Recent article by a respected economist. Well worth a read.
Saul Eslake: 50 Years of Housing Failure
Address to the
122nd Annual Henry George Commemorative Dinner
The Royal Society of Victoria, Melbourne
2nd, September 2013
by Saul Eslake
Introduction
I appreciate very much the opportunity to talk to you at the 122nd Annual Henry George Commemorative Dinner.
Henry George was one of the more innovative economic thinkers of the
19th century, and it is in some ways a pity that his work is not better
known among those who do know at least a little of the history of
economic thought, as that of some of his contemporaries such as John
Stuart Mill, William Stanley Jevons, or Alfred Marshall still is today.
I first ran across him when I was studying Australian History at Year
12, and focusing in particular on the Great Depression of the 1890s. I
learned then that George’s advocacy of a single tax on the unimproved
value of all privately-held land had found favour with sections of the
then newly-emerging Australian labour movement.
Perhaps for that reason, those Australians who have actually heard of
Henry George usually place him on the left of the political spectrum.
Yet that is a gross over-simplification. He was also a strident advocate
of restrictions on Asian immigration – as was the Australian Labor
Party in its early days, and indeed right up until the 1960s – although
these days, that is a position usually associated with the extreme
right. Like most other economists, he was concerned about the existence
and exploitation of monopoly power. And, also like most other
economists, in his time and today, he was an advocate of free trade,
pointing out that tariffs are not something that foreigners pay to get
their goods into the country which imposes them, but rather something
that a country’s government makes its own citizens pay in order to keep
foreigners’ goods out: or, as he put it, “it is not from foreigners that
protections preserves and defends us: it is from ourselves” (George
1905: 45-46).
Nor is the advocacy of a greater role for the taxation of land in
taxation systems an exclusively left-of-centre position. Adam Smith,
commonly if not entirely accurately regarded as the father of “laissez
faire”, proposed what he called ‘ground rents’ as ‘a proper subject of
taxation’ a century before Henry George (Smith 1776: Book V, Chapter 2).
Milton Friedman – who in no sense could be characterized as being
anywhere near left-of-centre (notwithstanding his principled advocacy of
the decriminalization of drug use) – once said that, in his opinion
“the least bad tax is the property tax on the unimproved value of land,
the Henry George argument of many, many years ago” (Friedman 1978). The
Economist – the antithesis of a ‘socialist rag’ – earlier this year
stated that “taxing land and property is one of the most efficient and
least distorting ways for governments to raise money”, citing an OECD
study suggesting that “taxes on immovable property are the most
growth-friendly of all taxes” (Economist 2013: 70).
The Henry Review of the Australian taxation system concluded that
“land is an efficient tax base because it is immobile; unlike labour and
capital, it cannot move to escape tax” and that “economic growth would
be higher if governments raised more revenue from land and less revenue
from other tax bases” (Henry 2009: 247). Henry George would have been
pleased.
All of this notwithstanding, very few economists – and I am not one
of them – would today accept that it would be either possible, or even
if it were possible, desirable, for a land tax to be the sole source of
government revenue, as Henry George advocated. He was writing at a time
when government revenue requirements were substantially smaller than
they are today; and when it was far less likely than it is today that
people could be ‘asset rich but income poor’. But there is still a very
sound case for the taxation of land to play a greater role in raising
revenue for public purposes than it does today.
Housing policy: a half-century of policy failure
Housing is important. It meets a variety of deeply personal needs,
including those for shelter and (ideally) security. It provides a sense
of attachment (the place where we live) and, for many people,
contributes to their sense of identity. These are pretty basic needs for
almost all of us, as human beings. In addition, for many people, it is
an important means of building wealth (and often the most important
one); and for some, it provides the foundation for starting a business.
In Australia, most of us are well-housed – at least in a physical
sense. Although it hasn’t always been the case, and it isn’t the case
for all Australians today (not least for Indigenous people), most of us
live in houses or apartments that are well-constructed, amply fitted
with various devices that make the accomplishment of household tasks
easier than it was in our great-grandparents’ day, and replete with
other appurtenances and chattels that in some way or other provide us
with enjoyment or add meaning to our lives.
