Taming the Auckland property market

The crazy Auckland property market needs reining in. Capital gains tax as a way of controlling house prices doesn't work overseas, but what about a land tax?

Virtually every day there is a new story about the Auckland property market. Mostly intended to scare us that the roof is about to fall in. But there is a serious side to it all. And that is the increasingly difficult challenge for first home buyers to actually afford a home.

Of course there are many reasons why Auckland property is increasing in price. The most important is population pressure. Migrants are more likely to settle in Auckland than anywhere else. There is also a continuing trend of New Zealanders shifting to Auckland for opportunity. That is what larger cities provide. Government initiatives to boost supply have yet to make a big difference. So demand is greater than supply.

The Reserve Bank Governor certainly thinks Auckland house prices are a problem. But he is unlikely to increase interest rates, so he is unable to remove one of the key drivers of price increases

Cheap money will certainly boost house prices when other factors such as shortage of supply are present. In my lifetime mortgage rates have never been lower. While that makes it easier for first home buyers, it makes it easier still for those who have substantial equity. They can borrow and become landlords.

There is plenty of evidence that more people are renting. The number of owner occupied homes continues to fall. That means more people are renting rather than owning their own home.  

So here is a two-fold problem to solve. Get more people into their own homes. And reduce price pressure.

Can tax policy play a part?

The government has already done something in respect of investment properties. It reduced the ability to deduct depreciation. But they have other tax tools. In terms of increasing severity they are, eliminating the deduction for interest, re-introducing land tax (abolished in 1988), and introducing a capital gains tax (CGT). I will focus on the latter two options.

Most other OECD nations have a CGT, including Australia. Based on the evidence from the larger Australian cities a CGT seems to have little or no impact on house prices. This seems to be because it is only ever applicable on an actual sale. Many landlords are long term holders, so a CGT is only an occasional impost. And perhaps that is not enough to affect prices.

In contrast a land tax has the virtue of being an annual tax. That means the government can predict with some precision how much will be paid annually. As part of the tax mix a land tax enables governments to plan their revenue flow.

Historically land tax was imposed on the unimproved value of land. But there is no reason why it could not be charged on capital improvements as well, though that will reduce the rate which could be charged.

What are the other features of a modern land tax? It could apply to all property being used to derive revenue. To avoid excessive land banking, it could also apply to bare subdivision land. There would need to be an exemption for land primarily used for farming. So in practise it would apply to land zoned commercial or industrial. It would also apply to residential rentals. To simplify administration the value would be the current government valuation.

The tax rate has to be sensible, probably around 1% if capital value is the basis of valuation. If unimproved value is used then a rate of more like 3% can be justified. That at least would strike more effectively at land bankers.

Would it work? This question is central; otherwise a land tax becomes just another tax.  The case for a land tax has to be based on its ability to restrain property price increases.

Based on overseas evidence we know that a CGT does not achieve this goal. The proponents for a land tax have to be able to show, either through empirical evidence or theoretical study, that it will have a moderating effect on price increases. Any greater effect than that would show the tax rate is too high. It would stop investors and entrepreneurs from investing in property or buying land for subdivision. That would restrict supply and have the effect of further pushing up prices. And that would be a rather self-defeating outcome.

At the very least the proposition has to be robustly tested. Are there policy analysts in Treasury and the Reserve Bank looking at this option?  If not there should be. And we should be able to see the results of their work.