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Bold tax treatment of housing needed to end the bubble

Image by Sandy Austin

Watching the political debacle unfolding over housing is as excruciating as watching the Black Caps play test cricket. Tentative steps forward, no application and not daring to do differently characterise both.

Some policies are just too important to leave in the hands of politicians. New Zealand was the first in the world to recognise that this applied to monetary policy, leading the way in creating an independent central bank in 1989. While we may disagree from time to time over the merits of a particular central banker, overall the “experiment” has worked well, as is evidenced by the fact that most countries around the world now have independent central banks.

If in doubt about the ineptitude of politicians with monetary policy, just witness the nonsense MPs have been spouting about prudential lending limits – deploying oxymorons like carving out first-home buyers from the prudential limits applied to banks. Their ignorance is stunning.

The time has come to consider creating an independent tax authority, “under renewable contract” to Parliament. The tax authority would be tasked with achieving revenue targets subject to operating within prescribed limits set by Parliament such as the balance of revenue to be collected between income, wealth and expenditure taxes, goals relating to redistribution from rich to poor, and the parameters of some specific corrective taxes such as those currently on tobacco, booze and fuel.

This is just like the “policy targets” agreement the Reserve Bank has with Parliament.

Beyond that, the authority would be free to design the tax regime that would collect the revenue in the most efficient way. Assuming they chose the right chief, the tax authority would be governed by the widely accepted principles of a good tax system – fairness, efficiency and simplicity.

New Zealand’s current tax system doesn’t stack up as either fair or efficient because it doesn’t tax the full benefits provided by housing and other types of wealth which produce non-cash returns to their owners. The key example here is the rental equivalent of living in your own home – it’s a real benefit to you, just like the interest coming from your term deposit that you also own, but it’s not taxed. Other examples are capital gains on property, shares and other investments.

The result of leaving vast amounts of wealth untaxed is that savings are incentivised to flow into housing in particular, creating huge distortions in the economy. There are a multitude of factors working on house prices in Auckland, but being tax-favoured is a major one.

In 1997 American economist Professor Alan Blinder suggested tax policy should be handed over to an independent tax authority. In building his case Blinder explained why independence was so essential and effective in monetary policy, and drew parallels between monetary and tax policy.

The usual defence of central bank independence is more pragmatic than philosophical: It works, and for three main reasons. First, and least important, monetary policy is a somewhat technical field where trained specialists can probably outperform amateurs from the political realm. Second, the effects of monetary policy take a long time to filter through the economy, so good policy decisions require patience and a long time horizon – two attributes not normally associated with politicians. Third, the pain of fighting inflation (high unemployment for a short while) comes well in advance of the benefits … So short-sighted politicians with their eyes on elections would be tempted to inflate too much …

Blinder then went on to consider whether the same risk factors of technical skill mismatch, political short-sightedness and vested interests plagued tax policy and concluded that they did.

His idea didn’t get much traction at the time, but then the US’s tax system and those of other countries have been more comprehensive than our own. The US has long taxed capital gains on housing, for example, while Europe has had the more sensible practice of taxing wealth directly. The Netherlands taxes the rental equivalent of owner-occupied housing. While New Zealand’s monetary policy system was an inspiration to the rest of the world, our tax system is so inconceivably inappropriate that it summons forth derision, albeit often carefully veiled in policy speak. This example is from a 2011 OECD report titled “Policies to rebalance housing markets in New Zealand”:

“Wealth is concentrated to a greater extent in property compared to most other OECD countries, leaving households and the banking system heavily exposed to a correction in land and housing markets. Supply rigidities and tax incentives that bias savings decisions towards property investment have amplified the increase in house prices, widening wealth inequalities in the form of larger homes for those who can afford them, but deteriorating affordability for the rest of the population. Substantial distortions via tax planning have been evident in rental property markets. Although the 2010-11 budget introduced measures to reduce some of these distortions, further reforms are needed to remove the significant tax bias favouring housing.”

New Zealand has had a housing bubble for over a decade, the fizz went out during the global financial crisis but it is back. Not only is National pretending the world doesn’t know their dirty little secret (“we won’t tax you even though we know we should”) the tax policies the Labour and the Greens propose – capital gains tax with exemptions for owner-occupied housing – are too timid to be our ticket out of this mess. Not a capital gains tax but a wealth tax which includes owner-occupied housing and is integrated with income tax would do a far better job of meeting those tenets of good tax policy.

Alan Blinder made a call to arms we surely, more than any other country, should be listening to. We succeeded in weaning politicians away from monetary policy, now we must turn our eye to tax.