By Dave Grimmond*
If politicians genuinely wish to address the perennial issues in the New Zealand housing market they need to get brave and address the tax status of home ownership.
And I am not talking about capital gains tax here.
Although a comprehensive and consistent capital gains tax system would be of help to New Zealand’s economic performance, in terms of the housing market a more critical issue is the lack of a tax on imputed rent.
The usefulness of taxing imputed rent may not be immediately obvious to many.
It will also be objectionable to the vested interests of home-owners as they have benefited from the lack of this tax.
The introduction of taxes on imputed rent will most likely reduce the financial incentive to own one’s own home (although non-financial reasons such as security of tenure and the ability to customise living conditions to one’s specific requirements will persist).
As a home owner myself I recognise that at first blush, the introduction of taxes on imputed rent are not necessarily in my best interests immediately.
But as a New Zealander I realise that a more efficient tax system will improve the wealth of New Zealand as a whole and that this is ultimately better for me and my family than being on the right side of an inefficient and unfair tax system.
What is imputed rent?
It is the rent that one effectively pays to oneself for renting one’s own house. There is no financial transaction but there is a real benefit.
If one does not own a house, one has to pay rent or lodging to the owner of your residence. In this situation the owner receives direct income from the tenant, which after factoring in costs is liable to normal income taxes.
But when the owner is also the tenant, the lack of financial transaction allows the owner to escape this tax liability.
The owner-occupier is implicitly receiving the same income as the landlord, but they face a lower tax liability. The implication is that home ownership enjoys an exalted tax status, and it is this preferential tax status that is the root cause of many housing market issues.
A wedge
The preferential tax treatment creates a wedge between home ownership and other forms of investment (eg buying into a business).
If one buys into a business, one faces initial finance costs and ongoing running costs, which are offset by the income one earns from the business. But any revenue in excess of these costs is subject to income tax. If instead one buy’s a house which becomes your home, one receives no revenue but one receives the valuable service of living in the house.
From a financial perspective, the homeowner must service the mortgage borrowed to fund the house purchase. As one does not pay any tax for the imputed rental service received, there is a strong incentive to pay down the mortgage as fast as possible to minimise finance payments.
Effectively this reduction in the size of one’s mortgage is an alternative to investing in other activities (like a business).
But the difference is that the net income from a business investment is taxable, but the reduction in mortgage payments effectively represents a tax-free reduction in living costs.
The implication is that the best use of spare cash for a home owner is to use it to pay down one’s mortgage. People may not think through the issue explicitly like this, but paying down their mortgage as fast as possible is what most people do and few would argue that this was not a sensible strategy for homeowners.
The homeowner advantage
The outcome of these incentives, as well as the lack of tax on capital gains, is that home ownership provides fantastic after tax returns, which makes home ownership a divide in wealth status for New Zealanders.
Home owners are typically better off than non-owners, not so much because home ownership is an intrinsic source of wealth, but because the tax system confers this wealth gain to homeowners.
This is what lies at the heart of New Zealanders deep interest in the importance of home ownership; home ownership confers disproportionate increases in household wealth, thus inducing ongoing demand for home ownership and ongoing concern about home affordability.
Skewing savings
The tax treatment also induces another distortion in the New Zealand economy, by encouraging people to quickly pay down their mortgage, it means that New Zealanders savings portfolios are typically heavily skewed and concentrated in home ownership.
As a result the wealth of retiring New Zealanders are typically asset rich but their ability to liquidise their wealth is overly exposed to the state of the housing market (again reinforcing our focus on housing).
Finally by concentrating wealth in an inflated housing market the tax system is effectively making access to capital more difficult for other activities. Businesses end up paying more for finance than they would otherwise, thus reducing non-housing market business activity.
How it would work
A tax on the imputed rent of home ownership is usually coupled with tax deductions on mortgage interest payments.
The implication is that a tax on imputed rent is not usually associated with large tax payments. Instead, the main impact is to slow the haste with which people pay off their mortgages – the increase in tax liability from lower interest payments offsets the incentive to pay down mortgages so quickly.
This in turn will make people more willing to make their investment decisions based on the economic merits of alternatives rather than on their tax status – encouraging both a more efficient allocation of capital for the economy and a more diversified investment portfolio for savers.
