Opinion & Commentary
More houses, not taxes
When the Weekend Australian reported that the Rudd government was looking at extending the capital gains tax to the family home, it took only a few hours for Treasurer Wayne Swan to dismiss 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 savings decisions in favour of housing, leading to over-investment in the housing stock. Together with the CGT discount introduced in 1999, the exemption is seen as driving house price appreciation due to increased demand. But this is a 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 from translating into additional houses being built. The dwelling investment share of gross domestic product has been close to an average of 6.3% for most of the post-war period. Neither the introduction of CGT in 1985, nor the Ralph reforms in 1999, led to a change in housing investment as a share of the economy.
What has changed is the number of houses being built as a result of this investment. Australia is producing fewer houses per person than at any time since the late 1960s. We face a shortage of housing stock due to what Reserve Bank governor Glenn Stevens has called supply-side impediments to the building of new houses. These constraints explain why housing investment is showing up in higher prices rather than increased supply.
The 2004 Productivity Commission inquiry into first home ownership noted that changes to the capital gains tax regime coupled with longstanding negative-gearing arrangements were seen to have contributed to higher prices through encouraging greater investment in housing, but the commission did not model the effects of the tax changes. If increased investment is putting upward pressure on prices, this is an argument for easing supply-side constraints, not for discouraging investment with a CGT. CGT is a tax on transactions that would reduce turnover in owner-occupied housing 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 US, offsetting any increase in revenue from a CGT.
In conjunction with negative gearing, the Ralph reforms were blamed for the housing boom in Australia in the early part of this decade. In reality, the boom was caused by the inability of housing supply to respond flexibly to the increased debt-servicing capacity of households in a low inflation, 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 not surprising demand for housing increased when prices of a competing asset class were declining. House price inflation was a global phenomenon, arguing against country-specific factors as the main cause.
Rather than increasing the tax burden on housing, policymakers need to tackle the impediments to new housing supply to improve affordability.
Dr Stephen Kirchner is a research fellow at The Centre for Independent Studies and author of Reforming Capital Gains Tax: The Myths and Reality Behind Australia’s Most Misunderstood Tax, released in November.
