COAG damns first home buyer grant

The Council of Australian Governments (COAG) report into addressing housing affordability was released late yesterday and at first glance (will look in further detail later) is a reasonable document with a range of supply side recommendations aimed at freeing land supply, reducing  land banking, reducing development costs and increasing market responsiveness that are all very welcome.

It also addressed the one demand side issue that it has some control over, the First Home Owners Grant, and concluded, also sensibly that policy is self defeating:

The HSAR Working Party found that the available evidence suggests that in its current form and in a supply-constrained environment, the First Home Owner Grant (the FHOG) may not be the most cost-effective way of improving housing supply and affordability in the longer term.

The FHOS was introduced on 1 July 2000 to provide assistance to first home buyers to offset the average impact of the Goods and Services Tax (GST) on home prices. The FHOS provides $7,000 to first home buyers who purchased either a new home or an established home.

The HSAR Working Party investigated the impact of the FHOG on the Western Australian and Tasmanian housing markets using econometric modelling. The modelling outcomes indicate that the state funded and administered FHOG and the time-limited First Home Owners Boost (the FHOB – introduced by the Commonwealth during 2001 and 2008) tend to increase house prices in both the short and long term. This price increase is more marked in the short term when supply is constrained.

Specifically, the findings from these case studies include the following:

• The FHOG and FHOB have encouraged first home buyers into the market (pull forward in demand), but the impact has been more marked for purchases of new homes than established homes.

– For example, in Western Australia the FHOB from October 2008 resulted in a 29.1 per cent increase in the growth of applications for new homes, while the half boost effective from October 2009 to December 2009, resulted in a 56.3 per cent increase in growth of applications for new homes.

• In the short term, where supply of housing is constrained, the FHOG can increase house prices.

– However, even in a supply-constrained environment, the HSAR Working Party’s modelling indicates that while the grants increase home prices, such increases are not as large as the grants themselves. To that extent, the FHOG does provide some help to potential first homebuyers in competing against existing homeowners, who have typically benefitted from capital gains from previous property price growth.

• The original FHOG had a lower impact on real house prices over time, largely because supply becomes more elastic over a longer time period.

In contrast to the FHOG, the FHOB was primarily designed to provide a short-term stimulus to activity in the residential construction sector as part of the Commonwealth’s $10.4 billion Economic Security Strategy. It played a crucial stimulatory role in responding to the acute economic downturn experienced during the GFC by boosting the turnover of property and supporting activity and jobs in the residential construction industry.

The extent to which the FHOG is achieving its intended purpose of offsetting the impact of the GST on housing has declined. These findings, together with the potential risks of housing stress resulting from the FHOG for some first home buyers when market conditions change, suggest that the scope of the FHOG could be reviewed and consideration given to better targeting the grant or even phasing out the grant completely.

In summary, the HSAR Working Party found that the available evidence suggests that, in its current form and in a supply-constrained environment, the FHOG may not be the most cost-effective way of improving housing supply and affordability in the longer term. The HSAR Working Party therefore recommends that as jurisdictions consider the future of the FHOS, they should take account of the HSAR Working Party’s analysis together with other relevant assessments.

It is important to note that any major changes to the FHOG must be agreed by all States and Territories and the Commonwealth.

Spot on.

Final Report – Housing Supply and Affordability Reform

Unconventional Economist
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Comments

  1. I just paid a rare ‘store’ visit to the BNZ (NAB’s local outfit), and out of curiosity asked “What kind of loan could I get if I wanted one?”. The young lady looked at her screen and leaned over to me and quietly said ” 100% wouldn’t be a problem for us on this occasion”. So maybe it’s not the FHBers that the banks will be after, now?

    • Good point.

      Minus the grant, do the banks maintain mortgage demand by simply raising their LVRs?

    • I am increasingly suspicious these days, that down this part of the world, there is some kind of secret deal worked out between the banks, the government, and the central bank, to keep the housing market inflated. I cannot believe that the banks, on their own initiative, would be so stupid given all the experience they should have learned from, from other countries.

