It's time the Reserve Bank saw the light on the property problem, says Gareth Morgan in the second part of a two-part special.
It is important to understand the source of the bulk of the profit in the property rental game and why it escapes tax.
It is the capital gain, and the relevant question is why does this asset class appear to have permanent and real (above inflation) long-term capital gain and others don't?
To answer that you need to consider that this is the asset class the Reserve Bank directs banks to favour the most.
So if the growth of lending for this type of investment is strong enough (that is, we're all in there borrowing to invest in it) then the price of property will rise - at least until such time that the market gets so overbuilt by speculators that the slightest tremor in interest rates or confidence sparks a collapse. Sound familiar?
So the capital gains can be self-fulfilling if the banks really want to lend on property in preference to lending on any other asset or business type.
Why might they have such a preference? It comes back to the prudential supervision from our Reserve Bank.
If it endorses a preference for property lending - and it does - then property will be the recipient of most of the credit in any credit expansion. And in response to that, its price will move more than others. And it does.
New Zealand is unique.
Its central bank endorses a preference for mortgage lending over all other forms (as per the Bank of International Settlements' bible) and yet, we have a tax regime that quite uniquely does not tax capital gains.
This is a toxic mix indeed. The result has been a skewed investment preference toward property that is deep-seated and long-lasting.
So much so, in fact, that the balance sheet of New Zealand households is the most saturated with residential property of any household sector in the world.
It's ironic then, isn't it, when you hear our Reserve Bank Governor in numerous speeches, like some bishop from a long-forgotten church, piously bemoaning the wicked damage the housing market does to the economy.
It's a parody of righteousness, when all along the bank is driving our allocation of investment money, high inflationary pressures and our interest rates, which are higher than in comparable economies.
A favourite of successive Reserve Bank governors has been to blame the tax system, and yet the tax authorities say - as they told Andrew King of the Property Investors Federation - that residential property gets no tax favours at all compared with other businesses or investments.
So if tax is to blame, why don't these other asset classes have the ingrained real capital gains that property gets?
Another favourite use by Reserve Bank governors who blame the tax system for the housing distortion is that the imputed rent of owner-occupiers leads to over-investment in housing. But all economies face this issue. It alone is no explanation for New Zealand's gross over-investment in property.
Like a couple of ostriches with their heads deeply buried, each blaming the other, our banking supervisory rules and our tax authorities don't seem to get it - the toxic combination of our unique tax system with our directive to banks to prefer mortgage lending over all other types is the cause.
Which is to blame, tax or the Reserve Bank?
Who cares - surely policy advisers can see that it's the combination that matters.
You could align our tax regime with international norms, or you could use a hammer to crack a nut - and develop a unique tax system just for property running into all the boundary definition problems of what is and what isn't property (just as the Tax Working Group suggested).
Or the Reserve Bank could just stop being such a blind adherent to the Old Testament, and acknowledge that because of the absence of taxing capital gains in New Zealand, it is not appropriate to follow blindly the international bible of bank prudential guidelines - those that instruct banks to favour lending on mortgage to lending on any other activity.
If the capital gains aren't taxed, we can't afford to slavishly follow the international template.
We'd all breathe a sigh of relief, if the Reserve Bank could be so insightful.
It would help issues like mis-allocation of capital and low productivity growth, reducing the bias toward household spending running faster than taxable income, and reducing imbalances such as inflation and an entrenched and large current account deficit.
This, instead of its drone-like adherence to central bank credos from the large Western economies that have totally different conditions to us, would give Prime Minister John Key at least a chance at scoring his "step change" in economic performance.
All in all there are no downsides. Well, perhaps some for King's constituency, but I'm sure the national interest would weigh more favourably.
All we need is for the ostriches to pull their heads up and Alan Bollard to put his bible down.
* Gareth Morgan is director of Gareth Morgan Investments.
