    And what about the people who –  because of youth, or desire for mobility –  don’t want to own a house and positively prefer, for time being at least, to rent.    And what about farmers?  Lifestyle blocks (presumably exempt from the land tax) instantly become much more affordable than farming (which presumably does face the tax).    To what social or economic end?

Attempt to impose such a land tax and my prediction would be (a) that it would never pass, since it would represent such a heavy impost on a large number of people (and yet on not enough to raise enough revenue to allow meaningful income tax cuts to offset the effect), and (b) if it did pass, exemptions and carve-outs would quite quickly reduce it to the sort of land tax we actually had in New Zealand only 30 years ago –  which only affected city commercial property.

Now perhaps there is a limited middle ground.  There is a plausible case that can be made for use of land value rating by local councils rather than the capital value rating system that most councils now use.  I’m not aware that we have good studies suggesting better (empirical) outcomes in places that still use land value rating, but the theory is good.  The problem, of course, is that by ruling out a land tax on the family home, Labour would appear to have ruled out (say) using legislation to encourage or compel councils to rely more heavily on land value rating.   Perhaps that might leave undeveloped land within existing urban areas as potentially subject to land value rating?  There might be some merit in that, but the potential seems quite limited.

So, as I say, it looks as though the proposed tax working group should really just be a CGT advisory group.

And that would be a shame because, whatever you think of the merits of a CGT, it isn’t the only issue that would have been worth addressing in a proper review of the design of our tax system.  For 30 years now –  since what was a fairly cynical revenue grab (recognised at the time by those involved) in 1988/89 –  our tax system has systematically penalised returns to savings  (both relative to how we treated those returns previously, and relative to how other countries typically treat such returns).    The prevailing mantra –  broad base low rate –  which holds the commanding heights in Wellington sounds good, until one stops to think about it.     We have modest rates of national savings, and consistently low rates of business investment –  and our productivity languishes –  and yet the relevant elites continue to think it makes sense to tax capital income as heavily as labour income.  It doesn’t, whether in theory or in practice.   They don’t, for example, in social democratic Scandinavia.  They don’t –  when it comes to returns to financial savings –  almost anywhere else in the advanced world.    We should be looking carefully at options like a Nordic system, a progressive consumption tax, at inflation-indexing the tax treatment of interest, and at whether interest should be taxed (or deductible) at all.

Plenty of people are worrying about the potentially radical nature of some aspects of a possible new left-wing government.  I come from the market-oriented right on matters economic, but I worry that in these areas they won’t be radical enough –  won’t even be willing to open up the serious issues that might be contributing to our sustained economic underperformance.  And frankly, when the debt levels are as low as they now, and sustained surpluses appear to be in prospect, if ever there is a time to look at more serious structural reforms it is now.   It is a great deal easier to do tax reform when any changes can be revenue-negative (actually the approach taken by the current government in 2010 –  see table of static estimates here) or (depending on your orientation) used to increase public spending.  But it looks as though another opportunity is going to be let go by.    That would be a shame.

(Having mentioned the 2010 package in passing, I am a little surprised that the increase in the effective rate of business taxation in that package doesn’t get more attention.     It often passes unnoticed because the headline company tax rate was reduced, but as the published Treasury assessment at the time put it

While the tax package lowers the company tax rate, changes to thin capitalisation rules and depreciation allowances mean that, on average, firms will pay more tax as the reduction in the company tax rate does not fully offset the impact of higher taxable income owing to the base-broadening measures. As a result combined company and dividend tax revenues are estimated to be about 3-4% higher than in the absence of the package. In the case where all investment is financed by equity, this could increase the user cost of capital by about 0.6%.
Using the New Zealand Treasury Model (NZTM) we estimate that the increase in the user cost of capital leads to the private business capital stock reducing by 0.45% compared to what would have been the case in the absence of the package.

Not obviously a desirable outcome for an economy that had, for decades, had low levels of business investment.)

And finally, a chart showing in just what good shape New Zealand public finances are relative to those in the rest of the advanced world.   New Zealand government debt has increased relative to GDP under the term of the current government (mostly some mix of a recession and earthquakes), but government debt as a share of GDP has increased in most other countries too.   Here is the gap between New Zealand and the median OECD country, using the OECD’s series of general government net financial liabilities.   Our net financial liabilities last year were around 5 per cent of GDP on this measure  (seven OECD countries have less net debt, or have net assets).  The median OECD country has net financial liabilities of 40 per cent of GDP.  But here is the gap, going back to 1993 when the data commence for New Zealand.

gen govt net liabs nz less oecd median

It is quite a striking chart –  and took me a little by surprise frankly.   If you didn’t know when the two changes of government had occurred, there would be no hint in this chart.  For almost 25 years now we’ve kept on lowering our net debt relative to that of other OECD countries, through good times (for them and us) and for tougher times, under National governments and Labour ones.  There just isn’t any obvious break in the series.  And as we have a lot fewer off-balance sheet liabilities (eg public service pension commitments) the actual position is even more favourable than suggested here.

I’m not a big fan of increasing government debt as a share of GDP –  and low as current interest rates are (a) productivity growth is lower still, and (b) our interest rates are still the highest around.  But you do have to wonder quite what analysis backs up the drive for still lower rates of government debt to GDP, absolutely and relative to the rest of the advanced world.   And persisting with the “big New Zealand” strategy of rapid population growth makes the emphasis on very low levels of government debt even more difficult to make much rational sense of.

Capital gains tax: quite a few reasons for scepticism

Going through some old papers to refresh my memory on capital gains tax (CGT) debates, I found reference to a note I’d written back in 2011 headed “A Capital Gains Tax for New Zealand: Ten reasons to be sceptical”.  Unfortunately, I couldn’t find the note itself, so you won’t get all 10 reasons today.    But here are some of the reasons why I’m sceptical of the sort of real world CGTs that could follow from this year’s election.  Mostly, repeated calls for CGTs – whether from political parties, or from bodies like the IMF and OECD –  seem to be about some misplaced rhetorical sense of “fairness” or are cover for a failure to confront and deal directly with the real problems in the regulation of the housing and urban land markets.

Anyway, here are some of the points I make:

