Australian housing policy remains under the microscope, with the Greens announcing a plan to scrap negative gearing, but a crucial element of the housing debate remains largely ignored: how should state governments tax property? A failure to act now could prove disastrous for state tax revenue over the next couple of years.
Each state has its own approach to property taxation. Stamp duty is a popular way of raising revenue and each state also imposes a land tax on the unimproved value of land owned (outside of your principle place of residence).
In Victoria, property taxes, including $1.79 billion in land tax and a further $4.88 billion in stamp duty, accounted for 41 per cent of the state’s total tax revenue in the 2014-15 financial year. In New South Wales, the figure was 37 per cent.
Both states are using the cyclical upswing from property prices to pave over the holes in their respective budgets. With the typical property cycle lasting only a few years during the past decade, these are the type of assumptions that come back to bite short-sighted politicians.
Just ask Western Australia Premier Colin Barnett, who bet his government’s credibility on another volatile income source, mining royalties, and assumed that iron ore prices would remain well above $US100 a tonne.
There’s not much to like about stamp duty. It’s inefficient, distortionary and volatile, and should have been scrapped decades ago. It makes forward planning difficult, which encourages short-term thinking and inadequate government investment.
Stamp duty is pro-cyclical and tends to increase rapidly when the economy -- or more correctly the property market -- is strong and contracts during a downturn or recession. State governments rely on it but it doesn’t have your back when you really need it.
However, it’s the unintended consequences of stamp duty which really grate on economists, while simultaneously undermining economic efficiency and the property market more generally. Stamp duty remains a considerable barrier to entry for many first time buyers, reducing home ownership rates and boosting inequality.
According to the Productivity Commission, stamp duty -- combined with mortgage registration and transfer fees -- accounts for between 1.8 per cent and 5 per cent of the total purchase price of a new property across Australia’s capital cities. When a 20 per cent housing deposit already runs into six figures these figures really start to add up.
It also acts as a deterrent for people to move or downsize their properties. A research paper by federal MP Andrew Leigh found that a 10 per cent increase in stamp duty lowers dwelling turnover by 3 per cent in the first year and by 6 per cent if sustained over a 3-year period.
In other words, it harms labour mobility -- a key requirement of any well-functioning economy -- and makes it more difficult for some people to find and maintain a job or find an appropriate place to live. The Productivity Commission agrees and has declared stamp duty a leading barrier to mobility.
Stamp duty -- combined with the exclusion of a person’s primary residence in calculations for the aged pension -- also discourages older Australians from downsizing.
Nevertheless, state governments still need to raise revenue to fund, among other things, the education and health systems that benefit so many. The academic evidence on property taxes -- such as this recent paper from the OECD -- suggests that property taxes in the right form can help stabilise tax revenue while also reducing house price volatility and excessive risk-taking.
The key for property taxes -- as with any other form of taxation -- is to choose a model that results in minimal distortions or what economists call a ‘dead weight loss’. Taxes often change behaviour -- high income taxes, for example, may discourage an individual from seeking employment -- but some taxes are more efficient than others.
According to the Henry tax review, the marginal excess burden of stamp duties is estimated at 34 cents in the dollar. That’s higher than the burden on income taxes but a little lower than the distortion generated by company taxes. The tax burden on stamp duty is far higher than the other major source of state revenue, the GST.
An alternative to stamp duty is a broad-based land tax -- applying to all land regardless of use -- which is estimated to have a ‘dead weight loss’ of around 8 cents in the dollar. Comparing the two approaches, the total cost -- including distortions -- of generating $1 billion in tax revenue is almost 30 per cent lower using a land tax than relying on stamp duties.
The indirect benefits of a broad-based land tax is that it encourages greater infrastructure and property investment. First, the government itself benefits directly from any project that increases the value of a piece of land. Second, it provides an incentive for developers to make better use of their existing land holdings.
By virtue of helping to address housing supply, a land tax indirectly becomes a housing affordability initiative.
With the tax base narrowing at the state and federal level, our politicians should embrace the urgent need for tax reform. The use of a broad-based land tax -- instead of stamp duties -- is one way in which state governments can improve the efficiency of their tax intake while also generating a more predictable revenue stream.
Housing policy in general is ripe for reform. Inadequate policy has distorted the flow of capital for decades now and undermined more productive investment. We are beginning to bear the fruits of that folly, with billions each year flooding into unproductive investment vehicles due to misguided tax policy.
With the current housing boom in Sydney -- and to a lesser extent in Melbourne – approaching its apex, smart government policy would see the likes of New South Wales and Victoria demolish stamp duty before revenue begins to fall. It’s the only way in which they can make good on their budget promises without becoming a laughing stock like their Western Australian peers.