Saul Eslake slams Australian housing policy

The AFR is today reporting that Saul Eslake, who has held multiple chief economist roles at various banks, as well as acted on the National Housing Supply Council, has provided a personal submission to a Senate Inquiry into Affordable Housing. The submission, entitled ‘50 years of failure’, provides a damning assessment of Australian housing policy, claiming that government self interest has led to the worst affordability problem since the end of World War II:

“Politics – more than any other single factor – means that Australians are likely to have to live with a dysfunctional housing system for a long time yet to come,” Mr Eslake said.

Government policies including cash assistance to first-time home buyers and negative gearing had only served to inflate the demand for housing whilst doing next to nothing to increase the supply and therefore made affordability worse, he said…

While political parties and governments professed to care about first home buyers, the reality was that they preferred to garner the votes of the 5.8 million households who sought policies that would increase house values.

Presumably, Mr Eslake’s submission to the Senate Inquiry is the same one as presented to the 122nd Annual Henry George Commemorative Dinner, hosted by Prosper Australia, last September. This presentation was summarised on this blog, and below are extracts taken directly from that post explaining Eslake’s position.

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Consider the next chart showing how the home ownership rate has decreased over the past 50 years, despite the massive decline in interest rates and subsidies to first home buyers (FHBs):

Moreover, home ownership has fallen across all age cohorts, although the decline has been particularly severe amongst younger cohorts:

According to Eslake:

…the decline in home ownership has been even more pronounced when one ‘looks through’ the effects of the ageing of the population, which (among other things) means that an increasing proportion of the population is within age groups where home ownership rates are always (and for obvious reasons) higher than in younger age cohorts…

Research by Judy Yates of the University of NSW shows that home ownership rates among younger age groups declined dramatically between the 1991 and 2011 Censuses – from 56% to 47% among 25-34 year olds; from 75% to 64% among 35-44 year olds; from 81% to 73% among 45-54 year olds; and 84% to 79% among those over 55…

This is also evident in the fact that home owners are taking longer to pay off their mortgages. According to the ABS’ just-released Survey of Housing Occupancy and Costs (ABS 2013b), only 45.8% of home-owning households owned their home outright in 2011-12, compared with 58.5% in 1994-95.

Eslake also showed how the supply of housing has become increasingly constipated since the 1990s in the face of rising demand, in concert with urban containment policies by Australia’s various state and territory governments:

…between 1976 and 1991, the housing stock increased at a much faster rate – 41% – than the population – 23% – although only 9% of dwelling completions during this period were by the public sector.

But the relationship between growth in the housing stock and population growth began to change after the early 1990s. Between 1991 and 2001, Australia’s population grew by 11.5%, while the housing stock grew by only 18.3% – less than 9 pc points more than the population.

And between 2001 and 2011, while the population grew by 15.9%, the housing stock grew by only 15.2%. That is, over the past decade, the housing stock has grown at a slower rate than the population – for the first time since the end of World War II.

This gradual narrowing in the ‘gap’ between the growth rate of the housing stock and that of the population – to the point of eliminating it entirely over the past decade – has come in the face of demographic trends that would have warranted a widening of this gap:

average family sizes declined between the early 1960s and the early 1990s, implying that more dwellings are required to accommodate the same number of people;

family breakdowns have meant that more dwellings are required to accommodate the same number of people; and

population ageing has resulted in more people living alone, again increasing the number of dwellings required to accommodate the same number of people.

Yet, in the face of these ongoing trends, the average number of people per dwelling actually rose (from 2.61 to 2.64) between the 2006 and 2011 Censuses – for the first time in at least 100 years (since the first Commonwealth Census was conducted in 1911 – see Chart 3). From 1911 to 2006, the average number of people per dwelling had fallen from 4.52 to 2.61. It would seem that the widespread angst among ‘baby boomer’ parents about how difficult it is to get their 20- (and in some cases 30-) something children out of the family home has a sound basis in fact.

Eslake puts the recent failure of housing supply to keep up with demand down to two main factors, namely:

The decline in the provision of social housing; and
Restrictive state and local government planning schemes and upfront charging for development and infrastructure.

Eslake is particularly scathing of policies that boost demand, such as FHB Grants and negative gearing.