That isn’t the case in many other parts of the world. In July, I
spent a week in Madagascar, which according to the IMF is the
sixth-poorest country in the world, measured in terms of
purchasing-power-parity per capita GDP. It ranks 151st (out of 186
countries) on the United Nations latest Human Development Index. People
in Madagascar are not, in general, well housed. From my own observation,
outside of the capital, Antananarivo, most people in Madagascar live in
wooden or mud-brick huts that, in many cases, are smaller than the
lounge room of a typical new Australian house, with roofs made of
thatch, and in many cases without glazed windows. It puts our housing
issues into a different perspective.
Reflecting the importance of housing to people’s well-being, as well
as to many broader objectives, Australian Governments of all political
persuasions have long purported to attach a great deal of significance
to goals such as promoting home ownership, improving housing
affordability, and increasing housing supply.
And, once upon a time, Australian Governments did actually pursue policies that promoted those objectives (see Charts 1 and 2):
- between 1947 and 1961, the housing stock increased by 50% -compared
with a 41% increase in Australia’s population over this period. The
Commonwealth and State Governments directly contributed 221,700, or 24%
of the total increase in the housing stock over this period, through
programs financed under the Commonwealth-State Housing Agreements, or
under the War and Defence Service Homes Schemes.
- during this period, the home ownership rate increased from 53.4% to
70.3% -the largest increase in home ownership in Australia’s history.
- between 1961 and 1976, the housing stock increased by a further 46%
-again outstripping the 33% increase in Australia’s population over this
period. During this period, the Commonwealth and State Governments
directly added a further 299,000 dwellings to the housing stock,
equivalent to 23% of the increase in the total housing stock over this
period.
during this period, the home ownership rate fluctuated between 68% and
71%, but remained at a high level by international standards.
In other words, during this period, Federal and State Government
housing policies were principally directed towards increasing the supply
of housing, and at increasing or maintaining home ownership rates. And
these policies actually achieved those objectives.
Chart 1: Growth in the population and housing stock, 1947-2011
Chart 2: Home Ownership rates accelerated post WW2
Chart 3: Home ownership rates at Censuses, 1947-2011
There were downsides to these policies, of course – in particular,
many of the dwellings built by State housing authorities, and by the
private sector, were poorly located from the standpoint of access to
employment, lacked basic infrastructure and community services, and
inadvertently served to concentrate socio-economic disadvantage. But
they did ensure that a rapidly-growing population was at least
adequately housed, and they gave many families an opportunity to gain a
first foothold on the home ownership ladder that they would otherwise
not have had.
Even between 1976 and 1991, the housing stock increased at a much
faster rate – 41% than the population – 23% -although only 9% of
dwelling completions during this period were by the public sector.
But the relationship between growth in the housing stock and
population growth began to change after the early 1990s. Between 1991
and 2001, Australia’s population grew by 11.5% , while the housing stock
grew by only 18.3% -less than 9 pc points more than the population. And
between 2001 and 2011, while the population grew by 15.9%, the housing
stock grew by only 15.2%. That is, over the past decade, the housing
stock has grown at a slower rate than the population – for the first
time since the end of World War II.
This gradual narrowing in the ‘gap’ between the growth rate of the
housing stock and that of the population – to the point of eliminating
it entirely over the past decade – has come in the face of demographic
trends that would have warranted a widening of this gap:
- average family sizes declined between the early 1960s and the early
1990s, implying that more dwellings are required to accommodate the same
number of people;
- family breakdowns have meant that more dwellings are required to accommodate the same number of people; and
- population ageing has resulted in more people living alone, again
increasing the number of dwellings required to accommodate the same
number of people.
Yet, in the face of these ongoing trends, the average number of
people per dwelling actually rose (from 2.61 to 2.64) between the 2006
and 2011 Censuses – for the first time in at least 100 years (since the
first Commonwealth Census was conducted in 1911 – see Chart 3). From
1911 to 2006, the average number of people per dwelling had fallen from
4.52 to 2.61. It would seem that the widespread angst among ‘baby
boomer’ parents about how difficult it is to get their 20-(and in some
cases 30-) something children out of the family home has a sound basis
in fact.
Chart 4: Average number of people per dwelling at Censuses, 1911-2011
This is what the National Housing Supply Council, of which I’m a
member, means when it estimates that Australia has a ‘shortage’ of
housing relative to the ‘underlying’ demand for it – a shortage which it
last estimated to be of the order of 228,000 dwellings as at 30 June
2011 (NHSC 2012: 24-25).
