It’s time to stop subsidising speculation on housing.

Listener: 19 September, 2013.

Keywords: Regulation & Taxation; Social Policy;

Scared by finance company failure, you decide to invest some of your savings in a rental property. You borrow just enough so the tenant’s payments cover the interest, rates and other outgoings. The return you get is not from those payments but from the capital gains, on which you pay no tax and which are high because the price of housing is rising.

Why do housing prices rise? There are numerous reasons but a major one is that housing is not simply something people live in. It can also be an investment with a good return. Sure, there may be some supply shortages – especially in Christchurch – which contribute to rising house prices, but even a major building programme will not increase the amount of accommodation sufficiently to head off price rises. Regrettably, much of this price-raising demand comes from the lack of a capital gains tax, with the borrowing – or leveraging – giving you an even greater return.

A capital gains tax is one of those things that never quite get onto the public policy agenda, perhaps because too many influential people avoid paying taxes by investing in capital gains. That does not include ordinary homeowners. Sure, they make a profit when they sell their houses but they promptly make a loss when they buy the next one. A capital gains tax needs be levied only on investment homes, the houses owned in addition to the one you live in.

I see no need for an onerous capital gains tax designed to expropriate private wealth. It would not be retrospective but use as the base the rateable value at the time of implementation. Only increases above the rate of consumer inflation need be treated as the capital gains to be taxed.

Taking the demand pressure off housing as an investment, even on the margin, will slow down housing inflation. And yes, people will have to start investing in real production, not bubbling paper.

Special interests will object with a host of arguments to the effect that – well, er – they will be worse off. Of course they will be. The absence of a capital gains tax is a subsidy; withdraw the subsidy and they are worse off.

Because they are not as well-organised, there is not the same outcry from those being squeezed out of owning a home by the inflating price of housing stimulated by the government subsidy to speculators. The family renting your investment may well have been outbid for their home by a better-capitalised investor simply after the best return.

Won’t the proposed restrictions on mortgage advances to those with small deposits help? Although it is popularly presented in terms of its effect on prices, this is but one of various Reserve Bank initiatives aiming at improving the robustness of the financial system. This one is about a possible bursting of the housing bubble. Banks with borrowers with too little equity relative to debt are less robust than those with better margins. You can now have even more confidence in the strength of your bank.

This restriction probably will reduce the demand for housing a little, especially from first-home buyers. In any case, people will find ways around the restriction. That will increase the vulnerability of those who deposit their savings with second-mortgage lenders: be warned.

What is going on here is a common problem: the Government fails to act. In this case, it continues to subsidise investment in housing, but more commonly the problem is a weak fiscal stance. So, we all hope someone else, often the Reserve Bank, will offset its cowardice. But in this case – and usually – the Reserve Bank does not have effective policy instruments to address the Government failure. Those are in the hands of the Government.

As long as policy confuses housing as a home with housing as an investment, we are going to get wasteful speculative investment in houses, a weaker performance of the economy, rising house prices and families without their own homes.