Against all odds, AHURI quantifies stamp-duty/land-tax switch
G. Wood, R. Ong, M. Cigdem and E. Taylor, The spatial and distributional impacts of the Henry Review recommendations on stamp duty and land tax (AHURI Final Report No.182, Feb. 2012), reviewed by Gavin R. Putland
Among the swiftly rejected recommendations of the Henry Review was a rationalization of State property taxes, in which the existing stamp duties and discriminatory land taxes would be abolished in favour of an all-in land tax with no aggregation, and with thresholds expressed in terms of land value per unit area (recommendations 51–54). The effects of that change on tax bills and land values in greater Melbourne have been modelled in the above-mentioned report by Prof. Gavin Wood et al., published last month by the Australian Housing and Urban Research Institute (AHURI).
The methodology of the report is thorough in quantifying the formal incidence of taxation (that is, who pays how much to the State revenue office), but less thorough in quantifying the effects on rents and prices of housing. In particular, the methodology does not quantify:
(a) the upward effect on rents, hence prices, due to stamp duty impeding the transactions that are needed to bring new housing supply to market;
(b) the downward effect on price/rent ratios caused by the “round-trip” effect of stamp duty — that is, the reduction in the total amount of interest that a rational buyer will be willing to pay during the purchase-resale cycle;
(c) the ability of a buyer to convert a stamp-duty reduction into an increase in the deposit and then “lever up” to a larger increase in borrowing capacity.
Because of (a), the report tends to understate the benefit of the reform in reducing rents. But because of (b) and (c), the report tends to overstate the reduction in prices under the proposed reform; indeed, points (b) and (c) describe mechanisms by which the abolition of stamp duty would tend to increase prices, and there is no guarantee that these mechanisms would be outweighed by those tending to reduce prices.
Concerning point (b), note that because the stamp duty is a deduction from the total interest that a rational buyer will be willing to pay while holding the asset, the reduction in the acceptable interest bill per unit time, hence the reduction in the acceptable price, is inversely related to the time for which the asset is to be held. The shorter the “round-trip” time, the greater the reduction in the acceptable price; and there is nothing to stop the effect on the price from being greater than the value of the duty.
Point (b) is overlooked in Figure 1 of the report [p.7], which considers how stamp duty affects transfers of a fixed stock of equally desirable homes from “insiders” (current owners, arranged in order of decreasing reserve prices for the homes, forming the demand curve Dc) to “newcomers” (arranged in order of increasing bids, forming the demand curve Dn). In the absence of stamp duty, the intersection of the two curves determines the division of the stock between insiders and newcomers, and the transfer price. Then the report argues:
But consider a duty of T per housing unit transaction that is paid by newcomers on purchase. If all newcomers have the same expected holding period, so that T is amortised over the same number of years, there will be a parallel downward shift in the demand curve from Dn to Dn−T.
The second sentence begins by acknowledging the relevance of the holding period and ends by concluding that the curve is shifted by a amount (T) that does not depend on the holding period! From the assumption that all newcomers have the same holding period, it indeed follows that the shift will be “parallel”, meaning that all points on the curve will be shifted downward by the same margin; but it does not follow that the margin will be T.
Points (b) and (c) above are consistent with the following observation by Andrew Leigh [“How do stamp duties affect the housing market?” (2009/2013), p.406]:
Across all postcodes, the short-term impact of a 10 per cent increase in the stamp duty is to lower house prices by 3 per cent.... Because stamp duty averages only 2–4 per cent of the value of the property, these results imply that the economic incidence of the tax is entirely on the seller... Indeed, the house price results are in some sense ‘too large’, in that they imply a larger reduction in sale prices than the value of the tax...
That said, lower prices do not imply improved affordability for first home buyers. As hinted in point (c), stamp duty increases the “deposit gap” and thereby weakens the position of first-time buyers relative to repeat buyers, who have usually accumulated more than enough equity (mostly through capital gains) to cover the stamp duty.
In summary, the effects that are not modelled in the report give us cause to doubt the findings concerning the effects of the proposed changes on prices. But they give us no cause to doubt the findings concerning the formal incidence of the reforms, and they should enhance our confidence that the findings concerning rents and the findings concerning land tax alone are not only reliable, but understated.
Redistributing the tax bill
Concerning the effects of the proposed reforms on the formal incidence of property taxation, we may well quote from section 5.2 of the report [pp.30–42], subtitled “Formal incidence under the proposed land tax and stamp duty regimes”.
