No taxes, cheap houses

Following my recent post, Blame your leaders, in which I explained why high house prices are partly the result of high property taxes I was asked by a voice of sanity in my household: “How can you keep a straight face and propose that one of the demand driven causes of driving up house prices, is over taxing the value of the house and land?”. Good question I thought and perhaps I should provide some evidence, or I should probably shut up on the subject. Is there any real evidence and how does it fit my proposition? This is a task of some magnitude for an individual but with some deduction I think I can provide some support.

Firstly, and as asked, I’ll summarise my proposition (but not the solutions) and also answer an important question.

  • The banks and other ADIs have set very high and risky levels for the maximum median house prices (MMHP) by over qualifying borrowers through too low serviceability and deposit levels.
  • The Banks have been able to fund these over qualified borrowers, cheaply, through mortgage rehypothecation which is the continual recycling of risk capital against house price increases on current mortgages to fund future borrowers. However, this has resulted in undercapitalized banks and the creation of serious systemic risks.
  • Since 2008 the federal government has been complicit with the banks on the raising of easy credit through both explicit and implicit guarantees.  These guarantees are not paid for at market value causing the socializing of losses or risk of losses with the privatisation of gains. The federal government guarantees have enabled the MMHP to rise to systemically risky levels.
  • State governments use the MMHP ceiling to push up values in order to maximize revenues primarily through both stamp duty and land tax. This is done through the controlled release of land (not necessarily undersupply), but through a mechanism that suppresses competition. State governments use this overpricing of new land releases to effect value government sanctioned increases across the board.
  • Local governments also work the system to fill any gap between land prices, building prices and the MMHP (ie the effect of demand) with infrastructure costs. It’s irrelevant whether these charges are able to be justified as value. The question should be asked about what is absolutely necessary not what’s nice to have. Local governments across the country can then justify increasing rates based on increasing values as per state governments. Although as DE has pointed out they’re now even breaking out of that constraint.
  • Australian banks are not well capitalized or well regulated. If the measure of capital is the difference between assets and liabilities, then according to RBA Statistics Australian banks have about 6.5% capital in total. Don’t confuse assets with risk weighted assets. As I’ve pointed at previously, the big 4 Australian banks are rorting the use and requirements of the advanced Basel II methodology for calculating risk weighted assets. Please refer to my post More Dodgy Disclosure.

So what’s the evidence to support my house price formula proposition? I’d like to refer you to the research of Professor Geoffrey West, a physicist and former president of SantaFe Institute. On The Edge website is an excellent 50 minute video of West where he partly focuses on his work in the scalability of cities and urban environments. Here’s a relevant quote

West speculates:

The great thing about cities, the thing that is amazing about cities is as they grow, so to speak, their dimensionality increases. That is, the space of opportunity, the space of functions, the space of jobs just continually increases. And the data shows that. If you look at job categories, it continually increases. I’ll use the word “dimensionality.”  It opens up. And in fact, one of the great things about cities is that it supports crazy people. You walk down Fifth Avenue, you see crazy people. There are always crazy people. Well, that’s good. Cities are tolerant of extraordinary diversity.

For me there was an enormous amount to be gained from this video including his work on corporations which is in stark contrast to the behavior of cities. But for now we’ll stick with cities.

In essence West’s research shows that as cities increase in size they become more efficient in use of resources but not just haphazardly, in both a predictable and constant way. That research in itself has large ramifications for urban planning but its his extended research that made me take notice. Not only are cities more efficient with size. Social, economic, educational and cultural benefits of cities increase at exponential rates as size increase. I admit you’ll have to dig much deeper if you want to see the numbers but to highlight my points, the overview of the evidence as outlined is sufficient.

The notion of supply and demand arguments for Australian housing seems to me to be framed in a far too general format for any meaningful debate to occur. What is housing supply? Please define what you are supplying? Demand for what? A bedroom with a bathroom for every person? Or a simple means to make money? Even in my world, there is a shortage of supply of Ferraris, well, affordable Ferraris. There is no shortage of housing for all in this country it may just be that most of us can’t have everything we want. There is a bed for every Australian, there just not in a mansion on Sydney harbour for all.