  • in a well-functioning efficient market, there are typically no real (ie inflation adjusted) expected capital gains.    An individual participant might expect an asset price to rise for some reason, but that participant will be balanced by others expecting it to fall.  If it were not so then, typically, the price would already have adjusted.  In well-functioning markets, there aren’t free lunches.    It also means that, on average, capital losses will be pretty common too, and thus a tax system that treated capital gains and losses symmetrically wouldn’t raise much money on average over time.   A CGT is no magic money tree.   And there is no strong efficiency argument for taxing windfalls.
  • if you thought, for some reason, that people were inefficiently reluctant to take risk, there might be some argument for a properly symmetrical CGT.  In such a system, the government would take, say, a third of your gains, but would also remit a third of your losses (the overall risks being pooled by the state).    The variance of an individual’s private after-tax returns would be reduced, and they might be more willing to take risk.   But, in fact, no CGT system I’m aware of is properly symmetrical –  there are typically tough restrictions on claiming refunds in respect of capital losses (one might only be able to do so by offsetting them against future gains).  There are some reasonable base-protection arguments for these restrictions, but they undermine the case for a CGT itself.
  • All real world CGTs are based on realised gains (and losses to an extent).   That makes it not a pure CGT, but in significant part a turnover tax –  if you never trade, you never pay (“never” isn’t literal, but tax deferred for decades discounts to a very small present value).    And that creates lock-in problems, where people are very reluctant to sell, even if their circumstances change or if a new potential owner could make much more of the asset, for fear of crystallising a CGT liability.  In other words, introducing a CGT introduces a new inefficiency to asset markets, making it less likely that over time assets will be owned by the parties best able to utilise them.
  • Basing a CGT on realised gains will also, over time, bias the ownership of assets subject to CGT to those most able to avoid realising the gains.  A long-lived pension fund, or even a very wealthy family, will typically be better able to  count on not having to sell than, say, an individual starting out with one or two rental properties, or some other small business, where changed circumstances (eg a recesssion or a divorce) might compel early liquidation.  Large funds are also typically better able to take advantage of loss-offsetting provisions.  The democratisation of finance and asset holding it certainly isn’t.
  • CGTs in many countries exclude “the family home” altogether.  In other countries, they provide “rollover relief”, enabling any tax liability to be deferred.  Most advocates of a CGT here seem to favour the exclusion of the family home, even though unleveraged owners of family homes already have the most favourable tax treatment in our system.  Again, a CGT applied to investment properties but not owner-occupied ones would simply trade one (possible) distortion for another.
  • In practice, most of the arguments made for a CGT in New Zealand have to do with the housing market.   But, on the one hand, all major (and minor?) parties claim that they have the fix for the housing market (various combinations of RMA reform, infrastructure reforms, changes to immigration, restrictions on foreign ownership, state building programmes or whatever).  If they are right, there is no reason to expect significant systematic real capital gains in houses.  If anything, real house prices should be falling –  a long way, for a long time.    Of course, prices in some localities might still rise at some point, if unexpected new opportunities appear.  But “unexpected” is the operative word.   Enthusiasm for a CGT, at least at a political level, seems to involve a concession that the parties don’t believe, or aren’t really serious about their housing reform policies.
  • Oh, and no one I’m aware of anywhere argues that a realisation-based CGT applied to (a minority of) housing has made any very material difference to the level of house prices, or indeed to cycles in house prices.
  • In general, capital gains taxes amount to double-taxation.    Think of a business or a farm.  If the owner makes a success of the business, or product selling prices improve, expected profits will increase.  If and when those profits are achieved, they would, in the normal course of affairs, be subject to income tax.  The value of the business is the discounted value of the expected future profits.  It will rise when the expected profits rise.  Tax that gain and you will be taxing twice the same increase in profits –  only with a CGT you tax it before it has even happened.   Of course, at least in principle, there is a double deduction for losses, but as noted above utilising losses (whether of income, or capital) is a lot more difficult.    If you think that New Zealand has had less business investment than might, in some sense, have been desirable,  you might want to be cautious about applauding a new tax that would fall heavily on those who took business risks and succeeded.
  • Perhaps double taxation of expected business profits doesn’t bother you.  But trying reasoning by analogy with wages.   If the market value of your particular skills has gone up, your wages would be expected to rise.  When they do you will pay taxes on those higher wages.  But by the logic of a CGT, we should capitalise the value of your expected future labour income and tax your on both that “capital gain” and on the later actual earnings.  Fortunately, we abolished slavery long ago, but in principle the two cases aren’t much different: if there is a case for a CGT on the value of a business, it isn’t obvious why one shouldn’t have one on the value of a person’s human capital.
  • (I should note here, for the purists, that there are other concepts of double-taxation often referred to in tax literature, none of which invalidate the point I’m making here.)
  • Real world CGTs also tend to complicate fiscal management?  Why?   Because CGT revenue tends to peak when asset markets and the economy are doing well, and when other government revenue sources are performing well.  CGT revenue doesn’t increase a little as the economy improves and asset markets increase, it increases multiplicatively.  And then dries up almost completely.  Think of a simple example in which real asset prices had been increasing at 1 per cent per annum, and then some shock boost asset prices by 10 per cent.  CGT revenue might easily rise by 100 per cent in that year (setting aside issues around the timing of realisations).  And then in a period of falling asset prices there will be almost no CGT revenue at all.   Strongly pro-cyclical revenue sources create serious fiscal management problems, because in the good times they create a pot of money that invites politicians to (compete to) spend it.  If asset booms run for several years, politicians start to treat the revenue gains as permanent, and increase spending accordingly. And if/when asset markets correct –  often associated with recession and downturns in other revenue sources-  the drying up of CGT revenue increases the pressure on the budget in already tough times.     It is easy to talk about ringfencing such revenue (mentally, if not legally) but such devices rarely seem to work.

None of this means that I think there is no case for changes in elements of our tax system as they affect housing.  The ability for business borrowers to deduct the full amount of nominal interest, even though a significant portion of that interest is simply compensation for inflation (rather than a real cost), is a systematic bias.  It doesn’t really benefit new buyers of investment properties (the benefit is, in principle, already priced into the market) but it is a systematic distortion for which there is no good economic justification   Inflation-indexing key elements of our tax system is highly desirable –  at least if we can’t prudently lower the medium-term inflation target –  and might be a good topic for a tax working group.  In the process, it would also ease the tax burden on people reliant on fixed interest earnings (much of which is also just inflation compensation, not a real income).

Of course, at the same time it would be desirable to look again at a couple of systematic distortions that work against owners of investment properties.  Houses are normal goods and (physically) depreciate.  And yet depreciation is no longer deductible.  Perhaps there was a half-defensible case for that when prices were rising seemingly inexorably –  but even then most of the increase was in land value, not in value of the structures on the land –  but there is no justification if land reform and (eg) new state building is going to fix the housing market.    Similarly, when the PIE system was introduced a decade or so ago, it gave systematic tax advantages to entities with 20 or more unrelated investors.  Most New Zealand rental properties historically haven’t been held in such entities.  There is no good economic justification for this distinction, which in practice both puts residential investment at a relative tax disadvantage as a saving option, and creates a bias towards institutional vehicles for holding such assets.  Institutional vehicles have their own fundamental advantages –  greater opportunities for diversification and liquidity –  but it isn’t obvious why the tax system should be skewing people towards such vehicles rather than self–managed options.  As noted above, any CGT will only reinforce that bias.  Funds managers, and associated lawyers and accountants, would welcome that. It isn’t obvious why New Zealand savers should do so.

I see that there are more than 10 bullet points in the list above.  I’m not sure it covers all the issues I raised in my paper a few years ago, but it is enough to be going on with.

And in all this in a country where we systematically over-tax capital income already.  I commend to readers a comment on yesterday’s tax post by Andrew Coleman, of Otago University (and formerly Treasury).  As Andrew noted:

Somehow, New Zealand’s policy advising community decided it would restrict most of its attention to the ways income tax could be perfected rather than question whether income taxes (which are particularly distortionary when applied to capital incomes) should be replaced by other taxes. It is almost as if we have the Stockholm Tax Syndrome – fallen in love with a system that abuses us.

A broad-based capital gains tax would just reinforce that problem.

 

Taxing business

One subject that seems destined to get little attention in the current election campaign is the appropriate tax rate to be applied to business income.  As I’ve noted previously, our company tax rate is now in the upper third of those in OECD countries.  And if there is any discussion at all in this campaign, it seems more likely to centre on plans to raise more money from companies –  foreign companies anyway.   The government has just announced measures designed to have that effect, and parties on the left seem keen on doing even more, under the cover of OECD-coordinated moves in that direction.

I was talking to some tax people yesterday, which prompted me to dig out the OECD data on company tax rates and company tax revenue.  Both matter.  A country can have quite a high statutory headline company tax rate but also have so many exemptions, deductions etc, that the company tax doesn’t actually raise that much money.  The United States is a good example –  the general government corporate tax rate is 38.9 per cent, the highest in any OECD country, and yet corporate income tax receipts are only 2.2 per cent of GDP, well below the median OECD country.  Corporate tax reform is well overdue in the United States (although my money is on nothing very fundamental happening in the current presidential term).

What about New Zealand?

Here is a chart, using OECD data, showing company tax receipts as a share of GDP for New Zealand (blue) and for the median OECD country (orange), all the way back to 1965.

corporate tax revenue

We take a much larger share of GDP in company tax revenue than most OECD countries do.  In fact, in recent years, the only countries that have taken a larger share have been Australia, Chile, Norway, and Luxembourg.   Given the importance of minerals in the first three of those countries, the company tax receipts may include a large chunk of what might be better described as resource rentals  (and in addition production processes in those extractive sectors tend to be quite capital intensive).

But several other things struck me:

  • the rising trend in company tax receipts as a share of GDP over the last 30+ years.  It probably isn’t the impression most people have when you hear all the talk about taxing (or not taxing) multinationals.    Presumably part of the increase will have been accounted for by the larger share in overall national income now accounted for by returns to capital in many countries.
  • just how large the gap was between the New Zealand line and the OECD line at the start of the period (and, hence, how much of a convergence happened during the period when Sir Robert Muldoon was our Minister of Finance –  most of the time from 1967 to 1984).
  • and the substantial rewidening of the gap since the reforms of the late 1980s.  The broad-base low(er) rate strategy seems to have raised a great deal of revenue.

But it does leave me with at least two questions:

  • why has New Zealand typically raised so much more (per cent of GDP) in company tax revenue than most other OECD countries?
  • is this a sensible approach to tax policy, particularly in the context of our long-term structural economic underperformance.

In the earlier decades, a heavily protected economy probably meant a business sector that was ripe for the (headlines of) plucking.    Between the non-tradable service sectors and the highly-protected manufacturing sector, there was plenty of scope to pass increased business costs, in the form of high headline business taxes, on to domestic consumers.  The export sector was mostly based around family farms –  and probably didn’t pay much company tax.  But bear in mind that exports as a share of GDP were shrinking through this period – high internal domestic costs (including business taxes) also help to erode competitiveness.

These days the economy is much less protected, but we are still back to taking a much larger share of GDP in company tax than most other countries do.  Many of our biggest tax paying firms are foreign-owned  (apparently around 40 per cent of all company tax revenue is paid by foreign-controlled firms), which command little public sympathy or support.  The Australian banks are perhaps the most prominent example.   Perhaps it looks like a “free lunch” to tax heavily such operations?