      I strongly suspect that they are shifting their mortgage portfolios stright off their books to the central banks (via Mortgage Backed Securities), or know that they can do so. Obviously there is nil transparency surrounding this process. Secret QE.

      Meanwhile, the international hedge fund operators who are “shorting” the Aussie Banks are on a hiding to nothing, and people “in the know” re the secret QE support of the mortgage lending sector are doing quite nicely taking the “long” side. A kind of Aussie “underarm bowling” tactic is happening in monetary policy and finance markets.

      My suspicions are certainly not diminished by the fact that comments like this frequently do not make it through MB moderation; and if MB is running scared of something, you can be sure everyone else in the “public watchdog” sector will be.

      • Meanwhile, the international hedge fund operators who are “shorting” the Aussie Banks are on a hiding to nothing, and people “in the know” re the secret QE

        Well you’d say that would be in the national self interest.

        Private banks in the clear, the RBA writing the opposite side of the short. They prop up bank prices ad infitinum, cuz they can aford to, and collect option premiums from overseas speculators until the ledger is squared.

        Good gambit if they can pull it off.

        I thought the master gambit was letting more foreigners, namely Chinese buy our houses here.

        make a monster book with Chinese lending.. push up the price, sell it back to the Chinese at inflated prices, we run through the doors with a fist full of cash, then let the market crash with the Chinese holding the can.

        But that would take a mother of all conspiracies.

  2. still, not a word of the impact of negative gearing on existing dwellings and the fact that on some markets (units ), more than 50% of the buyers are “investors”, displacing OO to renting.

    I hope the much needed mining “adjustment” coming will convince some of our pollies to find $$$ by getting rid of NG on existing dwellings and implementing a proper land tax ( and getting rid of the stupid transfer duty)

  3. rob barrattMEMBER

    COAG have worked out that FHOGs & FHOBs have put up the price of housing. Gosh, I’ll say one thing for Fair Work Australia – they look like polished greyhounds compared to this lot.

  4. The COAG report is really quite good. They appear to have been reading “The Unconventional Economist” and learning the links between increased demand, constrained supply, and prices. Well done.
    I still think I can summarise the situation better…

    10 Steps to a Housing Disaster

    Starting with only 21 million people and a giant island with 100 acres of land per person, how could we engineer some of the least affordable housing on the planet?

    Here is a recipe to make housing unaffordable:

    Step 1 – CHOKE NEW CITIES

    Divide the island into 7 states and create one giant city per state. Force almost all the people into the giant cities with policies such as:

    * All business zoned in the centre of the city
    * All government departments must be in the capital city
    * Non-giant cities given terrible infrastructure

    With decent transport this gives 7 areas with 40km radius, approximately 1700 square metres per person. Still too much land to create a crisis!

    Step 2 – CHOKE TRANSPORT

    Neglect the transportation system so that it is not practical to live more than 20km from the city centre. This cuts us back to 400 square metres per person. Still plenty of space on average, but the largest cities will need some high-rise housing to get by.

    Step 3 – CHOKE HIGH-RISE

    Refuse permission for high-rise in many cases. Old suburbs must be preserved for the old people who still live there. No extra housing to be built for young families.

    Step 4 – CHOKE LOW-RISE

    Much land within range of the city to be kept off the market in the form of national parks, government land and farms without permission to subdivide. If you have 5 acre or 25 acre farms within reach of CBD then declare the area semi-rural and don’t allow extra housing there. With policies like this even low-population cities like Darwin and Hobart can have a housing crisis!

    The first four points will choke-off all avenues of extra housing supply, so now let’s increase the need for extra houses – one house per family – by increasing the number of families.

    Step 5 – HAVE LOTS OF BABIES

    In 20-30 years they will leave home to start extra families.

    Step 6 – INVITE IN MANY IMMIGRANTS

    Why not increase the immigrant intake to record numbers?

    Step 7 – DIVORCE IN RECORD NUMBERS AND LIVE LONGER

    This will result in a declining number of people per household. We need more dwellings for a given number of people.

