In New Zealand, Labour stands in opposition to the National Party (the incumbent government) and has done since 2008.
At his party's recent annual conference, Labour leader Andrew Little announced plans to close the ‘tax loop hole that allows speculators to offset losses from their property portfolio against their personal tax liability.’ It is effectively a taxpayer subsidy to speculators, Little said, and its closure will allow first-time buyers to compete fairly in the market place with more housing stock being available to them.
Given they are in opposition, Labour will automatically gainsay anything proposed, done or permitted by the government and whilst on the face of it this issue may have some merit, it warrants a closer look.
Firstly, the policy is being formulated to address what is known as negative gearing, a term generally associated with house purchase and investment.
This is standard global business/accountancy practice based upon the fundamental economic tenet of companies paying tax on profit and profit, as it always has done equates to income less expenses. When income exceeds expenses, tax is levied, when it does not, then the loss is claimable.
This scenario is clearly perceived by Little as some holy grail of investment, but he seems to miss the point that in order for this to occur, the ‘speculator’ must make a loss. That, for most sensible people, is not a path to riches and it is often a byproduct of, for example, increasing housing costs and decreasing rents, major maintenance, interest rate changes (fixed rate to floating) or legislative/compliance requirements that - whilst necessary - carry cost, such as smoke alarms and insulation.
Secondly, he considers that this measure will ‘level the playing field’ and make more stock available to first-time buyers. That is a naive sentiment; availability of stock is not the primary economic hurdle that first-time buyers must clear, it is affordability. Granted, the one impacts the other; the less stock there is, the more it typically costs, but covering a mortgage of in excess of $600,000 - the deemed ‘affordability’ level of Auckland housing - is clearly a significant issue. A much greater one than the erosion of stock by investors.
The major flaw in Labour’s thinking is that constraining the demand-side on rental properties means that there is less stock available for renters. On the basis of Keynesian economics, that means the cost of stock goes up which means rents must increase and if rents increase, yields are adjusted accordingly and that inflates value.
Inflation is a tide that floats all boats and any increase in cost is also a higher affordability hurdle for first-time buyers to clear.
In addition, the increased rent and rental yield, lowers the barriers to entry. It encourages more people to offer housing for rent as they are likely to get a better return until at some point it reaches equilibrium.
Properties available for rent are not properties available for purchase and therefore this approach detracts from the stock available for first-time buyers and becomes a policy whose outcome is that which it was designed to avoid.
With the stated intent of the policy being to target those speculators with more than five houses, Labour has made an arbitrary decision that assumes (seemingly) that a significant number of investors holding more than this level of stock, are negatively geared and blocking this ‘loop hole’ will result in a windfall of income and of course, increase Labour’s popularity with the voters. The policy does not state how many speculators hold five or more properties, and nor does statistics NZ. So how then can it calculate the economic benefit of this policy and whether it is even worthwhile implementing?
Let's look briefly at the reality of this ‘tax loop hole’:
As mentioned, it requires that the investor makes a loss, and most people don’t invest on that basis.
Taking Auckland with an average house costing an even $1 million, for say a four-bedroom, two bathroom house is looking at a location where at that price level, the ‘benefits’ (in Labour party parlance) may be the greatest.
With the current reserve bank Loan to Value Rules (LVR) requiring investors or anyone buying a house for a purpose other than owner-occupancy to stump up 40 per cent of the cost, we’ll assume that the investor has a debt of $600,000 on the average house.
On an interest-only basis at say six per cent, interest as an expense is $36,000 per annum. Add to that rates - say $4,000 - plus $1,500 in insurance, and expenses exceed $40,000. Depreciation can be claimed, but it’s generally not much compared to that sum.
Rent is likely to be around $650 per week for 50 weeks (allowing for modest voids) we have income of $32,500. The result is a $7,500 yearly loss. It is negatively geared.
This loss can be offset against the taxable income of the individual (or elsewhere, but it is this option that seems to have Labour frothing at the mouth) and assuming he/she is a higher rate tax payer at 33 per cent, will receive a reduction in tax on the loss, which equates to $7,500 times that 33 per cent, or $2,475. It can also be carried forward and offset against eventual profits, which is the more likely scenario should this proposition become law.
That is still a net loss after tax of $5,025.
As a percentage of the value of the stock, the ‘tax break’ of $2,475 equates to 0.2 per cent of the asset value.
Taking a look at what this might yield as income, there are approximately 450,000 rented homes in Auckland in a population of 1.4 million people. It is hard know but it seems highly unlikely that more than one per cent of people own more than five homes. That would mean of the 450,000, 14,000 people own at least five houses or 70,000 houses in total.
Of those, a relatively small number will be in a loss making scenario - let’s assume 20 per cent.
That means there are 14,000 people getting tax relief of $2,475 at best! That adds up to $34.6 million, which if it was truly hypothecated towards providing houses instead, would allow the construction of maybe 40 to 50 houses. Hardly something that is going to make a major impact on the availability of housing stock for first-time buyers in a population of 1.4 million people.
Now that in the scheme of government expenditure (or savings) is not a significant figure and as stated above it is wholly in accordance with the basic principles of commerce as we know it. All other businesses operate the same basis and housing and ‘speculation’ thereon, is simply a convenient drum to bang on. Hypocritically, there is no mention of Labour foregoing the tax it would receive from that group of investors who own more than five houses who are making a profit!
To look briefly at Spark (Telecom as was) in NZ. In its 2016 annual report, its expenses (which is what we’re really talking about) which it sets off against tax at 28 per cent is $2.5 billion. The ‘tax loop hole’ allows it avoid paying tax of circa $700 million.
Is Little going to curtail this as well?
The Labour policy seems to be "we’re happy to tax the profits but we don’t want the same regime applied to the losses."
The other issue to consider is the legal structure that governs a lot of property ownership of this class. A significant volume is held in trusts. There are a large number of limited companies that will own both commercial and residential property, operating as a company on exactly the same principles of income and expenditure as the rest of the business world. Unless Labour wishes to rewrite the laws of companies and tax, these entities can and will continue to use expenses to offset profit before tax regardless of how many properties are involved.
It would be an unimaginably complex undertaking to separate residential from commercial and levy a different tax base on them.
In Little’s own words ‘mom and pop’ investors are not being targeted, but there are no doubt a number of those who have five or more properties and who aren’t ‘speculators’ but hard-working Kiwis simply trying to ensure a comfortable retirement.
Baby out with the bath water and all that!
This is an opportunistic policy that does several things:
- It jumps on the back of an extant housing problem.
- It is based upon an ill-conceived notion of taxpayers subsidising speculators’ income tax which is far from the reality.
- It seeks to stand the laws and practice of business and commerce on their head and God forbid, should it come to pass, will do more harm than good.
- Finally, it virtually ensures as a policy platform, Labour’s continued stance as the opposition party for the foreseeable future.
Once it has recovered from this ‘foot shooting exercise’ Labour may reconsider the realities of fanciful notions in favour of something more worthy of our time and consideration and something that might, actually, do some good in a problematic area of the economy.
Affordable housing. Now there’s a holy grail worth pursuing.