That 228,000 figure is not an estimate of the number of homeless
people in Australia (which the ABS put at just over 105,000, a number
which included 41,390 people living in ‘severely overcrowded’ dwellings,
at the 2011 Census – ABS 2012). Rather, it reflects the gap between the
existing housing stock, and what the Council estimates the stock would
need to be if household formation patterns had remained essentially
unchanged over the past decade.
In passing, I should note that these estimates pre-date the results
of the 2011 Census, which has resulted in some downward revisions to the
estimated level of Australia’s population compared with those which had
been based on extrapolations from the 2006 Census, and which will lead
to some consequential revisions to these estimates of the housing
‘shortage’.
However, it would be a mistake to think – as some other commentators
have – that the revisions prompted by the 2011 Census results have
eliminated the ‘housing shortage’ which the National Housing Supply
Council and others had previously identified (see NHSC 2013: 107-123).
Nor, in my view, is the idea that there is a ‘housing shortage’ in
the sense intended by the NHSC contradicted by the work that Philip Soos
has undertaken for Earthsharing Australia, using data from Melbourne
water suppliers to show that up to 6% of residential properties across
the Melbourne metropolitan area may have been vacant during the second
half of 2011 (Soos 2012).
If those vacant properties aren’t available (for whatever reason) for
sale or rent then their existence does not detract from the existence
of a housing shortage – although it may well be, as Philip argues, that
an increase in land tax could prompt at least some of the owners of
those properties to make them available for sale or rent.
I think there are two principal reasons for the increasing failure of
the stock of housing to grow at a rate commensurate with the growth
rate (and changing needs) of the population:
First, the direct contribution of the public sector to growing the
housing stock has declined substantially. From the mid-1950s to the
mid-1970s, public sector agencies completed an average of 15,512 new
dwellings per annum (and they indirectly financed the completion of
another 3,600 dwellings annually through low-interest loan schemes).
From the mid-1970s to the early 1990s, they completed an average of
12,379 new dwellings per annum. But since then, they have completed an
average of less than 6,000 new dwellings per annum (indeed between 1999
and 2009 the public sector built fewer than 4,000 new dwellings per
annum, on average).
Second, state and local government planning schemes and policies for
charging for the provision of suburban infrastructure have made it
increasingly difficult for the private sector to supply new housing,
especially at the more affordable end of the spectrum.
This second reason has three distinct dimensions.
First, state and local authorities have imposed increasingly more
onerous requirements on developers for the provision of infrastructure
and services in new housing estates. While that undoubtedly represents
‘progress’ in many respects – and certainly adds to the amenity of
‘greenfields’ developments from the perspective of those who move into
them – it comes at a cost.
Second, local authorities have changed the way in which this
infrastructure and these services are provided, from a model based on
paying for them largely through debt, which was then serviced and repaid
out of subsequent increases in rate revenues, to one based on paying
for them through ‘up front charges’ on developers.
While this is consistent with a ‘user pays’ philosophy, and appeases
the growing voter aversion to public debt, it has meant (especially in
New South Wales, where developer charges have risen to much higher
levels than in other States) that developers find it increasingly
difficult to produce house-and-land packages at prices which are
affordable for first-time buyers and still make a profit, so they have
reacted by building a smaller number of more expensive houses targeted
at the trade-up market.
Third, metropolitan planning authorities and inner-city local
governments have made it increasingly more time-consuming and onerous to
undertake higher-density or ‘infill’ developments on ‘brownfields’
sites – in particular by imposing tighter planning controls, and by
providing more opportunities for objections to and appeals against
planning decisions.
As with the more onerous requirements for infrastructure provision in
‘greenfields’ sites, there are two sides to this story, and I have a
lot of sympathy with the desire of residents in established areas to
prevent developments which detract materially from their quality of life
(and/or from the value of their properties). But whatever perspective
one might take on that debate, there is no doubt that developments in
planning law have contributed to the mismatch between housing demand and
housing supply.
What is also noticeable about the last twenty years is that – despite
mortgage interest rates having been substantially lower, on average,
over this period (7.59% pa over the past 20 years, compared with 11.95%
over the preceding 20), and despite unprecedented expenditure on grants
to first home buyers – the overall home ownership rate has actually
declined by 5 percentage points, to 67% at the 2011 Census, its lowest
figure since the 1954 Census.