When I think of West’s research in the terms of supply, demand and the price of housing, I can’t help feel that reality is being strongly distorted as the politico-housing complex manipulates society’s structure. If cities become more and more efficient with size, it follows that “brick for brick” housing should become increasingly cheaper relative to income not more expensive. But people love cities, they thrive in cities and not in urban or country wastelands.

So if the research shows that housing should become cheaper in growing cities. Cities like Sydney, Melbourne, Brisbane, Perth that we love, want and thrive in, how did we get into a situation where government policy distorts what should be a logical economic course?  Policies create expanded isolated suburbs with unwanted green zones which reinforce the isolation but with unsustainable pricing and a loss of efficiency? Add on the question about how inner city efficient housing is somehow also priced out of reach of most, when practically, it should be relatively cheap? And I’ll give you evidence of government manipulation and taxing policies which entrench rising house prices as bribes for the populace to toe the line, until of course the borrowers reach breaking point and the new entrants to the game disappear.

My proposition is that increasing tenants rights will remove incentives for short term speculation by landlords and therefore not allow government policy at all levels to dominate revenue raising through ever increasing house prices fits with West’s research. Why, because most of us want to live in cities with all the economic and social benefits that brings. This is better abled to be maximized by having housing at reasonable affordability levels and renters with longevity of tenure.

Comments

  1. “If cities become more and more efficient with size, it follows that “brick for brick” housing should become increasingly cheaper relative to income not more expensive.”

    Wooooah, hold on there. That’s one hell of an assertion to make. Why do cities become more efficient as they get larger? A large part of it has to be that resources (e.g. land) become relatively scarcer as population grows, and thus become increasingly valuable.

    Isn’t that the whole thing driving apartment buildings and sky scrapers? The land becomes more valuable due to scarcity, and tall buildings are a more efficient way to utilise it?

      • Scale support the theory. Small towns are less efficient, big cities are more efficient.

        Same with companies…

        Yes there are exceptions…but the general rule holds in my opinion.

        The reason our cities are so poorly run is not a natural result of cities by nature…its caused my meddling politicians looking to boost their own chances of reelection

        • ? Well, if that’s the case it would be natural for home prices to be higher in rural areas, and much lower in cities. Has that happened anywhere, ever? (apart from considering factors like pollution, crime etc – which would signla inefficient cities).

          Home prices are determined by peoples willingness to pay to live in a location. If cities become ‘more efficient’ with size, they probably become more attractive places to live, with more job opportinities etc. Hence, we are willing to pay more to live there and home prices rise.

          • CM, I agree with your comment in the 2nd para. But it does not further follow that house prices should become unreasonably unaffordable and put the system at risk. To do that, there has to be policy interference

    • Construction costs are as cheap as ever. It’s the land prices that have risen beyond control predominantly due to artificial restrictions on land supply. Sure, inner city areas will always be more expensive due to their greater positional value and relative scarcity. But homes on the fringe of our cities should be no more expensive in inflation-adjusted terms, and of better quality, than they were 30 years ago.

      • Agreed Leith – I think this realisation is sinking in, particularly places like Caboolture, North Lakes etc on the northside fringes in Brisbane.

        There still is bad inefficiencies in housing construction (e.g most new estates are pretty much clonesvilles – but each house is built as an almost semi-customised job. Why aren’t they are just pre-fabricated on a production line and installed within days on site? Germans do this fantastically), and labor costs are ridiculously high, but agreed, adjusted for inflation and hedonic improvements, they really should only cost the same as 20-30 years ago.

        • “Why aren’t they are just pre-fabricated on a production line and installed within days on site?”

          Because builders and tradies charging extortionate fees will be out of work

        • There’s been the occasional article about these modular houses/apartments in the MSM every now & then. I think they’re fantastic and wish they’d get going sooner rather than later – reasons being:
          1/ They offer much safer work environments since tradies are only working 1 level high and inside a well lit, dry warehouse environment.
          2/ They are much faster to produce (no inclement weather issues, opportunity to do overtime, etc) and hence much reduced holding costs which equate to a cheaper end result.

        • Funnily enough the major problem with modular houses is getting finance.

          The larger (or any) developers – who can (normally) get finance won’t touch modular/pre-fab housing construction because of the stigma attached to the customer.

          My favourite is the NZ Bach House – the Germans have the Huf Haus

          Very environmentally friendly and energy conserving to boot.

