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Rising rents – another symptom of tax break on housing

Stories of the impending rental crisis in Wellington have reached fever pitch in recent weeks. A perfect storm of mismatched supply and demand, short-sighted Government policy ( such as the tertiary policy driving more students into the city), and the overarching inability to fix our tax system has led to a situation where rents are predicted to rise around 20% relative to this time last year.

We can finger point and lament poor Government policy (past and present) all we like, unfortunately this will not help us drag our property prices (and along with those, rents) back to affordable levels. Yes, the new Government is barely dipping its toes into their first term, but they have already thrown away their biggest asset in achieving housing affordability having hamstrung their tax working group with a long list of terms that makes any real improvements hard to envisage. 

The reality is these continued price hikes are felt most acutely by the poorest in our society and continue to widen the ever-growing inequality that we have. We already have a situation where more New Zealanders than ever are spending over 30% of their income on housing (the percent that is considered the threshold at which housing is considered as being ‘unaffordable’), and as far as we can tell, things are only getting worse.  

What are we doing about it? 

Some of the policy changes that we have seen, in an isolated sense and to varying degrees do alleviate some pressures. Building more houses will help, and even bright line tests ensure that at least some of the financial gains from housing speculation are taxed. The problem is that most are incremental fixes and are focused on the symptoms rather than the cause of the long-term housing disequilibrium (we have written about here).

So, what is the answer?

Under our tax system, owner-occupiers of houses do not pay a cent on the effective income they earn each and every year. Yet those working the 9-5, the double shift, or two different jobs, just to make ends meet, pay by far the highest portion of their income to tax. And, once that money is in the bank, they are taxed on the interest gain too. Meanwhile, those who have their wealth in property pay next to nothing and as a result get to enjoy semi-permanent tax-free capital gains because of that tax loophole! The average New Zealand house rose in value $48,142 in 2016. If that was earned through wages, they would be required to pay around $10,000 in tax. Teachers, doctors, lawyers, checkout operators, none can escape being skimmed by the swipe of the tax brush, yet property owner-occupiers are exempt. The worst part is that investing in housing is actually costing our society income – in the form of a crippling drag on productivity that such low-returning investment engenders.

By closing these loopholes in our tax system and making owners of assets (not just those with owner-occupied housing, but all owners of capital assets that continually declare lower than market income) pay their fair share we can lift the tax burden from wage earners. This will allow us to reduce every single New Zealander’s income tax rates by around one third. For the average Kiwi, this works out to be around $3,000 a year in your back pocket. Not only is this great for the vast majority of us, it also means house prices should steady and become more affordable as there is no longer any incentive to bid the prices up against one another – as we scramble to enjoy the tax advantage of ownership. Meanwhile, all that money that was once stored in housing gets funneled back into the productive economy, helping kick start our stagnant wages and productivity levels.

It’s human nature to dislike change, but often the greater evil is to do nothing. Yes, we should build more houses, yes, we need better rental standards, all these things help. But, unless we address the crux of the issue that is a tax loophole, expect little to change.

 

Andrew Courtney

[email protected]

Showing 39 reactions

  • John Robson
    commented 2018-01-27 13:27:55 +1300
    Hi Michael,

    In reply to your previous two posts (part 2):

    Tax rates:

    Tax rates are not set arbitrarily – they are driven by a number of factors – and constrained by a number of factors. You don’t need to go to a library – Google can list them for you. The issue of the rate proposed by Gareth (or the Morgan Foundation or TOP) is that the #1 policy rate underpins the promise of 30%+ tax cuts, and is claimed to address both national housing and productivity issues. If the numbers don’t ‘add up’ then it is unlikely that the ‘promises’ can be kept. And if the rate is ‘wrong’, (or the model is flawed), there are likely to be unintended, and possibly, perverse, consequences.

    Local Government rates:

    You pose the question, “…if rates are a tax, as you seem to be implying, why can we not deduct ongoing expenses…”. My short answer is that local government rates are not an income tax, they are an asset (either land, or land and improvements) tax. Further, I am not ‘implying’ anything, I am stating it as a fact. My position that rates are a tax is supported by organisations as diverse as the OECD and the Auckland City Council.

    A pro-tem summary:

    Michael, we have covered a range of topics. To summarise my position, I want taxation to be equitable and of a sufficient level to effectively fund a fair society. I want all income taxed equally (regardless of source), and I favour, due to my personal philosophy, progressive taxation. I think some countries are doing a better job than we are here, and I advocate benchmarking NZ’s system against other countries systems. My position is not one of envy, but one of privilege – I have enough advantages already (I retired last century at age 41) without having the tax system heavily tilted in my favour.

