Nibbling at the Edges

The introduction of a possibly contentious policy on a controversial issue under this government usually follows the same pattern, especially when the interests of the government’s supporters might be affected.  First, the broad outline of the new policy is floated, both to gauge reaction and to get people used to the idea.  The new policy is often said to be contingent on some further piece of information that is already available to the government but not yet known to the rest of us.

Criticisms from political opponents are rubbished; comments from supporters are taken into account; and the new policy eventually emerges fully fledged, often in a form that is subtly different and with less impact than was originally proposed.

So it has been with the notion of a land tax.  The initiative is nevertheless to be taken very seriously, for at least two reasons.  First, it is an acknowledgment by John Key that housing affordability is now of major public concern, not just because of the difficulty it means for those seeking to start a new life in a new home, but for what it is doing to social cohesion.

The $70,000 untaxed capital gain made by the average Auckland home-owner in a single month should be contrasted with the Prime Minister’s “generous” 50 cent increase in the hourly minimum wage.  And, since the capital gain (admittedly as yet unrealised for most) does not represent any corresponding increase in real wealth for the nation as a whole, it has to come from re-distribution – from the poor to the rich.  Asset inflation in housing is the principal driver of inequality.

The government is cautious in dealing with it is because Auckland home-owners are naturally (and short-sightedly) very happy with what is happening.  They are inclined to thank the government for the cosy glow that getting richer without any effort can produce.

The second point to notice is that a land tax would endorse an analysis of what lies behind soaring land prices that has so far been rejected by the government – and most others.  A land tax for foreigners (as is proposed) would represent an attempt to discourage investment and thereby to reduce the volume of demand and purchasing power that is currently fuelling the Auckland market.

This focus on the level of demand is at odds with the reasoning so far adopted by the government and by most so-called experts.  Their preference has been to point to supply-side issues as creating inadequate supply and therefore unaffordability – the shortage of land, bureaucratic rigidities, construction bottlenecks.  A new focus on bearing down on demand is welcome, but threatens to take the government further than it wishes to go.

If the problem can be eased by reducing the level of demand, why does that argument not apply to the whole market and not just to foreigners?  And if the volume of purchasing power coming into the market is a central factor in causing prices to rise, as it surely is, then why do we not look at where the overwhelmingly greater part of that purchasing power really comes from?

If we were to do that, we would rapidly come to the realisation that the Auckland market is the product of a veritable tsunami of new credit flooding into it day by day, week by week, month by month.  This huge volume of new credit is created by our banks and is made available for the sole purpose of buying property.  Without it, the housing market would be unrecognisable.

The banks have created the housing market and will go on fuelling it until they are restrained.  In the meantime, asset inflation in the housing market could not suit them better.  The demand for mortgage finance from those whose purchasing power is inflated by their ability to borrow many times their income is stimulated ever further by soaring house values.  Lending on mortgage keeps growing – as do bank profits by virtue of the rising volume of interest paid on the ever-increasing volume of new loans.  The risk is minimal since the value of the security – houses – will keep on rising for as long as the banks keep on lending.

Tweaking interest rates or imposing a low rate of land tax in an attempt to cool the housing market are likely to be ineffective for as long as the market is awash with constantly growing volumes of new credit.  Small marginal increases in the cost of investing in property will be quickly swamped by the tidal wave of new credit and by the capital gains thereby created, and will just become another (small) factor to be added into the price structure.

It is unlikely that government will have the courage to tackle the banks (or their home-owning supporters) on this issue.  Any action that might be taken would in any case have to be taken gradually and cautiously, so as to avoid a bursting of the bubble and great damage as a result both to individual family budgets and the national economy.

It is now up to the Reserve Bank.  They must devise “macro-prudential” measures that will effectively restrain bank lending on mortgage.  The longer the current situation prevails, the more damaging and dangerous it becomes.

Bryan Gould

27 April 1016