GUEST BLOG: Gareth Morgan – Weak Analyses Plus Political Bias

By   /   May 16, 2018  /   8 Comments

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The TWG has been set an impossible mission – improve the tax regime, make it more efficient and fair, but don’t recommend any changes to the tax treatment of owner occupied housing. And another – make the tax system fairer but don’t deal with the interface between tax rates and welfare (which is just negative tax after all).

The TWG has been set an impossible mission – improve the tax regime, make it more efficient and fair, but don’t recommend any changes to the tax treatment of owner occupied housing. And another – make the tax system fairer but don’t deal with the interface between tax rates and welfare (which is just negative tax after all).

Due to the contorted nature of its terms of reference, the TWG will fail; its recommendations will be so dependent on what it has been barred from considering as to render any recommendations irrelevant. But given the political nature of its pedigree it’s bound to come up with some silly recommendations nevertheless. Worse, they could even be adopted if the political landscape remains unchanged.

I won’t deal with the nonsensical requirement of excluding the labyrinth of targeted welfare benefits that make a mockery of fairness in the tax regime as that has been outlined elsewhere, but with respect to housing there are two dimensions that need to be analysed separately. Firstly, the dynamic of recent house price inflation that has at its source demand-factors that have been common in several economies around the world and we should not conflate those with the more fundamental distortion to fairness and economic efficiency. This second influence arises from the peculiar interface between the income tax regime and owner occupied property which New Zealand has almost uniquely concocted. It is this latter factor that lies at the heart of the inefficiency and unfair nature of tax, tenancy, ownership and intergenerational equity.

Don’t expect this government to address competently this fundamental issue – simply because it has ruled it out of the Tax Working Groups terms of reference.

The Housing Market Macro Dynamic

Over the last decade or so the house price to income ratio has soared but the ratio of interest costs to real disposable income hasn’t. In other words the rise in (nominal and real) house prices has been in large part driven by the fall in (nominal and real) interest rates, augmented by a global slackening of lending criteria on housing that came from financial market deregulation. New Zealand household debt rose as did our private sector foreign debt (as this is where the banks sourced their funding). In addition New Zealand’s population growth rate lifted from 1-1.5% pa to 1.5-2% pa due to higher net immigration.

The rise has been so large that the ability to accumulate the deposit on a first home has fallen – real house prices are over double what they were before the year 2000

Blaming Land Shortages – An Easy but Incorrect Conclusion from Official Advisers

“Section prices have grown more quickly than house prices over the last 20 years, indicating thatappreciating land prices have been a key driver of house price inflation in New Zealand. This suggests a shortage of residential land in places where people want to live.” NZ Productivity Commission 2012

No it doesn’t suggest that at all. The inference made by the Productivity Commission that land shortage is contributing to house price inflation doesn’t necessarily follow at all. If the underlying drivers of the increasing price of housing are demand-based (and some of these are as the Commission outlines) then it’s inevitable that higher demand will hit the constraint of inelastic supply at some point. But that does not change the conclusion that it is demand which is the primary driver and that supply constraints only arise once demand gets to a sufficiently high level to reveal that supply inelasticity.

One of the real risks with the fallacy of the Productivity Commission’s interpretation (alleging supply is the problem), is that the Commission concludes that if we release more land that will solve the house price inflation issue. Of course it does only to the extent of offering breathing space until the inevitable rise in demand once again pushes against the (new) supply ceiling. In other words such an inference results in recommendations for policy that do not address the underlying primary driver – demand.

It behoves the Commission then to delineate the extent that it sees the primary drivers of real house price rises being demand rather than supply ones. The Commission has failed to do this and worse, it has promoted publicly that land supply is the major constraint. That analytical shortcoming has now led to Tax Working Group Secretariat advising the Tax Working Group that land supply is the primary driver of house price rises –

“..but the existence of substantial constraints on the supply of housing means that tax policy is unlikely to be the dominant driver of high house prices.” – p28 op cit

Error upon error is compounding, all because the analysts have been too cavalier in their analysis. Neither the Productivity Commission nor the TWG Secretariat have produced any evidence whatsoever that supply is the primary driver of the house price rises. Indeed the TWG Secretariat provides itself with a very weak “out clause” to excuse the shortcomings of its work –

“It is very difficult to quantify how much the tax system affects the housing market.” – p28 op cit

Unfortunately because it’s “difficult”, the Secretariat has preferred to conclude that land supply is what matters most – that is just not intellectually acceptable, and would certainly attract a “fail” in any introductory economics exam.

An Alternative Explanation

It’s pretty simple really and has been highlighted by two previous tax working groups that were arguably more independent than the one currently sitting. Both the 2001 McLeod Enquiry and the Tax Working Group of 2010concluded that owner occupied housing confers a tax privilege. Put simply, the owner of a house receives a benefit in terms of the roof over their head each year, and that benefit is not subject to income tax. A tenant who instead owns a bank deposit or a business, pays tax on that benefit (interest or profit) and then pays for the “roof over their head” from tax paid income – which is taxable as well in the hands of the landlord.

This is a massive difference in effective rates of return from the alternative assets, and underpins a permanent and ongoing year-by-year benefit to owner occupiers of property. So long as this persists it makes sense to buy more and more valuable property because the tax wedge rises concomitantly.

And of course to the extent that we all recognise this and clamber to get into home ownership, the demand for property far exceeds any level of demand our accommodation needs alone would imply, and the supply constraints in the market will always be tested.