Why not?
So why do we not have taxes on imputed rent in New Zealand?
It is not because they need to be overly complicated taxes – the Netherlands enforces a reasonably simple version.
The key reason is entrenched self interest.
The introduction of such a tax would induce a reduction in house prices that will result in an effective transfer of wealth from home-owners (like myself) to owners of other assets. Of course, many will have assets on both sides of the ledger, and these people may come out reasonably even.
Eventually a better performing economy will have a more material impact on wellbeing, but this will mean that the people who have already invested in houses based on existing tax rules would discover that they paid too much for the houses they live in and as a result they would not be as wealthy as they now consider themselves to be.
This perhaps leads us to the main area of entrenched self interest: political inertia.
We elect our politicians to deliver policies that will enhance the wellbeing of New Zealanders. In many cases the democratic process encourages an alignment of the interest of politicians and society in general.
But situations involving structural changes to the economy and wealth transfers, like those induced through major reforms of the tax system, are areas where the long term interest of New Zealand are not met by the short term interests of elected officials. The beneficiaries of better tax policies are diffuse and opaque – they may not benefit for many years, and when they do they may be totally unaware of the benefit they have gained. Yet the initial losers are very obvious.
The political cost today far outweighs the future political benefit – even though the result of the economic analysis is the opposite.
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David Grimmond is a senior economist at Infometrics. You can contact him here »
50 Comments
This would lead to all homeowers remortaging their house (to balance out the imputed rent with the interest payment) then using the money to buy more investment properties which are held for capital gain. This will perpetuate a house price bubble as increasing prices will casue more investment.
The only ones who can't follow this strategy are those that cannot afford a mortgage e.g. the retired.
Net effect - more expensive houses and even poorer retirees.
Combine with a CGT and there would be no incentive to borrow against your own house to chase capital gains.
In effect its a wealth tax, thus encouraging wealth to be used as effeciently as possible rather than inefficiently tied up in housing.
Not necessarily a bad thing.
I don't understand how encouraging home owners to have even higher levels of personal mortgage debt is meant to help the economy?
Surely the solution to housing speculation in NZ is to encourage longer term ownership of investment property over shorter term speculation? While I'm against a blanket capital gains tax for investors (it will only add to rent costs), I think that a CGT that reduces over say a 10 year period would be beneficial.
We still need personal ownership of rental properties as there will always be a large number of people who either choose not to, or will never be able to, buy their own home.
Taxing imputed rents would be tacking a step back toward the days when almost everyone had to fill out an annual tax return. The accounting industry (which is in a steep decline), would be thrilled!
And while they are at it...way past time we had an imputed health tax...them what live to 65 clearly had an advantage over those that carked it...and so they should pay a tax based on their entitlement to super and good health...a tax that would increase as they aged until at 99 all super payments stopped but the tax began to increase at a quadrilantic scale....
Throw in compulsion to be DNA tested to identify age potential...so those most likely to collect the pension get to pay more paye....sounds fair to me....it's the sort of idiot scheme our govts have opted for in the past....
Im not an accountant, so maybe this stuff is over my head. But:
1. If this is the cause of the housing bubble, why didnt we have the housing bubble before given we didnt have imputed rents before?
2. Doesnt this apply to other areas, not just housing. ie any area you get a benefit that means you avoid having to pay for something. As a silly example, if I buy a spade am I avoiding paying a gardener? Is that an implied benefit I should be taxed on?
3. Does it imply some sort of state control over individual property/assets. It seems to be forcing someone to effectively *have* to invest, and perhaps to invest at a rate that covers the assumed rental which may not be a wise move.
Im trying to understand, not argue.
"senior economist at Infometrics"
I could moonlight this position with some random thoughts, crazy or not.
"tax deductions on mortgage interest payments"
so effectively it encourage more ppl to load up their debt and will lead to more property bubbling.
not only can I continue to receive tax refund from LTC owning rental properties, I can buy more rental and get tax refund on my home as well. Wet dreams.
I really hope this is a April's fool article.
"But situations involving structural changes to the economy and wealth transfers, like those induced through major reforms of the tax system, are areas where the long term interest of New Zealand are not met by the short term interests of elected officials."
