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.