The primary driver of real property price rises is categorically the factors that drive demand. Supply constraints are a second order issue (including obviously any changes to the RMA).

But of course this government has instructed the Tax Working Group not to look at closing the loophole on owner occupation of property. The TWG is thus compromised from the start; it is subject to a political agenda that seeks to protect the tax privilege of property owners and by inference, discriminate against tenants – most of whom are younger generations.

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8 Comments

  1. Cemetery Jones says:

    This is actually the tax policy which makes the most sense for both ironing out inequality and funding social democratic policy in the current environment. It’s not that ‘taxing the rich’ doesn’t appeal to me; it is simply the case that pursuing it through income tax rather than property tax will continue to miss the real target. The existing and on-going reality of wealth inequality now isn’t in a monthly paycheck. It is under our very feet.

    Diminishing since the 18th century, the old dynamic is returning. ‘The rich’ once more get there and stay there by owning land, the more the better. By choking off the supply of land available for sale, and narrowing the band of developed housing which ever does come up for sale, they ensure continually rising prices – like the grain hoarders of old, who held it back from the market to inflate the price of bread and make their gains in artificial scarcity. Tax the holding of land while winding it back off wages, and you really cut the Gordian Knot of 21st century political economy.

  2. Mjolnir says:

    I doubt either Labour or National want housing prices to drop. The propertied middle class vote, and most vote ferociously based on their perception of personal wealth. And devil take the hindmost. (How else to explain National’s continuing high rating in political polls?)

    It’s a shame TOP didn’t get at least one mp in Parliament. It would make a refreshing change from the usual narrative.

    • Michelle says:

      The problem with many of the middle class in NZ (and I don’t like to use the word class its not a NZ thing) they need to remember how they got to where they are. Also the majority of settlers that came here from the UK were mostly lower class fleeing the UK and they came from places like Scotland and Ireland. Yes many will say they worked hard but they need to remember they had some help (from our past governments and their policies) to get where they are today. Now we are living in completely different times and this group continue to put the boot into many others. (namely the current poor) when really they should shut the f…k up.

  3. Andrea says:

    “And of course to the extent that we all recognise this and clamber to get into home ownership, the demand for property far exceeds any level of demand our accommodation needs alone would imply, and the supply constraints in the market will always be tested.”

    It feels that two things have been wodged together that shouldn’t be.

    Basic reasons for clambering – if you’re going to be spending large dollops of money each payday then it makes more sense to end up with something that isn’t going to be lost at the whim of someone else. If you play fair with the bank – mostly they’ll be sort of fair back.

    At this point a tenant can’t onsell the tenancy to another person – or swap with another person to improve their commuting time or for some other valid reason.

    There is no mention of the peculiar lure of Auckland, or any of the other ‘magnet cities’ where there is a diversity of work and the chances of high pay are much greater than out in the sticks.

    Some people want to speculate in real estate, and a smaller set may actually be good at it – or have access to people who know how to play this. For the moment – most people don’t know how to play this brand of Monopoly, and many have no interest in doing so. Why do they need to pay for the sport of speculators?

    It’s not ‘land shortage’ per se – it’s ‘land shortage in those delicious magnetic cities’. Or those within commuting distance.

    This concept needs more time on the drawing boards of a spread of disciplines. Just not politicians.

  4. Zack Brando says:

    If/when rents double in NZ there will probably be a housing crash.

  5. Michal says:

    Of course the TWG will fail. One only has to look at the composition of the panel. There is only one person on the side of the poor and wage earners, the rest know all the loops in tax law as that is what most them advise their clients on. It is disgraceful and especially because it is not looking at personal rates. The personal tax rate for the highest earners is considerably lower than the countries that we often compare ourselves with, Australia, Britain and the USA. We need a wealth tax, death duties, capital gains tax and others.

    • Cemetery Jones says:

      Capital gains tax is totally flawed. It only kicks in when the owners of multiple properties sell them, which makes them less motivated to sell them and instead to pass them on to their descendants. If you do as Morgan advocates here and tax the *holding* of property rather than the *selling* of property, and then dial it back on sources of income derived from actual economic activity then you do actually motivate them to sell the property off and make their money elsewhere. And when a large group of people dump their property in the space of just a few years, prices drop.

      Death duties are bs though. The state has no right to get anything out of someone’s death. I’d rather see the state tax more efficiently and simply than deal people a thousand cuts. Only lawyers tend to benefit from labrythine systems. It also locks in inequality, as the more complex systems of taxation or compliance are, the harder it is for someone working class and/or non-tertiary educated to get into business, self employment, etc.

  6. SPC says:

    Taxing equity in property (regardless of income) and then paying a universal income to those in high paid jobs – yeah that makes sense – not.

    For one it fails to take account of those/the money who will move their property ownership into the retirement village model form when they leave employment.

    There are others ways of going about this.

    1. Stop paying super to those still working (they own homes, are empty nesters and do not need the money).
    2. Apply CGT on owner occupied homes on property over a certain value (quite common overseas), making it a form of wealth tax (and discouraging accumulation of wealth in non productuve assets) when the gain is realised.
    3. A land tax on land in areas zoned for residential property without housing and or in regular use property (ghost homes and air b n b’s).
    4. A wealth tax – including equity in the residential home. OK I do not mind this if at a lowish rate and including other forms of wealth (such as rental property/holiday homes/shares etc also subject to CGT on sale).

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