Addressing an inefficient tax system with land tax
What is the issue?
The issue at stake is New South Wales’ inefficient tax system. The inefficiency of the tax system of NSW results in housing affordability problems, a creeping of tax burden via stamp duty, housing market immobility, and fluctuations in stamp duty revenue. Addressing these issues will be beneficial for the State Government. A strong method of addressing the problems that arise out of this issue is by phasing out stamp duty and replacing it with a broad-based land tax. It will enable a more stable government revenue stream, lower house prices, less of a tax burden, and better mobility in the housing market, which will improve efficient allocation of resources.
What problems have arisen out of the issue?
The problems that have arisen out of an inefficient state tax system, particularly as it pertains to property and land, is that housing prices have failed to remain under control, the effective stamp duty rate has increased as house prices have increased, and there is less propensity to be mobile in the market.
Lack of housing affordability
House prices have not increased in line with wage growth or other living costs. Twenty years ago, house prices were rising in line with wages, CPI, and rent (Daley et al, 2018 p.25). However, between then and now house prices have been increasing at about twice the rate of rents, wages, and CPI (Daley et al, 2018 p.25). The percentage of households in the bottom half of the national income distribution whose housing costs have exceeded a third of their income rose from 15% to 20% between 1982 and 2007 (Wood, Ong & Winter, 2012a, p.332). There will come a point where no one will be able to afford the house sale prices and the market may crash. This will have a flow on effect on stamp duty revenue, which increases and decreases with average house prices. Therefore, a housing price crash can also impact the State’s finances.
Increased tax burden over time
Over the past 20 years, average rates of stamp duty have risen dramatically, due to the dramatic increase of average house prices (Daley, Coates & Wiltshire 2018 p.122). In NSW, the effective stamp duty rate has gone from less than 3% to 4% over the 20 years between 1995 and 2015 (Daley et al, 2018 p.123). The increase in stamp duty costs has a flow on effect to a lack of mobility and turnover in the market, which will be explained below.
Lack of mobility in the market
Stamp duty is quite inefficient. One of the ways that makes it inefficient is that it can produce market failures and inefficient economic outcomes. One of these is mobility in the property market. Because it is a conveyance tax, i.e. a tax on transactions, it makes those transactions more expensive. A more expensive transaction means that people are less likely to perform said transactions (Henry, 2010 p.49). This means people are less likely to move to a new house or purchase a new one. The result of the expense of stamp duty is that housing turnover has gone from about 8% a year in the early 2000s to less than 5% now (Daley et al, 2018 p.122). Reduced mobility is also an issue in housing markets as it slows the movement of property from lower value uses to higher value uses, which therefore results in an inefficient allocation of resources in the property market (Wood et al, 2012a p.335).
Exposes the state to fiscal fluctuations
The New South Wales State Government relies heavily on revenue collected by stamp duty. Property cycles are volatile which can expose state government finances to large fiscal holes (Irvine, 2020). This is an issue as it means that state governments may have to borrow more money, or limit public spending, which can have flow on effects with service delivery. Providing the State with a steady stream of income allows the state to spend more on infrastructure and service delivery, which will improve economic outcomes for the state.
Policy history, past attempts at fixing the problems
A significant historical advocate of land taxation was Henry George, and American classical economist. He proposed the abolition on all forms of taxation except for the collection of the ground rent from the value of the land, irrespective of the improvements made (McLaren, 2014 p.51). His intention with a land tax was that it would destroy land monopoly by making the holding of all land unprofitable unless it was being put to a profitable use, and that land speculation would not exist as that would no longer be cost effective (McLaren, 2014 p.51). George did not want land to be nationalised, instead he wanted it to be held in the hands of its respective owners, and then taxed accordingly.