    That being said, I have little time for politicians (and prospective politicians) who while parroting my concerns, propose simplistic, silver-bullet solutions with little or no evidence to support their proposals, and who resort to ad-hominem attacks when any engagement becomes too challenging.
  • John Robson
    commented 2018-01-27 13:26:53 +1300
    Hi Michael,

    In reply to your previous two posts (part 1):

    Taxing land:

    I support the idea of a land tax. But land is already taxed in New Zealand (at a local government level), and the annual discussion of ‘rates’ suggests that land taxes are not without issues – not least being asset valuation and the taxation rate. Unfortunately, land taxation in New Zealand is not progressive, nor is capital gain effectively taxed. Because land taxation does not automatically tax capital gain “as you go” as you assert, This would only be the case if the tax rate for the land tax is the same as the tax rate for income.

    CGT (i):

    You are aware (I hope) that capital gain on residential property is, in fact, and in law, currently taxable, as income, in New Zealand. Further evidence that capital gain is income. The ‘twist’ in New Zealand is that the tax is dependent on the ‘intent’ of the investor. If they invested for the purpose of making a capital gain, then that gain is taxable. If they did not have that intent, then the gain isn’t taxable. Not surprisingly, when asked, no (amoral) rational investor admits to investing for the purpose of capital gain. But of course, some/many/most are lying through their teeth. One of the reasons behind the so-called ‘Bright-Line Test’ is the duplicity became so egregious that our legislators recognised that something needed to be done.

    Realised vs unrealised gain:

    Although I don’t accept that land taxes automatically tax capital gain (see first para.), I feel that implicit in your supporting arguments is the idea of taxing an asset that does not generate cashflow. If you are comfortable with that in principle, then that is one less objection to taxing capital gain.

    TWG ToR:
    I agree with Andrew’s point that the Terms of Reference for the Tax Working Group effectively undermines any chance that the TWG can effectively deliver on one of the key elements of their overarching objective – fairness. Indeed, I am currently drafting a submission to the TWG on the issue of the ToR that makes exactly that point.

    CGT (ii):

    Whether the banking community supports (or doesn’t support) a CGT is of little import to me. My analyses of taxation systems, like my analyses of investments, are done on the basis of fundamentals within a framework of principles – and tested against theoretical and empirical evidence. Someone else’s position per se is irrelevant, although their arguments are almost always of interest.
  • Michael Roberts
    commented 2018-01-26 11:12:03 +1300
    Hi John

    From Andrew’s article:
    “We can finger point and lament poor Government policy (past and present) all we like, unfortunately this will not help us drag our property prices (and along with those, rents) back to affordable levels. Yes, the new Government is barely dipping its toes into their first term, but they have already thrown away their biggest asset in achieving housing affordability having hamstrung their tax working group with a long list of terms that makes any real improvements hard to envisage.”

    Surely the fact that the banking community favours a capital gains tax, if there has to be a tax on property at all, must give you pause. Clearly the banks favour CGT because it will not affect interest rates or do anything to interrupt the ponzi scheme that property investment has become.

    The question of how one determines the rate to be applied in the case of an imputed rent tax is a red herring. How does one determine the rate of any tax? Why 15% in the case of a CGT for example? Why not 10% or 15%? And if rates are a tax, as you seem to be implying, why can we not deduct ongoing expenses such as insurance and interest from our rates demands?
    The point is that levies such as rates, land tax, GGT, and imputed rent tax, need to be estimated; and in the case of the latter the estimate will need to take into account the fact that the householder has ongoing expenses. I’m inclined to think that the same rate should be applied as to landlords as to own-your-owners, and that ongoing expenses such as rates and insurance should not be deductible in their case. Of course a tax on land only would avoid these sorts of problems; which is why I favour a land tax over Gareth’s imputed rent tax.
  • John Robson
    commented 2018-01-26 09:38:17 +1300
    Hi Ben,

    No confusion – I was discussing the non-taxation of imputed income (the clue is in the heading). This has been specifically identified by TOP as a driver of house prices as the income ‘received’ by owner-occupiers is not taxed. My argument is that it could be taxed (based on some nominal minimum return), but then the expenses relating to it should be tax deductible – as they are for an investor. My key point was that the principle of horizontal equity requires that both investors and owner-occupiers are treated the same. And it follows that these deductions would reduce the level of taxable income significantly – which would negate the possibility of raising sufficient revenue to reduce income tax by 30+%.