(In principle, our dividend imputation system  –  also adopted in Australia –  may act to make people more relaxed about conducting business through a corporate vehicle, since for domestic shareholders there is no double-taxation of dividends.  I don’t know whether this will be part of the explanation, although I’d be surprised if it explained much, given the other advantages of limited liability.)

And our large share of company tax revenue as a share of GDP isn’t just because New Zealand taxes everyone heavily –  in fact, our tax revenue as a share of GDP doesn’t stand out as being high.  Here is the chart showing company tax revenue as a share of total tax revenue (NZ in blue, OECD median in orange).

coy tax revenue

Our heavy reliance on company tax revenue looks to be a deliberate choice to favour that soource of revenue.

Whatever the reason for why we take such a large share in company tax, it seems unlikely to be a sensible element of a successful economic strategy.    It is well-known that business investment as a share of GDP has been quite low in New Zealand for many decades.  It is one of the more obvious symptoms of our economic underperformance.  We also now have a quite moderate level of inward foreign investment.  It seems at least plausible that the tax regime might be one part of the explanation –  after all, particularly for foreign investors, the choice to operate here (or not) is purely an economic one, influenced largely by the expected after-tax returns, and the risk around those returns.   For foreign investors (who can’t take advantage of imputation credits) the New Zealand company tax rate should matter a lot.    Partly for that reason, the estimated deadweight costs of business taxation are far higher than those for most other taxes. You get less of what you tax, and foreign investment is likely to be particularly sensitive to taxes.

The OECD data on company tax rates does not go back as far.  But here is how our rates have compared to those of:

  • the median OECD country, and
  • the median “poor” OECD country (ie those who’ve had consistently lower GDP per capita or productivity than New Zealand).

corporate tax rates Of the “poor” OECD countries, only Mexico and Portugal now have higher company tax rates than we do.  Whereas most of the “poor” countries are closing the income/productivity gaps to the richer OECD countries, Mexico and Portugal (and New Zealand) aren’t.  I’m not suggesting it is the only factor by any means, just highlighting the choice that the more successful converging countries have been making.

In much of the debate around these issues, all the focus is one who writes the cheque, not on who actually bears the burden of the tax (the incidence).  Foreign investors, for example, will have target after-tax rates of return.  Higher tax rates discourage reinvestment in the business, discourage new investment, and in time result in lower average productivity and lower wage rates.    By contrast, lowering business taxation is a pro-growth, pro working people, policy.

Again, there is a tendency to discount this point with a response along the lines of “look at all the existing investment; cut taxes on the profits on those businesses and it is just a windfall transfer to existing owners”.     That often seems particularly unappealing if the owners are foreign –  as if it was a pure welfare loss to New Zealanders.     The banks are good example of what bothers people –  mostly owned by big Australian operations.  But actually, the banks are a sector where lower tax rates offer the prospect of genuine savings across the board, for all users of financial services in New Zealand, even if the size of the banking sector itself doesn’t change much.   Cut taxes on banks’ profits and, over time, you’ll find fees and interest margins falling.  Not from the goodness of a bank’s heart, but from the competitive process at work, as each competes for market share and finds they can discount their pricing a bit more and still deliver on Sydney or Melbourne’s after-tax return expectations.

I don’t think we should be making tax policy specifically to favour foreign investors over domestic ones –  which would be the effect of simply cutting the company tax rate – but I do think there is a good case for materially lower taxes on business income.  I’ve argued prevously for a Nordic system, in which capital income is taxed at a lower rate than labour income.  A more ambitious approach still would be to work towards the development of a progressive consumption tax.   Whatever the precise solution, the current arrangements –  high rates of company tax, high shares of GDP taken in company tax – don’t look like the right answer if we serious about lifting economic performance in New Zealand, and with it raising the capital intensity of production in New Zealand.

(Commenters on previous posts have asked whether I’m being consistent, in calling for lower business tax rates and at the same time noting the serious limitations of our remoteness.   I certainly accept that if we were adopt the Irish company tax policy it would not have the scale of benefits for us it has had for Ireland.  But an integrated economic strategy for New Zealand would also involve lower real interest rates and a lower real exchange rate, and in conjunction with lower business tax rates, that would be likely to bring forth quite a range of new business investment –  in some cases in new sectors (or retaining firms in New Zealand that might otherwise relocate), and in other cases, adopting more capital intensive (ie higher labour productivity) modes of production in existing sectors, including agriculture.)

The Labour Party is campaigning on establishing a tax working group if it forms the next government.  I hope they envisage something more than just a tidy-up and a recommendation for a capital gains tax, and that in thinking now about the possible terms of reference for the proposed tax working group –  which they will presumably want to move quickly on once in office –  they are willing to cast the net rather wider, and invite the proposed group to consider connnections between the design and balance of our tax system and our overall economic performance.   Higher taxes on business – especially the dreaded multinationals – might be some sort of “progressive” shibboleth, but in fact lower business taxes should be an option that any seriously progressive government, concerned to lift living standards for all, takes very seriously.

 

A fresher approach for ordinary New Zealanders

I’m as fascinated by the rise of Jacinda Ardern as any other political junkie.  I’ve always been a bit puzzled, struggling to see what issue she has led or what blows she had managed to land on the government.    Then again, she seems to have something different –  perhaps even more electorally important.   I’ve been dipping into accounts of Bob Hawke’s rise –  the last case I’m aware of that where major opposition party changed leaders close to an election (in that case only four weeks out) and won.     It isn’t clear that Bob Hawke was a better Prime Minister than Bill Hayden might have been, or that David Lange was a better Prime Minister than Bill Rowling would have been, but in both cases the new leaders had something –  a degree of connection, engagement etc –  that the deposed leaders didn’t.     Reading the accounts of the last weeks of Bill Hayden’s leadership of the ALP, the party had become as disheartened and lacking belief in its own ability to win (despite still leading in the polls), as some suggest the New Zealand Labour Party had become.    Quite what the Ardern phenomenon amounts to I guess we’ll see over the next few weeks.  From her comments so far, I could imagine her campaigning as Hawke did –  both the upbeat theme of “reconciliation”, and the more cynical description in (sympathetic) leading Australian journalist Paul Kelly’s book “no avenue of vote-buying or economic expansion was left untouched”.

For now, we are told that the “Fresh Approach” slogan is apparently out, and a new slogan and some new policies are soon to be launched.  Since no party really seemed to be campaigning on policies that might make a real and decisive for ordinary New Zealanders’ prospects, in many respect a fresher approach should be welcome.  Of course, it rather depends what is in that policy mix.

My interests here are primarily economic.  In an interview with the Dominion-Post this morning, the journalist put it to Ardern that “National will campaign on its economic record. Is that where Labour is weak?”.     Perhaps it is Labour’s weak point.  But what sort of “record” is the government to campaign on?  An unemployment rate that, while inching down, has been above the level it was when they took office –  already almost a year into a recession –  every single quarter of their entire term?  An economy that has had no productivity growth for almost five years?     House prices that, in our largest city, have gone through the roof?  Exports that are shrinking as a share of GDP?    And, at best, anaemic per capita real GDP growth?   If it is a weakness for Labour, it must be in large part because (a) their messaging has been terrible, and (b) nothing they offer seems likely to make any very decisive difference to the mass of ordinary New Zealanders.

What might?   Here’s my list of three main sets of proposals.    An effective confident radical Labour Party could offer the public these sorts of measures –  in fact, on some points arguably only a left-wing party could effectively do so (Nixon to China, and all that).