The Junkers Curse strikes again.....
P'raps we betta wait for a Benevolent Dictator! I'm sure there are one or three takers, and I can think of one now: Gladstone Gander good looks, even at 68, an immaculately coiffed hairdo, and the beginnings of a personality cult which could easily be - er - Cultivated.
i'm making an assumption here, but the comments contained within seem to be from those property owners with a vested interest in the status quo. It seems fairly obvious to me that the author is merely offering up a reasonable suggestion that would help balance the NZ economy to the benefit of all over the longer term. This is yet another "tool" that would allow balance to take place in the economy, without causing chaos. To not address the problems we face, to not discuss the possible solutions, is to perpetuate the imbalance. Extrapolating that out leads to a "correction" that will harm all .... tick, tick, tick ...
That's what I call The "broken leg" solution
A guy who breaks his leg, compound fractures and all, gets toe to hip plaster on his broken leg and off he goes, he goes, and over the next few months while walking develops a limp to accomodate the weight and height differential of the two legs, one with plaster and one without.
12 months later he still has the limp. Limping badly.
Goes back to the hospital and complains something must be seriously wrong .. maybe requiring surgery, break and reset the leg, metal pins etc ..
The attending intern takes a look and says, maybe it might help if we remove the plaster.
The reason I laughed is:
Firstly - this would encourage people to buy and then rent out their home. This gives all the benefits of home ownership but the one of living in the house. People would still get the tax deductibiilty of expenses like interest, insurance, rates etc against income from rent.
Secondly now that everyone is established in the market as a landlord they would have to rent a home to live in. As they are operating a business now they can claim some of the rent, power, phone, insurance costs etc against their business activity of being a landlord.
Grandma could transfer into a retirement home village, keeping her house as a rental property and claim against her retirement village costs. Grandma could draw down all equity she held in her original home and run her life like a business entity or pay someone else to organise her affairs and these costs would be tax deductible also.
Will all this activity see house prices lowered - no. But a whole heap of extra business activity would take place which could lower current tax obligations overall which would more than likely put more pressures to the upside on the housing market as more and more people aim to lower their overall annual tax oblgations and get in on the benefits.
Most people would probably register for GST purposes to obtain maximum advantage of costs they incur along the way.
If we all rent from each other there are certain tax efficiencies to be made for those who care to undertake the challenges. This type of concept will push house prices up further and faster as people understand the gains that could be made.
Grimmond has made some interesting assumptions , including one that says Auckland house prices will come down because they would now be subject to another tax . I suggest this thinking is flawed.
Quite apart from some Kiwi's obsession with complicated new taxes as a solution to everything , he ignores some fundamentals about the situation in which we find ourselves
- He ignores the fact we all have to live somewhere and there is a severe shortage of houses to rent or, buy and an acute shortage of land for greenfield sites , in Auckland.
- Nothing , other than increased land supply is going to bring prices down
- NZIS stats show we are gaining many new arrivals from Asia , and they are all settling in the environment where they are most comfortable , Auckland.
- In plain language , there are not enough houses in Auckland for all these people and simply the price has to go up in the absence of a supply of houses coming onto the market
- We have the lowest interest rates in my 55 year long lifetime , which has reduced my mortgage repayments by half since 2007, imagine what this has done to everyone else ?
- Leftwing councils have a legacy of trying to contain Auckland inside some arbitrary boundry
- Meanwhile , Wellington( central Government) has a policy of encouraging migration to NZ, and most migrants find work in Auckland .
- The collision course of the two policies has manifested itself as it only could have , there was no other outcome, we dont have enough housing.
Thats it folks , there is no tax , restrictions on investors , banning foreigners from buying a roof over their head , or any other hare-brained scheme that will alleviate the housing shortage . We need more space for Auckland to grow
Good question , rents are going up but dont appear to be in tandem with , or the same pace as selling prices in AKL , which could mean there is a delayed reaction , and rents start to increase as pressure on yields build
Low Interest rates have had the effect illustrated below :
In 2004/5/6 , a payment of $550 a week serviced a mortgage of $286,000 at 9,75%
By 2009 , the same $550 a week serviced a mortgage of $515,000 at 5.5%
This cheap money has fired the market up
In 2009, 2010 and early 2011 it was cheaper to buy than rent, but thats no longer the case.