There has been attempts at implementing a land taxation in Australia, most notably the enactment of the Land Tax Act 1910 (Cth) and the Land Tax Assessment Act 1910 (Cth). The aims of these laws was to break up large land holdings, and penalise land owners that were not Australian residents by imposing a progressive rate on unimproved land in excess of 5000 pounds (McLaren, 2014 p.51). The tax in this historical context was not meant to generate revenue, but to govern the market and allow for a more diverse ownership of land. In 1942, the Federal Government removed the States’ power to collect income tax, leaving them with remarkably less revenue raising power (Mangioni, 2018 p.192). In 1952, the Land Tax Abolition Act 1952 (Cth) was enacted and it abolished the land tax at a federal level. After this, Australian States adopted some form of land taxation (McLaren, 2014 p.52). There is no constitutional impediment for the Commonwealth reintroducing a land tax, however it is more likely that Australian States are going to introduce or broaden their own land taxation.
More recently, in 2010, the Henry Tax Review, a root and branch review of Australia’s tax system, gave four recommendations regarding land tax and conveyance stamp duty:
“Recommendation 51: Ideally, there would be no role for any stamp duties, including conveyancing stamp duties, in a modern Australian tax system. Recognising the revenue needs of the States, the removal of stamp duty should not be achieved through a switch to more efficient land taxes, such as those levied on broad consumption or land bases. Increasing land tax at the same time as reducing stamp duty has the additional benefit of some offsetting impacts on asset prices.
Recommendation 52: Given the efficiency benefits of a broad land tax, it should be levied on as broad a base as possible. In order to tax more valuable land at higher rates, consideration should be given to levying land tax using an increasing marginal rate schedule, with the lowest rate being zero, determined by the per-square-metre value.
Recommendation 53: In the long run, the land tax base should be broadened to eventually include all land. If this occurs, low-value land, such as most agricultural land, would not face a land tax viability where its value per square metre is below the lowest rate threshold.
Recommendation 54: There are a number of incremental reforms that could potentially improve the operation of land tax, including:
(a) ensuring that land tax applies per land holding, not on an entity’s total holding, in order to promote investment in land development;
(b) eliminating stamp duties on commercial and industrial properties in return for a broad land tax on those properties; and
© investigating various transitional arrangements necessary to achieve a broader land tax” (Henry, 2010 p.90)
Another attempt at addressing lack of housing affordability, albeit unsuccessfully, is negative gearing. The idea was that it was going to incentivise investment in construction, leading to more housing stock and thereby putting downward pressure on rents and average house prices (Pawson, 2018 p.122). However, house prices and rents have continued to grow beyond the rate of CPI, wages, and general economic growth. Scholars have considered this policy to be a more sinister form of market-based welfare (Pawson, 2018 p.122), by encouraging the private sector to provide housing supply and affordable housing. This is designed to ensure the State does not have to provide social housing of its own.
Another policy tool that attempted to address the affordability issue was a first homeowner’s grant and the varying concessions around it. The idea was that it made it easier to access a deposit for a new house, therefore enabling more people to enter the housing market. However, the unintended consequence was increased house prices due to a surge in demand for housing that outstripped housing supply (Davies, 2020). Homeowners who were selling knew that they could sell for just a bit more as the government was giving away money into the housing market, in the hopes that it would improve housing affordability. The theme with some of these government incentives is that they had unintended consequences of pushing up housing prices more than is needed.
Key arguments
The debate on land tax has been going on for more than one century. Here the debates for and against land taxation will be outlined and discussed.
Proponents
Many see land taxation as solving a loophole in aggregate taxation. The theory is that “when a tax is applied conditional on the use of a factor input (land, labour or capital) in production, the resource will flow out of the types of production that are taxed and into the untaxed ones (Wood et al, 2012a p.335). This is because the post-tax return on investment is lower when a tax is applied on a certain factor of production.
Proponents see a broad-based land tax, when uniformly applied, avoids distortionary effects resulting from the current taxation arrangements (Wood, et al, 2012a p.335). They see a land tax as appropriately addressing the market failure caused by the current system, which gives us skyrocketing house prices and an unstable revenue stream for the State Government. It has the potential to generate $5 billion in gross state product growth, due to mobility in the market (McNally, 2016).