In fact the decline in home ownership has been even more pronounced
when one ‘looks through’ the effects of the ageing of the population,
which (among other things) means that an increasing proportion of the
population is within age groups where home ownership rates are always
(and for obvious reasons) higher than in younger age cohorts.
Research by Judy Yates of the University of NSW shows that home
ownership rates among younger age groups declined dramatically between
the 1991 and 2011 Censuses – from 56% to 47% among 25-34 year olds; from
75% to 64% among 35-44 year olds; from 81% to 73% among 45-54 year
olds; and 84% to 79% among those over 55. In fact the only age cohort
among whom home ownership rates didn’t decline over the past 20 years
was 15-24 year olds: but that was only because their home ownership rate
had already fallen 34% in 1961 to 24% by 1991 and didn’t decline any
further.
The decline in home ownership rates among younger age groups is
almost certainly due in part to changing preferences (including
partnering and having children at older ages, and greater importance
attached to proximity to employment or entertainment venues): but it
also undoubtedly owes more to declining affordability.
This is also evident in the fact that home owners are taking longer
to pay off their mortgages. According to the ABS’ just-released Survey
of Housing Occupancy and Costs (ABS 2013b), only 45.8% of home-owning
households owned their home outright in 2011-12, compared with 58.5% in
1994-95.
Chart 5: Home ownership rates by age cohort, 19961-2011
This may be partly due to the fact that households can, and do, use
mortgages for other purposes apart from simply acquiring the property
which is mortgaged: but I think it is far more due to the fact that
people need to borrow much more money initially in order to acquire a
property now than they did 20 years ago.
So, when set against the stated objectives of the housing policies
pursued by successive governments of various political persuasions, the
results have been dismal.
Although most Australians are, as I noted at the beginning,
physically well housed, it can no longer be said that we are, in
general, affordably housed; nor can it be said that the ‘housing system’
is meeting the needs and aspirations of as large a proportion of
Australians as it did a quarter of a century ago. And in making that
assertion I am thinking of the extent to which the housing system meets
the needs and aspirations of those who don’t want, or can’t and won’t
ever be able to, become home-owners, as well as of those who do seek
that status.
That is why I gave this talk the title, ‘Fifty Years of Failure’. In
order to develop that proposition more fully, I want to turn now to two
of the principal policies which governments of both persuasions have
pursued throughout this period.
Assistance to first home buyers
It’s hard to think of any government policy that has been pursued for
so long, in the face of such incontrovertible evidence that it doesn’t
work, than the policy of giving cash to first home buyers in the belief
that doing so will promote home ownership.
The Commonwealth Government started giving cash grants to first home
buyers in 1964 when, at the urging of the New South Wales Division of
the Young Liberal Movement (whose President at the time was a young John
Howard), the Menzies Government began paying Home Savings Grants of up
to $500 to ‘married or engaged couples under the age of 36’ on the basis
of $1 for every $3 saved in an ‘approved form’ (generally, with a
financial institution whose major business was lending for housing) in
the three years prior to buying their first home, provided that the home
was valued at no more than $14,000.
This scheme was abolished by the Whitlam Government in 1973 (in
favour of an income tax deduction for mortgage interest payments by
persons with a taxable income of less than $14,000 per annum);
re-introduced under the name of Home Deposit Assistance Grants (without
the age or marriage requirements and the value limits, and with a larger
maximum grant of $2,500) by the Fraser Government in 1976; replaced by
the Hawke Government in 1983 with the First Home Owners Assistance
Scheme, initially with a maximum grant of $7,000 (later reduced to
$6,000) and subject to an income test; abolished by the Hawke Government
in 1990; and then re-introduced as the First Home Owners Grant (FHOG)
by the Howard Government in 2000, without any income test or upper limit
on the purchase price of homes acquired, ostensibly as ‘compensation’
for the introduction of the GST (even though the GST only applied to the
purchase of new homes, and not to existing dwellings which the majority
of first-time buyers purchase). In this guise it was really just the
first of what became an explosion in ‘status-based welfare’ payments to
selected groups irrespective of needs during that decade. On two
occasions since 2000, the FHOG has been temporarily increased in
response to an actual or feared slump in housing activity (and in 2008,
in response to a feared decline in house prices).
