The art of the possible

The problem is clear. Monetary policy has inflated the property market with cheap money. The result has been a mushrooming wealth divide, riches for some, and sheer panic, desperation and despair for first home buyers, renters and the growing homelessness.

If nothing is done and housing ownership rates continue to fall as prices accelerate, then we are headed for a landed gentry class completely at odds with egalitarian ideals held by Labour and one that will further entrench the wealth gap between Māori and Pakeha. Couple this with the inequality of the ongoing impact of the Covid-19 recession and a permanently fractured future looms.

Along with all the other tools, we need to send the right signals to investors by levelling the playing field. Currently policy subsidises both speculation and investing in ever more elaborate homes using scarce resources of skilled labour and materials and that should be diverted to building more state and low priced private homes.

The bright line tests pick up some but not all short-term speculative gains made in this frothy market. These must continue and be tightened. But they will not be enough. Policy could disallow interest costs to be deducted against rental income but this does not touch the heart of the massive accumulated gains made by wealthy property owners.

Surely it is time to pick up the tax hose? We face unprecedented conditions that demand political skill and fortitude. While the government has ruled out a capital gains tax, a wealth tax, or any new tax, it is not too late for them to argue that income tax base must be widened so that better-off people pay more tax on their non-cash housing income.

The total net equity (Capital Value (CV) minus registered first mortgages) held by an individual in all housing outside of a modest family home could be be deemed to have earned an annual return that will be included in personal taxable income. After all, the same money invested elsewhere would earn a taxable return.

The rate of return or deemed rate could be a policy lever and might initially be set at 1%.
While current CVs may underestimate current house values, they are readily attainable, standardised, and relatively uncontroversial. If sale prices increase, capital gains will accrue and will eventually be reflected in higher CVs.

This approach would save landlords the trouble of filing rental tax returns and the need to pay high-priced accountants to generate tax losses. Murky issues disappear like how airBNB is taxed, or what is a capital expenditure and what is repairs and maintenance. Good landlords who were filing rental profits may actually find themselves better off and feel encouraged. We need good landlords to provide a valued social service.

Those individuals with multiple properties and high-priced owner-occupied homes will pay more income tax as is required to reign in this housing bubble. The impact is progressive. The better-off older age group is more likely to have high net equity in their own homes and if there is no cash flow to pay the tax, it can be set as a debt against the property’s eventual sale or the death of owner. Those with high equity on lower incomes would pay tax at a lower marginal rate. Young people even if in expensive family homes, are more likely to have large mortgages and unlikely to exceed the net equity exemption that might be set at $1 million per person. There is no incentive to reduce net equity by borrowing more as the loan interest still has to be paid and is not deductible.

Some may argue that the inability to deduct the costs of maintaining a rental property will be a disincentive for landlords to do essential work, but rental healthy homes regulations will still apply. Holding empty houses for capital gain would be a thing of the past. If landlords who are mainly there for capital gains exit the market, house prices may fall making it easier for first home buyers.

This extension to the income tax base is both practical and doable politically. There will always be issues around the edges such as the treatment of real estate held in family trusts but these are relatively minor. The most important thing is that government gives a strong signal that our perverse market signals will be corrected with as little delay as humanely possible.