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Last Year’s Model
Decent, affordable housing for all should be a policy priority. In principle, it is readily achievable in Australia, with its relatively abundant land, economic affluence and a population that evidently values housing highly, both as an item of consumption and investment. Yet we are a long way from the ideal, and probably getting further from it. Housing affordability, particularly in the major cities, is currently a central political, economic and social concern in Australia. It shows little sign of easy resolution. The establishment by the Federal government of the Productivity Commission inquiry into how first-home buyers are affected is indicative of the concern.
This article (i) examines the stresses in the different segments of the housing market and nature of the 'housing affordability' problem; (ii) discusses whether these trends are linked to the structure of taxes; and (iii) considers the possibilities for restructuring of government finances in order to make housing more affordable. It focuses on the situation in NSW, particularly on the situation in Sydney where the housing problems are so acute, but the principles have nationwide applicability.
Home Ownership and Housing Affordability
There are four general housing sectors: home ownership, private rental, public rental and hostel accommodation. Each has its advantages, and its current stresses.
Home ownership is the biggest sector, comprising nearly 70% of housing provision. For many Australians it is an attractive option, giving security of tenure, prospects of capital accumulation and zero-cost housing in old age when the mortgage debt has normally been paid off. But it is becoming prohibitively expensive. An inflationary housing market has seen residential property prices rise nearly fivefold in Sydney and nearly threefold in the rest of NSW over a seventeen period between 1986-2003.
In the last three years there has been a particular inflationary surge, echoing the previous surge in Sydney (but not elsewhere in the State) during the housing boom of 1988 when median house prices rose in one year by about 67%. In the year 2002-03 the price rises averaged 29% in Sydney and 39% in the rest of the State, the latter from a lower base, of course.
How have these trends in housing prices affected housing affordability? The usual index of affordability, calculated regularly by the Housing Industry Association in conjunction with the Commonwealth Bank; is defined as 'the ratio of average household income to the ('qualifying') income required to meet payments on a typical dwelling' (HIA/CBA, Housing Report, February 1991, p4). The index responds primarily to three variables: average house prices, average incomes and housing interest rates.
The HIA/CBA data shows housing affordability in Sydney falling in the 1987-89 period when both house prices and interest rates were rising sharply, then rising in the 1990's as interest rates fell and house price inflation was more modest. But affordability began to fall again after 1997 as the more rapidly rising house prices outweighed the effects of low interest rates. By 2003 Sydney's affordability index was at its lowest level for the whole seventeen year period. The situation in NSW outside Sydney, according to this index, reflects a broadly similar cyclical pattern, but at a generally higher level of affordability because of lower average house prices.
A simpler alternative measure of housing affordability can be constructed by relating data on median housing prices directly to average annual earnings. This shows a more dramatic picture, because it sets aside the effect of the low interest rates in recent years that have kept the HIA/CBA affordability index up. It more directly shows the effect of housing prices outstripping average wages. According to this alternative index, housing affordability has declined sharply: a typical house Sydney cost just under 4 years of average earnings in 1986, while in 2003 it costs over 12 years' worth of earnings. In other words, affordability has deteriorated to a third of the level it had been in the mid 1980's.
It must be borne in mind that the time taken to buy a house in practice is usually much longer than indicated by this ratio of house prices to average earnings. Some household income necessarily goes to other consumption expenditures and to interest payments, lengthening the relevant time period for buying a house by a factor of at least three. For many individuals and families aspiring to first-home ownership, the relevant time period is infinity. In other words, they can never afford to buy a house in their lifetime.
It is little wonder that the proportion of houses being purchased by first-home buyers has dropped to a historically record low, notwithstanding the government subsidies that are available. Recent ABS figures show that first-home buyers accounted for only one in eight of all new loans for owner occupied homes.
House price patterns tend to operate with a 'ratchet effect'. Periods of rapid inflation, such as 2000-2003, alternate with periods of relative stability, such as the current 2004 plateau. However, it seems that there are no significant periods of deflation to offset the long-term upward tendency. As with any such asset inflation, the impact is felt most severely by aspiring entrants to the market, ie. those who do not have existing assets to trade-up for more valuable property. The generalised housing affordability problem is thereby manifest as a particular crisis for first-home buyers.
