Prosper Australia

A rental property is said to be negatively geared if the owner’s expenses (including mortgage interest and maintenance) exceed the rental income, so that the property makes an annual loss. If the tax system allows negative gearing deductibility, that loss can be deducted from other income for tax purposes. Abolition of this deductibility, loosely known as “abolition of negative gearing”, would make the owner’s expenses deductible against the rent alone — not against other income.

SPIN: Negative gearing deductibility helps renters and first home buyers by encouraging property investors to “supply accommodation”; the larger the supply, the lower the rents and prices.

FACT: The only investors who actually add to the supply of accommodation are those who build new accommodation. Therefore, if negative gearing deductibility were really intended to maximize the supply of accommodation, it would be allowed only for new construction — not for future purchases of established properties. But in fact the negative gearing rules fail to distinguish between new and established properties, giving no incentive to build rather than buy. So the supply of accommodation is lower than it could be, and rents and prices are consequently higher than they could be. That’s good for current owners of rental properties, but bad for renters and first home buyers.

VERDICT: Negative gearing deductibility could help renters and first home buyers if it were done properly. But it isn’t. It’s done so that established property investors get a tax break at the expense of other taxpayers plus higher rents and prices at the expense of renters and first home buyers.

Who are the real winners and losers under the Howard government’s industrial relations reforms? We think you can work it out for yourselves. Here are some hints:

1. If workers in firms with less than 100 employees have lost their protection against unfair dismissal (not to be confused with unlawful dismissal), and if all other workers have lost their protection against unfair dismissal as long as their employers can claim “operational requirements”, how will this effect workers’ ability to get home loans? And how will that affect the value of your home?

2. If workers’ wages become more dependent on the workers’ own bargaining power, which workers will lose more: those with more bargaining power, or those with less? In the past, have these workers been comparatively well-paid or poorly-paid? Are they more likely to be home owners or renters? How will this affect the rents received by mum-and-dad property investors, and the values of their investments?

3. If small employers initially become more profitable, how will this affect their ability to pay rent for commercial premises? And how will that affect commercial rents, and prices of commercial property?

4. Will commercial landlord be winners or losers? What about residential landlords? So will the winners tend to be bigger or smaller than the losers?

There — that wasn’t hard, was it?

The Howard government’s industrial relations agenda is supposedly about job-creation, as if the cost of labour — including wages and salaries, penalty rates and other perks, and the difficulty of reversing bad hiring decisions — were the last remaining barrier to full employment.

Sorry that we have to state the bleeding obvious, but:

• Jobs cannot be created unless the employer can pay the rent or mortgage on the business premises out of the proceeds of the business; and
• Jobs cannot be created unless the workers can pay the rent or mortgage on housing within commuting distance of those jobs, out of wages that the employer can pay out of the proceeds of the business.

So, if job-creation is the aim, why is the Government so concerned about the cost of labour and so unconcerned about the cost of accommodation? Why is it bad news when wages blow out, but good news when housing prices blow out? Why is the Government willing to force down labour costs by freeing up the supply of labour — e.g. by requiring more disabled people to seek work — but not willing to force down accommodation costs by freeing up the supply of accommodation — e.g. by taxing vacant land so that the owners have to build on it, and taxing unoccupied premises so that the owners have to seek buyers or tenants?

The only possible explanation is that the unearned profits of property speculators are considered more important than the earned wages of workers. In other words, the property market is privileged while the labour market is not.

In every marginal electorate, politicians promise to take revenue raised by nationwide or statewide taxes and spend it on projects that confer purely local economic benefits. This practice is corrupt and unnecessary — corrupt because a minority of taxpayers are bribed at the expense of the majority, and unnecessary because, if a project is economically justified, it can be funded out of the benefit that it confers — and, by implication, from within the area that gets the benefit.

If a project confers a benefit on a limited area, you can’t share in the benefit unless you live or do business in the area; and for that purpose you need access to real estate in the area. Therefore the market value of the benefit is manifested as uplifts in land values in the affected area. If the project satisfies a cost-benefit test, the total uplift will exceed the cost, so the project can be funded by clawing back only a fraction of the uplift through the tax system, leaving the rest of the uplift as an unearned windfall for owners of property in the affected area — and without burdening the taxpayers outside that area.

This funding mechanism can be set up in a revenue-neutral manner by increasing marginal land tax rates and abolishing or reducing other taxes. Then, when a certain project increases land values in a certain area, the land tax assessments automatically rise only in that area, even if the government funding the project is responsible for a much larger area, such as the State or the Commonwealth. The affected property owners can only gain, because their tax bills don’t increase unless their land values do, and their land values don’t increase unless, in the judgment of the market, the owners are better off in spite of the tax implication. Moreover, the higher the marginal rate of land tax, the greater the range of projects that become self-funding through the ensuing uplifts in land values, hence the greater the number of projects that actually proceed, delivering windfalls to property owners — and the greater the range of other taxes that can be scrapped when the new system is introduced.

In short, when a public project passes a cost-benefit test, and when its benefit is confined to a specific area and measurable in economic terms, there is “never ever” any excuse for failing to fund the project, and “never ever” any need to draw funding from outside the affected area. Voters should therefore punish any politician who claims that the government can’t afford a much-needed project in their area, or who promises to spend their taxes for the economic benefit of any other area!

