Land tax must kill negative gearing, stamp duty

ScreenHunter_04 Nov. 12 09.44

By Catherine Cashmore, a market analyst and journalist with extensive experience in all aspects relating to property acquisition. Follow Catherine on Twitter or via here Blog.

There’s been a lot of debate around property taxation in Australia – significantly negative gearing, which allows an investor to use the short fall between interest repayments and other relevant expenditure, to lower their income tax.

The policy promotes speculative gain meaning the strategy is only profitable if the acquisition rises in value rather than holding or falling. Therefore, in Australia, investor preference is slanted toward the established sector – the sector that attracts robust demand from all demographics and as such, in premium locations, has historically gained the greatest windfall from capital gains.

Aside from the impact this creates in terms of affordability – pushing up the price of second-hand stock, burdening new buyers with the need to raise a higher and higher deposit just to enter ownership – it also negatively affects the the new home market, which traditionally struggles to attract consistent activity outside of targeted first homebuyer incentives; albeit, the headwinds resulting from planning constraints and supply-side policy should also not be dismissed.

Additionally, Capital Gains Tax and stamp duty have also received much debate. Both are transaction taxes, and therefore have a tendency to stagnate activity, acting as a deterrent to either buying and selling.

Stamp duty as modeled by economist Andrew Leigh, is shown to produce a meaningful impact on housing turnover, leading to a potential mismatch between property size and household type – a deterrent to downsizing and therefore selling.

Additionally, it burdens first-time buyers by increasing the amount they need to save in order to enter the market. Frequent changes of employment concurrent with a modern day lifestyle are also hampered, as owners are unwilling to move any meaningful distance outside their local neighbourhood, and search for work in local areas alone.

But, outside of academia and intermittent articles, there is scant debate in Australian mainstream media regarding land value tax and it’s practical impact.

The theory is taken to its extreme, and best advocated by American political economist and author Henry George who wrote his publication ‘Progress and Poverty’ 1879 – an enlightened and impassioned read – and subsequently inspired the economic philosophy that came to be known as ‘Georgism.’

The ideals of Henry George reside in the concept that land is in fixed supply, therefore we can’t all benefit from economic advantage gained from ‘ownership’ of the ‘best’ sites available without effective taxation of the resource.

George advocated a single tax on the unimproved value of land to replace all other taxes – something that would be unlikely to hold water in current political circles. However, his ideals won favour amongst many, including the great economist and author of “Capitalism and Freedom” Milton Friedman and other influential capitalists such as Winston Churchill, who gave a powerful speech on land monopoly stressing:

“Unearned increments in land are not the only form of unearned or undeserved profit, but they are the principal form of unearned increment, and they are derived from processes which are not merely not beneficial, but positively detrimental to the general public.”

In essence, raising the percentage of tax that falls on the unimproved value of land has few distortionary or adverse affects. It creates a steady source of revenue whilst the landowner can make their own assessment regarding the timing and type of property they wish to construct in order to make profit without being penalised for doing so.

However when the larger percentage of tax payable is assessed against the value of buildings and their improvements – through renovation, extension or higher density development for example – not only can those costs be transferred to a tenant, there is less motivation to make effective use of the site – having a flow on effect which can not only exacerbate urban ‘sprawl’, but also increase the propensity to ‘land bank.’

The Henry tax Review commissioned by the Government under Kevin Rudd in 2008 concluded that “economic growth would be higher if governments raised more revenue from land and less revenue from other tax bases” proposing that stamp duty (which is an inconsistent and inequitable source of revenue) be replaced by a broad based land tax, levied on a per-square-metre and per land holding basis, rather than retaining present land tax arrangements.

The Australian Housing and Urban Research Group attempted to mimic the proposed changes using their AHURI-3M micro-simulation model in a report entitled The spatial and distributional impacts of the Henry Review recommendations on stamp duty and land tax.

And whilst it’s difficult to qualify how purchasers may factor an abolition of stamp duty into their price analysis, perhaps adding the additional saving into their borrowing capacity, and therefore not lowering prices enough to initially assist first homebuyers, it does demonstrate how over the longer-term falls in house prices have the potential to exceed the value of land tax payments, assisting both owner-occupier and rental tenant as the effects flow through.