Not surprisingly, many of the resulting pressures show up in the private rental sector. Many people prefer to rent, because the greater flexibility of rental housing has advantages for relatively mobile segments of the population. But the demand for rental housing is swollen by those who would prefer to become home-owners but cannot afford to do so. Numerous surveys have shown that it is in this sector that the incidence of 'housing stress' is most acute. Paying more than a third of income in rent, even more than a half, is common.
Meanwhile, other stresses show up in the massive waiting lists for public housing. Public rental can be an attractive, efficient form of housing provision, as a previous report by the Productivity Commission conceded. But public housing has fallen below 5% of the total housing stock, so it is inevitable that it be used only as a residual, primarily for low income tenants. The current government policy has thereby rendered public housing inherently incapable of being economically self-financing. This is tragic because, in principle, a bigger public housing sector could stabilise the inflationary process affecting the other housing sectors. It would also make possible a greater social mix in public housing itself, thereby overcoming the problem of social stigma that is often said to be associated with public housing.
Not surprisingly, these problems in the three main housing sectors affect the fourth - emergency hostet accommodation. The problem of homelessness persists because people are unable to access decent, affordable housing, and enormous strains are faced by the providers of hostel and other emergency accommodation seeking to respond on a day-to-day basis. In effect, there is a 'filtering down' through the interconnected housing tenure categories. The result is a continuing crisis of major economic and social proportions.
Understanding the Housing Market
What has gone wrong? The root problem concerns the nature of the housing market in a capitalist economy. The demand for housing as a commodity is driven by exchange values, not just by use values. Of course, housing does have use value - the value of shelter, security and amenity provided to its occupants. However, housing wealth is also a store of value and a source of capital gains. This biases the demand for both owner-occupied and investment properties. Owner-occupied housing is favoured by its tax treatment, particularly because of its exemption from land tax (other than for a tiny proportion of very highly valued properties in NSW that have been subject to the 'premium property tax', soon to be removed). Owner-occupiers have also enjoyed exemption from capital gains tax. Meanwhile, negative gearing provisions provide a subsidy to owners of investment properties, further fuelling the overall demand for housing in the market.
The demand for housing also responds to changes in the broader investment environment. This imports a cyclical tendency, causing periodic inflationary booms in housing prices. There is switching of investable funds between share markets and housing markets, for example, such that surges of housing demand tend to follow share market declines, as in 1987-89 and 2001-02. Facing falling rates of return on share capital, investors switch into real estate, and vice versa. It is these surges of demand that tend to impart the 'ratchet effect' into the pattern of housing prices.
Housing therefore becomes a focal point for speculative processes which further fuel inflation. The 'herd' behaviour of investors in speculative markets is well known. Rising prices cause increases in demand, contrary to simple 'textbook' economic theory, because they are seen as signals of expected future price rises. The resulting increases in demand then bring about those further price rises: in effect, the expectations become self-fulfilling. First-home buyers are not normally drivers of this process, but they become minor players to the extent that they bring forward their purchases (sometimes encouraged to do so by the availability of a first-home subsidy) in expectation of future price rises.
Any analysis of housing markets must also recognise that it is the price of land rather than the housing itself that is the inflationary driver. Between 1993 and 2003, only about 20% of the total price rise of a new medium priced house was due to the house itself, the other four fifths being the result of rising land prices. What this means is that no general solution to the problem of housing affordability for first-home buyers is possible without tackling 'the land question'.
Finally, it is important to consider how the activities of the state, particularly taxation policies, bear on the housing situation. Like other aspects of economic behaviour, tax structures can substantially affect the land use patterns and housing market behaviour.
Stamp duty has been particularly in the spotlight. The NSW State Government got 22% of its total 'self-generated' revenues from stamp duties related to real estate transfers in 2003.
Historically, stamp duty was intended to be a modest fee to cover the cost of stamping and filing documents that transferred an interest in property. However, the lack of any 'indexation' in the scales for stamp duty payments means that the relentless land/housing inflationary process has dramatically raised the absolute levels of stamp duty payable on the purchase of residential properties everywhere. The stamp duty payable on the transfer of a median priced house in NSW increased over fifteenfold in the seventeen years from 1986 to 2003. Today the stamp duty payable on a median priced house in Sydney is $23,000.
