Housing tax reforms require a close look at the numbers

The $200 billion figure would assume that the average value of rented housing was similar to the average for the housing stock as a whole. Photo / Christine Cornege

"We need to stop the tax system creating the wrong incentives," said Treasury Secretary John Whitehead in a speech last week.

Citing Inland Revenue data, Whitehead said 1996 was the last year that more people made profits than losses from rental properties, yet the number of such properties had increased significantly since then.

"Now why would increasing numbers of people - rational New Zealanders - invest billions of dollars collectively in an area that is unprofitable?" he said.

"It's hard to believe it's not because of the tax advantages. People can claim depreciation against their investment properties - even when most real estate was significantly increasing in value. They can deduct tax losses on property against their other income.

"And if they sell a rental property the capital gain they make is usually untaxed."

A widely quoted passage of the Tax Working Group's report in January said that in 2008 the $200 billion invested in rental housing yielded net rental losses totalling $500 million.

That meant that collectively landlords not only paid no tax on their rental income, they were able to escape paying around $150 millon of tax on other sources of income they had.

However, Michael Littlewood, of Auckland University's Retirement Policy and Research Centre, has cast a lot of doubt on the robustness of the $200 billion figure.

It seems to be derived by taking the 2006 Census figures for the proportion of dwellings owned or partly owned by their usual residents (51.1 per cent) plus those held in a family trust by their usual residents (another 11.6 per cent) and assuming the other 37.3 per cent are rented.

If that is applied to the Reserve Bank's estimate of the value of the entire housing stock - $568 billion at the end of 2008 - you arrive at a figure, $211 billion, which might be rounded down to $200 billion for rhetorical purposes.

But Littlewood points out that more than 6 per cent of the Census results on dwelling tenure were either "not stated" or "unidentifiable" and in another 4 per cent of cases the usual residents neither owned them nor paid rent.

In addition, 4.3 per cent of all dwellings are state houses, rented, but not from private landlords.

All this imparts a lot of sponginess to any Census-based binary split between owner-occupied and rented housing.

And the $200 billion would assume, unsafely, that the average value of rented housing was similar to the average for the housing stock as a whole.

Littlewood also argues that the $200 billion looks high or very high when compared with data from the national accounts or from the 2002 household savings survey (extrapolated forward).

But if he is right to conclude that the true combined value of residential investment properties could well be less than half the $200 billion stated, how much ice is that likely to cut with policymakers?

It depends what they are most worried about. If their concern is that New Zealanders are over-invested in property and that that is for tax reasons rather than, say, a shortage of other investment opportunities, then Littlewood's results are highly relevant.

But if the concern is purely fiscal - how to fund the gap between the $2 billion and change that a GST increase would yield and the cost of comprehensive income tax cuts and compensating adjustments to superannuation, benefits and family tax credits - then the focus would be not on how much is invested in rental properties but on the aggregate $500 million of net tax losses.

That ought to be a much harder number. After all, it is a legal requirement to disclose rental income and landlords have every incentive to claim all the deductions available to them.

The Property Investors Federation says the reason for recent losses is transient, explained by increasing mortgage interest rates from 2005 to their peak in 2008. Interest payments are the largest expense for most rental property owners and give rise to the largest tax deductions.

But that explanation glosses over the impact of a doubling in house prices between 2002 and 2007; interest costs depend not only on interest rates but the size of the debt.

Investors were undoubtedly one of the driving forces in the boom, and to a greater extent than the share of properties they ended up buying would indicate.

In much of the market the investor is the marginal buyer - he or she doesn't necessarily end up securing a property but an owner occupier who wants it more would have to outbid him or her to secure it.

The IRD data charted by the tax working group shows a clear downward trend in net rental income for the past decade, and it was 10 years ago that the Labour Government raised the top marginal tax rate from 33 to 39 per cent, increasing the incentive to shelter income through highly geared property investment.

But that raises another complication. Even if we could be more certain about the value of privately owned rental properties, it would not tell us how much of that is funded by equity and how much by debt.

To the extent it is debt-funded the taxman does get a piece of the action, by taxing banks' profits and local depositors' interest income.

REASONS FOR CLAMPDOWN

Next month's Budget will lower the boom on property investors, there is not much doubt about that.

"Why us?" they ask. Four reasons are generally given:

No 1. The Government needs the money. It wants to cut income taxes across the board. Raising GST to 15 per cent will cover most, but not all, of the costs. It is likely to be several hundred million dollars short.

No 2. The status quo is unfair on other taxpayers. Providing rental accommodation is a large industry and investment properties a major asset class, which should contribute significantly to the tax revenue. But in fact the net collective tax yield lately has been less than nothing.

No 3. New Zealanders invest too much in property and too little in businesses, hobbling productivity, incomes and our ability to pay our way in the world.

No 4. It is imperative to avoid a repeat of the housing boom of the last decade, which did nasty things to affordability and overheated the economy, driving interest rates and the dollar painfully high.