The Mitcham-Frankston tollway, also known as EastLink, will reduce commuting times in suburbs serviced by the tollway and in suburbs serviced by alternative routes, such as the untolled Springvale and Stud roads, whose congestion levels will be reduced by EastLink. The market value of this benefit (net of tolls) will be manifested as uplifts in land values in the lucky suburbs (because you have to live or work in those suburbs to get the benefit). So owners of property in those suburbs will benefit from EastLink even if they don’t use it and don’t pay the toll on it. But people who live in rental accommodation and who commute via EastLink will pay for it twice — they’ll pay the toll and their rents will go up. How equitable is that?

To satisfy the “beneficiary pays” principle, road projects must be funded out of the uplifts in land values that they cause. If a project satisfies a cost-benefit test, the total uplift will exceed the cost, so the project can be funded by clawing back only a fraction of the uplift through the tax system, leaving the rest of the uplift as an unearned windfall for the property owners.

This system can be set up in a revenue-neutral manner by abolishing payroll tax and other job-destroying State taxes, and strengthening land tax. From then on, desirable infrastructure pays for itself through the increase in taxable land values that it causes. The higher the marginal rate of land tax (or the fraction of properties to which that marginal rate applies), the greater the range of projects that become self-funding through the ensuing uplifts in land values, and the greater the range of other taxes that can be scrapped when the new system is introduced.

Property owners can only gain from this arrangement, because their tax bills don’t increase unless their property values do, and their property values don’t increase unless, in the judgment of the market, the owners are better off in spite of the tax implication. Indeed, if projects pay for themselves, they are more likely to proceed, so property owners are more likely to get the uplifts in land values. The tax means the owners get only a fraction of the uplifts, but a fraction of something is better than 100 percent of nothing!

So is there ever any need for tolls? Yes — on certain routes, at certain times of the day, tolls can prevent congestion by encouraging travel at other times. But they are not needed 24/7, and they are never needed for funding.

In this age of internationally mobile capital, we are repeatedly told that if we want to attract and retain investment, we must make our tax system more “competitive”. Very conveniently for the investors, competitive taxes are taken to mean low taxes, in which case governments must engage in a “race to the bottom” — competitively cutting taxes and public expenditure, sacrificing their schools, hospitals, transport systems and other essential services on the altar of global finance.

Fortunately this is bunk. In fact the attractiveness of the tax system to investors has more to do with the type of tax than with the amount of tax collected. “Taxes ain’t taxes!”

Consider land tax — that is, a holding tax of a certain percentage per annum on the value of land, excluding buildings. Clearly the land can’t flee overseas to escape the tax. As land is a limited natural resource and has no cost of production, its price is determined simply by what people are willing to pay for it. A holding tax on land reduces what buyers are willing to pay and encourages selling, and therefore reduces land prices. More importantly, it drives speculators out of the market, further reducing prices for the benefit of productive investors. So productive investors actually find it easier to acquire land. Similarly, land tax does not discourage investors from renting land for productive purposes; on the contrary, it forces landlords to offer their properties at affordable rents in order to attract tenants and cover the tax liability. Neither does it discourage building on the land, because that is another way to earn income to cover the tax, and because the tax does not apply to the buildings themselves.

So land tax can raise revenue without discouraging productive investment. To replace existing taxes by land tax is to go straight to the bottom as far as investors are concerned, but requires no sacrifice of revenue or essential services.

The flat tax fanatics are back. They say that if there were only one rate of income tax, the system would be simpler, and the rich couldn’t reduce their tax by converting one kind of income into another kind taxed at a lower rate. In the case of a pure flat tax — that is, a tax with one rate and no tax-free threshold — the tax rate could be lower, and the rich couldn’t claim multiple thresholds by splitting income between persons or between financial years.

But of course such reforms would make the tax system less progressive — a “progressive” tax being a tax that takes a higher fraction of income as income increases.

Well, it so happens that the more income people earn, the higher the fraction of their annual income that they tend to have tied up in assets. This fraction rises very rapidly with income; for example, if you can barely pay the mortgage on your home, you probably know of people who own numerous properties but whose salary is only slightly higher than yours.

So a pure flat tax on asset values — that is, a certain small percentage of the value per year, with no tax-free threshold — is highly progressive because “progressiveness” is defined in terms of income, not assets. With no threshold, there is no possibility of juggling assets to claim multiple thresholds. What if your income was high in the past but is now low — e.g. because you have retired — leaving you asset-rich but income-poor? No problem: you can defer the tax until you sell or bequeath the asset; deferral takes the place of thresholds. If the flat asset tax is confined to assets that taxpayers can neither create nor destroy nor move out of the taxing jurisdiction — assets such as land and monopolies — taxpayers’ efforts to minimize their tax by rationalizing their asset holdings do not affect the total stock of assets and therefore do not cause any overall loss of revenue. So all the advantages claimed for a pure flat (income) tax are retained.

We don’t have to choose between flat taxation and progressive taxation. By taxing assets instead of income, we can have a tax that is both flat and progressive!

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.