  1. A serious commitment to cheap urban land and much lower construction costs.
    • In a country with abundant land, urban land prices are simply scandalous.   The system is rigged, intentionally or not, against the young and the poor, those just starting out.  Too many of Jacinda Ardern’s own generation simply cannot afford to buy a house.
    • To the extent that there are poverty and inequality issues in New Zealand, many of them increasingly trace back to the shocking unaffordability of decent housing.   With interest rates at record lows, housing should never have been cheaper or easier to put in place.
    • And yet instead of committing to get land and house prices down again, the Labour Party has been reluctant to go beyond talk of stabilising at current levels.  Talk about entrenching disadvantage……(and advantage).
    • It is fine to talk about the government building lots of houses, but the bigger –  and more fundamental –  issue is land prices.  It is outrageous, and should be shameful, for people to be talking of “affordable” houses of $500000, $600000 or even more, in a country of such modest incomes.  International experience shows one can have, sustainably, quite different –  much better –  outcomes, but only if the land market is substantially deregulated.
    • I don’t have any problem if people want to live in denser cities –  I suspect mostly they don’t –  but it is much easier and quicker to remove the boundaries on physical expansion of cities (while putting in place measure for the associated infrastructure).   Labour’s policy documents have talked of moves in this direction –  as National’s used to do –  but it is never a line that has been heard from the party leader.     If –  as I propose –  population growth is cut right back, there won’t be much more rapid expansion of cities, but make the legislative and regulatory changes, and choice and competition will quickly collapse the price of much urban, and potentially developable, land.
    • It is clear that there is also something deeply amiss with our construction products market –  no one seriously disputes that basic building products are much more expensive here than in Australia or the US.  Make a firm commitment to fix this.  Perhaps it involves Commerce Commission interventions (supported by new legislation?)?  Perhaps it might even involve –  somewhat heretically –  a government entity entering the market directly.     But commit to change, to producing something far better for New Zealanders.
    • The vision should be one in which house+land prices are quickly –  not over 20 years –  headed back to something around three times income.  A much better prospect for the next generation.
    • No one will much care about rental property owners who might lose in this transition –  they bought a business, took a risk, and it didn’t pay off.  That is what happens when regulated industries are reformed and freed up.    It isn’t credible –  and arguably isn’t fair –  that existing owner-occupiers (especially those who just happened to buy in the last five years) should bear all the losses.   Compensation isn’t ideal but even the libertarians at the New Zealand Initiative recognise that sometimes it can be the path to enabling vital reforms to occur.  So promise a scheme in which, say, owner-occupiers selling within 10 years of purchase at less than, say, 75 per cent of what they paid for a house, could claim half of any additional losses back from the government (up to a maximum of say $100000).  It would be expensive but (a) the costs would spread over multiple years, and (b) who wants to pretend that the current disastrous housing market isn’t costly in all sorts of fiscal (accommodation supplements) and non-fiscal ways.
  2. Deep cuts in taxes on business and capital income
    • the political tide is running the other way on this one –  calls for increased taxes on foreign multi-nationals and so on –   but it remains straightforwardly true that taxes on business activity are borne primarily not by “the rich”, but by workers, in the form of lower incomes than otherwise.  So if you really care about New Zealand workers’ prospects, cut those taxes, deeply.
    • and one of the bigger presenting symptoms of New Zealand’s economic problems is relatively low levels of business investment.   Taxes aren’t the only thing businesses  –  and owners of capital  –  think about, but they are almost pure cost.   Tax a discretionary activity and you’ll get a lot less of it.   That is especially true as regard foreign investment –  those owners of foreign capital have no need to be here if the after-tax returns aren’t great.  For all the (mostly misplaced) concerns about sovereignty, foreign investment benefits New Zealanders –  ordinary working New Zealanders.     Cut the tax rates on such activity  –  they are already higher than in most advanced countries –  and you’ll see more of it taking place.    More investment, and higher labour productivity, translates into meaningful prospects of much higher on-market wages –  the sorts of wages they have in the advanced countries we were once richer than.
    • simply cutting the company tax rate will make a material difference to potential foreign investors.   It won’t make much difference for New Zealanders’ looking to build or expand businesses here, because of our imputation system    That’s why I’ve argued previously for adopting a Nordic system of income taxation  –  in which capital income is taxed at a lower rate than labour income.  Note the description –  it is a system not run in some non-existent libertarian “paradise” but in those bastions of social democracy, the Nordic countries.  Not because they want to advantage owners of capital over providers of labour, but because the recognise the well-established economic proposition that taxes on capital are mostly borne in the former of lower returns to labour.
    • some argue against cuts to business taxes on the grounds that it will provide a windfall to firms (especially foreign firms) already operating here.  Mostly, that is false.  It might be true if foreign firms dominated our tradables sector –  where product selling prices are set internationally.  But in New Zealand, foreign investment is much more important in the non-tradables sectors.  Cut taxes on, say, the banks, and you’ll find the gains being competed away, flowing back to New Zealand firms and households in lower fees and interest margins.  If for some reason it doesn’t happen, feel free to invoke the Commerce Commission (and/or expand its powers).
    • much lower business taxes should be a no-brainer for an intellectually self-confident centre-left party serious about doing something about long-term economic underperformance and lifting medium-term returns to labour.     I’m not really a fan of capital gains taxes, but if you need political cover promise a well-designed CGT –  it probably won’t do much harm, especially if you take seriously the goal of delivering much cheaper houses and urban land (see above –  there won’t be many housing capital gains for a long time).
  3. Deep cuts to target levels of non-citizen immigration
    • This item might be entirely predictable from me, but it is no less important for that.    Labour started out with some rhetoric along these lines, but as I’ve noted previously what they actually came out with was a damp squib, that would change very little beyond a year or so.   So
      • Cut the number of annual residence approvals to 10000 to 15000 per annum –  the same rate, per capita, as in Barack Obama’s (or George Bush’s) United States,
      • Remove the existing rights of foreign students to work in New Zealand while studying here.
      • Institute work visa provisions that are  (a) capped in length of time (a single maximum term of three years, with at least a year overseas before any return on a subsequent work visa) and (b) subject to a fee, of perhaps $20000 per annum or 20 per cent of the employee’s annual income (whichever is greater).
    • In substance, you will be putting the interests of New Zealanders first, but you will also strongly give that impression –  a good feature if you are serious about lifting sustained economic performance, while being relentlessly positive about it, and about your aspirations for New Zealanders.
    • Change in this area would immediately take a fair degree of pressure off house prices, working together with the structural housing/land market reforms (see above) to quickly produce much much more affordable houses and land.  Markets trade on expectations –  land markets too.
    • You’ll also very quickly alter the trajectory of urban congestion –  those big numbers NZIER produced in a report earlier this week.
    • But much more importantly in the longer-term, you’ll be markedly reducing the pressures that give us persistently the highest real interest rates in the advanced world, and
    • In doing so you’ll remove a lot of pressure from the exchange rate.  Lets say the OCR was able to be reduced to around typical advanced country levels (say 0.25 per cent at present).  In that world, the NZD offers no great attraction to foreign (or NZ institutional) holders – it is just one of many reasonably well-governed countries, offering rather low interest rates.  In that world, why won’t the exchange rate be averaging 20 per cent (or more) lower than it is now?
    • And that should be an adjustment to be embraced.  Sure, it will make overseas holidays and Amazon books etc more expensive, but in sense that is part of the point.  We need a rebalanced economy, better-positioned for firms to take on the world from here.  Combine a lower exchange rate, lower interest rates, and lower business tax rates, and you’ll see a lot more investment occurring –  and firms successfully selling more stuff internationally.  And with more investment will come the opportunities for sustainably higher wages –  and all the good stuff the centre-left parties like to do with the fiscal fruits of growth.

I don’t suppose anything like this will actually be part of the fresher approach.  But if it were……we could really look forward to a better, more prosperous, and a fairer New Zealand.

Another Budget in an underwhelming economy

If people had wanted a centre-left government, one might suppose that they would have voted for the real thing.  Despite the additional redistribution announced in yesterday’s Budget, perhaps they still will.

Still, for all the headlines about money being put (back) in people’s pockets, it is worth keeping the overall numbers in perspective.  Core Crown tax revenue as a share of GDP was 27.8 per cent last year, is estimated at 27.7 per cent of GDP this year, is forecast at 27.5 per cent in 2017/18, and in the final forecast period it is predicted to be 27.7 per cent.  The government isn’t yet shrinking its pre-emptive claim on overall economic resources.  Expenditure as a share of GDP is forecast is gradually shrink, and if that was sustained –  which will be a challenge, including because of the reluctance to act soon on NZS –  it could open the way to future real reductions in the tax burden.

It is sad to reflect that much of the increased spending announced yesterday was simply a palliative for the failures of the government.   The cost of housing is, pure and simple, the fault of successive governments’ land-use regulation.  In a country with plenty of land, and the lowest real interest rates for decades, housing should be more affordable than ever.  That it isn’t, should be something governments are held accountable for (and although governments of both parties have had much the same flawed policies, the current government has now been in power for almost nine years).    And the lack of productivity  growth –  recall that we have had none at all for five years now –  is the biggest single thing that holds back the income growth of working people.    With a well-functioning housing market, and an economy with robust productivity growth, many of the pressures that led to increased spending yesterday would simply have been unnecessary.

As for tax, how many more decades will we have wait before a simple reform like inflation-indexing the income tax brackets is enacted?  Even the United States, with its enormously complex and distorted tax code, manages that one.

Perhaps more importantly, for all the rhetoric about encouraging enterprise –  and more subsidies for favoured uneconomic industries (film, rail and so on), there was no sign at all of action to lower what is probably the most costly and distortionary major item in our tax system –  the company tax rate.   It is curious to reflect that the previous Labour government cut the company tax rate more than the current government has.

I ran this chart a few weeks ago
company tax rates

New Zealand’s company tax rate is in the upper third of OECD member country rates.   For a country that talks a good game about welcoming foreign investment, and supposedly aspires to reverse the decades of productivity underperformance,  it simply isn’t good enough.    Politicians seem afraid of making the well-established economic point that taxes on businesses are typically borne substantially by wage-earners, not by owners of capital.   Less investment than otherwise means fewer high productivity and, thus, high wage jobs.  And if our company tax rates are high, it makes it harder for overseas investors to justify locating an operation here rather than in a lower tax country.   For a country with a pretty disadvantageous location to start with, it is the sort of additional burden we shouldn’t be putting on enterprise.    (I’ve focused this paragraph on foreign investors.  Taxes also discourage domestic-owned business investment, but for owners of those businesses, the maximum personal tax rate is ultimately the important consideration, rather than the company tax rate itself).

