Suppose you have an apple orchard. You hire labour to pick and pack your apples. You sell each box of apples for $40. You deduct labour costs of $30 and earn a profit of $10. After paying tax at 33 cents in the dollar, you have $6.70 per box to live on.
Now the government announces that it is rushing legislation through parliament to remove what it calls the wage deductibility tax “loophole”. Anyone buying your business will pay tax at 33 cents on the dollar on the $40 per box revenue. This raises the ‘income tax’ on the business from $3.30 to $13.20. Costs now exceed revenue by $3.20 a box. You no longer have a buyer for your business. Worse, in four years, you will be in the same tax situation. Your business will be bust. Your workers will have to find other work or go on welfare. Your former customers will have to do without apples.
The government is pleased you are gone. Orchardists are speculators; they are hoping that the market value of their business will rise. Speculation is bad. Speculators should be driven from the apple market.
Does this sound far-fetched? Not if you are a landlord. This week the government announced it will close the “interest deductibility loophole” in rental housing for new investors. For existing investors, it is to be closed over four years. The government explained that it wants to remove incentives for speculators, equating them with investors.
Here are some of the things that are wrong about this.
First, an income tax should tax income (ie profits), not revenue. Income is what is left of revenue after all business-related expenses have been paid. The apple orchard case illustrates why it is wrong to tax revenue. If there is little or no after-tax profit, there is no business.
In the extreme, if landlords cannot make an after-tax profit, there will be no houses to rent. Those who cannot afford to buy a house are at the mercy of the only remaining landlord – the government. Former East Germans have experienced that situation.
Second, how can it be that landlords are speculators, but owner-occupiers are not? How many recent home buyers paying high prices have not been expecting prices to go even higher? Why discriminate against rental accommodation?
Third, the tax system was already seriously biased against the supply of private rental housing. Owner-occupiers do not pay any tax on the income they receive in the form of forgone rental payments. If you and I own identical houses, but I rent from you and you rent from me, we both pay tax on our net rental income. If we each live in the house we own, neither of us pays any such tax. The government is increasing this bias against the provision of rented accommodation.
The government has increased the system’s bias against the supply of rented accommodation in other ways. Forcing landlords to raise the quality of their properties is undoubtedly well-intentioned. But it risks rent increases which price some people out of the rental market. What happens to them? Which is worse, families sleeping in cars or substandard rental housing? Should those families not at least have the choice? Similarly, would-be tenants with the worst records as tenants are most likely to be the victims of policies that aim to increase tenants’ legal powers for landlords. Landlords cannot afford to have their properties wrecked by tenants whom they cannot evict in time.
Fourth, speculation is a symptom, not a cause. The Reserve Bank has lowered interest rates and flooded the banking system with liquidity to an unprecedented degree. It has jawboned the banks to lend more freely since Covid-19. These actions must have boosted house prices. Imprudent borrowing is the only game in town, with the government leading by example.
Inducing people to borrow to the hilt to buy over-priced properties is a recipe for much future grief. But that is what current policies are doing. If the average house in New Zealand has gone up 25% recently to, say, $1 million, that is a wealth transfer of $200,000 on average. Across 1.8 million dwellings, that is a gain of $360 billion. The losers are largely the lenders – bank depositors – and those who do not own houses.
Perhaps the worst aspect is the signal that the government cares so little for sound income tax principles or prior public debate or scrutiny. If interest deductibility can be wilfully declared a tax loophole, what category of business expense is not a tax loophole?
When governments play fast and loose with the definition of taxable income, they undermine the basis for economic activity. Labour has an absolute parliamentary majority. That would be OK if its policies were not so unprincipled and unnerving. US nineteenth Century lawyer and politician Gideon Tucker’s warning, that “no man’s life, liberty or property are safe while the Legislature is in session”, seems apposite. The overnight drop in the value of the New Zealand dollar is a warning signal.
The proximate cause of disastrously high house prices is the failure of house-building to keep pace with rising demand. A fundamental source is the strong anti-development bias embedded in the Resource Management Act 1991 and subsequent legislation. Between 1890 and 1990, New Zealand’s population grew at 1.6% per annum on average, and house prices were largely reasonable relative to incomes. Between 1990 and 2020, the population has grown at 1.3% per annum on average, and house prices have gone berserk relative to incomes.
Such legislation and other changes have gravely weakened local authorities’ incentives to permit adequate housing development. The perversity of those incentives is now a problem in its own right. Planners with anti-development plans are entrenched. The common person is disempowered.
Of course, past governments are at fault for kicking this can down the road. But that does not excuse this government's failure to use its parliamentary majority to address the problems at source. Instead, it is making housing policy even more incoherent and distorting.
To subsidise homeownership for the relatively well-off while making it harder for others to find an affordable place to rent is hardly consistent with a concern for people at the bottom of the socio-economic ladder. On this form, the next step to wrecking the housing market could be rent controls. Heaven forbid.