    • …and i guess the question then becomes, “efficient, with respect to what?”

      And the: how representative of holistic life is that/those parameters…

      yes, i’m an engineer, and i pull people up on their notions of “efficiency” all the time.

      “Efficient? With respect to what? and why only that/those? How representative is that/those of the whole?”

      Not offering specific criticism for anyone, or offering suggestions here, but am just playing some devil’s advocate for a common logical oversight many make….

      My 2c

  2. Unfortunately to own a house (to live in) was made a competition, made by people and organisations that had a vested interest in making it so. Governments have made easy money by a rising property market and have become to greedy, losing focus on the whole reason people are interested in houses in the first place; a place to keep warm and dry, raise a family and call home. Now due to their greed the market has risen to levels where many Australians are not going to be able to afford to realise this. There can be no more handouts, no more incentives as this effectively discriminates against the various classes of potential home owners.

    This is the death of the great aussie dream

  3. Housing is such a big part of the economy I can’t see any level of government reducing taxes. In Australia currently it’s all about more regulations which drive up prices and hence taxes. In the last few years regulation account for about 20K on a new home my builder mate tell me (Victoria so it might be different in other states).

    There is such a belief that you home is an investment as well, and people forget it’s where you live.

    Generally, other than Super we have no incentive to save, and the Keynesian’s want us to spend “it’s all about the flow, and the velocity”.

    Friends of my family just retired, sold the big suburban home for a good price, and then tried to buy smaller in the same suburb, and are now renting as after all the costs they could not complete what they’d thought they’d be able to do – trade down and have some money in the bank. You can do it IMO, but you’d better accept a lot less than you had.

    I agree with what your premise however.

  4. Great post Deep T – I agree regarding tenant rights, it is appalling in this country.

    Interesting notion about cities, let me absorb that before commenting, but I must say that dwelling prices – like a lot of other consumer products, should be going down in price whilst increasing in productivity and luxury, even in the fact of continued increased in commodity prices.

    Reducing taxes on the consumption of housing (e.g land taxes, rates, etc) needs to go hand in hand with re-regulating behaviour with regard to investing in housing (e.g introducing CGT for PPOR, doubling/quadrupling CGT on a timescale for investment property etc).

    I’m afraid any regulatory change in housing needs to be met with a larger change in attitudes that housing is a consumption item valued based on cashflow – not an investment or speculation in capital gains.

    • *need a preview/edit button – sorry about spelling mistakes.

      I also mean to say with taxation, the taxation on capital gains needs to skyrocket, but the tax on earnings – particularly rent but also other earned income – needs to plummet, thus rewarding those investors who provide low cost housing with great post-tax yields.

      Explaining that paradox will also be a difficult task, possibly made easier after a housing bubble….

    • I really like the idea of increasing tenants rights, however, there is the issue of bad tenants.

      Yes, 5 year (at least much longer ones) leases should be the norm. But home owners still need an efficient recourse against late paying rent and property damage.

      Totally agree on housing as an investment. The incentive needs to be there for investment in income, not capital gains.

      Maybe even doubling CGT and halving any tax on rental profits?

      • Doubling CGT?

        I’m not sure what you’re trying to allude to here. Removing of the discount?

        Keating implemented it correct with the indexation system, a discount in line with stated inflation (albeit this has major flaws).

        But 50% after one year is a major distortion. Firstly it distorts the incentives of capital gain, and secondly it actually works against long term investment.

        There will come a time when a long enough investment should draw a greater than 50% discount via indexation.

        Stuff that, flip the thing.

    • Wouldn’t higher land taxes act to rebalance housing investment away from speculation and towards consumption / earning? The pro-land tax argument always goes along those lines.

      The same amount of land tax would have to be paid regardless of whether a speculator or earner / consumer bought the land. So a land owner is encouraged to put the land to productive use or to sell it to avoid paying the tax.

  5. Great article. The government just have too much of an incentive to keep prices high. The taxes, the wealth effect, happy home owners, etc…

    We need to get rid of that incentive. Governments at all levels need to be incentivised to keep prices down at all costs somehow. Tenants rights are a start but there should be more. Removing rates and stamp duty would be a start (honestly councils are the epitome of bloated, arrogant bureaucracy I’d be happy if their numbers and revenue halved).