Over the past decade, most State and Territory Governments have
‘topped up’ the basic FHOG payments to first-time buyers with grants
from their own resources, with some States providing even larger grants
to buyers meeting certain additional criteria (for example, the
Victorian Government provided an additional $5,000 for buyers of new
homes in rural and regional areas).
I estimate that the Commonwealth, State and Territory Governments
spent a total of $22.5bn (in 2010-11 dollar values) on cash grants to
first home buyers between 1964 and 2011.
Chart 6: Explosion in status based welfare
State and Territory Government also provide indirect financial
assistance to first-time buyers by partially or totally exempting them
from the stamp duty they would otherwise pay on their purchases. In
2011-12 alone, these were worth around $3bn.
Chart 7: Spending on cash assistance to first home buyers, 1964-65 to 2011-12
Governments have thus been providing cash handouts to first-time
home-buyers for almost half a century. Yet, as I mentioned earlier, the
overall home ownership rate has never been higher than it was at the
1961 Census, immediately before governments started going down this
path; and among the age groups which are supposedly most intended to
benefit from these handouts, home ownership rates have declined almost
vertiginously over the past two decades.
And it’s pretty obvious why. Cash grants and other forms of
assistance to first-time home buyers have served simply to exacerbate
the already substantial imbalance between the underlying demand for
housing and the supply of it.
In those circumstances, cash handouts for first home buyers have
simply added to upward pressure on housing prices, enriching vendors
(and making those who already housing feel richer) whilst doing
precisely nothing to assist young people (or anybody else) into home
ownership. For that reason, I often think that these grants should be
called ‘Existing Home Vendors’ Grants’ – because that’s where the money
ends up – rather than First Home Owners’ Grants.
Encouragingly, perhaps – after what in my case has been more than 30
years of putting this kind of argument – State and Territory Governments
appear at last to have gotten this message. Over the past 18 months or
so, every State and Territory Government has either abolished or at
least substantially reduced grants to first home buyers who buy existing
dwellings, whilst increasing their grants to those who buy new ones,
with a net effect of reducing the total spend on assistance to first
home buyers.
I have no doubt that some of the increased grants to first time
buyers of new homes will end up boosting developers’ or builders’
profits: but I accept that at least some of it will induce a supply side
response to any resulting increase in demand for new homes, while
considerably fewer taxpayers’ dollars will be wasted inflating the
prices of existing homes.
‘Negative gearing’
Another long-standing policy which I have long argued has not only
failed to deliver on its oft-stated rationale of boosting the supply of
housing – in this case for rent – but has actually exacerbated the
mis-match between the demand for and the supply of housing, as well as
having distorted the allocation of capital, and undermined the equity
and integrity of the income tax system, is so-called ‘negative gearing’.
It is perhaps a telling indication of just how generous Australia’s
tax system is to investors in this regard, compared with those of other
countries, that one usually needs to explain to foreigners what the term
‘negative gearing’ actually means (see for example RBA 2003: 4045).
‘Negative gearing’ originally allowed taxpayers in effect to defer
tax on their wage and salary income (until they sold the property or
shares which they had acquired with borrowed money, on which they were
paying more in interest than they received by way of dividends or rent).
However, after the Howard Government’s 1999 decision to tax capital
gains at half the rate applicable to other income (instead of taxing
inflation-adjusted capital gains at a taxpayer’s full marginal rate),
‘negative gearing’ became a vehicle for permanently reducing, as well as
deferring, personal tax liabilities. And the availability of
depreciation on buildings adds to the way in which ‘negative gearing’
converts ordinary income taxable at full rates into capital gains
taxable at half rates.
Chart 8: ‘Negative gearing’, 1993-94 to 2010-11
It’s therefore hardly surprising that ‘negative gearing’ has become
much more widespread over the past decade, and much more costly in terms
of the revenue thereby foregone (see Chart 6 above).
In 1998-99, when capital gains were last taxed at the same rate as
other types of income (less an allowance for inflation), Australia had
1.3 million tax-paying landlords who in total made a taxable profit of
almost $700mn. By 2010-11, the latest year for which statistics are
presently available, the number of tax-paying landlords had risen to
over 1.8mn (or 14% of the total number of individual taxpayers), but
they collectively lost more than $7.8bn, largely because the amount they
paid out in interest rose more than fourfold (from just over $5bn to
almost $23bn over this period), while the amount they collected in rent
‘only’ slightly less than trebled (from $11bn to $30bn), as did other
(non-interest) expenses.