    Now with the supply of extra houses choked and the need for extra houses increased, price will race upward, as the poorer families are priced-out of housing. Now let’s goose the price even more with idiotic economic “demand side” techniques

    Step 8 – LOWER INTEREST RATES AND LOWER LENDING STANDARDS

    Instead of paying off a $100,000 house at 13% interest, why not service a debt of $500,000 at 7%. Why not use 80% of two incomes and eat poverty food for the rest of your life?

    Step 9 – FIRST HOME BUYER’S GRANT

    It won’t create a single extra house, but it might drive existing house prices up.

    Step 10 – TAX ADVANTAGE TO SPECULATORS

    With prices racing up, beyond the reach of first home buyers, give more money to those people most capable of driving prices even higher. Use government tax money to encourage rich people to borrow money and buy existing housing to rent-out to poor people. We can pretend that this creates extra cheap housing and is good for the poor people.

    Step 11 – A WORLD-WIDE CREDIT BOOM AND ASSET BOOM

    Improper to include in the list of 10, but it doesn’t hurt to mention it.

    …..

    Poking Demand and Choking Supply

    Government has done something very bad to the supply and demand of starter homes which has led to outrageous prices of starter homes, and supported much higher prices of better homes. In short, government has poked the demand and choked the supply of starter/marginal/extra homes.

    Poking Demand:

    * Government brings in many immigrants

    Choking Supply:

    * Government refuses permission to build extra housing on the fringe or extra units in the city, and new cities
    * Government adds taxes, charges and levies to extra housing
    * Government requires onerous compliance with regulations
    * Government creates delays in approving dwellings.
    * Government neglects transport and other infrastructure which reduces the area in which well-located and well-serviced homes can be built

    There is much debate on which of the five chokers (refusal, taxes, compliance, delays, neglect) is the biggest and baddest. Interestingly, if refusal is the big one, then lowering taxes will give a windfall to developers, whereas if refusal is a small one, then reducing taxes will cause a drop in prices. This debate is fascinating from an academic point of view, but rather pointless if the aim is to solve the housing crisis.

    It is like watching a man being attacked by five dogs and debating which dog has the bigger bite. Far better to chase off ALL the dogs and save the man.

    • DelraiserMEMBER

      Brilliant!

      It really comes down to the short-termism and pocket pissing mentality that drives governemnt policy. Everything you have listed here (apart from point 7) is a stop-gap vote buyer with real negative long term consequences.

      The choke side is all about appeasing the NIMBY’s and pandering to a “good old days” mentality, and the demand side is about appeasing vested interests like banks, developers etc. under the guise of good policy.

    • Great comment! More like this, well thought out and reasoned rather than vitriolic attacks and slogans.

      Keep up the good work.

  5. I haven’t read the report yet, let alone the econometric modelling, but I wonder what assumptions they’ve used to come up with the conclusion that the grants increase house prices by less than the value of the grants themselves.

    That conclusion makes complete sense if you ignore credit constraints and assume FHBs can borrow as much as they want. In that case, giving a $7K grant to some purschasers should increase the price of homes but by less than $7K. However, if you assume that one of the major limiting factors for FHBs is how much they can borrow then that changes the effect of a grant dramatically (as Steve Keen’s pointed out time and again). If FHBs finance with a ‘conservative’ 90% LVR, a $7K grant (assuming they can meet serviceability requirements) gives them an additional $70K to spend. If 95%, they have an additional $140K to spend. I find it hard to believe that that additional $70 to $140K FHB spending money increases prices by less than $7K. There are also second round effects where those selling to FHBs, where grants have boosted the selling price, then have an increased deposit which they can again lever up with potentially 90%+ LVRs to bid up the prices of the houses they buy, and on it goes…

    • I’ve often wondered whether the FHOG actually increases State government revenue by more than it costs them. i.e. The increase in prices and turnover that it generates produces more Stamp Duty per punter than it cost the State Govt in the first place (especially if you consider the flow-on effect to existing vendors). This would increase state government revenue right up until the point when mortgage servicing costs became too much to bear even with the FHOG (i.e. now) and the whole thing collapses.