Anyone who listened to, or read, the Budget speech itself was clearly supposed to come away with a message about how well the New Zealand economy was doing.  There on the very first page was the Minister’s claim

“Our economy is 14 per cent larger than it was just five years ago”.

Yes, but the population is about 8 per cent larger.  That would leave an annual average growth in per capita terms of 1.1 per cent.  Better than nothing, to be sure, but not the sort of stuff most finance ministers would want to boast about.

And Treasury’s own numbers –  done at arms-length from the Minister –  don’t really back up the Minister’s story, whether cyclically or structurally.

Take the cyclical position first.  Here is Treasury’s estimate of the output gap (positive numbers suggest activity and demand are running a bit ahead of what is sustainable –  “potential GDP” – and negative numbers suggest there is still slack in the economy).

treasury output gaps

On these estimates, New Zealand will have had a negative output gap –  resources being underutilised –  for 10 consecutive years, including the whole of this government’s term to date, and the next year as well.    One can argue all one likes about what governments should or shouldn’t have done to lift potential productivity growth, but these estimates just take for granted what actually happened with structural policy and look at the cyclical position.  And there is really no excuse for putting the economy through such sustained period of resource underutilisation.  I can’t think of any time in modern New Zealand history, when the output gap would have been negative for so long.

Output gap estimates are pretty bloodless things, that don’t necessarily resonate with a wider audience.  They also can’t be observed directly.   But here are the unemployment rate numbers (actual and Treasury forecasts).

Tsy U

Last year, Treasury told us that they thought the

Treasury takes the view that the unemployment rate consistent with full employment (the nonaccelerating inflation rate of unemployment or NAIRU) has also fallen over time, so that…. it would be closer to 4.0%

I’m not sure precisely what number they had in mind, although in a chart included in that 2016 paper, the unemployment rate levelled out at around 4.1 per cent, so I included an indicative NAIRU line in my chart at 4.1 per cent.   But whatever the precise estimate, on official numbers and Treasury estimates we are looking at 10 years (or perhaps 11) with an unemployment rate higher than necessary to keep inflation in check.  The government has consistently presided over less than full employment.  That is simply poor economic management, and since we know that having a job is one of the best ways to secure better life outcomes, it is pretty poor management more generally.

Perhaps such unfortunate results might be excusable in a country that had no discretionary monetary policy leeway left (interest rates were already at or just below zero), or which was in fiscal crisis and had no borrowing capacity left.   Places like Portugal spring to mind.    But not New Zealand.   We have a floating exchange rate and our OCR has never got below 1.75 per cent (and even if that capacity had been exhausted, our public debt has been relatively modest).

It is also easy –  and right at one level – to blame the Reserve Bank.  They do short-term macroeconomic management.  But only as agent for the government and the Minister of Finance.  The Minister sets the targets and is ultimately responsible to citizens for their performance.  I do hope that Treasury, in offering advice to the Minister of Finance (whoever he or she may be after the election) on the appointment of a new Governor, and the design of the PTA, will take seriously the record of underperformance over the last decade.  This isn’t some trivial inside-the-Beltway governance issues.  These are real lives and opportunites that are unnecessarily blighted.

The government also likes to pretend that New Zealand’s economy is doing very well by international standards.   Thus, we are told by the Minister that

“we are at the moment growing faster than the United States, the UK, Australia, the EU, Japan and Canada”

One would certainly hope so.  Our population is growing materially faster than the population in any of those countries/regions.

But what about per capita growth?

I noticed various commentators yesterday suggesting that Treasury’s growth forecasts looked a bit optimistic.  I had some sympathy for that view, but here I’ll just take them at face value.   And I wondered how their forecasts for real per capita GDP growth compared to those the IMF has recently published for each advanced economy.

Treasury forecasts on a June year basis, and the IMF numbers are for calendar years. Over a forecast horizon of four years (Treasury’s horizon), it shouldn’t make much difference.    In the chart below I used Treasury’s forecasts of real per capita growth for the four years to June 2021, and compared them to the average of the IMF’s forecasts for the four years to December 2020 and the four years to December 2021.

IMF forecasts of real GDP pc

If the Treasury numbers are right for New Zealand, our growth in real GDP per capita would be just slightly below that of the median advanced country over the next four years.   I guess that isn’t that bad, but it isn’t much to boast about either.

After all, our per capita incomes are a long way down this list of countries.  On the IMF’s numbers

IMF real GDP pc.png

The aim –  supposedly –  for a very long time has been to catch up again with those top tier countries, almost of whom we were richer than not that long ago.    And catch-up or convergence certainly isn’t unknown, or unexpected, for other countries.   Here is how those Treasury forecasts for New Zealand’s real per capita GDP growth compare to the IMF’s for the 12 countries poorer than us.

IMF and the poor advanced countries

We only manage to beat two of those countries.    In fairness, of course, some of those poor advanced countries are recovering from savage recessions.    But even if one just focuses on the six former eastern-bloc countries, all but one is forecast to not only manage faster per capita growth over the next few years, but also to have achieved faster growth than New Zealand for the whole period from 2007 (just before the global recession) to 2021.  They are catching up. We aren’t.

(Compared with the richest 12 advanced countries, we are forecast to match the median per capita growth rate of those countries over the next four years, but the eastern Europeans are actually catching up.)

In wrapping up his Budget speech, the Minister of Finance claimed that

“we have a strong and growing economy built on a strong economic plan.  We must maintain our focus on growing the economy and sticking to the plan”

Earlier he had claimed that

Under the Government’s strong economic leadership, New Zealand is shaping globalisation to its advantage.  We’ve embraced increased trade, new technologies, innovation and investment.

All this in a country where exports as a share of GDP have been shrinking.  And productivity growth has been all-but-non-existent for years.

The bare-faced cheek of these assertions should be breath-taking.  Sadly, it seems like just another episode in a long succession in which the government simply makes stuff up.

 

Gareth Morgan’s tax policy

Economist and commentator, Gareth Morgan, has begun releasing the policy platforms that his new party, The Opportunities Party, plans to contest next year’s election on.  Fairness seems to be his watchword and –  within limits –  who can argue with that aspiration?  But whatever “fairness” means, it doesn’t automatically translate into an obvious set of policy prescriptions.

The first policy he announced was that on tax (document here, and lots of FAQs here).  The centrepiece of the tax policy is to apply a deemed rate of return to  (the equity held in) all productive assets (including all houses) and tax that deemed rate of return at the owner’s marginal tax rate.  Own a million dollar house freehold and if the deemed rate of return was 3 per cent, you’d have an additional $30000 added to your assessed annual taxable income and those on the top marginal tax rate would have to pay, for example, an additional $10000 per annum.   The promise is that any revenue raised from this tax would be fully used to cut income tax rates, with a focus on those on below-average incomes.  In their own words, they expect this policy would

a. Make the tax system fairer;

b. Make housing more affordable over time;

c. Lead to more sensible investment of capital (everyone’s savings);

d. Make capital more readily available for productive businesses that create jobs  and pay wages;

e. Encourage a lot more “trickle down” from those who have stockpiled wealth courtesy  of this loophole; and

f. Reduce New Zealand’s reliance on foreign investment and debt to finance our growth.

I’m sceptical.

No doubt tax accountants and lawyers will have their own detailed concerns (some interesting issues were raised in this post from former Treasury and IRD tax adviser Andrea Black).

At the heart of the policy is a concern that the returns on houses are not appropriately taxed.    There are two strands to that.  The first, and most important in their thinking, is that the imputed rents on living in your own home aren’t taxed.  Everyone will, more or less, accept that that is something of an anomaly.  After all, if you rent an equivalent house and put your equity in a bank deposit, the returns to that deposit will be taxed.    The second is that capital gains typically aren’t taxed (and capital losses typically aren’t deductible).    There is much more room for debate about even the theoretical merits of taxing capital gains –  to say nothing of the practical problems.  But over the last 15 years in most of the country there have been large capital gains associated with housing.  Many rental property owners have not been declaring positive net taxable income, but have still made good overall returns through capital gains.

TOP eschew a capital gains tax –  rightly in my view –  but they appear to believe that their deemed rate of return policy will make future (untaxed) capital gains –  house price booms – less likely.

The idea of a deemed rate of return approach to taxing asset income isn’t new in the New Zealand debate.  Such an approach is already applied to holdings of foreign equities, and only a few years ago the government’s Tax Working Group reviewed the option as an approach to changing the taxation of housing.

Here are some of the reasons why I’m sceptical.