'An economist says pressure on the Auckland housing market is going to be intensified by increased immigration.
New Zealand has had its fourth month of migration gains with more people arriving and fewer New Zealand citizens departing for Australia.
Official figures show the country had a seasonally adjusted net gain of 1600 in April - the highest since January 2010. Migration has been trending upwards since September last year.
The managing director of Infometrics, Gareth Kiernan, says the main shift over the last year seems to have been the softening of the Australian economy and labour market.
Mr Kiernan says better economic prospects and increasing numbers of immigrants will put more pressure on the housing market.
He says the speed in which the market has turned around suggests the pressures will be more intense. He predicts the Reserve Bank's moves to bring the housing market under control are unlikely to affect interest rates until later in the year or early in 2014.
Mr Kiernan says about half of immigrants settle in Auckland - which means up to 45,000 more people a year in the city, and at least 15,000 more households.
Land Tax
Simply
Unavoidable
captures everyone
Mechanisms for Iwi and old people needed
Stops trusts, offshore, debt, coporates etc
We will move to this, in time as more and more activity is offshored we will have to.
When you pay for your groceries into a company in Singapore at a supermarket whoose building is owned in the Cook Islands, which is loaded up with debt with interest payments to the Caymans etc etc
Google says that tax should be paid where the risk happens rather than where the transaction happens- funny that so no GST, no paye, no company tax in NZ ( or not miuch at all)
Getting very tired of all the nutty suggestions to correct a problem with Auckland's overheated housing market. There is no issue in the regions so can we just confine the "solutions" to Auckland and maybe Christchurch. And maybe that will encourage people to move to the regions. Have been mortgage free in a large regional town for years. Since then invested in businesses and holidays. Don't need to pay any imputed rent, thanks very much. Love visiting Auckland but don't want to live there.
Oh dear, the Netherlands just happen to be a really good example of what not to do:
http://www.macrobusiness.com.au/2013/05/dutch-economic-crisis-worsens/
These clever sounding ideas are just Stalinist social engineering in pretty clothes. Central planning is just a false but seductive hope that ends up benefiting a few who work out how to rort the system, give people more choice not less.
NB I do not own a house.
Yes it can. I don't think government need be more or less efficient than private business. Or that government necessarily makes bad decisions. The problem is it makes big decisions. So the consequences are greater when they are bad ones. The free market is chaotic in it's workings but that chaos encourages new ideas to be tried and minimises the cost of bad decisions. In short, the chaotic free market is generally more robust and more anti-fragile as it allows individuals more choice in how to solve their own unique problems.
Gosh... even his basic premise is wrong.
People have to live... have a roof over their head.
The choice IS NOT between a home to live in vs an investment property ( to earn rent )
The choice is between owning a home to live in vs renting...
In this regard ... if he wants to be fair... he would have to create a "virtual imputed world" where as well as "imputed rents" the homeowner would be an "imputed landlord" ..and there would be "imputed costs"...etc..etc .....
Otherwise his idea is simply punative...
His basic premise isn't about housing, its about saving
I have a 300K mortgage and receive an interintance of 100K
I can either pay off 100K of my mortgage - save myself $5,500 in interest payments or Invest in shares with a 5.5% dividend - thus receiving $5,500
The dividends I get taxed at 33%. thus to achieve the same benefit from investing as paying off the mortgage I would need a gross return of 8.2%
Therefore I am incentivised to pay down housing debt rather than invest, which is good for me but not necessartily the economy as a whole
I think that is his point, that NZer's are incentivised through the tax system to pay down housing debt.
The arguement could be made the other way around and saying that investment income shouldn't be taxed, to level the playing feild between where savings should be put.
By investing in markets and not paying down debt you are also helping the financial industry!
Much of the malice towards housing shown by fund managers is actually anger at not being able to clip the ticket on billions of dollars in assets.
This is entirely self interest, as those that benefit from housing investment are actually the people who live in houses, the tradespeople and of course realestate people - ie a large chunk of the economy.