A land tax based on square metre land values will radically change the spatial incidence of the revenue by concentrating the tax burden in the inner ring of business districts and suburbs. For example, almost half of the land tax revenue would be raised from land plots within 10 kilometres of the CBD, where land is most expensive (a mean value of $1335 per square metre). Less than one third of stamp duty revenue is levied from property transactions within the same 10 kilometre ring. On the other hand, the tax burden would be lower on the urban fringe where land is comparative cheaper at around $300 per square metre. For example, within the 30–40 and 40–50 kilometre bands, only 4 per cent of land tax revenue will be raised as compared to 15 per cent under stamp duties [p.30].
. . .
It is noteworthy that the proposed reforms will shift the tax incidence onto suburbs with high taxable income per taxpayers, in particular Stonnington, Bayside and Boroondara [p.34].
. . .
Per capita land taxes are much higher in LGAs where income per capita is correspondingly high. The relationship is a strong one with a correlation coefficient (between per capita land tax and per capita income) exceeding 0.8.
... LGAs such as Port Philip, Stonnington, Yarra and Melbourne, that typically feature suburbs with more expensive land per square metre, contain the highest proportion of highly qualified residents in professional occupations. The relationship is a strong one with correlation coefficients of around 0.7 [p.35].
. . .
We can expect the proposed reform to result in accelerated development, and given the spatial pattern of land tax liabilities, this should be particularly apparent with respect to Brownfield sites nearer to the CBD where land values per square metre are particularly high. Where stamp duty can deter potential transfers of property from lower value uses to higher value uses, its removal might well accelerate such transfers and improve allocative efficiency.
... The cheapest 30 per cent of transactions according to unimproved land values account for almost 10 per cent of total stamp duty revenue, but close to zero land tax revenue [p.39].
. . .
Properties built during the last ten years account for one-quarter of stamp duty revenue from property transactions in 2006; this is more than double the stamp duty revenue generated from stock built in any other ten-year vintage. This is despite the fact that the average property price of stock constructed more than 60 years old is higher than that of newly constructed buildings. There is no clear discernible pattern in the distribution of land tax revenue by age of building [p.40].
The following statement from the executive summary [p.1] is largely, but not entirely, about formal incidence:
Our findings suggest that under the proposed arrangements, the formal incidence of the tax will be felt most keenly where pressure on land use is most acute. This is in part due to progressive marginal rates of land tax; land with higher per square metre values attracts a higher marginal rate of land tax. Hence, we can expect the proposed reforms to speed up development in areas where land is more expensive, especially if developers face binding borrowing constraints (i.e. they are unable to meet land tax payments by borrowing). Furthermore, the proposed land tax will concentrate the tax incidence on municipalities that contain relatively well-off communities. The removal of stamp duty might also affect the timing of development as its abolition will speed transfers of property from lower value uses to higher value uses and generate efficiency gains, as ‘empty nesters’ now find trading down is a more effective method of releasing housing equity, with the result that housing stocks are more fully utilised.
Thus the tendency of land tax to “speed up development” is acknowledged. But the effect of the increased housing supply on rents and prices is not quantified.
A similar passage from the final summary [p.44] covers some of the same ground but also refers to “a strong correlation between land tax burdens and income, occupation and education indicators.” It adds:
Our land value segment analysis confirms findings from the spatial and municipality analysis; suburbs that are located closer to the CBD, and relatively affluent, have the most expensive land and will therefore bear the highest tax burdens under the reforms.
Under the “theory of tax incidence” [p.6] the report refers to another disadvantage of stamp duty:
Those who move more frequently pay relatively high amounts of duty, while the duty also deters the transfer of property from lower value uses to higher value uses and results in an inefficient allocation of resources.
The second part of that statement acknowledges point (a) above — that stamp duty impedes “the transactions that are needed to bring new housing supply to market” — but again the effect is not quantified.
The first part (that stamp duty discriminates against frequent movers) is certainly true under the prevailing habits of home owners. But I must point out that if you are a home owner, you don't have to pay stamp duty in order to relocate or downsize. You can let your old address to tenants, and rent your new address, thus avoiding a dutiable transaction. And you can use some of the saving in stamp duty to buy whatever security of tenure you need at your new address. The same trick lets you claim negative gearing on your old address (if the interest and other outgoings exceed the rental value). If enough home owners adopt this tactic, governments will be forced to abolish stamp duty in favour of something that cannot be so easily avoided — such as land tax. In the mean time, the opportunity to avoid stamp duty is there for the taking.
