Housing policy

Why we should tax the family home – and why it’s difficult

Why we should tax the “family home”

We’re living longer – that’s why.

In Australia two generations ago we were dying in our 60s. That was about when our children, probably in their thirties, were in their financially toughest years in terms of income and the demands of a young family. An inheritance in the form of a house, or the proceeds of a house sold, would have been most timely, even after the small deduction taken by death duties (abolished in 1979).

Now we’re dying anything up to twenty years later. The inheritance comes to the next generation when they are past their period of peak need. The inheritance is more likely to fund the next generation in a retirement lifestyle above the standards of anything they could have enjoyed in their working life. And so it goes on, as a drag on intergenerational mobility.

Ideally inheritance taxes would allow for a better intergenerational spread of income. They could fund important aspects of the social wage for young families, including child care and high-quality public school education, and if some of the revenue were devoted to public housing it could help keep all housing affordable.

Inheritance taxes are problematic, however, because they are easily avoided by the well-off. Even the moderately-well off can get around inheritance taxes with a trickle of gifts to children and grandchildren. A tax on one’s main dwelling, however, is a reasonable second-best to an inheritance tax, because a house is the ultimate illiquid asset. It cannot be passed on as a series of small gifts.

Why it won’t happen any time soon

In one of the idiotic rule-it-in-or-rule-it-out traps set by journalists seeking their 15 minutes of fame, Prime Minister Albanese and Treasurer Chalmers last week had to promise that there would be “no change ever” to the tax exemption for one’s main residence – emotionally known as “the family home”.

Even the Treasury’s Tax Expenditure and Insights Statement, while identifying the absence of capital gains tax on the main residence as the largest of all concessions ($26 billion a year), did not pursue it further in its analysis of 21 specific items.

Under our present taxation system, and in view of the huge nominal and real (inflation-adjusted) rises in the price of houses, there won’t be any capital gains tax on the “family home” because the amount of tax would be absurdly high. That’s because over the last 35 years the nominal price of Australian houses has risen approximately 11-fold. Even after adjusting for inflation, using the CPI, the rise has been approximately 4-fold.[1] Rises in Sydney and Melbourne have been even steeper.

Is it still subject to CGT?

To illustrate, consider a house bought in 1986 for $100 000, and sold in 2021 for $1.1 million. That would have a nominal capital gain of $1.0 million, or $0.5 million when discounted by 50 percent. Even under the Hawke-Keating more rational system of indexed capital gains, the base price would have been lifted only to about $400 000, resulting in a $0.7 million assessible capital-gain. In either system that lump sum of $0.5 million or $0.7 million would take the taxpayer into the higher 47 percent marginal tax rate, all in one year.

By any defensible theory of taxation, that would be poor public policy, on four counts. First, the tax is collected in one year, bringing the taxpayer into the highest marginal tax bracket – 47 percent – even though the capital gain has been accruing incrementally over 35 years. Second, it involves a degree of double-taxation, because local government rates have been paid over that period, and some of the improvement in our house value relates to investment by local government. (Revenue needs of local government are growing as our expectations of local government grow). Third, it is essentially a tax on the illusory gains of inflation. Even if it is indexed by the CPI, housing inflation is not covered because the CPI ignores asset-price inflation, including the inflation of land prices. And fourth, it would put a brake on housing mobility, because the house seller would not have the funds to buy an equivalent dwelling.

The source of the problem lies in a series of bad public policy moves over many years. Most notable has been the commodification of housing, a worldwide phenomenon, encouraged in Australia by the Coalition’s concessions on capital gains tax and “negative gearing”. And there are other factors. Because governments, state and federal, have under-invested in public housing, they have worsened supply-side constraints on the housing market. And from late 2011 until late 2020 the Reserve Bank was lowering nominal interest rates, fueling housing price inflation.

Those seeking a better approach to raising revenue from capital gains on housing would do well to direct efforts to rectify the structural distortions identified in the above paragraph. They may have to re-frame the way they see the issue, and abandon the idea of using capital gains tax as a means of raising revenue from inflating house prices.

Rather, they should consider the application of wealth taxes, as advocated by Thomas Piketty and others. In fact the idea of taxing land – an absolutely immobile factor of production – goes back to Henry George 140 years ago. Although local government rates are payments for services, they are applied de facto as a progressive wealth tax, and the governments of the ACT and New South Wales have been slowly replacing property transfer taxes with land taxes (but not being so daring as to call them wealth taxes because that would come across as too “socialist”). The principle behind wealth taxes is that capital gains should be levied as they accrue, rather than when they are realized. That can cause cash-flow problems for some who are rich in fixed assets and poor in liquid assets, but there are means of deferring payment for those facing hardship.

1. This price rise is in the now-discontinued ABS series Residential Property Price Indexes: Eight Capital Cities, which shows, when spliced with the ABS earlier index on property prices, that the index for established houses in capital cities has risen from 61.3 in June 1986 (the start of the series), to 684.7 in December 2021 (the end of the series). When discounted by the CPI the rise has been from 157.3 to 609.7.

The causes of our rental market nightmare

The stories we are hearing about the rental market have us wondering what sort of society we are becoming. A real estate agent is advising owners to raise rents and kick out existing tenants. A studio apartment with the toilet in the kitchen area is advertised for rent at $20 000 a year. There are bidding wars among competing renters. There are now renters’ agents helping people jump the queue.

The Grattan Institute has a 27-minute podcast, What’s causing Australia’s nightmare rental market?, presented by three of their researchers – Kat Clay, Trent Wiltshire and Joey Moloney. They note that our present rental vacancy rate is around one percent, compared with a long-term average of around three percent, and that rents in most regions are rising at about 10 percent a year.

In simple terms the problem is about demand and supply – demand in the short and medium term, and supply in the medium and long term.

Covid-19 was one factor boosting demand: many group houses broke up as more people sought to live alone or just with their partner. The house or apartment, hitherto only a dormitory, became a workplace, and people needed more room. As Covid eased, resumption of immigration has been another factor boosting demand.

Rising interest rates are adding to the problem. People who had been saving for a house deposit have spent those savings on increased rent. And, indirectly, rising interest rates are discouraging house builders, which means supply is tightening and therefore market forces are putting up rents. (Yet another example of the way the Reserve Bank’s dysfunctional macroeconomic model is contributing to inflation). The other supply factor has been the long-term reduction in governments’ investment in public housing.

The consequences are felt most by the poor and the young, for whom the outcome is often homelessness. A rental market in which speculators play a large part is a market with a great amount of turnover, resulting in many people being unable to put down roots in a community. (It is surprising that the panel did not discuss the possibilities of build-to-rent schemes being promoted by some state governments in cooperation with the Commonwealth.)  

There was consensus on the need to boost Commonwealth rent assistance payments (even though they add to demand-side capacity), and on the need for more investment in public housing, particularly because private sector housing construction will be falling off in the next couple of years.

The panelists presented the usual arguments against rent control, which, if sustained, results in communities of poor landlords with poor tenants in run-down buildings, as has happened in the USA.

But perhaps Grattan’s researchers are too hasty in ruling out rent control. There are better models of rent control, more in tune with long-term supply and demand, such as Germany’s Mietpreisebremse, (Stuttgart example in English). And even without rent control governments can do more through consumer protection laws to drive sleazebags out of the market.