What NZ has is actually under investment in new housing, and adjusting taxes to encourage investment in new housing rather than existing housing is the solution. The reason we have this underinvestment in new housing is because the tax system discriminates against developers so greatly.
odessakiwi.. this is what he said.
"If one does not own a house, one has to pay rent or lodging to the owner of your residence. In this situation the owner receives direct income from the tenant, which after factoring in costs is liable to normal income taxes.
But when the owner is also the tenant, the lack of financial transaction allows the owner to escape this tax liability.
The owner-occupier is implicitly receiving the same income as the landlord, but they face a lower tax liability. The implication is that home ownership enjoys an exalted tax status, and it is this preferential tax status that is the root cause of many housing market issues."
To me he is saying that there is some kind of tax benifit to homeowners because they make "make believe" income by renting their home to themselves ...and they should pay tax on that.
Landords buy Realestate as an investment because they have surplus Savings to invest and think they can get a return from real Estate..
Most homeowners buy a home to "live in"....
There is a world of difference... in my view.
Again another tax that will only penalise grandma!
But this is worse than that - it will actually give tax deductions to Auckland yuppies!
This will only encourage huge mortgages to be taken out by Aucklanders to buy homes beyond their owners' means as those mortgages are now tax deductible.
In fact this kind of tax would probably drive the average freestanding house price in the Central Auckland suburbs from $1m to $1.5m as the net after tax cost to the marginal purchaser would be about the same once this tax was introduced.
Those penalised would include new homeowners in the regions where yields were above the average interest rate, and of course those with no mortgage - the elderly, the financially responsible and the prudent - all paying for a tax deduction for the reckless!
This policy suggestion is so ridiculous, it really brings into question the intelligence of the writer who put pen to paper!
The only circumstance where such a tax could work, would be in a place where rental yields on houses were above significantly above the interest rate across the entire market. It simply could not work where negative gearing is the norm.
As an economist.... why can't he see where the real distortions are.
Why is savings such a losers game.???
The real reason is that money loses value... ( much of the gains in Real estate is pseudo gains as a result of a forever growing money supply ... ie. inflation )
For the sme reason... savings is a losers game.. ( . money depreciation )
eg $100,000 @ 5% = $5000/ yr... tax @30% = 1500... so net income = $1500 BUT.. if inflation is 3% then the $100,000 has lots $3000 in value....SO.. net income is only $ 500 on a $100,000 investment.... this is a 1/2 of a % return.. in real terms.... and he wondors why we don't save.
(We measure inflation with the CPI..but a better proxy for inflation might be Nontradable inflation or even building cost inflation )..... so in real terms the returns on savings is probably -ve.
Savings is a losers game because of the the Govts. fiscal policy toward savings.. ie. they tax the nominal income without allowing any depreciation for the loss in value .
Why can't this economist address this fiscal distortion.??? This distortion is so profound that after 40 yrs we have all learnt to have our saving in Real estate.
Why does he have to wander off into the wonderland of twisted logic..where even our recreational time might be taxed because we could have earnt taxable income instead..Maybe there can be an imputed tax for sleeping... as well ....??
As you say the logical extension to an imputed rent is the tax deductibility of mortgage payments and then, of course, a fortiori, all the repairs on my house, the rates, my life insurance policy to repay the mortgage when I die, and anything else I might think of, should also be tax deductible. I certainly can't see it helping the Country. It might help the Accountants though
A window tax, calcuated on a formula that combines the number of windows and their dimensions thus avoiding the problems associated with one very large window or the equally problematic, a great many extremely smll windows. The tax would be based on a formula of the total surface area of windows calculated on height x width per window x total number of windows. Colour glass and bathroom windows would be based on one half of the normal window rate and glass bricks would be exempt. if structural but would be captured if replacing areas normallt associated with glass windows. Problems with use of fly screens to replace glass can be envisaged but I believe that this can be miniimised through catch all provisions in the resulting act. The accounting industry would be altered beyond recognition with former carpenters replacing actual accountants and building firms moving wholesale into the tax minimisation industry. An inspectorate would also have to be developed.
"But the difference is that the net income from a business investment is taxable, but the reduction in mortgage payments effectively represents a tax-free reduction in living costs.'
This is goodie.. :)
This is the first time I've ever read that reducing ones cost of living should be a taxable offence.