Who are key proponents?
There are several proponents of this sort of tax change. Many of them being economists. Some significant proponents include Ken Henry, who was Treasury Secretary under the Howard and Rudd Governments. He authored the landmark Henry Tax Review which was a root and branch analysis of the current tax and transfer system, and a list of recommendations on how to change the system to improve efficiency. Four of his recommendations related to land taxation and scaling back and abolishing stamp duty.
The current Reserve Bank of Australia Governor Phillip Lowe has indicated support for a land tax, as he wants Australian Federal and State Governments to rethink the way we tax income generation, consumption and land (Rollins, 2020). When one talks about reforming the way we tax resources and land, they typically want taxation to better tax the economic rent of land and resources, and to appropriately price externalities.
Dr Gareth Bryant of the University of Sydney is also a proponent of a land tax. He argues that the three key arguments for a land tax is that it is simple and stable, efficient, and that it is fair (Kelly, 2019). He argues that economists like land taxes because they are levied on unimproved land, meaning that the building on the land or improvements on the land are not taxed. This means that the tax does not discourage productive use, and does not behave like a value added tax, in the way that stamp duty does (Kelly, 2019). The price one pays for stamp duty is dependant on the value of their property. If they improve the land and property, the stamp duty will increase, making it harder to sell the property as fewer people will be able to afford the stamp duty charges, let alone the value of the property.
The Grattan Institute is also in favour of abolishing stamp duty and replacing it with a land tax. They see that it could raise $7 billion nationally, if adopted by all State Governments (Daley, Duckett, Goss, Terrill, Wood, Wood & Coates, 2018 p.84). They believe that stamp duty distorts decisions about land use, while taxes on land do not. This is because it is broad based, and just about no piece of land is immune from the tax (Daley et al, 2018 p.84).
Having strong academic backing to an idea makes it more viable as a policy option. It also demonstrates that it is not an idea that has been plucked out of thin air.
Opponents
Opponents of replacing stamp duty with a land tax is its effect on prices. They believe its effect on prices are less clear than a stamp duty, as they think it could either push prices up, or bring them right down (Murray, 2018). Opponents may also be concerned about the validity of the housing mobility problem. Opponents to this reform see policy solutions that slow down housing turnover and capital gains as a better idea than taxing land (Murray, 2018). They believe the slowdown in housing turnover over the past 20 years is due to investors buying houses to speculate on, rather than people being locked out of the market by stamp duty (Murray, 2018). Another point that opponents of land taxation make is that it may produce a less stabilising form of taxation. They see the stamp duty revenue rising and falling with house prices as a stabilising measure (Murray, 2018). Their idea is that an efficient tax increases its takings during boom periods and reduces its takings in economic downturns. Opponents may also see a broad based recurrent land tax as an impost on many households, being a relatively visible tax, and might disadvantage asset rich, income poor households without an appropriate deferral system (Eccleston, Warren, Verdouw & Flanagan, 2017 p.13)
Critique of Opponent’s views
Opponents have 3 major concerns about the land tax, which being its effect on prices, the problem of mobility in the market, and revenue stability. These points can be addressed. As for prices, it can be argued that a land tax keeps prices low, or in keeping with economic growth, wages, rents, and CPI. This is because it penalises landowners for not improving their land or waiting for it to rise in value. If you wait for it to rise in value, the amount of tax needed to be paid will increase.
Key Stakeholders for Land Tax
There are several key stakeholders when it comes to levying a land tax. Here the stakeholders will be outlined and the reasons for them holding a stake will also be outlined.
State Government: The State Government is a direct stakeholder as it relies on revenue collected from stamp duty. It would therefore stand to reason that they would have an interest in the changing revenue structure that would occur if stamp duty is phased out and land tax is phased in. In particular, the Treasury is a significant stakeholder within the State Government.
