Prosper Australia

SPIN: The First Home Owners’ Grant (FHOG) helps first-time home buyers enter the market.

FACT: More precisely, the FHOG helps first-time buyers to compete with other buyers who can use the equity in their old homes to bid up prices. But by increasing bids from first-time buyers, the FHOG also raises prices, especially at the bottom of the market where first-time buyers are concentrated. Thus the FHOG partly defeats its own purpose. Moreover, the FHOG only helps people who are rich enough to be contemplating home ownership; it does nothing for life-long renters.

SOLUTION: Make the grant available only for new homes in order to encourage construction, so that the increase in demand is offset by the greatest possible increase in supply. Then make the grant available to investors as well as intending owner-occupants, so that the increase in supply extends to rental accommodation. But keep the grant in the form of a fixed sum per dwelling, so that investors have an incentive to build a larger number of cheaper dwellings rather than a smaller number of more expensive ones; that maximizes the supply at the affordable end of the market. In short, turn the FHOG into a New Home Builder’s Grant.

Because new homes and “first homes” historically account for similar fractions of turnover in the housing market, this reform would be roughly budget-neutral. But more of the outlay would be spent on increasing the supply of housing for the benefit of renters and first-time buyers, not pumping up prices for the benefit of established investors.

In 1978 the voters of California, resentful of increases in property tax assessments caused by rapidly rising land values, enacted Proposition 13, which added Article 13A to the state constitution. This Article limited annual property taxes to 1% of the assessed value, capped annual increases in the taxable value until the property was sold, and required that the assessed value be the combined value of land and buildings — not the value of the land alone as with the Australian “land tax”. Thus the voters ensured that property owners would be taxed more heavily than ever before, because land tax takes only as much from property owners as it delivers to the Treasury, while almost every other tax takes more from property owners than it delivers to the Treasury.

The overall supply of land is fixed. From the viewpoint of the taxpayer, the supply of land zoned for any particular purpose is also fixed, as is the supply of land within acceptable distance of any particular services, infrastructure, or markets. Yet access to suitably located land is essential to life and livelihood. Therefore land rents and land prices are competed upward until they absorb the entire capacity to pay. All taxes are deductions from that capacity. If a tax is only a deduction from taxpayers’ capacity to pay for land, it will take as much from landowners as it delivers to the Treasury. But most taxes do more than that; most taxes target productive transactions, causing otherwise viable transactions and hence otherwise viable enterprises to become unviable. Thus they reduce the total capacity to pay for land — and reduce the income of landowners — by more than the tax paid: property owners are overcharged!

Direct taxation of land values avoids the overcharge because the taxable value is independent of, and therefore cannot deter, any productive activity of the taxpayer. (Even selling the land does not destroy the taxable value or the incentive to use the asset productively, but merely transfers both to the buyer.) As there is no loss of production, property owners suffer no loss apart from the actual tax paid.

Voters don’t have a choice between property taxes and non-property taxes. They have a choice between visible, efficient property taxes and hidden, inefficient property taxes. The voters of California picked the latter.

Opinion pollsters have consistently found that voters are more likely to support or tolerate a proposed tax if the revenue is hypothecated (i.e. reserved or “earmarked”) for a purpose of which the voters approve. They catch is: how can the voters know that the revenue will be spent as promised?

For example, a rational property owner should support a property tax if the revenue is spent on infrastructure that raises his/her property values by more than the amount of the tax. But how does the owner know that the tax will be spent in that way?

If the tax is properly implemented, the answer is: “Because if the government doesn’t spend the revenue as promised, it won’t get the revenue!”

Suppose a tax recovers a fraction 1/x of all real increases in site values. Then the government will have a financial incentive to invest in any infrastructure project that increases site values by more than x times the cost of the project, because such a project will pay for itself (and more) through part of the uplift in site values that it causes, while the affected property owners will retain the rest of the uplift as an after-tax benefit. But if the government doesn’t proceed with the project, the uplift won’t happen and the associated revenue won’t come in. And you won’t contribute to that revenue unless your property increases in value.