    What else could we do? I’d like to buy a home some time in my life but there is just no way I will do it when prices are astronomically high.

    • Sandgroper Sceptic

      In WA the government has tried to get the 141 local councils to amalgamate or merge with other small councils to improve efficiency and reduce waste. Unsurprisingly aside from a few very small rural councils that have decided to bulk up, they don’t want to. The main reason is of course those nice lucrative CEO and staff jobs that would be rationalised in a heartbeat if the council merged with another. Efficiency does not get much of a look in, who pays? The local property owners of course.

    • “We need to get rid of that incentive. Governments at all levels need to be incentivised to keep prices down at all costs somehow.”

      It’s very hard here.

      For local government, rates tend to be percentage based, so higher prices favour them. Diversion from this requires flat rates whcih will incentivise them to increase population density with reckless abandon.

      State governments need stamp duties, again percentage based, though they are volume weighted. Flat rates would see them incentivise flipping.

      Federal governments pursue tax on capital gains, which is incentivised by asset price inflation. Again volume weighted. The only thing for them is an alternative revenue source.

      “Tenants rights are a start but there should be more.”

      Unless there is advocy for more public housing, or incentives for institutional investing, it’s going to remain the domain of the bogan investor.

      “Removing rates and stamp duty would be a start (honestly councils are the epitome of bloated, arrogant bureaucracy I’d be happy if their numbers and revenue halved).”

      Stamp duty has a big effexct on labour mobility, I’d be happy to see that go, but council rates are a hard thing to replace.

  6. Most of the housing wealth is being financed by debt and very little equity – that is the problem.

    The banks are supported by the government, they still argue for less regulation and exemption for Basel III. Have we learned anything for the overseas experience? I think -NOT.

    Fed chairman Ben Bernanke backs action on Australian banks

    http://www.theaustralian.com.au/business/industry-sectors/fed-boss-backs-action-on-australian-banks/story-e6frg96f-1226071987216

    • “Most of the housing wealth is being financed by debt and very little equity – that is the problem.”

      Well functionally it is not a problem. High LVR’s are just increased risk. The asset class is immaterial.

      I know Andrew Forrest started FMG with very little equity, and had abnormally high levels all the way through it’s development.

      The risk matrix accorded to Forrest, and all other creditors is an arms length decision and not a ‘problem’ that government should intervene in.

      The issue here here the distorted risk matrix with property due to a myriad of other policies, and risk being able to be passed off by banks due to firstly tacit, then explicit guarantees of banks by government.

      Debt/equity ratios are very little concern.

  7. ‘Debt/equity ratios are very little concern.’

    That is true until default.

    Why doesn’t APRA go all out and let banks lend 125% LRV? Then just wait a few years – until the chicken will come home to roost.

    Try telling the EU, USA, UK, etc that ‘debt’ is not a problem. As far as i can see – they all are in for a few years of deflation, deleveraging and austerity.

    In other worlds – reducing/repaying debt and increasing savings. It is high time to purge the debt from the financial system – it is not sustainable.
    Let the banks and bondholders take a haircut, reward the savers and equity.

    • “That is true until default.”

      No, even with default the lender then has security over the asset to get their money back.

      If the underlying asset is not worth the loan amount, then the lender (i.e. bank) stuffed up, and their management should be hauled over the coals for it.

      Moral hazard however has seen bank management not held into account for their poor decisions.

      But proper valuation and risk management should never see a secured asset worth less than the loan amount. That is why lending practices SHOULD be counter cyclical in bubble formation, not pro-cyclical as they currently are.

      That will be addressed with the next comment.

      “Why doesn’t APRA go all out and let banks lend 125% LRV? Then just wait a few years – until the chicken will come home to roost.”

      APRA Guidelines are there (in theory) to protect savers against agency theory.

      A banker does lender his/her money out. They lend out those of savers. And a saver always will require that they get their money back. A banker doesn’t care if savers get their money back, they are remunerated by volume.

      Lending at 125% would reduce dramatically the probability of savers getting their money back, thus their input has been legislatative protection, such as APRA.

      “Try telling the EU, USA, UK, etc that ‘debt’ is not a problem. As far as i can see – they all are in for a few years of deflation, deleveraging and austerity. ”

      That’s not the fault of existence of debt, that’s the fault of bankers being able to absolve risk.