Additionally, increasing the tax base would provide developers with an incentive to speed up the process and utilise their holding for more effective purposes. And importantly for Australia, it can provide a reliable provision of revenue to channel into the development of much-needed infrastructure.

The rational for this is coined in the old real estate term ‘location, location, location.’ Everyone understands that in areas where amenities are plentiful – containing good schools, roads, public transport, bustling shopping strips, parks, theatres, bars, street cafes and so forth – increases demand and therefore land values, invoking a vibrant sense of community which attracts business and benefits the economy.

The idea behind spruiking a ‘hotspot’ – such a common industry obsession – is based on purchasing in an area of limited supply, on the cusp of an infrastructure boom, such as the provision of a new road or train line for example, enabling existing landowners to reap a windfall from capital gains and rental demand for little more effort than the advantage of getting in early and holding tight whilst tax payer dollars across the spectrum fund the work.

Should a higher LVT be implemented, the cost and maintenance of community facilities could, in part, be captured from the wealth effect advantaging current owners, compensating over time for the initial outlay. Imagine the advantage this would offer residents in fringe locations who sit and wait for the failed ‘promises’ offered, when they migrated to the outer suburbs initially?

Take New York for example – between the years 1921 and 1931 under Governor Al Smith, New York financed what is arguably the world’s best mass transit system, parks, libraries, schools and social services shifting taxes off buildings and onto land values and channeling those dollars effectively.

The policy influenced by Henry George ended soon after Al Smith’s administration, and eventually lead to today’s landscape – a city built on a series of islands, with limited room to build ‘out’ facing a chronic affordable housing shortage with the population projected to reach 9.1 million by 2030.

More than a third of New Yorkers spend half their paycheque on rent alone yet like London, there is little motivation for developers to build housing to accommodate low-wage workers concentrating instead on the luxury end of market, broadening the gap between rich and poor as land values rise and those priced-out, find little option but to re-locate.

New York’s Central Park is the highest generator of real estate wealth. The most expensive homes in the world surround the park with apartments selling in excess of $20 Million, and newer developments marketed in excess of $100+ million.

Like London it’s a pure speculators paradise – in the ten-year period to 2007, values increased by 73% – owners sit on a pot of growing Gold and there’s little to indicate America’s richest are about to bail out of their New York ‘addiction’ with an expansive list of ‘A’ class celebrities, high net worth individuals, and foreign magnates, owning apartments in the locality.

New Mayor-elect Bill de Blasio who won his seat, based on a promise to narrow the widening inequality gap – preserve 200,000 low and middle income units, and ensure 50,000 affordable homes are constructed over the next decade, will struggle to subsidize plans whist facing a deficit reputed to be as much as $2 billion in the next fiscal year.

Yet economist Michael Hudson has recently assessed land values in New York City alone to exceed that of all of the plant and equipment in the entire country, combined.

Currently more than 30 countries around the world have implemented land value taxation – including Australia – with varying degrees of success not only based on the percentage split between land and property, but how those funds are channeled back into the community, and the quality of land assessments in regularly updating and estimating value.

Pennsylvania is one such state in the USA to use a system which taxes land at a greater rate than improvements on property – I think I’m correct in saying nineteen cities in Pennsylvania use land value tax with Altoona being the first municipality in the country to rely on land value tax alone.

Reportedly, 85% of homeowners pay less with the policy than they do with the traditional flat-rate approach. When Mayor of Washington county Anthony Spossey, who also served as Treasurer from 2002 to 2006, and under his watch enacted an LVT was interviewed on the changes in 2007, he commented:

“LVT ..helps reduce taxes for our most vulnerable citizens. We have an aging demographic, like the county, region and the state. Taxpayers everywhere are less able to keep up with taxes, and that hurts revenue. LVT helps us mitigate the impact both to them and the city. It’s a win/win..”

Until fairly recent times, another good example to cite is Pittsburgh. Early in the 1900s the state changed its tax system to fall more on the unimproved value of land than its construction and improvements.

Pittsburgh’s economic history is a study in itself, and has not been without challenges. For those wanting to research further, I strongly advocate some of the writings of Dan Sullivan – (former chair of the Libertarian Party of Allegheny County, (Pittsburgh) Pennsylvania) – who is an expert on the economic benefits of LVT and has written extensively on the subject.