    Or we could just remove the tax deductibility of expenses for property investors!

    On one specific point you make in your first paragraph: When you say that “a business can claim expenses to reduce their taxable income – where an individual cannot”, you are incorrect. Whether the taxable entity is a business or an individual (or some other legal construct… e.g. a trust), costs incurred in generating an income are, in principle, deductible. Of course, contrary to popular belief, NZ has a complex tax system (ironically, not least because of the failure to tax capital gain) and there are exceptions to this principle – but the principle applies in most cases.

    On the (different) topic of a capital tax (or asset tax), I make the following observations:
    1. In relation to ‘real’ property, NZ already has a capital tax – it is used to fund a significant proportion of local government expenditure.
    2. The use of a capital tax (as a surrogate to effectively tax the owner-occupier’s imputed income) fails to address the horizontal equity issue mentioned above.
    3. Setting the deemed rate will be entertaining to say the least – in the Big Kahuna, a 6% rate was assumed (this rate coming from the TWG discussions), a few years later TOP suggests 5%… but it is not that simple. For some insight into this issue, and wider issues with TOP’s policy #1, try: https://croakingcassandra.com/2016/12/16/gareth-morgans-tax-policy/
    4. And determining the asset classes and values will be even more interesting. The devil, as ever, is in the detail – and Gareth refuses (ironically, against best practice) to release any details of the modelling that underpins the TOP #1 policy.

    Ben, I would ask you to engage your critical faculties – not in a reflexive, rebellious teenager, way – but rather in a reflective, rational, adult way. Gareth claims that he has a single, silver-bullet, tax-based solution that will address both ‘the’ housing issue, and, ‘the’ productivity issue.

    Yet not one country on planet Earth has identified – and implemented such a solution. Does this not give you pause?
  • Michael Roberts
    commented 2018-01-23 23:54:17 +1300
    Hi John
    I’m fairly sure that Gareth’s 6% in The Big Kahuna is a net figure, so homeowners’ are already receiving a theoretical deduction for outgoings.

    As for the Treasury paper you mention, I think they are talking about “realised” capital gain rather than capital gain itself. However capital gain is an addition to capital, and I do not think that swapping the asset in question for cash really changes that; so a CGT is actually a tax on capital rather than a tax on income. There is nothing wrong with taxing capital of course, but there are better ways of doing this. A land tax for example would tax capital gain “as you go” since it would be based on the value of the land from time to time. It would also be collectible even if the asset is never sold. A land tax also reduces an owner’s capacity to pay interest and, as bankers base the amounts of money they are willing to lend on the amount of interest they can expect to receive, a land tax would be likely to reduce house prices.

    The left seem to be obsessed with the idea that receiving untaxed gain from the increased asset values is somehow “unfair” (despite that fact that the more blatant examples will be caught by the bright line test). They need to ask themselves whether the effect a tax has on the housing market is in fact a more important consideration. Experience in Britain and Australia seem to indicate that CGTs have little effect on that market.

    Incidentally, I did not say that I could not produce support for my views, just that I could not do so “off the top of my head”. I would have to pay another visit to the local library, just as I did a couple of years ago.
  • Ben Wylie-van Eerd
    commented 2018-01-23 17:40:20 +1300
    John, I think you may be confusing the capital tax with an income tax. A business can claim expenses to reduce their taxable income, where an individual cannot, this is true. But expenses cannot be claimed against the tax to pay on capital in TOP#1.

    Both the individual and the investor would pay the same amount assuming their equity was the same; The owned-occupier would generate no taxable income from their property, and so pay the full amount of the capital tax. The investor would generate rental income from their property, and pay tax on that income. Any tax on the income generated by the house can be credited against the property tax to pay on that house, so the investor would pay less property tax, but more income tax. Does that make sense?
  • John Robson
    commented 2018-01-23 15:35:44 +1300
    Hi Michael,

    Thanks for the response… my reply follows:

    Non-taxation of imputed income:

    To be clear, I am in favour of taxing imputed income. But, I also support the principle of horizontal equity. The TOP #1 policy treats the owner-occupier very differently to the ‘investor’ in terms of the taxation of their income. The key difference being that costs are deductible for the latter but not for the former. In effect, TOP proposes taxing the owner-occupier’s gross income. Combined with TOP’s refusal to tax capital gain, the effect would be to further discourage home ownership, encourage property investment – and provide an increased incentive to game the tax system. This might be the reason there are no countries on planet Earth that have implemented a TOP #1 policy.