      NINJA loans should never be written. No saver would actually authorise the practice with even the slightest amount of knowledge. They were written however out of the self-interest of lending agents, bankers. The bankers didn’t care of the abnormally high levels of risk because they are not held into acount for them.

      Debt isn’t the problem, risk is because it has been underwritten by government.

      “In other worlds – reducing/repaying debt and increasing savings.”

      Enormous levels of debt can be taken if it produces a productive, sustainable income that covers the cost of the debt.

      Assessment of the risks associated with the sustainability is a bankers job. They have no other role. If they weren’t to do that, then borrowers could just walk into a vault of savings and leave behind an IOU.. contract done.

      “It is high time to purge the debt from the financial system – it is not sustainable. Let the banks and bondholders take a haircut, reward the savers and equity.”

      I agree, it’s called bankruptcy. This is how debt is repudiated.

      The prime example here of how it should occur is Iceland. The prime example of how it shouldn’t occur is Ireland.

      Irish lenders should have claim to the houses of mortgage defaultees to get their money back. if the houses are no longer worth the amount lent out, then the bank didn’t assess risk properly and loses capital and credit. The providers of capital and credit should however be vigilant in monitoring their agents function.

      If the capital loss of Irish banks makes them insolvent, then their creditors get ownership of Irish banks, namely British and German lenders.

      If they don’t get their money back, then again insufficient risk management was applied.

      If they go bust, and it proceeds down a daisy chain, it will eventually come to a last man standing with free cash, that is not secured against any debt.

      I have a $1 coin in my pocket that I will use to by the assets of any failed bank. The creditors can divvy up that $1 dollar.

      If anyone wants to outbid me for $2, then I will go to $3, and this will proceed until we find a clearance price.

      Warren Buffet did this with his 10% stake in Goldman Sachs to restore its solvency and then promptly put in place new rules for the agents within Goldman Sachs.

      He promptly ceased any further like activity when after Lehman’s the U.S government intervened to save banks, thus preventing their proper cleansing of poor management, and meaning the taxpayer had to bear the cost of this failure, not the limited liability shareholders that should.

      • True but the bank doesn’t just lend out the savers money. We run a fractional reserve banking system where the banks are only required to hold a percentage of the money lent out as capital and hence create new money supply when making a loan. The government acts as lender of last resort.

    • Well said!

      The UK situation is five years at least of austerity just to balance the budget and get back under control what Brown inflicted on the nation, and that does not account for the debt. They have some time as the average Gilt is 13 years, and there is hope that inflation will do it’s dark deed. I’m not sure however if they’ll be successful as you need to economy to grow and it’s not really.

      Many say the US is ok, but there are a lot of assumptions in that prediction.

      As for Europe the ECB only needs a 4.23% drop in asset value to be wiped out.

      Meanwhile here in Australia Julia is adding to our debt daily. A balance budget is great, but what about the debt if the rates do go up significantly, and China slows …..??

      There are a lot of crossed fingers in Canberra IMO hoping everything does roll on.

  8. Rusty Penny,

    We agree to a large extent – your description is the perfect ‘theory’ how banking/financial system should work.

    Unfortunately the reality hasn’t turned has not followed the rule book. Housing prices (and financial assets) collapsed, but the leverage has not, it actually has increased.

    Now, we can argue about Miller & Modigliani, but we need to change the theoretical models to fit the reality – not the other way around.

    Remember – there is not one historical precedent to show the contrary – governments have always ‘saved’ the banking/financial system. That will unlikely to change, so moral hazard is here to stay.

    • “Rusty Penny,

      We agree to a large extent – your description is the perfect ‘theory’ how banking/financial system should work.
      Unfortunately the reality hasn’t turned has not followed the rule book.”

      Governments only get away with what we let them. That’s the only thing that’s need to change.

      “Housing prices (and financial assets) collapsed, but the leverage has not, it actually has increased.”

      Debt goes to zero when it’s repudiated via bankruptcy.

  9. ‘Governments only get away with what we let them. That’s the only thing that’s need to change.’

    When, where and how do we start ‘the change’? I don’t dare to call it a revolution, do you?

    We agree:-), but there is only two of us.

  10. Acronyms. Aargh!!! The bane of anyone dropping into a thread. Please put an explanation in brackets. Jargon is not cool.