The government will allocate nearly $ 4 billion into a scheme to accelerate the pace of new housing construction, which it hopes will help see “tens of thousands” of new properties built.
Economists like to talk about “optimal policy instruments” – in essence, policies that achieve their objectives more effectively or efficiently than alternatives, and have minimal undesirable consequences.
Judging by these criteria, the package of housing policy instruments recently announced by the New Zealand Government is still far from optimal. You might even call it messy.
How? For those who are uninformed, a key element of the package can solve the housing affordability crisis by doing a number of things:
• removing tax deductions on loan interest for residential property investments
• expand bright line test – the period after the sale of the property attracts capital gains tax (CGT) – from five to 10 years
• support new buildings under this tax change
• introducing a “change of use” rule that effectively makes the family home the responsibility of CGT if it is sold within 10 years and leased for more than one year
• increase incomes and limit housing prices to the Government First House Grants scheme.
However, if we examine the package against the three optimal policy requirements, we can see the problem.
Achieve policy objectives
Economists have a policy “rule” that in order to achieve a variety of policy objectives, you need at least as many policy instruments. Housing packages are a mixture of actions that are interrelated, but have several explicit purposes:
• stabilizes house prices
• facilitate home ownership
• discouraging speculative investments (unclear)
• increased the supply of housing with mostly (unspecified) “affordable housing”
• closing what the Government claims is a housing “tax loophole”.
To this, add an implicit goal of addressing the perceived inequality of income and wealth between tenants, landlords and homeowners.
Overall, it is a daunting task, and it would be great if the housing policy suite could achieve such broad objectives.
Arguably, the main target of this policy package is to stop the inevitable increase in house prices (especially in Auckland). Failure to achieve it will only place it among a long line of efforts by the previous government (National and Labor) for at least the last 20 years.
In all cases, the biggest problem is a lack of political commitment to increasing the housing supply.
All taxes cause “distortions”, mostly unintentional, that need to be reduced. Moreover, policies that have conflicting goals are “incoherent” and are usually among the most deviant. This applies to the elimination of reduced interest from housing packages.
Previously, in New Zealand and nearly every other country, interest on business loans was treated as a legal expense and therefore tax deductible, regardless of the nature of the business.
With a coherent principle that currently doesn’t apply to housing, then what about other types of business loans that the government thinks should be liked or disliked?
No doubt arguments can be made for such a policy, but the result is an ad-hoc tax system that produces many unwanted distortions and harmful incentives.
It could be argued that the “new building” aspect of the housing package received several incentives by directing rental housing investment to increase housing stock.
But given the existing constraints to new housing construction – such as planning regulations and suitable land availability – the policies are likely to have little impact. This will only divert real estate investors from competing with first-time buyers for existing properties to competing with them for new property.
Over time, the inventory of rental housing becomes a mix of homes that meet or do not qualify for tax exemptions. Taking advantage of these new loopholes and various distortions in property prices will likely provide tax accountants with a lot of jobs.
Back door capital gains tax
It is rare to find transaction-based and time-based obligations among the principles of sound taxation policy. But a bright-line test manages both – it prompts postponement of property sales to evade taxes even when the reverse sale would be in the taxpayer’s best interest.
It was originally introduced in 2010 with a two-year threshold, without supporting evidence, that should stop so-called speculators from flipping properties for quick profits. The 10-year threshold cannot be labeled as an anti-speculation policy, it is simply a back door capital gains tax (CGT).
Like most back door policies, this CGT is bound to be less transparent and coherent than policies designed to deal with problems head-on.
Consider the case of a hypothetical Auckland home owner who moved to Sydney to work for two years. It doesn’t make sense to sell a home in Auckland because of high transaction costs and the risk of slipping on the property ladder when trying to buy back later. It is much better to rent in Sydney while also renting a house in Auckland.
But this will now generate a potentially large tax bill on the family home. Indeed, one calculation suggests such a plausible scenario could result in a CGT obligation of nearly one year of salary – only to move into a house for the same price.
Alternative policy instruments
If a better alternative exists, it does not lie in more ad-hoc tinkering with a coherent tax regime.
Conversely, like the famous real estate mantra of “location, location, location”, the mantra for New Zealand’s housing policy must be “supply, supply, supply”. In particular, supply in Auckland.
Successive governments have adopted national policies at a time when rapid house price inflation is almost exclusively urban and is essentially an Auckland phenomenon.
Without policies reforming construction sector regulations and opening up more land for urban housing, it is unlikely that housing prices in Auckland will stabilize while demand-driven trends remain.
Worse, the Government’s first home buyer scheme would only increase demand without incentivizing supply.
With too many goals and possibly many unintended consequences, the Government’s housing policy risks being grossly incoherent.
Norman Gemmell is chair of public finance at Te Herenga Waka – Victoria University of Wellington.