Sullivan demonstrates that Pittsburgh not only enjoyed a construction boom whilst avoiding a real estate boom under a broad based LVT system, but also effectively weathered the great depression whilst maintaining affordable and steady land values along the way.

In comparing it to other states struggling to recover from the recent ‘sub-prime crisis’ he points out:

“In 2008, just after the housing bubble broke, Cleveland led the nation in mortgage foreclosures per capita while Pittsburgh’s foreclosure rate remained exceptionally low. Since then, the foreclosure rates in Las Vegas and many Californian cities, none of which collect significant real estate taxes, have passed Cleveland’s foreclosure rate. However, on September 15, 2010, The Pittsburgh Post-Gazette reported that while at the end of the second quarter of 2010, 21.5% of America’s single-family homes had underwater mortgages (the American term for negative equity), only 5.6% did in Pittsburgh. As a result Pittsburgh was top of a list of the ten markets with the lowest underwater mortgage figures.”

When land value tax is implemented – with the burden taken of buildings and their improvements ensuring good quality assessments and sensible zoning laws – it not only assists affordability keeping land values stable, but also benefits local business through infrastructure funding, discourages urban sprawl, incites smart effective development of sites, reduces land banking, and as examples in the USA have demonstrated – assists in weathering the unwanted impacts of real estate booms and busts.

Despite the numerous examples across the world where a broad based land value tax has been deployed successfully, changing policy and bringing about reform is never easy and rarely without complication.

Additionally, the implications of a yearly tax on fixed ‘low-income’ retirees must be handled with care and understanding, as there are ways to buffer unwanted effects whilst changes are implemented.

Therefore, the process adopted in the ACT which is abolishing stamp duties over a slow transitional 20 year period to phase in higher taxation of land is not altogether unwise.

With any change to the tax system, the headwinds come convincing the public that it’s a good idea. In this respect, balanced debate and conversation is necessary, as questions and concerns are brought to the fore.

The increased tax burden also falls on those who have significant influence across the political spectrum; therefore strong leadership to avoid lobbying from wealthy owners with vested interests is essential.

Albeit, as I said last week, we have a new and growing generation of enlightened voters who are well and truly fed up with battling high real estate prices, inflated rents, and care not whether it’s labelled as a ‘bubble’ – but certainly care about their future and that of their children.

Therefore – I do see a time when all the ‘chatter’ around affordability, will finally evolve into ‘real’ action – and a broad based LVT should form an important part of that debate.

Unconventional Economist
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  1. Very good article.

    Required reading for politicians, policy makers and journalists across the land.

    Of course, such a policy would be unpopular with those currently placing all their chips on a negative geared speculation on capital gains.

    And as they are out and about at the moment with a spring in their step, we can expect all sorts of comments about how land tax is a govt impost beyond the pale.

    And lots of stories about retirees driven from their homes.

    Oh so predictable.

    With a sensible approach to its introduction – see the ACT – it would be a potent reform.

    Combined with reform on the supply side and financing of new development it could be a spur to productive investment that improves our competitivness.

  2. We might have a better chance of reforming the system if we call it an “infrastructure levy” rather than a “land tax”?

    • It could be introduced around railway stations and the like as an infrastructure levy.
      I too dislike the name land-tax. It is a fair user-pay fee (paid to the community) for using a community resource that way created by no man.

  3. Sound economics and sound public policy, Catherine.

    The astute application of land tax has an interesting consequence for government too. If they undertake an infrastructure project that does not raise land values (I think of Melbourne’s East-West road tunnel) then it wont lift tax revenues. The consequences of mal-investment are immediately apparent.

    • Yes, that is an important point.

      Dud infrastructure investment decisions that do not generate real value will quickly been seen as such.

      In a short time, people will quickly clue on to the fact that good infrastructure generates economic value and the value of property will reflect that.

      The impact of non urban infrastructure development on land values in non urban locations could be a powerful driver for the development of regional Australia.

      • Pfh, please tell me more about the non-urban drivers you see. This is not a trick question. Our country has been centralizing on its capital cities for a century and many minds have been devoted to our underutilized hinterlands and the democratization of land access. I am eager for ideas.