If all of the 1.2mn landlords who in total reported net losses in
2010-11 were in the 38% income tax bracket, their ability to offset
those losses against their other taxable income would have cost over
$5bn in revenue foregone; to the extent that some of them are in the top
tax bracket then the revenue loss is obviously higher.
This is a pretty large subsidy from people who are working and saving
to people who are borrowing and speculating (since those landlords who
are making ‘running losses’ on their property investments expect to more
than make up those losses through capital gains when they eventually
sell them).
And it’s hard to think of any worthwhile public policy purpose which
is served by it. It certainly does nothing to increase the supply of
housing, since the vast majority of landlords buy established
properties: 92% of all borrowing by residential property investors over
the past decade has been for the purchase of established dwellings, as
against about 72% of all borrowing by owner-occupiers.
Precisely for that reason, the availability of ‘negative gearing’
contributes to upward pressure on the prices of established dwellings,
and thus diminishes housing affordability for would-be home buyers.
Supporters of ‘negative gearing’ argue that its abolition would lead
to a ‘landlord’s strike’, driving up rents and exacerbating the existing
shortage of affordable rental housing. They repeatedly point to what
they allege happened when the Hawke Government abolished negative
gearing (only for property investment) in 1986 – that it ‘led’ (so they
say) to a surge in rents, which prompted the reintroduction of ‘negative
gearing’ in 1988.
This assertion is actually not true. If the abolition of ‘negative
gearing’ had led to a ‘landlord’s strike’, as proponents of ‘negative
gearing’ repeatedly assert, then rents should have risen everywhere
(since ‘negative gearing’ had been available everywhere). In fact, rents
(as measured in the consumer price index) only rose rapidly (at
double-digit rates) in Sydney and Perth – and that was because in those
two cities, rental vacancy rates were unusually low (in Sydney’s case,
barely above 1%) before negative gearing was abolished. In other State
capitals (where vacancy rates were higher), growth in rentals was either
unchanged or, in Melbourne, actually slowed (see Chart 7).
Chart 9: Rents and vacancy rates in the mid-1980s
However, notwithstanding this history, suppose that a large number of
landlords were to respond to the abolition of ‘negative gearing’ by
selling their properties. That would push down the prices of investment
properties, making them more affordable to would-be home buyers,
allowing more of them to become home-owners, and thereby reducing the
demand for rental properties in almost exactly the same proportion as
the reduction in the supply of them. It’s actually quite difficult to
think of anything that would do more to improve affordability conditions
for would-be homebuyers than the abolition of ‘negative gearing’.
There’s no evidence to support the assertion made by proponents of
the continued existence of ‘negative gearing’ that it results in more
rental housing being available than would be the case were it to be
abolished (even though the Henry Review appears to have swallowed this
assertion).
Most other ‘advanced’ economies don’t have ‘negative gearing’: yet
most other countries have higher rental vacancy rates than Australia
does.
Chart 10: Rental vacancy rates in Australia and the United States
In the United States, which hasn’t allow ‘negative gearing’ since the
mid-1980s, the rental vacancy rate has in the last 50 years only once
been below 5% (and that was in the March quarter of 1979); in the ten
years prior to the onset of the most recent recession, it has averaged
9.1% (see Chart 8 above).
Yet here in Australia, which does allow ‘negative gearing’, the
rental vacancy rate has never (at least in the last 30 years) been above
5%, and in the period since ‘negative gearing’ became more attractive
(as a result of the halving of the capital gains tax rate) has fallen
from over 3% to less than 2%.
During that same period, rents rose at rate 0.8 percentage points per
annum faster than the CPI as a whole; whereas over the preceding
decade, rents rose at exactly the same rate as the CPI.
Similarly, countries which have never had ‘negative gearing’ – such
as Germany, France, the Netherlands, the Nordic countries and (low-tax)
Switzerland – have much larger private rental markets than Australia.
Some supporters of negative gearing also argue that since businesses
can deduct all of the operating expenses they incur (including interest)
against their profits in order to determine their taxable income, and
can also ‘carry forward’ net losses incurred in any given year against
profits earned in subsequent years so as to reduce the tax otherwise
payable, it is only ‘fair and reasonable’ that investors should be able
to do the same.
