Busting the boomers

Economist Rory Robertson was recently quoted as saying "… there simply is no getting around the fact that the unexpectedly rapid increase in home (including land) prices has significantly devalued the lifetime earnings of non-homeowners, particularly young people."

The scale of this devaluation of earnings for the current generation of first home buyers is hard to quantify exactly, but to get some idea, we can consider that over the last 20 years Australian median house prices have gone from four times median income to about seven times median income.

If Sydney prices were on the 1986 multiple today, the median Sydney house would be $299,000 instead the current $523,000 (ignoring interest rate variations over both periods). For first home buyers in Sydney today this equates to (PDF 56KB) $224,000 extra to be paid on the purchase price of their house. Over the life of a 20-year mortgage including interest (at current rates) this blows out to a massive $453,000 extra to pay.

This $224,000 upfront cost to new home buyers is of course a $224,000 benefit to those with homes bought before the boom and in particular those with multiple houses bought before the boom. In generational terms, with the average age for a first home purchase being about 30 that means the main beneficiaries are people born before about 1968, a demographic overwhelmingly populated by the baby boomers (born approximately 1945-1961).

The bloating of Australian house prices was driven by multiple factors, including an extended period of low interest rates and land release policies that limited supply, matched with high immigration pushing demand. But another significant factor, which can still be seen at work every Saturday morning at auctions across the country, has been speculative property buying by baby boomers.

With federal tax incentives egging them on many boomers effectively got their hands on this generation’s first homes before they had a chance to save a deposit. In the stock market the equivalent practice is called “front-running”. If you see someone about to buy, beat them to it, raise the price and sell it to them shortly thereafter. It is not considered an ethical activity, and it is certainly not a productive activity economically.

Rather than saving for their retirements the hard way, many boomers planned to gamble their way to retirement riches by “borrowing virtually all the price of a rental property, then hoping capital gain and various tax lurks would cover the debt and leave them ahead” as one commentator put it. And so far it has worked, albeit at the direct expense of the next generation.

The challenge for the younger generation now is to figure out how to “revalue” their lifetime earnings. There are a lot of things that could be done politically to correct the current intergenerational financial imbalance, but unfortunately, as Australia enters its 24th year with a baby boomer as Federal Treasurer, none of them are likely to happen soon. Still, this is probably the right time to look at what can be done when the boomers do (finally) lose power.

There are many ways the problem can be approached. One option would be to move the tax and welfare systems to one that targets assets, particularly unproductive or uneconomic assets, rather than income. This could involve a wide range of tax changes such as increases in capital gains tax and land taxes and decreases in income tax. It could also include savings in welfare and subsidies paid to very asset rich but income poor farmers and retirees.

Such measures would have some impact and may ultimately be part of the solution but it is difficult to see how they could address the large amount of money young people are now behind. The most efficient and effective way to unwind the inequities would be to actively deflate the housing bubble and to put in place measures to prevent it from recurring.

While we could reasonably expect that over the long term that the housing bubble will deflate due to any number economic factors, particularly a rise in unemployment, there is no guarantee that it will do so in an equitable time frame. Japan’s housing bubble, for example, took 15 years to unwind. If that were to be the case here it would condemn an entire generation to a serious financial disadvantage.

Deflating the bubble and returning prices to a more moderate multiple of wages could be achieved through a combination of approaches. The removal of tax incentives for speculative housing investment could result in a lot of negatively geared properties being sold down. The tax changes could include an increase in capital gains tax to parity with the highest marginal tax rate, the removal of tax deductions associated with real estate investment and increases in land taxes associated with investment properties.