A tax on uplifts in site values is not a means of raising revenue for promised projects that may or may not proceed as promised. Rather, it is a means of making desirable infrastructure projects pay for themselves if and only if they go ahead, so that the government doesn’t get the tax unless it delivers the infrastructure.

If you own a piece of land, the State government wants to know. Why? Because you expect the government to enforce your exclusive right to occupy or let that land. Moreover, as the total supply of land is fixed, it is a matter of public interest that you are depriving other people of a certain part of that supply. Fair enough.

If you claim a patent on an idea, the Federal government wants to know. Why? Because you expect the government to protect your exclusive right to profit from that idea, and because it is a matter of public interest that other people cannot use that idea without your permission. Fair enough.

But if you bake a loaf of bread and sell it, the Federal government still wants to know. Why? You’re not claiming an exclusive right to bake bread. The supply of bread isn’t fixed. You’re not taking bread from anyone else. So why should the government want to know what you’re doing? Because it wants to tax you for it!

And if you hire someone to help you bake the bread, the State and Federal governments want to know. Why? You’re not claiming an exclusive right to hire workers. You’re not even claiming an exclusive right to hire that worker. So why should two governments want to know what you’re doing? Because the State wants to tax you for hiring and the Commonwealth wants to tax the worker for working!

We think this has got out of hand. As long as you’re not hurting anyone else, there’s no need for Big Brother to know what you sell or whom you hire or whom you work for. To avoid invading your privacy in the name of taxation, governments should tax you only on things they need to know about anyway — things like the land you own and the patents you hold.

Otherwise we say your business is… your business.

Spin: The venerable D&J Evans Hardware store was unable to pay its $120,000 land tax bill. So it would be forced to close and 32 employees would lose their jobs [Russell Skelton, “Soaring Land Tax Costs Jobs, Investment”, Sunday Age, Nov.21, 2004].

Reality: The big news was buried in a subordinate clause further down the page: “Although the site was sold to Woolworths for a record $15.25 million…” Oh. So the land tax was so onerous that Woolworths volunteered to pay $15,250,000 up front for the privilege of paying the land tax in perpetuity! The article said nothing of the number of jobs that would be created by Woolworths, or re-created by Evans Hardware when it reinvested the money.

Spin: The Whitehorse Inn of Hawthorn (Victoria) was forced to close because the lessee, Jim Ryan, was unable to pay the land tax bill which had increased from $1440 (in 1998) to $40,000. Some 15 staff would lose their jobs. Mr Ryan was liable for the land tax because he had signed a contract containing a tax-increment clause, whereby the owners could charge their land tax to the lessee [according to Farrah Tomazin in The Age, Feb.15, 2005].

Reality: By the time Mr Ryan got into trouble, tax-increment clauses in rental contracts had been banned in Victoria, but contracts signed or renewed before the ban were grandfathered. The Parliament could have capped land tax increases for lessors in grandfathered tax-increment contracts in order to protect the lessees, but failed to do so. So the fault lies not with land tax as such, but with the legislators, who botched the initial implementation and then botched the correction.

Horror story: John Ribbands of the Metung Hotel faced a land tax bill of almost $81,000, which had doubled in a year [according to Kirsty Simpson in The Age, Mar.6, 2005].

Reality: Actually the land tax bill was for the hotel site plus the adjacent vacant site, not just the hotel site. But because of this “usurious” tax, poor Mr Ribbands sold the hotel and the adjacent site to David Strange for more than $4 million [Christopher Webb, “Strange Metung spot is a real little boaty”, The Age, July 19, 2005]. Mr Strange’s plans to develop the adjacent site [www.metunghotel.com.au/land.htm] are a textbook example of how site-value taxation encourages investment and creates jobs. The new owner acknowledged as much when he said that the income from the existing hotel alone “wouldn’t support the land value” — that is, it wouldn’t cover the tax on the combined land value.