On the incidence of land tax [pp.7–8], the report notes:
Under present land tax arrangements... single property owners typically have a small or more often zero tax liability, while multiple property owners have relatively high tax burdens. This tax base is the source of diseconomies of scale that are a barrier to the attraction of wholesale sources of private finance (superannuation funds, for instance) into the private rental housing market...
The implication is that if the land-tax base were not aggregated, institutional investors would be more likely to enter the rental housing market, and some of their investment would be in new construction which would add to the supply of housing. One might be tempted to suggest that institutional investors would simply “crowd out” individual investors and owner-occupants. But they would not, because institutional investors would be more likely to build at the highest permitted density in order to economize on an expensive input (land) — whereas the building options of smaller investors and owner-occupants would be constrained by their limited borrowing capacity, and owner-occupants would be further constrained by their consumption preferences (what sort of dwelling they want to live in).
Redistributing land values
Section 5.3 of the report, subtitled “Impacts of the proposed land tax on land values” [pp.42–43], refers to the effects of the land tax only. Unfortunately that qualification is not always clear in the text, which is therefore more than usually dangerous to quote out of context. However, the qualification is duly mentioned in the captions of Table 15 [p.42] and Figure 17 [p.43], and in the following text [p.42]:
Table 15 shows that the expected decline in land value as a result of the proposed land tax will be greatest in those suburbs in and around the CBD, where land is currently most expensive.
The following statement appears in the executive summary [p.2] and in the final summary [p.45]:
We find that the average plot with a land value of $335,000 (at 2006 prices) will decline by $24,000, or approximately 5 per cent. However, the expected decline in land value will be greatest in those suburbs in and around the CBD (at around 12%), where land is currently most expensive. However, in suburbs further away from the CBD, the percentage decline in mean land value will be lower at 8 per cent or less. These estimates are conservative because they do not include estimates of the fall in land and house values that will eventuate due to the elimination of stamp duties. Their inclusion will mean that owner occupied housing is more affordable under the proposed reforms, since the aggregate fall in house prices will exceed the capitalised value of land tax payments.
The estimates are “conservative” in that they ignore the upstream effect of stamp duty, which impedes the supply of new housing and therefore tends to raise rents, hence prices. They are conservative in neglecting the effect of stamp duty on the “deposit gap”, which is of particular concern to first home buyers. But they are not conservative in ignoring the round-trip effect of stamp duty. Hence they may not be conservative overall in terms of prices (as distinct from rents or the competitive position of first-time buyers).
Effect of land tax on rents
The last-quoted passage [pp.2,45] continues:
There will also be a boost to the supply (and affordability) of rental housing as the broad based land tax puts landlords and home owners on an equal footing.
This statement implies that a land tax treating landlords and owner-occupants alike would give more affordable rental housing than the present land tax (which exempts owner-occupants). It rightly does not imply that the complete abolition of land tax would have the same effect. Unfortunately the report implies elsewhere, and wrongly, that the complete abolition of land tax would have that effect.
One mechanism by which land tax tends to reduce rents is the imposition of a holding cost which makes it unattractive or uneconomic to hold unoccupied land for speculative purposes; to cover the holding cost, the owner must either get a tenant or sell the land to someone who will. That mechanism is not compromised if the tax exempts owner-occupied land, which by definition is not “unoccupied land” held for speculative purposes. But in Figure 2 of the report [p.9], that mechanism is ignored.
Figure 2 uses reasoning analogous to that of Figure 1, except that the price (vertical dimension) is in annualized (rental) terms. It considers how land tax affects the division of a fixed stock of equally desirable lots between owner-occupants and providers of rental housing (ignoring any other possible allocations, including speculation on vacant lots). The owner-occupants are arranged in order of decreasing bids for the land, and the providers of rental housing are arranged in order of increasing bids. In the absence of land tax, on the false assumption that no lots are taken by speculators and left vacant, the intersection of the two curves determines the division of the land between owner-occupants and investors, and the rent.
Figure 2 then argues that the effect of the land tax on providers of rental housing is to lower their demand curve by the value of the tax, shifting the intersection in favour of owner-occupation and causing an increase in the tax-inclusive rent (which must be recovered from tenants if the investment is to be viable, and can be recovered from tenants because of the shift in the intersection). This argument fails to allow for the unused land to which the tax would apply, and some of which would be forced into use.