At the top end of the market the stamp duties are enormous, even before the additional surcharge announced in the State government's 2004 mini-budget. In 2002 Sydney's top 200 real estate sales ranged from $4.5 million for a Wahroonga home to $28.5 million for a house in Point Piper. The stamp duty on a $4.5 million home is $232,990 and on a $28.5 million home it soars to $1,552,990. A second or even third home could be bought outright with the amount of stamp duty payable on these homes!
Maybe people in those top housing price brackets don't feel the pinch too much but, more generally, the increased stamp duty payments have generated substantial socio-economic concerns. To the extent that stamp duty adds to the total cost of acquiring housing it has posed a particular problem for first-home buyers. Saving up enough for a deposit is hard enough as it is in an inflationary property market. It is especially so for people who are renting their current residence and confronting the inflation in rents that generally accompanies inflation in house prices. Stamp duty adds to the total loan required, which makes it yet more difficult for first-home buyers to generate the deposit required by banks.
Responding to this particular stress, the NSW government's 2004 'mini budget' has exempted first home buyers from stamp duty if they are buying reasonably modestly priced homes, but the government has simultaneously increased stamp duties on sales over $3 million. The heavy reliance on stamp duty as a revenue source remains.
However, stamp duty is not a good tax from an economic or environmental perspective. Its effect on spatial mobility warrants particular attention. Any such charge on property transactions (along with other fixed costs such as legal fees) can be expected to act as a disincentive to movement between houses. People who might consider a change of location, perhaps because of a new job or because of retirement, can be put off by the extra cost of making the change. If so, therein may lie significant social costs. If people stay in inconveniently located housing, they may have to undertake long-distance commuting, which impacts adversely on transport and environmental conditions as well as being costly in itself. Of course, people may want to stay in inconveniently located housing for all sorts of personal reasons, but it is presumably better if they don't feel 'locked in' because of the tax system.
These taxes on property transfers have, not surprisingly, been politically targeted as a culprit for the housing affordability crisis - part of the process whereby the Federal government seeks to pass blame to the States. But what proportion of the housing affordability problem is actually due to stamp duties? Contrary to some recent political rhetoric, it is evidently very small. In round terms, the increase in stamp duty payable on a median priced house has been about 2% of the total increase in the price of houses in the Sydney metropolitan area and under 1.4% on average of the total in non-metropolitan areas of NSW. These comparatively low figures tend to suggest the crux of the housing affordability crisis lies elsewhere.
Tax Reform and the Importance of Land Tax
The more important drivers of housing demand, and hence of housing prices, have been the exemption of owner-occupied housing from land tax and capital gains tax and the 'negative gearing' tax advantages of that have been given to those buying additional housing to rent out. These tax concessions make housing a highly tax-favoured form of personal investment. It is hard to see any general solution to the crisis of housing affordability without policy changes that directly address these tax biases.
Land tax warrants particular consideration in the process of reforming taxes in order to ameliorate the problem of housing affordability. Until the recent NSW state 'mini budget', land tax has been accorded less attention by the policy-makers than stamp duty. The annual land tax in NSW had been 1.7% of the value of the land ever since 1986. But it has not applied to land used for owner-occupied residential purposes. The exception was during the period from 1999 to mid 2004 when properties were liable to pay the 'premium property tax' if the land value was above a threshold level, set originally at $1 million in 1998 and subsequently adjusted for inflation. Following implementation of the land tax changes announced in the 2004 'mini-budget', land tax will be taxed in future on a sliding scale from 0.4% to 1.4%, with the existing tax free threshold abolished. The premium property tax is to be dropped.
Land tax has contributed much less than stamp duties to NSW State government revenue. The ratio of land-related stamp duty revenue to land tax receipts was a little over 3:2 twenty years ago, and it is now well over 3:1 ($3.6 billion compared with $1.1 billion). A strong case can be made for reversing this trend by putting a greater emphasis on land tax as a means of increasing housing affordability.
Land tax has significant advantages as a revenue source, compared with stamp duty. As a regular annual tax, rather than an impost on buying and selling property, it has no equivalent disincentive effect on mobility. Indeed, it may even work in the opposite direction, encouraging mobility among people who are 'asset rich, income poor' and seek to reduce their land tax commitments by moving to lower-valued property.
More importantly from the housing affordability perspective, land tax tends to reduce property price inflation. Because it 'creams off' part of any potential capital gain, it reduces the attractiveness of land as a speculative investment. Other things being equal, that reduced speculative demand can be expected to produce more price stability in land and housing markets, helping to stem the damaging inflationary and cyclical effects that speculation causes. To the extent that it stabilises house prices, a uniform land tax also can be expected to take some of the pressure off the housing rental and emergency accommodation sectors too. Thus, the extension of land taxation could hold an important key to resolving the housing affordability crisis.