First, Gareth claims that a big part of the economic problem in New Zealand is an over-investment in housing, and that imposing a heavier tax burden on housing will reduce that.  As a result, so it is argued, more resources will be attracted towards business invesment.

This is old ground, but there is simply no evidence of systematic over-investment in housing.  Real investment (gross fixed capital formation) in housebuilding has,if anything, been less –  over recent decades- than we might have expected given our rate of population growth.  Countries with lots more people need lots more housing.  Most indications are that we haven’t built enough new houses.  And perhaps the best indication of that is the high price of houses and urban land.  Over-investment in something is usually consistent with low prices over time, not high prices.

But perhaps TOP have in mind something other than a national accounts meaning of “investment”?  They hint at a belief that houses make up more of household overall asset portfolios than is the case in other countries.  First, that factoid has been substantially discredited since the Reserve Bank last year introduced new and more comprehensive household balance sheet data.  Second, even to the extent it is true it partly reflects (a) overall modest rates of total household savings (people still have to live somewhere), and (b) the extent to which our tax system does not work to bias the ownership of the housing stock towards corporate or funds management entities (often tax-preferred in other countries).  And third, for every housebuyer there is a seller –  typically, from within the household sector.

Is there reason to think that New Zealand in some sense devotes “too many” real resources to housing.  The only one I can think of is that the average size of New Zealand houses –  like those in Australia and the United States – is quite large (much larger than in Europe).  Perhaps there is something in that, although since TOP argue that we need this policy partly because other countries (including the US and Australia) already deal with the distortions in other ways, it isn’t overly compelling.  Nor is it probably great politics to suggest smaller houses –  as we get richer – rather than more houses.

TOP claim that their tax policy will “reduce New Zealand’s reliance on foreign investment and debt to finance our growth”.  They don’t explain what they have in mind here.  Since, as I’ve pointed out, we already devote fewer real resources to building houses than one might expect given our population growth rate, it can’t really be through a channel of less housebuilding.  All else equal, less investment would reduce the current account deficit but……the TOP policy document argues we would see more business investment if their policy was adopted, so it isn’t even obvious why the current account deficit would narrow.

I think they must have in mind a wealth effect from high house prices onto consumption.  If high house prices encourages more overall consumption then, all else equal, that will widen the current account deficit –  although, contrary, to Gareth’s speaking notes at the launch of the policy, not since 1984 have these deficits involved “our political leaders trotting round the world with the begging bowl out”.    But as I have noted on various occasions previously, the evidence for a material wealth effect from higher house prices just isn’t very strong.  Here is a chart from a post I ran a few months ago showing consumption as a share of GDP over the last 30 years or so.

household C to GDP

Almost dead-flat (the red line is the full period average), and if anything edging slightly downwards, even as house prices have gone crazy.   That isn’t surprising: high house prices don’t make New Zealanders as a whole richer, they just redistribute wealth from one group to another (and in most cases –  since people want to stay living in the same house –  even the redistribution is more apparent than real).

In principle, of course, taxing an asset more heavily will tend to reduce its value.  Adopting the TOP policy could be expected to reduce house prices, to some extent.  But it won’t change the fundamental imbalances in the housing and urban land market (regulatory restrictions on land use the most important, but running head on into sustained government-induced population pressures).   And I wonder quite how much there is in the TOP policy proposal.

When the Tax Working Group looked at these issues a few years ago, they could talk loosely about a deemed rate of return of 6 per cent, something like the 10 year government bond rate at the time.  These days, having rebounded somewhat in the last few months the 10 year government bond rate is not much above 3 per cent.  And the Reserve Bank assures us that its modelling of long-term inflation expectations shows that they are firmly anchored around 2 per cent.    Real interest rates –  the real risk-free benchmark rate of return in New Zealand are very low.  And even then, our interest rates are still materially higher than those in most countries abroad –  and, as everyone accepts, that isn’t because productivity growth and real opportunities here are so much better than those abroad.  In the UK for example –  with a better long-term productivity record than New Zealand, much more government debt, and a similar inflation target –  the 10 year bond yield is around 1.3 per cent.

One of the problems with the TOP policy document is that there are no details.  They say that is all to be negotiated once they get into Parliament, but it makes a lot of difference whether they plan to use a real or nominal risk-free interest rate, or even a short or long-term rate.  Much discussion has tended to assume that a nominal long-term rate should be used.  I could make a strong –  stronger I think –  case for using a real short-term interest rate.

One of the flaws of our tax system –  or at least its interaction with our monetary policy inflation target –  is that all of nominal interest is taxed, and where interest is deductible all of nominal interest is deductible.  That is so even though the portion of the interest that simply compensates for inflation  –  maintains the real value of the asset – is not (in economic terms) income at all.  As a parallel, inflation raises the nominal value of your human capital to maintain the real value of that asset, but it is only the returns to that higher nominal asset value (any increase in annual wages) that is taxed.  Economists tend to quite like the idea of inflation-adjusting the tax system, while tax administrators hate it (for practical reasons).  It is already more of a problem in New Zealand than in most countries (because we fully tax –  and thus double tax –  all interest income).  But it would be a major new distortion, on a much more serious scale, to impose a nominal deemed rate of return across a much much larger stock of assets (than just fixed income assets that are already over-taxed).

So to me if the TOP policy were to be adopted the logic of using a real interest rate as the deemed rate of return (or fixing the zero lower bound and lowering the inflation target) seems pretty clear.

What about the short-term vs long-term rate issue?  No doubt, defenders of using a long-term rate would note that these are typically long-term assets.  But…..one has to assume that the deemed rate of return will change over time (even long-term bond rates do).  And it seems unlikely that if I buy a house today, Gareth’s policy would offer me tax certainty –  say, using today’s 10 year bond rate for the next 10 years.  If not, and if the deemed rate of return is subject to, say, annual review at each Budget, then using something like a one year government bond rate would seem a reasonable approach.    But the one year government bond rate is around 1.9 per cent at present, and year-ahead inflation expectations aren’t much lower than that.  A real risk-free government bond yield in New Zealand at present is around 0.5 per cent. And it is even lower in other, generally more successful, economies.

Now a reasonable rejoinder might be that the times are exceptional, and that these rates can’t last for ever.  If I were a betting man, I would probably agree.  But……our interest rates are higher than those in the rest of the world, and one of the goals of the Business Growth Agenda is to see that gap close.  And we aren’t in the depths of a recession: best estimates are that the output gap might be somewhere near zero, and yet our Reserve Bank expects no change in the short-term policy rate for the next few years.  If one is taking a policy to the electorate over the next 12 months, one surely has to work on the basis that the interest rates we have now might be around for some time.

If real short-term interest rates are the conceptually and practically appropriate rate to use in a deemed rate of return model, the tax on that million dollar housing equity would be around $1666 per annum, even for those on the top marginal tax rate.  That would be an annoyance to homeowners but –  especially with some income tax relief on the other side –  hardly likely to materially transform the housing market.   From Gareth’s perspective, that could have an upside –  an unthreatening introduction, and then when/if real interest rates return to “normal” it begins to bite much harder semi-automatically.  But it is a hard sell to make big changes in the tax system for such small potential payoffs at anything like current interest rates.

What else makes me uneasy (more briefly):

  • one of my objections to a practical CGT is that it tends to make government revenue even more highly pro-cyclical, encouraging unsustainable spend-ups as asset booms go on.   The deemed rate of return approach seems to face very similar problems.  Because a lot of housing assets are leveraged, the equity in housing changes more than proportionally with changes in houses prices.  A 20 per cent annual increase in house prices –  perhaps at a time when interest rates were rising anyway  –  might induce a 25 per cent rise in annual revenue from this tax.  While it is all very well to talk of full offsets in income tax reductions, it is very unlikely that would happen year by year –  or else, there will be material increases in income tax rates in the middle of asset busts, which again seems highly unlikely.  So, it looks like a policy that will tend to undermine spending discipline just at points of cycles when it is most needed, and undermine government revenue just at the point of the cycle when it is most valuable.
  • it is a systematic tax on Aucklanders  (most of the asset-based revenue will be raised in Auckland, but income tax rates are national and low income people aren’t concentrated in Auckland).  As a Wellingtonian that might not unduly bother me, and as an economist there might be a plausible argument for it, but there are awfully large number of voters in Auckland.
  • Valuation issues seem more substantial than TOP allow for.  In their FAQs there are blithe descriptions of how house values might be triangulated, but if I am facing a large annual tax on the imputed rent on my house I will likely care much more about the assessed value being used than I will in respect of local body rates.  The compliance costs seem non-trivial –  and that is before getting into business assets.
  • There is a reasonable economic case for a pure land tax. The quantity of unimproved land is fixed, and so taxing that value doesn’t change the supply of land.  But this isn’t a land tax.  It would apply to business assets as well, as –  in effect –  an underpinning minimum tax (if existing income tax liability is lower than the deemed rate of return).  But many businesses fail –  they never succeed in making much taxable income.  And while we want a strong stream of highly profitable businesses, one of the ways one gets there is to have plenty of entrepreneurs take risks, and often enough fail.   The TOP document talks about the ability of firms to   “allow those businesses facing a temporary or cyclical earnings downturn to defer their minimum income tax for a period of up this to 3 years (use of money interest to be charged)”.  But that doesn’t seem to deal with businesses that never succeed at all.  Imposing a fixed minimum tax, even if it can be deferred for a few years, is an increased tax on entrepreneurship.  What you tax, you get less of.    And yet TOP talk of encouraging more “productive” business investment and more entrepreneurship.