    • About that econometric modelling…the report doesn’t seem to provide anything of that nature, not even footnotes to suggest what their methodology and data-set might have been. Has anyone managed to find anything on this?

      Your notions of how a down-payment subsidy might magnify asset prices in the context of inelastic supply and latent demand has a fair bit of empirical backing in literature on the U.S. housing market pre-crisis. Do you happen to know of any Australian research along these lines? You mentioned Steve Keen, but I’m guessing this was more media commentary than actual published research?

      I doubt the HSAR modelling took this angle, and all the work on the price effect of the FHOG in Australia that I have come across thus far has been fairly simplistic. Generally it has been lumped it in with the whole raft of subsidies and tax breaks on housing and even then estimated price effects have been very, very low.

  6. tsport100MEMBER

    For a measure that was originally introduced to soften the introduction of GST, all FHB incentives are well and truly past their use by date.

    Unfortunately this HSAR Working Party’s analysis has about as much chance of guiding policy as the Rudd commissioned Henry Tax Review which recommend a gradually move to a uniform land tax (i.e. abolish Negative Gearing) and remove transfer taxes (stamp duty)….. this report has been sitting in the too hard basket for 2 years with only the ACT having moved to phase out stamp duty!

  7. I would not hold my breath that australian governments can inplement any meaningful changes, let alone a comprehensive overhaul of the taxation system.

    It must be obvious that neither the negative gearing nor the 50% discount on CGT can be abolished in isolation. To understand why, it helps to go back to the basic principles.

    Let us examine the negative gearing first. For the sake of argument, imagine two businesses, A and B, owned by the same parent entity. In year 1, Business A made $30,000 profit and Business B also made $30,000 profit. In year 2, Business A made $90,000 profit and Business B made $30,000 loss. The question is whether the profit made by these two businesses should be taxed separately (no negative gearing) or together (with negative gearing). In the former, each business should fully qualify for all tax breaks. If the “parent entity” happens to be an individual, the first $18,000 made by each business should be tax free and the remaining $12,000 should be taxed at the lowest marginal tax rate in year 1. In year 2, only Business A qualifies for the tax break and pays the tax for $90,000 (needless to say, Business B does not pay any tax in year 2). In the latter method, the parent business pays the same amount of tax for the combined revenue of $60,000 in each year.

    The above example makes abundantly clear that negative gearing cannot be abolished in isolation. It is coupled to the indexation of the income tax. The central question is whether an individual’s combined income should be taxed as a whole or as separate entities. A government can choose one of them but CANNOT have it both ways. Then the only way to abolish negative gearing is to separate wage incomes from investment incomes. In other words, each individual would be required to file two tax returns every year, one for wages and the other for investment incomes. The wages should be taxed as they are now. The investment income should be taxed at a flat rate that matches the corporate tax rate. Doing so would remove incentives for setting up a dummy share holding company or subdividing one’s income to multiple entities for taxation purposes, and thus would close loopholes.

    Now let us examine CGT. Capital gains should be taxed at half the rate as all other investment incomes. If the investment income is taxed at a flat rate of 30% then the CGT should be taxed at a flat rate of 15%. Capital gains can be taxed at the full flat tax rate of 30% only if capital losses are fully deductible from the other investment income. In other words, as long as a government is unwilling to allow full deduction of capital losses from the other investment income (which is a prudent thing to do to discourage excessive risk taking), CGT must be taxed at half the rate.

    The reason for this is again fairly obvious. In a short term for which the GDP growth of the country is negligible, a share market is a zero-sum game. There are equal amounts of capital gains as capital losses. And a government should not raise revenue from nothing! Other than this principle, there is also a practical reason. If capital gains are taxed at the same rate as risk-free bank interests, AND if capital losses are not deductible, nobody will invest a cent into shares. Such a silly policy would guarantee anaemic economic growth, probably a prolong recession or even a depression.

    I have always been in favour of abolishment of the negative gearing & each individual filing 2 tax returns. By the way, the recommendations in the Henry tax review are in the right directions but do not quite go far enough.