The next step in the argument, in Figure 3 [p.10], says that when the land tax is extended to owner-occupants, it lowers their demand curve by the value of the tax, shifting the intersection in favour of investors and causing a fall in the tax-inclusive rent. Again it is assumed that no unused land is forced into use. But this time the assumption is reasonable because the extension of land tax to owner-occupants does not change the treatment of unoccupied land.
So, what Figures 2 and 3 actually prove is that rents are now higher than they would be if land tax were extended across the board. They do not prove that rents are higher than they would be if there were no land tax at all. (So the descriptions of PP in Figure 2, and of R0 and X in Figures 2 and 3, are wrong as regards the words “not taxed”.)
The following statements in the report, in so far as they refer to forward shifting of land tax or an increase in rents, must therefore be rejected as being based on inadequate assumptions:
“In a housing market where land can be used for rental or owner occupied housing, the taxation of the former will then result in a contraction in the supply of rental housing, as some rental investors seek higher returns elsewhere, and an increase in rents” [p.8];
“But under current arrangements illustrated in Figure 2 only part of the land tax burden is shifted back to landowners; the rest is borne by tenants as competition between developers will result in forward shifting into the rents paid by tenants” [p.10];
“In a housing market where land can be used for rental or owner occupied housing, the taxation of the former results in a contraction in the supply of rental housing, as some rental investors seek higher returns elsewhere, and an increase in rents” [p.13, p.44].
Figure 4 [p.12] likewise fails to allow for the reduction in speculative holding of vacant land, invalidating the conclusion that “Provided a land tax is broad-based such that there are no exemptions, it will have no impact on the size of cities or their density” [p.11]. In fact, any land tax that discourages waste or under-use of valuable land will tend to produce more compact cities, with consequently shorter commuting distances and smaller ecological footprints.
[P.S. (Mar.29): See also “Why land tax can't be shifted onto tenants”.]
Obstacles to the research
The principal findings of the report concern the change in the formal incidence of taxation if the existing land tax and stamp duty were replaced by a broad-based land tax as recommended in the Henry review. These findings, which are contained chiefly in section 5.2 of the report [pp.30–42], are not impugned by any of the above criticisms of the underlying assumptions.
The evaluation of formal incidence was an impressive feat in view of the obstacles faced by the authors in obtaining access to raw data held by the office of the Victorian Valuer-General (VG).
For the stamp-duty side of the calculation, the authors needed to know the location, property type, price and date for every Victorian residential property sale in 2006. The VG was able to supply that information — not only for 2006 but for 1990 to 2010.
For the land-tax side, the authors needed to know the area and value of the land under every Victorian residential property, as assessed for rating purposes in 2006 — nothing about the building or the owner, but only the land area and value. And the land value was obtainable only from the VG.
However, the “confidentialised” data supplied by the VG (for 2008, not 2006) omitted the land value, but included the value of the building (“improvements”), together with the land-use classification code, dwelling size, number of bedrooms, year of construction, and material of construction! From all that information, together with the aforesaid sales data, the researchers constructed estimates of the required land values.
Obviously the land-tax calculation would have been much easier had the authors been given the land value in lieu of all the other information. And it strains credulity to suggest that disclosing the value of the land under your house is a greater invasion of your privacy than disclosing the value of your house itself, let alone the size, age, material and number of bedrooms of your house.
It must be emphasized that the round-trip effect of stamp duty, which tends to reduce property prices, is one effect among many, and that all the other effects are unequivocally evil.
By increasing the deposit gap, stamp duty weakens the competitive position of first home buyers relative to repeat buyers and therefore makes entry to the property market less affordable, regardless of its effect on nominal prices.
Stamp duty is a highly unreliable source of revenue, the more so because it is easily avoided by property owners who are willing to flout the social convention that a person who owns only one property also lives in it. Among owners who adhere to that convention, stamp duty discriminates against frequent movers. If frequent moving is due to unstable employment, stamp duty compounds the difficulty — or deters relocations, causing non-optimal employment choices or unnecessarily long commuting distances.
Stamp duty impedes transfers of title. In particular, it impedes the transfers that are needed to bring new housing to market, reducing supply and raising rents. That mechanism tends to raise prices. The same mechanism impedes the reallocation of land to more productive uses and therefore impedes economic growth and the creation of wealth and employment.
Replacing stamp duty by land tax would avoid these evils. If the round-trip effect of stamp duty reduces land prices, then that is the one thing that stamp duty has in common with land tax, and it neither strengthens nor weakens the argument for replacing one by the other.
[Main text last modified Mar.30, 2012. Links/references updated July 24, 2015.]