Cross posted from The Australian, former EJ Craigie winner Adam Creighton writes up our recent Designing the Transition: Stamp Duty to Land Tax report.

Stamp duty is much better than land tax if you stand to inherit a mansion

They reckon it is political suicide: that’s the best argument against dumping punishingly high rates of stamp duty and shifting to a land tax. “It is difficult to think of any other reform for which expert opinion and the forces of politics are so firmly in opposition,” economist Tim Helm states in a research paper examining how to overcome the political challenge of taxing the “family home”.

Productivity growth has stagnated and a better tax system is among the obvious levers governments can pull to revive it.

With bold reform on hold federally, it’s incumbent on the big states — which rely on the most damaging tax of all, stamp duty — to take the lead.

Helm’s analysis, published by Prosper Australia, shows the politics needs not be so dire if the transition is managed sensibly. Of course, if you inherited a castle with expansive gardens, land tax is a terrible idea. But for the bulk of us, the economic dividends from a more efficient, fairer property tax regime far outweigh the costs, ­imagined or otherwise.

Last week the NSW Productivity Commission, set up by state Treasurer Dominic Perrottet, showed stamp duty cost the economy $2.35 for every collected dollar, compared with 16c for land tax. It’s not hard to see why. Stamp duty punishes people for moving, locking other households and businesses into their properties for longer than they would like.

Letting assets move freely to those who put the highest value on them is the bedrock of a free market. The 5 per cent transaction tax we impose on property transfers is throwing nuts and bolts into the cogs of the economy.

Taxing something typically means you get less of it — work, transactions, innovation and so on — but, uniquely, not for land, whose supply is naturally fixed.

Moreover, the vast parasitic tax avoidance ­industry that lives off other taxes, ­especially income, doesn’t get much work from taxes on land, which can’t be hidden. Shifting to land tax is, economically, the lowest hanging fruit, but politically it’s at the top of the tree.

In NSW only 170,000 out of three million property owners pay land tax. Mainly property investors and business owners, they would back the reform, as the punishing land tax rate they pay ­(1.6 per cent to 2 per cent in NSW on land above $692,000) would tumble as the land tax base broadened. But the other 2.83 million would face a new tax.

As Helm points out though, property owners could receive a credit for the full amount of stamp duty they had paid against any land tax, which would defer payment for years. It could even be lifted up to today’s dollars by some indexation factor as an added softener.

About half of all property owners paid stamp duty in the past ­decade. The other half wouldn’t have recourse to a credit; but the government could allow land tax to be ­deferred until the sale of the property. In that way the pain of the tax would be ameliorated by the absence of stamp duty on the next purchase.

So what of the millions of future buyers yet to buy property? Well, they could have an “opt out” alternative and could choose to pay stamp duty rather than be eligible for land value tax. This option eventually would be phased out. “By making the change voluntary it would allow a kind of ‘no worse off’ promise to be made to prospective buyers, and provide a means for buyers most concerned about predictability in future taxation to secure more certainty,” Helm says.

Whatever the specifics of the transition arrangements, stamp duty should be dumped. Phasing it out, as the ACT is admirably doing, only delays the benefits for the economy. The government should set a land tax rate below what’s needed to replace existing stamp revenues (estimated by Helm to be 0.46 per cent in Victoria). It doesn’t matter if the low rate blows out state budgets for a few years; the tax will pay for itself in increased economic activity. Moreover, state and federal governments can effectively borrow for free.

“The economic case for taxing land is very strong,” Nobel prize-winning economist James Mirrlees concluded in his 2010 tax review of the British tax system. The godfather of free market economics, Milton Friedman, called land tax the “least bad tax”.

It’s also fairer than stamp duty, as has been recognised for cent­uries. “Every improvement in the circumstances of the society tends either directly or indirectly to … ­increase the real wealth of the landlord, his power of purchasing the labour, or the produce of the ­labour of other people,” Adam Smith wrote in The Theory of Moral Sentiments in 1759.

“Roads are made, streets are made, services are improved, electric light turns night into day … and all the while the landlord sits still. Every one of those improvements is ­effected by the labour and cost of other people and taxpayers,” Winston Churchill noted in 1909. Land tax is an honest tax, salient rather than sneaky. Stamp duty is typically paid out of a home loan — new, borrowed money — whereas land tax would be paid out of disposable income (unless deferred). It’s therefore more difficult to lift its rate — a useful constraint on the growth of government.

A general land tax isn’t unprecedented. Three political parties in Denmark imposed one between 1957 and 1960. The economic benefits were enormous and immediate, according to Phillip Anderson in his 2008 book The Secret life of Real Estate and Banking: lower ­inflation, unemployment, interest rates and higher wage increases. The New York Times hailed the results as a “big lesson from a small nation”. But it didn’t last.

“The Danish opposition didn’t take the improvements lying down and, in the elections of 1960, used the largest amount of money ever donated (by conservative land property owning associations) to overthrow the triumvirate,” he writes. Castle owners would similarly succeed in thwarting reform here unless state governments coupled education campaigns with politically prudent transition arrangements.

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