Homeowners: Homeowners are likely to be affected by changes to stamp duty and an introduction of land tax. Land tax is more likely to be a visible tax which may affect household disposable income. It will also affect how much they would be able to sell their house and land for. However, related to the home buyers’ section, it will be easier to purchase other houses due to the reduction in average land values.
Home buyers: This category of stakeholder is significant, as they will immediately feel the impact of a change in tax regime. They will be affected by lower house prices. This will make it easier for them to enter the housing market, or it will make it easier to move around the housing market.
Property developers: Property developers are likely stakeholders in the change from stamp duty to land tax as it will change how much they can charge for land and construction. It may also have a positive impact on property developers. When they want to purchase land to develop on, it might be cheaper to purchase the land due to the existence of a land tax on unimproved land.
Real estate agents: Real estate agents are in a similar boat to property developers. The commission they make is based on the sale of property. If the property value is lower, it makes sense their returns may also be lower. However, housing supply may increase with the imposition of a land tax, as it incentivises productive uses of land. Due to the increased housing supply it may benefit the real estate agency industry due to more houses to sell. Economies of scale may offset the reduced commission made per property due to the land tax.
Political Constraints
There are going to be political constraints whenever dealing with tax reform. Tax reform is hardly a popular issue and raising new taxes can be politically unpopular (Kelly, 2019). People are currently used to stamp duty and may see a land tax as an impost on the family home, this would be, optics wise, politically harmful (Kelly 2019). However, it can be stated that individuals in the state would not be taxed any more than they currently are. It critically needs to be stated that this is not a tax upon a tax. The idea is to phase out stamp duty and replace it with the land tax. Communication is going to be key to making this a politically viable move.
As for the Minister’s political affiliations, the current Treasurer is a member of the Liberal Party, being part of the current Berejiklian Ministry. The political affiliation of the Treasurer should not be a significant issue for this policy change. It is traditional for Liberal governments to aim for smaller government and lower taxes. However, at present, the current government is spending a great deal of money on infrastructure construction. This new tax regime will assist the government in funding these projects and would ensure they do not have to rely on asset recycling or cutting government services. It must also be noted that the current Treasurer is open to the idea of tax reform, particularly abolishing stamp duty and implementing land tax reform (Smith & Wade, 2020). It can therefore be stated that the Minister’s political affiliations should not have an impact on the viability of this reform.
Electoral significance
The electoral significance of such a policy depends strongly on how it is framed, communicated, and sold. Introducing new taxes to Australia is not generally a popular move (Kelly 2019). This policy change could have both positive and negative electoral impact. On the one hand, one could view this policy change as having a positive electoral influence, as you have just reduced the value of land, thus making housing more affordable. On the other hand, one could see it as a negative impact because you have just made it less attractive to sell properties at higher prices. Therefore, it could be said that this tax policy reform would have a neutral net electoral significance. It might be popular to some of the populace, and less popular to other parts of the populace. It also does not require any sort of referendum, so can be done entirely through legislating in Parliament.
The policy solution
What is a Land Tax?
A land tax is levied on the value of land, including owner occupiers (McLaren, 2014 p.45). It is a tax that is difficult to avoid since land is immobile. Because of this, people cannot change their behaviour to avoid the tax, apart from not owning any land or property in the first place (McLaren, 2014 p.45). It is largely levied on the unimproved value of land. This should encourage the improvement of the land. This can include building a home on the land, using it for manufacturing or agriculture. It can have the effect of boosting housing supply, and increasing economic production.
Why implement a Land Tax?
A land tax is quite different to other forms of tax, such as company tax and income tax. Both of those taxes are on productivity and people’s work effort (McLaren, 2014, p.45). A land value tax is levied on landowners and does not actually distort the supply of land, like the other taxes distort work effort or capital. Rather, a land value tax ends up taxing the economic rent of the landowner.
What is economic rent?