    Non-taxation of capital gain:

    Again, to be clear, I am in favour of taxing capital gain. I reject your assertion that my argument is a non-sequitur. Both imputed income and capital gain are ‘non-cash’ forms of income. This is one thing on which I’m reasonably confident Gareth and I would agree. It follows that I am not surprised that you cannot easily reference experts to support your assertion that capital gain is not income. Whereas, I can easily find expert confirmation of my position. One obvious source is the previous TWG – and the following paper:
    https://www.victoria.ac.nz/sacl/centres-and-institutes/cagtr/twg/publications/3-taxation-of-capital-gains-ird_treasury.pdf

    Low productivity “investments’:

    I went to four public meetings where Gareth talked of taxing assets (not just residential housing) using an imputed income model. The logic being that if you tax my bigger (than ‘economically’ optimal) house, then I just might buy a boat, or a bigger car, or an additional car, or… I’m sure you get the picture. My point is, ceteris paribus, under a fair tax system, what you spend your post-tax income is your choice. And the component of that spend that fails to produce an (acceptable to Gareth?) economic return is effectively ‘consumption’. No different to any other spend that does not produce an “economic’ return.

    Michael, the issues with the taxation of both imputed income and capital gains are similar and relate to the practicalities of calculation and cashflow. But these are not insurmountable, and we can look to other comparable countries for models. I accept that neither provides a silver-bullet solution for issues such as productivity or housing costs, but that is not a rational basis for their rejection. Both have a role in the creation of an equitable tax system – and the creation of a fairer (and ‘better’) New Zealand.
  • Michael Roberts
    commented 2018-01-22 12:41:10 +1300
    Hi John
    I would like to take issue with the three points mentioned in your comment.

    First – non taxation of imputed income
    The impression, though I could be wrong,?? I have from reading The Big Kahuna was that the 6% figure Morgan suggested for imputed income was a net figure after deducting outgoings such as insurance and rates – but not interest. Morgan deals with interest by basing his imputed rent on the homeowner’s equity rather than the total value of the property, though I think I would ignore interest altogether on the grounds that it does not relate to the actual benefit from living in one’s own home. It is more a cost of acquiring capital.

    Second – non taxation of capital gain
    The contention that, if you can tax imputed income you can tax capital gain seems a non sequitur. Expert opinion seems to regard capital gain as not constituting income. (I did some research on this point at Wellington Public Library a few years ago, though I cannot at this point quote references of the top of my head.) The main reason seems to be that capital gain is not severable from the asset – you cannot remove a chunk of property and spend it.

    Third – low productivity “investments”
    I do not think you can redefine assets in that way simply as a matter of personal convenience, though I think it would be up to the IRD to show that the asset was in fact earning income that was not being taxed.
  • John Robson
    commented 2018-01-19 09:34:25 +1300
    Hi Andrew…

    You identify three issues… which are separate… and appear to confuse them.. and how you might address them.

    First – non-taxation of imputed income:

    The issue is real, but smaller than you think, because you confuse ‘turnover’ or gross income with net income. If you wish to tax owner-occupiers imputed income, then the principle of horizontal equity requires that you make the associated costs tax deductible. Do the arithmetic for the owner occupier and compare the numbers with those of the ‘investor’. Ceteris paribus [see, I’ve successfully studied economics], the numbers do not support your vision of 30+% cuts to income tax.

    Second – non taxation of capital gains:

    The issue is real – but TOP doesn’t want to tax capital gains! Why not? Repeatedly, TOP spokespeople conflate the imputed income issue with the capital gains issue. If you can tax imputed income, you can tax capital gain.

    Third – low productivity “investments”:

    If income and expenditure is fairly (and effectively and efficiently) taxed, then one can reframe low productivity investments as consumption. And, if someone wishes to spend more than ‘needed’ on land, house, car, capital equipment, food, holidays, whatever… so be it. It might be economically irrational, but who cares. There is no problem here. And even if there was, we just need to do what we do with all problematic expenditure – tax it and/or regulate it.

    Andrew, to sum up, TOP’s #1 policy is seriously flawed in both grounds and logic. Time for a rethink…