Whats wrong with trying to pay off ones mortgage before one retires.... it really is the prudent thing to do.
In the real world.. investments come with risk.. ( just look at the finance company debacle)
Why on earth would anyone want to create distortions that would force us to all end up with big mortgages on our homes and forced to invest money in what alot of people, from bitter experience, might call a "shark pool"..... just to try and make ends meet.
Dave Grimmond kind of implies that the "investment world" is some kind of utopia...whereas ..the reality is that even the best minds can lose money..and with all these Managed funds... the "ticket gets clipped'.. bigtime.
http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_i…
All economies are awash with tax distortions.
Maybe the whole tax structure needs flipping over and do the complete opposite to what we do now.
Murray's suggestion fails for all the reasons mentioned above. The most likely outcome, it seems to me, is that New Zealanders would mortgage up, and spend up (not invest up)- a good amount of which under current settings would race offshore, and be exactly the result we don't want.
If there must be property taxes of some sort, (and if we follow the traditional paradigm that government books must balance over time, then there will need to be), my preference would be a modest tax based on CV (so, similar to Rates now) rather than a capital gains tax, which has its own distortions. The horse may well soon have bolted for a while on CGT producing any real money, in any case.
This article proves that conservative home ownership by kiwis is the best foundation for a financial foundation. The govt cant tax you on your mortgage repayments (repaying a 5.5% mortgage = to a pre-tax treturn of 9%). The financial/investment outfits cant clip the ticket (other than the inflated floating rate & arbitrary est fees). The home owner has total control over their property & can improve it with small low cost work each weekend.
Too much upside for the individual. How can we clip the ticket/tax this??!
The author of this article may have been intending to provoke a useful debate, for me this line of thinking highlights the tradgedy of current economic world that belives government intervention is a solution.
The reality is that government is the problem, the size of the state and the expectations put upon it to provide solutions to every day problems of us all individually, has become so broad and deep that it sucks a massive amount of resource to fund it operations. We have to work for 40% of the year to pay for government. We don't need any more taxes to try and change a behaviour brought about by economic mistakes in the first place.
Using the Netherlands to justify the arguement is not a good example, the housing market there has been crushed and still falling, all due to government intervention, by making mortagage interest tax deductable people could afford to borrow more and lenders were happy to oblige, central bank manipulate of interest rates, kept them too low for too long causing a massive housing bubble that has now burst. I live in the Netherlands currently, around my neighbour hood are houses that have been for sale for the 3 years we have been here. Its a real example of government intervention causing the opposite of what was intended.
Give a politician a chance to tax you and he will, then he'll take the money and promise it to some one else who has not been so proudent in return of their vote. Don't let a politicians tell you any thing else, they are all the same every where. What we should be talking about is how to have fewer politicians and smaller government.
Gee, why stop at just homes.
I own a TV set. By owning it, I'm getting the benefit of not paying a hire purchase, or renting it. This is clearly unfair to the people who can't/won't/don't want to save up and spend some moolar on a new Samsung.
Therefore, I should be taxed on the ownership benefits on said TV.
Gee, why stop at just homes and TV's
I own a pair of Levi's .................
How accomodating is this accomodation benefit?
How much does it pay?
As a mortgage free property owner I am looking forward to paying my imputation tax on all the rent I have saved in all this time I have been paying property taxes on the money that I used to buy my house which I payed taxes for when I first earned it. Pheeew... what a mouthfull.
HGW
Dave seems to be arguing that if we tax houses in the same way we do international shares (ie on inputed or notional income) then potential householders will make different decisions and house market prices will fall. They may but we still need houses so if we change investment decisions and don't buy houses this should drive up rental demand and rents
The whole idea seems to ignore the basic market principal that prices will increase when demand exceeds supply and visa versa. If we had a surplus of houses then prices would fall as sellers try to entice buyers. The answer to high prices is therefore is to build more houses as fast as possible to increase supply.
The arguement for taxing imputed rents can be applied to all asset classes for example buy a car and you are avoiding car rental costs (he argues you are paying yourself rents) and you should pay tax on the imputed rent to yourself. The same seems to apply to any capital item so what we really need is a capital tax! ....Yeh Right
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