Economic rent, simply put, is the “return over and above the return necessary for the activity to take place” (McLaren, 2014 p.47). Another way of putting it is total revenue minus total economic cost (McLaren, 2014 p.49). A land tax is designed to tax that economic rent, in the attempt to keep property and land prices reasonable.
Who would be most impacted by a land tax?
Studies show that the decline in land value as a result of a land tax would be felt the most in and around central business districts, where the land value is the highest (Wood, Ong, Cigdem & Taylor, 2012 p.42). In suburbs further away, the reduction in land value will not be as significant. The result of this change in land value is that more people will have access to higher land use intensity areas, such as central business districts and inner suburbs. This might make transit-oriented development even more attractive than it currently is. If one currently lives in the outer suburbs of a city, and works in the centre of the city, a land tax could incentivise them to move closer to their place of work. This would reduce their travel costs, and could have a positive environmental impact on the State.
Implementing a Land Tax
Initially, the necessary legislation to levy a tax should be passed by both houses of New South Wales Parliament. It is likely that this measure would pass the particularly troublesome Legislative Council.
The implementation of a land tax should be staged and orderly. What is meant by this is that land tax should be phased in, while stamp duty should be phased out. A significant example of this is the Australian Capital Territory, who over 20 years are transitioning to a land tax. It would be unwise to impose a land tax overnight, as suddenly everyone is imposed with a tax. This could be important for elderly people, whose retirement incomes and pensions may not be enough to pay for land tax payments. This can be addressed by moving properties to the land tax regime as they are sold. This means that no current homeowner would pay tax on their property and land for which they have already paid stamp duty (Wood et al, 2012a p.345). This prevents a form of double taxation.
The rate of land tax should be in a progressive structure, where the rate changes depending on land values per square metre (Wood et al, 2012 p.52). It can then be argued that a progressive land tax will be redistributive in its effects, with the revenue generated from it going to much needed infrastructure projects and maintenance.
The transition of housing onto a new taxation regime will need to be gradual, taking multiple years. An advantage of this is that it would prevent possible disruption in land and housing markets that might be triggered by some overnight change (Wood et al, 2012 p.346). However, it needs to be noted that there will be a potential disadvantage with this transitional arrangement. It is likely that there will be a short-term revenue shortfall during the transition period (Wood et al, 2012 p.346). Stamp duty revenue is a significant source of income for State Governments, so it would be understandable why States may not want to forego such revenue, in the transition period. However, governments need to be thinking long term, and should understand the long term benefit this reform would have on the State’s finances, and its overall effect on the property market and economy as a whole.
Conclusion
The current taxation regime for the New South Wales State Government is inefficient, and results in house prices skyrocketing out of control, stamp duty rates increasing in real terms, and market immobility. This does not promote a healthy economy, and it also renders the revenue steam the State Government relies on to be unstable, and subject to market conditions, in this case, house and property prices. Stamp duty is regressive and locks people out of the property market. It also allows unimproved land to go untaxed. Phasing in a broad-based land tax while also phasing out stamp duty will address these issues. It will enable a stable revenue stream for the State Government, reduced property, and land values, particularly in high intensity use areas, and more market mobility, fostering an efficient allocation of resources in the economy. The implementation of a land tax needs to be gradual, preferably over a period of years, possibly a decade or two. This should prevent shocks in the economy, which are undesirable. It also allows the public to get used to the idea of not having to pay stamp duty upfront, rather they would be paying a yearly bill. This tax reform has a higher chance of being successful than otherwise because it has strong academic backing via the Henry Tax Review, which gives recommendations on the implementation of a land tax, a history of performing its role (back when Australia had a federal land tax), plus the current Treasurer, Dominic Perrottet is open to the idea of scaling back inefficient taxes, including stamp duty and payroll taxes. He is also open to a land tax. “Selling” this reform may be tricky, as some New South Wales residents may not like to be imposed with a yearly tax. It needs to be marketed in a way that shows how beneficial it is, including how it can make housing more affordable for more people. This form of tax reform is long overdue and will give the State an economic and financial boost.
References
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