FHB Grants began in the 1960s and have been cancelled and then re-introduced a number of times ever since. According to Eslake, governments have spent a total of around $22.5 billion in grants in 2010-11 values over the past 50 years, yet homewonership rates have not increased over this period. They provide minimal benefit to FHBs, acting to inflate values for the benefit of vendors. In this regard, they have been a massive failure, although the recent shift towards newly constructed dwellings is a significant policy improvement.

On negative gearing, Eslake noted that it has “actually exacerbated the mis-match between the demand for and the supply of housing, as well as having distorted the allocation of capital, and undermined the equity and integrity of the income tax system”.

Australia is one of only a few developed nations that allow negative gearing, which was made all the worse by the Howard Government’s 1999 decision to tax capital gains at half the rate applicable to other income (instead of taxing inflation-adjusted capital gains at a taxpayer’s full marginal rate). Thus negative gearing became “a vehicle for permanently reducing, as well as deferring, personal tax liabilities. And the availability of depreciation on buildings adds to the way in which ‘negative gearing’ converts ordinary income taxable at full rates into capital gains taxable at half rates”. As such, it has also become increasing popular:

Eslake sees no policy rationale for negative gearing. It costs taxpayers a fortune – roughly $5 billion in revenue foregone. It does nothing to increase the supply of housing – “92% of all borrowing by residential property investors over the past decade has been for the purchase of established dwellings, as against about 72% of all borrowing by owner-occupiers”. It increases investor demand and prices. And it does nothing to improve rental availability or affordability.

As for common arguments in favour of negative gearing:

Supporters of ‘negative gearing’ argue that its abolition would lead to a ‘landlord’s strike’, driving up rents and exacerbating the existing shortage of affordable rental housing. They repeatedly point to what they allege happened when the Hawke Government abolished negative gearing (only for property investment) in 1986 – that it ‘led’ (so they say) to a surge in rents, which prompted the reintroduction of ‘negative gearing’ in 1988.

This assertion is actually not true. If the abolition of ‘negative gearing’ had led to a ‘landlord’s strike’, as proponents of ‘negative gearing’ repeatedly assert, then rents should have risen everywhere (since ‘negative gearing’ had been available everywhere). In fact, rents (as measured in the consumer price index) only rose rapidly (at double-digit rates) in Sydney and Perth – and that was because in those two cities, rental vacancy rates were unusually low (in Sydney’s case, barely above 1%) before negative gearing was abolished. In other State capitals (where vacancy rates were higher), growth in rentals was either unchanged or, in Melbourne, actually slowed (see Chart 7).

However, notwithstanding this history, suppose that a large number of landlords were to respond to the abolition of ‘negative gearing’ by selling their properties. That would push down the prices of investment properties, making them more affordable to would-be home buyers, allowing more of them to become home-owners, and thereby reducing the demand for rental properties in almost exactly the same proportion as the reduction in the supply of them. It’s actually quite difficult to think of anything that would do more to improve affordability conditions for would-be homebuyers than the abolition of ‘negative gearing’.

Eslake also notes that there is no evidence to support the claim that negative gearing results in more rental housing being available that would otherwise be the case:

Most other ‘advanced’ economies don’t have ‘negative gearing’: yet most other countries have higher rental vacancy rates than Australia does.

In the United States, which hasn’t allow ‘negative gearing’ since the mid-1980s, the rental vacancy rate has in the last 50 years only once been below 5% (and that was in the March quarter of 1979); in the ten years prior to the onset of the most recent recession, it has averaged 9.1% (see Chart 8 above).

Yet here in Australia, which does allow ‘negative gearing’, the rental vacancy rate has never (at least in the last 30 years) been above 5%, and in the period since ‘negative gearing’ became more attractive (as a result of the halving of the capital gains tax rate) has fallen from over 3% to less than 2%.

During that same period, rents rose at rate 0.8 percentage points per annum faster than the CPI as a whole; whereas over the preceding decade, rents rose at exactly the same rate as the CPI.

Similarly, countries which have never had ‘negative gearing’ – such as Germany, France, the Netherlands, the Nordic countries and (low-tax) Switzerland – have much larger private rental markets than Australia.