        • Nothing specific beyond that the cost of land outside our capital cities should be a major opportunity for businesses of all types – lower cost land, lower cost employees (attracted by lower cost residential land etc).

          Instead, land costs in many regional locations remain high and the costs of changing use or developing the land are high.

          Few people ask the question?

          Why are so few new settlements and towns created in Australia?

          Transport is cheaper and faster than ever before yet our towns remain a relic of the 19th century pattern of development.

          We were better at developing regional Australia 150 years ago when there was little planning and development was largely organic.

  4. There is great potential behind LVT. The key is education. Once the majority (see link ‘85% of homeowners pay less’ above) understand they will be better off personally and that infrastructure will also improve, then the old system will no longer appeal.
    So the questions are, how to educate mainstream and how to seed the idea at Federal level?
    At Federal level, it is going to be a walk in the park for a new party promoting LVT. The spin-off is more affordable housing for future generations and an end to speculative investing. Labor & Libs are going the way of the dinosaur unless they adapt.
    Regards education of mainstream – Prosper Australia has done a good job.
    The page needs propagation.

  5. No offence to the MB team but as was stated in another thread: MB is just preaching (very convincingly) to the converted.

    This topic is being ducked by both sides of politics and the msm. Heck even the ABC (Q&A and Four Corners) won’t seriously tackle this ‘elephant in the room’.

    I think that either some sort of poltical party needs to be formed and one whole episode of Q&A with Leith,Catherine, Steve Keen, Bill Shorten and Joe Hockey needs to be aired.

    • As HnH stated yesterday, macro-prudential was an elephant in the room too. Now with many economists mentioning it, the return to mainstream speak has happened. It helps that NZ actioned MP of course but it is there and a serious topic for debate.

      There is no reason why concerted campaigns like or the aged demographic concerns cannot eventually reach mainstream conscience. Just takes time and continued message spreading.

    • Kliff_Fiscal,

      Policy debates like this can take years but over time fringe ideas that are sound can become received wisdom.

      The reforms of the 1980s were debated endlessly within the political tribes and across the political divide.

      Persistence, patience and engaging with opposing opinions will gradual refine excellent policy but more importantly spread new ideas through the community – starting usually with a new generation of opinion makers.

  6. It’s very nice to read an article that actually contains some analysis that is not obviously biased by idealogy. I hope to see more articles by Catherine in MB in the future. Now let’s turn to the article and arguments themselves.

    There appears to be some conflation of independent issues in Catherine’s article. Catherine uses the AHURI research report to imply that they had modeled the effects of the Henry review recommendations including: stamp duty, land tax and negative gearing. Scanning through the two relevant AHURI reports, removal of negative gearing is NOT included in the modeling.

    To summarise the points made by Catherine we have the following:

    1. Negative gearing promotes activity in the housing market (which Catherine defines as buying and selling property) due to investors chasing capital gains.
    2. Stamp duties (and capital gains tax) are transactional taxes that inhibit activity in the housing market.
    3. AHURI modeling of Henry Tax Review recommendations suggest renters and home-owners are better off.

    Some Questions:

    A. Given the Henry recommendations modeled by AHURI do not include abolition of negative gearing, why is this post titled “Land tax must kill negative gearing, stamp duty”? The argument put forward by Catherine is not strong in support of this contention with respect to negative gearing – stamp duty yes but not negative gearing.

    B. The modeling shows that abolition of stamp duty is enough to make renters and home-owners better off (in a tax system that retains negative gearing for property investors), so is there any modeling or research that shows what ADDITIONAL benefits and costs arise from removing negative gearing, and whether there is a NET benefit to removing negative gearing?

    As an interesting aside, the AHURI reports reference a number of studies that demonstrate that restrictions on gaining access to bank loans is detrimental to home ownership. This suggests that calls to introduce macroprudential constraints on peoples’ ability to obtain loans are misplaced. Does anyone have any evidence to the contrary? And the unfolding New Zealand situation does not provide evidence either against or in favour of macroprudential policies.

    • Macroprudential policies are largely a temporary solution to a problem which is properly solved by supply side reforms. Certainly that is the way they are being used in New Zealand.