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Capital gains tax wont make housing more affordable

By Stephen Kirchner - posted Monday, 23 November 2009


When The Weekend Australian reported that the Rudd Government was looking at extending the capital gains tax (CGT) to the family home, it took only a few hours for Treasurer Wayne Swan to issue a press release dismissing the idea. Many commentators think a CGT on owner-occupied housing is good economics, but bad politics. In reality, it is bad economics too.

The principal residence exemption from CGT is blamed for skewing saving decisions in favour of housing, leading to “over-investment” in the housing stock. Together with the CGT discount introduced by the Ralph business tax reforms in 1999, the exemption is seen driving house price appreciation and reduced housing affordability due to increased demand. But this is a very partial analysis that ignores the supply-side of the housing equation.

House price inflation can only co-exist with “over-investment” in housing if constraints on new housing supply are preventing this investment expenditure from translating into additional dwelling units.

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The dwelling investment share of real gross domestic product (GDP) has cycled around an average of 6.3 per cent for most of the post-war period. Neither the introduction of CGT in 1985, nor the Ralph reforms in 1999, led to a fundamental change in dwelling investment as a share of the real economy.

However, dwelling investment as a share of nominal GDP has been steadily increasing, reaching a peak in 2004. Housing investment expenditure is increasingly showing up as house price inflation rather than as additional housing supply.

Australia is producing fewer dwellings per person than at any time since the late 1960s. Australia consequently faces a growing shortage of dwelling stock due to what Reserve Bank Governor Glenn Stevens has called “serious supply-side impediments” to the building of new houses.

The 2004 Productivity Commission inquiry into First Home Ownership noted that “changes to the capital gains tax regime, coupled with long standing negative gearing arrangements, were seen to have contributed to higher prices through encouraging greater levels of investment in housing,” but the Commission itself did not actually model the effects of the tax changes. If increased investment in housing is putting upward pressure on prices, this is an argument for easing supply-side constraints, not for further discouraging investment with a CGT. Like stamp duty, CGT is a tax on transactions that would reduce turnover in the owner-occupied housing stock and lead to a less efficient allocation of that stock.

Some mistakenly see a CGT on the family home as a way of soaking the rich. Yet a CGT on owner-occupied housing would most likely be accompanied by tax deductibility for mortgage interest payments, as in the United States, offsetting any increase in revenue from CGT.

The Treasury’s Tax Expenditures Statements are frequently misreported as a measure of the revenue forgone as a result of various CGT concessions. As the Treasury makes clear, its approach does not measure revenue forgone. The methodology makes no allowance for changes in behaviour on the part of taxpayers. In fact, the CGT share of Commonwealth tax revenue has nearly doubled since the Ralph reforms, demonstrating that lower tax rates often result in more revenue not less.

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In conjunction with negative gearing, the Ralph reforms were widely blamed for the housing boom in Australia in the early part of this decade. In reality, the boom was attributable to the inability of housing supply to respond flexibly to the increased debt servicing capacity of households in a low inflation and low interest rate environment.

The boom in house prices also occurred in the context of a bear market in equities between 2001 and 2003. It is hardly surprising that the demand for housing should increase at a time when prices of a major competing asset class are declining. Pronounced house price inflation was a global phenomenon at this time, arguing against the 1999 CGT concessions being the main cause.

Housing is not the only asset that qualifies for negative gearing and the concessional treatment of capital gains. The choice to invest in housing must be driven by factors other than CGT concessions and negative gearing, particularly given the much higher transaction costs associated with property compared to other assets such as shares.

Rather than increasing the already high tax burden on housing, policymakers need to tackle the structural impediments to new housing supply to improve housing affordability.

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About the Author

Dr Stephen Kirchner is a research fellow at the Centre for Independent Studies. He blogs Institutional Economics.

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