Eslake also debunked claims that removing negative gearing would create distortions in the tax system:

Some supporters of negative gearing also argue that since businesses can deduct all of the operating expenses they incur (including interest) against their profits in order to determine their taxable income, and can also ‘carry forward’ net losses incurred in any given year against profits earned in subsequent years so as to reduce the tax otherwise payable, it is only ‘fair and reasonable’ that investors should be able to do the same.

There are two flaws in this argument, in my view. First, a large part of the appeal of ‘negative gearing’ comes from the way in which it allows income which would otherwise have been taxed at the investor’s marginal rate effectively to be converted into capital gains, which are taxed at half the investor’s marginal rate. Businesses – if they are incorporated, as most businesses these days are – can’t do that. Companies aren’t eligible for the 50% discount on tax payable on gains on assets held for more than one year.

Second, while individuals are allowed to deduct expenses incurred in connection with producing investment income from their taxable income, they aren’t allowed to deduct many types of expenses incurred in producing wage and salary income.

To take an obvious example, wage and salary earners aren’t allowed to deduct the cost of travelling to and from work; nor are they allowed to deduct child care expenses.

Or, to take another example which may be an even closer analogy with ‘negative gearing’ for investment purposes, individuals aren’t allowed to deduct interest on borrowings undertaken to finance their own education as a tax deduction, even though that additional education may contribute materially to enhancing their future earnings – and even though any such additional future earnings will be taxed at that individual’s full marginal rate, as opposed to half that rate in the case of capital gains on an investment asset.

Finally, Eslake finished by offering seven key policy reforms to improve the functioning of the housing market:

The fundamental change that such a set of policies might embody would be a switch from policies which inflate the demand for housing to policies which boost the supply of housing. Such a suite of policies might include some or all of the following.

First, the abolition of all existing policies which serve only to increase the prices of existing dwellings, such as cash grants to and stamp duty exemptions for first time buyers, and ‘negative gearing’ for investors (in all assets, not just property, and if politically necessary, only for assets acquired after the date on which such a policy was announced);

Second, the redirection of the funds thereby saved (and/or the additional revenue raised) towards programs that increase the supply of housing – for example, by directly funding the construction of new dwellings (as the Rudd Government did as part of its response to the global financial crisis), or by providing some combination of grants, loans or tax incentives to induce private sector developers to increase the proportion of ‘affordable’ dwellings within their developments, whether for sale or rental;

Third, expanding or replicating programs like Western Australia’s ‘Keystart’ scheme which assist eligible people to become home owners on a ‘shared equity’ basis, with eligibility being subject to a means test, and which creates a ‘revolving fund’ as the ‘shared equity’ is returned to the State Government upon sale;

Fourth, changes to the way in which State and Territory Governments tax holdings of and transactions in land, with a view to encouraging more efficient use of it. That would include replacing stamp duty on land transfers (which are ‘bad’ taxes on many grounds, including that they discourage people from changing their dwellings as their needs change) with more broadly-based land taxes (ie, no exemptions for owner-occupiers, but with appropriate transitional provisions) and possibly higher rates for undeveloped vacant land in established urban areas;

Fifth, taking a more ‘holistic’ view of urban infrastructure investment, by recognizing that it has an important housing dimension – that is, that public (or private) investment in transport infrastructure (both public transport and roads) can make a tangible contribution towards improving housing supply and affordability by making ‘greenfields’ developments more accessible to both buyers and renters – and considering funding such infrastructure by levies on the increments to the value of the land which result from such investments (as for example with the levy that funded the Melbourne Underground Rail Loop Authority in the 1970s and early 1980s);

Sixth, revisiting current models for financing the provision of infrastructure and services in ‘greenfields’ housing estates with a view to reducing the extent to which these are funded by ‘upfront’ charges (something which could be assisted by changes to the land tax regime which I mentioned a moment ago); and

Seventh, reducing the cost, complexity and regulatory uncertainty associated with ‘brownfields’ and ‘infill’ developments in established areas – which doesn’t have to mean traducing the property rights of other property owners, but which should mean clearer and more uniform planning rules, with fewer opportunities for frivolous or vexatious objections and appeals.

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