There are two flaws in this argument, in my view. First, a large part
of the appeal of ‘negative gearing’ comes from the way in which it
allows income which would otherwise have been taxed at the investor’s
marginal rate effectively to be converted into capital gains, which are
taxed at half the investor’s marginal rate. Businesses – if they are
incorporated, as most businesses these days are – can’t do that.
Companies aren’t eligible for the 50% discount on tax payable on gains
on assets held for more than one year.
Second, while individuals are allowed to deduct expenses incurred in
connection with producing investment income from their taxable income,
they aren’t allowed to deduct many types of expenses incurred in
producing wage and salary income.
To take an obvious example, wage and salary earners aren’t allowed to
deduct the cost of travelling to and from work; nor are they allowed to
deduct child care expenses.
Or, to take another example which may be an even closer analogy with
‘negative gearing’ for investment purposes, individuals aren’t allowed
to deduct interest on borrowings undertaken to finance their own
education as a tax deduction, even though that additional education may
contribute materially to enhancing their future earnings – and even
though any such additional future earnings will be taxed at that
individual’s full marginal rate, as opposed to half that rate in the
case of capital gains on an investment asset.
Let me be clear that I’m not advocating that ‘negative gearing’ be
abolished for property investments only, as happened between 1986 and
1988. That would be unfair to property investors.
Personally, I think ‘negative gearing’ should be abolished for all
investors, so that interest expenses would only be deductible in any
given year up to the amount of investment income earned in that year,
with any excess ‘carried forward’ against the ultimate capital gains tax
liability, rather than being used to reduce the tax payable on wage and
salary or other income (as is the case in the United States and most
other ‘advanced’ economies).
But I’d settle for the recommendation of the Henry Review (2009,
Volume 1: 72-75), which was that only 40% of interest (and other
expenses) associated with investments be allowed as a deduction, and
that capital gains (and other forms of investment income, including
interest on deposits) be taxed at 60% (rather than 50% as at present) of
the rates applicable to the same amounts of wage and salary income.
This recommendation would not amount to the abolition of ‘negative
gearing’; it would just make it less generous than it is at the moment.
It would be likely, as the Henry Review suggested, ‘to change investor
demand toward housing with higher rental yields and longer investment
horizons [and] may result in a more stable housing market, as the
current incentive for investors to chase large capital gains in housing
would be reduced’.
I could even accept the Henry Review’s recommendation that “these
reforms should only be adopted following reforms to the supply of
housing and reforms to housing assistance’ which it makes elsewhere,
even though I disagree with the Henry Review’s concern that these
reforms ‘may in the short term reduce residential property investment’.
I could also accept, grudgingly, that any of these changes could be
‘grandfathered’, in order to minimize opposition from those who already
have negatively geared investments, and who would understandably see the
modification or removal of ‘negative gearing’ without such a provision
as directly disadvantageous to them.
However, the alacrity with which both major political parties moved
to distance themselves from even these modest proposals in the Henry
Review when it finally saw the light of day a few days before the 2009
Budget doesn’t provide much grounds for hope in that regard.
What could be done instead?
I’ve argued that two of the principal long-standing government
interventions in the housing market – cash assistance to first-time home
buyers and ‘negative gearing’ – have not only failed to achieve their
stated objectives, but have actually exacerbated the difficulties facing
those whom these interventions are supposed to assist:
-
they have served to inflate the demand for housing – and in particular,
the demand for already-existing housing – whilst doing next to nothing
to increase the supply of housing.
-
they have therefore made housing affordability worse, not better.
-
and to the extent that the ownership of residential real estate is
concentrated among higher income groups – 36% of all property owned by
individuals, and 47% of all property other than owner-occupied
dwellings, is owned by households in the top 20% of the income
distribution (ABS 2013c) – they exacerbate inequities in the
distribution of income and wealth.
In passing, it is perhaps worth wondering why successive governments
of various political persuasions have been so unwilling to alter
policies which have not merely failed so abjectly to meet their stated
objectives, but have demonstrably had such an adverse impact on those
whom successive governments repeatedly assert they are keen to assist.