In the end, I think my assessment of the TOP policy is that a very high level it isn’t necessarily inappropriate, but would be hard to make work well, doesn’t offer very much in a low (real) interest rate world, and is misconceived as a structural answer to either our housing price problems or our sustained economic underperformance.

Next week I will write about TOP’s new immigration policy, which I strongly agree with parts of, while being quite sceptical of other parts.  To their credit, it is a more serious engagement with the issues than we’ve seen from other parties to date.

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).

 

 

Housing, land tax, and associated things

The Prime Minister attracted considerable coverage last week for his suggestion that a tax might be applied non-resident (however defined) holdings of land.  The Prime Minister wasn’t very specific about the options he had in mind, but it probably didn’t matter – it got some mostly favourable coverage on an issue (house prices, in Auckland in particular) where the government probably senses that it might be politically vulnerable.

Quite how house prices play politically has never really been clear to me.  I’ve noted before that I’m not aware of a single example of a city or country that, having once put in place restrictive land use regulation, has ever substantially unwound those controls.  I can well understand existing users’ unease about greater intensification, and in particular the coordination challenges that can arise. Existing owners as a whole in suburb near the central city might be (considerably) better off financially from allowing their land to be used more intensively, but that won’t necessarily be so for each of them if such development occurs piecemeal, or if benefits are captured by those first in the queue.   The market seems to deal with these issues through private ex ante contracts, the covenants that are now used in most new subdivisions (and which the Productivity Commission was quite disapproving in its report last year).

And I can also understand that no one really wants the value of their property to fall much.  Of course, for many it actually doesn’t matter very much.  If you haven’t got a mortgage and plan to live in the same city for the rest of your life, the market price of houses in your area just isn’t (or shouldn’t be) that important to you.  For those with very large recent mortgages it is another matter.  For them, and especially those who aren’t owner-occupiers, falling house prices look like a visceral threat.

But then the mortgage-free are in many cases those with children, already adult or approaching adulthood, who face the huge –  increasingly insurmountable – hurdles to entering the owner-occupation market.  That should be quite some motivation to be concerned about policies which keep house prices very high, or keep driving them up further.  Increasing the physical footprint of cities, and allowing that process to happen in ways and in places that offer the best opportunities (rather than where Council officials and politicians dictate) looks as though it should be the answer.  But bureaucrats and politicians obstruct those processes, and seem to get away with it because the issues are complex, and because they cover their tracks, blaming high house (and urban land) prices on banks, the tax system, the building industry, “speculators”, “land bankers”, becoming a “global city”, or whatever.

Other bureaucrats and politicians peddle the line that high levels of non-citizen permanent immigration are somehow good for us.  High house prices are just one of those things –  a price of progress, indeed of success, so the Prime Minister would often have us believe.

Once in place, distortionary policies, even very costly ones, often last for a long time.  We saw that in New Zealand with the import licensing regime first put in place in the 1930s, which wasn’t finally abolished until 1992.  It was an enormously inefficient system, driving up costs on many items (and restricting choice) for most people, it was contested politically (largely unwound in the early 1950s, and then re-imposed by the next government).   But the entrenched interests of those who benefited from the system (or thought they did) combined with ideologies of “national development” to make it very difficult to undo.  Licence-holders themselves obviously benefited, but many of the employees of firms producing products protected by the licensing regime thought they did too.    And transitions are/were costly – we saw a lot of that in the 1980s, when big steps were finally made in dismantling the regime.  A larger proportion of the population is employed now than was then, but that didn’t mean the transition wasn’t difficult, and even traumatic, for many individuals, and even for whole towns.

One might have hoped that the rigged housing market was different, but it doesn’t seem to be.  The distributional effects (winners and losers) are far larger than any aggregate adverse effects (I’m skeptical that GDP is much smaller than otherwise because the housing market is so badly distorted).  And unfortunately, those most adversely affected tend to be the poorer, younger, less sophisticated elements in society –  those on the peripheries.  One might have hoped that one or other main party would have made grappling with these issues a real priority, consistent with the underlying values they claim to represent:  National perhaps on some ‘property-owning democracy’ line, in which communities will be stronger etc when property ownership is more broadly based, providing a “fair go” to the hardworking and aspiring classes.  Or Labour, built on a fight for the rights and interests of ordinary workers, campaigning for the full inclusion and equal opportunities for peripheral groups.

But it simply doesn’t happen.  Instead, the Prime Minister keeps talking of high house prices as “a good thing”, and a sign of success.  And for all the somewhat encouraging talk from Labour’s Phil Twyford, less than 18 months out from an election, there is little public sense of a party making fixing the housing market a defining issue.  Time will tell.  Rigged markets are hard to unscramble –  politically hard, not technically so.    Doing something far-reaching could be very costly for groups who would quickly become quite vocal, and loss aversion is a powerful force.

Where do land taxes fit within all this?  I outlined some of my skepticism about a general land tax in a post late last year.    But the Prime Minister’s latest comments relate only to non-resident purchasers.  The theoretical arguments for a general land tax don’t apply to one explicitly targeted at a specific subgroup.  Instead a land tax appears to be one of the few possible tools (specific to foreign purchasers) left to the government –  having signed up to a succession of preferential trade (and other) agreements – if, as the Prime Minister put it, it could be shown that non-resident purchasers were a big influence on the housing market.  Of course, we haven’t yet seen the data the government has started collecting, but even when we do there will no doubt be lots of debate about what it means.    Say that it shows that 1 per cent of purchases in the last six months have been from non-resident foreigners.  One per cent doesn’t sound much.  But the significance depends on a various things, including a variety of elasticities.  If the supply of houses and urban land was totally fixed (it isn’t, but this is just an illustrative example), a one per cent boost to demand could have a considerable impact on the price of houses.  If New Zealand residents were deterred from buying by even the slightest increase in price, then an increase in non-resident foreign demand might have very little impact on price even if supply was largely fixed.    Various quantitative researchers will have various estimates of these different elasticities.   But some past work has suggested that a 1 per cent increase in population, say, can have a material impact on house prices.

I had a couple of posts on the non-resident purchases issues last year.  Despite my general stance strongly favouring a pretty liberal regime for foreign investment, the housing supply market is so badly messed up that I don’t think we should rule out restrictions targeting non-resident foreign purchasers, as a second or third best option (perhaps especially if there was evidence that a large proportion of such purchases were being left empty).  The capital outflows from China –  which is where the main issue is –  are historically unprecedented.  They aren’t a normal phenomenon of an emerging economy, but a reflection of a whole variety of things that are badly wrong with the governance and rule of law in China.

But is a land tax the answer?  If it is, it is a pretty unappealing one.   It would seem to be a tax planners’ dream.  One of the appeals of a general land tax is that the land is fixed, and some identifiable entity (person, company, trust, government) one owns each piece of land.  It doesn’t really matter who owns it, but someone will have to pay the tax.  A land  tax focused only on some definition of non-resident purchasers means it makes a huge difference who owns the land.  If I own it, there is no tax liability.  If a family in Shanghai owns it there is.  Which looks like a pretty clear incentive to have the land owned by New Zealanders, and (to the extent there is demand) the things on the land owned by the foreigners.  No doubt lots of clever intrusive anti-avoidance provisions could be added to any land tax legislation but to quite what end?  Are we better off if, say, the non-residents purchasers bought apartments (which typically have a smaller land component) rather than, say, standalone houses?  Perhaps if it stimulated a supply of new apartments –  for which there would be an enduring demand –  but not if it largely just reallocated who owned what within an existing housing stock.

And there is, of course, the question of what might be a reasonable rate of land tax.  Long-term New Zealand government bond yields in New Zealand are among the highest in the world.  At present, those real bond yields are just over 2 per cent per annum.  Imposing a tax of 1 per cent per annum on value of land (including farm land?)  would be a very heavy burden in such a low yield environment.  Perhaps it might not matter too much to those seeking to safeguard their capital (return of capital rather than return on capital), but if so it might not make that much difference to offshore demand either.   I’ve seen talk of higher rates –  Rodney Hide’s Herald column yesterday talked of a 3 per cent annual rate –  but in such a low yield environment such tax rates could quickly starting looking like expropriation, confiscatory in intent.  I suspect our preferential trade agreement partners might start looking askance at that.