Land taxation also captures increases in social wealth that are otherwise privately appropriated. Total land values in NSW more than doubled in the decade from 1993 - 2003, with a total increase in value of 153% or $361.5 billion. Residential land was the major contributor to total land value, and accounted for 80% of the total land value increase over the two decades. Some part of this surplus has been 'clawed back' by government through land taxes, stamp duty, capital gains tax and local government rates. But it has been quite a small proportion of the total increase in land values. From 1993 to 2003 the total land-based tax revenue collected by all levels of government was $44 billion. This was only 12% of the $361.5 billion increase in land values over the same period. The other 88%, comprising $317.5 billion in increased land values, was left in the hands of private landowners.
A uniform land tax on all property at a progressive rate would also be a fairer source of regular revenue. Unlike stamp duty, it would not discriminate between movers and non-movers. As a regular annual payment it would not have the 'lumpy' characteristic of stamp duty and would not impact at times of particular financial stress (like when moving house). It would result in a more rational use of our residential and transportation resources because, unlike stamp duty on property transfer, it is not a disincentive to spatial mobility. People's locational choices could be expected to factor in the ongoing land tax obligations associated with living in particular cities and regions.
The Potency of Land Taxation
Narrowing these concerns to matters of 'fiscal arithmetic', it is interesting to ask how existing land tax provisions would have to change to produce comparable revenue to the existing stamp duties. If, for example, the rates of stamp duty were cut back so that their share of the total 'self-generated' NSW State revenues were halved (from the 2002-03 level of 22% to 11%) that would mean a fall in revenue of about $1,775 million (in 2002-03 figures). The most direct measure to produce that amount of revenue would be to remove the exemption of owner-occupied property from land tax.
It is not difficult to establish a 'ballpark' figure of what the land tax rate would need to be if the owner-occupier exemption were removed and an additional revenue of $1,775 million were sought. My conservative estimate indicates a necessary land tax rate of 0.32%. Put differently, were the 1.7% land tax rate that existed as the standard rate until the NSW mini-budget of 2004 to be maintained and extended to owner-occupied properties, the revenue would be much more than sufficient to eliminate stamp duty altogether and contribute substantial additional funds for the provision of more public housing.
Judging whether this policy change is desirable would entail an array of broader political and social as well as economic judgments. The preceding calculations are only meant to be indicative of the broad magnitudes of revenues involved in the hypothetical tax changes. However, what this simple 'fiscal arithmetic' reveals is that quite low rates of land taxation can be potent revenue-raisers. That is pertinent to the politics as well as the economics of tax reform.
In its 2004 mini-budget the NSW State government has made a 'courageous' political judgement, removing the threshold for land tax payments, so that over a quarter of a million more small investors will be liable to pay this tax from now on. Concurrently, land tax rates on more valuable investment properties are being reduced. It is a strange stand for a Labor government since the opposite policy would have less regressive income distribution effects. It would have been yet more sensible to extend the scope of 'premium property tax' (eg. by removing its indexation), thereby using it as a vehicle for a more uniform land tax system rather than, abandoning this important land tax initiative. Embracing a bigger role for land taxation would produce revenues to fund an increased supply of public housing as well as other forms of desirable public expenditure.
Of course, making more properties subject to annual land tax may generate significant political opprobrium, and that is presumably the reason why the major political parties have shied away from any such tax reform that can be interpreted as 'a tax on the family home'. But not to 'tax the family home' indirectly results in the denial of decent, affordable housing for other Australians and their families.
In the broader sweep of electoral judgments, the key issues are what form the overall reform package takes and how it is presented. A combination of lowered stamp duties and moderate but uniform annual land tax, perhaps eventually replacing local government rates, together with more expenditure on public housing and a phasing out of negative gearing could be politically viable as well as economically and socially desirable. Property presented, it could come to be seen as the sort of reform package that is necessary if we are to address the housing crisis in an equitable manner. Anything less - such as the exemption of first-home buyers from stamp duty - is tinkering with the symptoms, rather than addressing the root problems of housing affordability. Meanwhile the goal of decent, affordable housing for all becomes ever more elusive.
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