At the risk of appearing cynical – not that, in my experience, being
cynical about the motivations of political parties and governments
carries a serious risk of leading one into making erroneous predictions
about what they might be– I think the answer is obvious. While political
parties and governments profess to care about first home buyers, the
reality is that in a typical year fewer than 100,000 people succeed in
attaining home ownership for the first time; whereas there are some 5.8
million households (and over 8 million people) who already own at least
one property. Hence there are 100,000 votes for policies which might
result in lower house prices, and over 8 million votes against policies
which might result in lower house prices (or in favour of policies which
result in higher house prices). As the Americans say: ‘do the math’.
John Howard – who could ‘do the math’ better than most – often used
to say that no-one ever came up to him complaining about the increase in
the value of their home, or asking him to do things that would reduce
the value of their homes so that younger people could buy them more
readily.
Nonetheless, if by some chance a political party really did want to
advocate and implement policies that really would stand some chance of
improving the capacity of the Australian housing system to respond to
the needs and aspirations of Australian citizens, what might they say?
The fundamental change that such a set of policies might embody would
be a switch from policies which inflate the demand for housing to
policies which boost the supply of housing. Such a suite of policies
might include some or all of the following:
-
first, the abolition of all existing policies which serve only to
increase the prices of existing dwellings, such as cash grants to and
stamp duty exemptions for first time buyers, and ‘negative gearing’ for
investors (in all assets, not just property, and if politically
necessary, only for assets acquired after the date on which such a
policy was announced);
- second, the redirection of the funds thereby saved (and/or the
additional revenue raised) towards programs that increase the supply of
housing – for example, by directly funding the construction of new
dwellings (as the Rudd Government did as part of its response to the
global financial crisis), or by providing some combination of grants,
loans or tax incentives to induce private sector developers to increase
the proportion of ‘affordable’ dwellings within their developments,
whether for sale or rental;
- third, expanding or replicating programs like Western
Australia’s ‘Keystart’ scheme which assist eligible people to become
home owners on a ‘shared equity’ basis, with eligibility being subject
to a means test, and which creates a ‘revolving fund’ as the ‘shared
equity’ is returned to the State Government upon sale;
- fourth, changes to the way in which State and Territory Governments
tax holdings of and transactions in land, with a view to encouraging
more efficient use of it. That would include replacing stamp duty on
land transfers (which are ‘bad’ taxes on many grounds, including that
they discourage people from changing their dwellings as their needs
change) with more broadly-based land taxes (ie, no exemptions for
owner-occupiers, but with appropriate transitional provisions) and
possibly higher rates for undeveloped vacant land in established urban
areas;
- fifth, taking a more ‘holistic’ view of urban infrastructure
investment, by recognizing that it has an important housing dimension –
that is, that public (or private) investment in transport infrastructure
(both public transport and roads) can make a tangible contribution
towards improving housing supply and affordability by making
‘greenfields’ developments more accessible to both buyers and renters –
and considering funding such infrastructure by levies on the increments
to the value of the land which result from such investments (as for
example with the levy that funded the Melbourne Underground Rail Loop
Authority in the 1970s and early 1980s);
-
sixth, revisiting current models for financing the provision of
infrastructure and services in ‘greenfields’ housing estates with a view
to reducing the extent to which these are funded by ‘upfront’ charges
(something which could be assisted by changes to the land tax regime
which I mentioned a moment ago); and
-
seventh, reducing the cost, complexity and regulatory uncertainty
associated with ‘brownfields’ and ‘infill’ developments in established
areas – which doesn’t have to mean traducing the property rights of
other property owners, but which should mean clearer and more uniform
planning rules, with fewer opportunities for frivolous or vexatious
objections and appeals.
Note that I am not advocating something that is often widely assumed
to find favour with economists – namely, the removal of the exemption of
owner-occupied housing from capital gains tax. I don’t favour that,
because consistency with other parts of the tax system would require
that mortgage interest payments be deductible. That would in turn almost
certainly encourage people to take on more debt, and would thus inflate
the demand for housing, putting further upward pressure on prices. And
it could well end up being revenue negative.
Sadly, however, the political calculus to which I referred earlier
means that there is probably less chance of any of these proposals being
taken up – let alone all of them – than there is of Andrew Demetriou
calling a press conference to announce that Tasmania really should have
its own team in the Australian Football League. Politics – more than any
other single factor – means that Australians are likely to have to live
with a dysfunctional housing system for a long time yet to come.