For what it is worth, I think a serious response to the house and urban land price affordability issue would have several dimensions, including:

  • limiting the assessability and deductibility of interest to the real (inflation-adjusted) interest only.  The ability to offset losses in one activity against profits in others is a good feature of the tax system not a flaw, but there is no good economic case for taxing the inflation component of nominal interest, or allowing borrowers to deduct the inflation component.  This is a small issue, especially at present when inflation is so low, but it would be good tax policy and work towards slightly better housing market outcomes.
  • creating a presumptive right for owners to build, say, two storey dwellings on any land, with associated provisions to developers/purchasers to cover the costs of associated infrastructure (whether through private provision, or differential rates).
  • sharply cutting the target level of residence approvals under the New Zealand immigration programme, from the current 45000 to 50000 per annum to perhaps 10000 to 15000 per annum.  Since there is no evidence that New Zealanders, as a whole, have been gaining from the high trend levels of immigration –  and indications that Auckland, prime recipient of the inflows, has been persistently underperforming, this would represent immigration policy reform in any case.  But it would also have material implications for trend housing market pressures as well.

The third element would be the one that would be easiest to implement.  But, of course, like the policies around housing supply –  or import licensing (see above) –  the distributional implications of the current arrangements (positive and negative) are probably larger than the overall economic effects.  Those who see themselves as “winners” from the current arrangements –  a funny mix , including those who genuinely benefit, and those with a “feel good” preference for diversity  –  are likely to be more vocal, and more easily heard, than those who pay the price of an misguided approach to economic management: a “critical economic lever” (MBIE’s words) that has done little or nothing positive for New Zealanders as a whole.  The parallels with Think Big in the 1980s, or with the protective regime of the 1930s to 1980s, each well-intentioned and with their own internal logic, are sobering.

 

 

 

Are land taxes the answer to house prices?

I’ve been pondering a post on land taxes for some time, but was prompted to jot something down today by a couple of recent pieces, including in today’s Herald  by two lecturers in politics at AUT, Nicholas Smith and Zbigniew Dumienski.  Sub-editors present their arguments under the headline “Land tax best fit for housing crisis”, and the authors’ own conclusion is only a little more nuanced.

Given the multiple problems stemming from Auckland’s housing crisis, an LVT stands out as the best-rounded of the policy options on the table. Not only would it address house price inflation, it could also result in a more efficient use of land, mitigate urban sprawl, lower the burden on the natural environment and reduce the risk of real estate bubbles; all without undermining the foundations of economic growth.

I’m not a land tax expert, but I’m no longer so convinced.

Which doesn’t mean that I’m inherently unsympathetic to the argument for a land tax. In fact, I once wrote a Treasury paper on overall economic policy direction, that ended up on Bill English’s desk, and which was, with hindsight, rather too readily enthusiastic about a land tax.

In principle, taxing things that are in fixed supply has some theoretical and practical appeal.  Collection is pretty easy –  every piece of land has an identifiable owner.  And  whereas if one taxes business profits (say) heavily there will be less investment taking place,  taxing land won’t make much difference to how much land there is  (it will make some difference because the value of land is partly about work done to it (drainage etc).

And, of course, as the authors point out we’ve had a land tax previously –  it finally disappeared in the early 1990s, by when it apparently applied mainly to land under urban business districts.  And we still have, in effect, some partial land taxes: in some areas, local authority rates are levied on the basis of land values, and in many places (especially Auckland) even the capital value rating system have come a lot closer to a land tax as the land share of a typical “house + land” has climbed sharply.  And OECD data show the New Zealand property taxes, as a share of GDP, are already a bit above the OECD average.

property taxes

Had we put a land tax on in 1840, and kept it in place ever since, I’m not sure I’d be arguing for abolition now.  But the historical track record of the tax we had was not that good.  Apart from anything else, the rules kept changing (and changing), with the base being progressively whittled down.  Smith and Dumienski note that “it was arguably an important factor contributing to New Zealand’s once-famed egalitarian character”.  I’d be keen to see the evidence for that claim.   New Zealand economic historians, at least those I’ve read, don’t seem to have seen the land tax in quite those terms.

Any material change in the tax system involves significant redistributive consequences (or big compensation packages).    No doubt there isn’t much public sympathy for “land bankers” in and around our cities (and since these people are mainly profiting from other regulatory distortions, I wouldn’t have much sympathy either).  But what, say, about the sheep farmer, in an area where values haven’t been much affected by dairy conversion opportunities?

I’m also not quite sure what sort of tax rate the advocates of a land tax have in mind.  People often glibly talk (and I have in the past) of a 1 per cent annual land tax as if this is a pretty small amount.    But real risk-free returns are not what they were.  New Zealand has probably the highest real interest rates among advanced economies and a long-term real interest rate here (20 year inflation indexed bond) is still just under 2.5 per cent.  The comparable US yield when I checked this morning was 1.1 per cent, and that is now quite a common sort of rate internationally.  People (especially central bankers) keep talking about interest rates “normalising”, but real interest rates have been trending down now for decades, and no one really knows with any confidence whether the process has ended, let alone whether it will be materially reversed.   In this climate, a land tax of anywhere 1 per cent would seem quite incredibly burdensome (in a way that it might not have seemed in New Zealand in the 1990s when real risk-free interest rates were touching 6 per cent).  Even if one could make a theoretical case for such an onerous tax, the political economy suggests that it could not be sustained (and would not be expected to be sustained).

Perhaps we could have a rather lower rate of land tax?  Perhaps a half or a quarter of a per cent land tax could be politically sustained?  But then one is left asking whether it is really all worth it.  Bearing in mind that urban land is already taxed, would it make that much difference to the cost of urban land –  the issue Smith and Dumienski are driving at  – or allow a material gain in economic efficiency from shifting away from more distortionary taxes (eg lowering our high taxes on capital income)?   After all, most people now agree that the real issues around urban land prices are not ultimately the tax system, but the regulatory restrictions on land use that central and local governments facilitate.  To some small extent, those restrictions seem endogenous to land prices –  ie when land prices get sky high (or least rise rapidly) there is pressure to ease the land use restrictions. If so, perhaps a land tax would just allow Councils to keep tighter restrictions in place for longer, undermining any possible efficiency gains from a land tax.

But let’s get back, in conclusion, to the Smith/Dumienski list of benefits.  They argue that a land tax would

  • address house price inflation,
  • result in a more efficient use of land,
  • mitigate urban sprawl,
  • lower the burden on the natural environment and
  • reduce the risk of real estate bubbles;

All without undermining the foundations of economic growth.

What’s not to like?  Well, first, in principle a land tax should lower the value of land (ie a one-off shift in the price). But it is not obvious that it will have much impact on either house price cycles, or trend pressures resulting from, say, the interaction of population pressures and land use restrictions.    Perhaps the authors have in mind some more sophisticated land tax that would  effectively be  a capital gains tax, but they don’t suggest so in their article. And as we know, real world capital gains taxes don’t appear to have done much to improve the functioning of housing and urban land markets

Would it result in a more efficient use of land?  I suppose that depends on one’s model, but I’d have thought that taxing an asset will result in a more intensive use of that asset, with no necessary presumption that the more intensive use is more efficient.  Of course, it might be less inefficient than the alternative possible taxes, but that is a different issue surely?

Relatedly, if land (across the country, not just in cities) is used more intensively, why is there a “lower burden on the natural environment”?  Land in its natural state poses no such burden, but if (say) farmers need to use marginal land more intensively, to maximise profit subject to a land tax, I’m not sure why this is an environmental gain.

And I simply don’t see the argument made that to “mitigate urban sprawl” is an appropriate public policy objective.  As is well known, urban areas in New Zealand make up a very small proportion of New Zealand’s total land area, and I’d have thought that revealed preference (reflected in prices) suggested that the most valuable use of land on the fringes of cities was typically for housing, rather than for agriculture.  “Sprawl” is just the pejorative term for “space” –  most people seem to want some (and historically as cities get richer they have gotten less dense) much though the planners might disapprove of their preferences.

To repeat, 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.

There is no great secret to why New Zealand urban land prices are high. It is largely down to the impact of the central and local government regulatory restrictions on land use.  Far better to tackle those at source, and give freedom back to landowners.  Competitive market processes could then be expected to produce affordable houses, as they have in much of the United States (which doesn’t mean Mt Eden prices will ever be the same as Invercargill ones).    Of course, one can reasonably argue that such reforms themselves might not prove durable, and if reform were totally “open slather” that would probably be true, but whether or not we have a land tax is simply not at the heart of the urban land price issues.

I’d welcome comments and thoughts on this issue, and if (for example) Andrew Coleman, at Otago, felt inclined to add one of his occasional, typically very insightful, comments drawing on his own past work (eg here) in the area I’d be very interested to read it.