Dialogue: Rising home prices a taxing issue

A capital gains tax might be the best way to avoid further speculative rises in property prices, writes PETER LYONS*.

The housing market in Auckland appears to be heading for a resurgence.

It is too early to say whether the increased turnover will lead to substantial price inflation as occurred in the mid-1990s, but the possibility of that happening highlights an ongoing distortion in New Zealand's economic policies.

Property price inflation in Auckland, in particular, was a contributing factor to the tight monetary policies operated by the Reserve Bank during the 1990s, which resulted in relatively high levels of real interest rates.

Keeping inflation in the required policy target range of 0 to 3 per cent is the main objective of the 1989 Reserve Bank Act and the bank has shown itself to be fairly adept at achieving this result over the past decade.

But it would be a lesson unlearned if such property price inflation were allowed to recur.

Using monetary policy to target speculative behaviour in one particular sector can cause substantial damage. It can also mean lost opportunities in other parts of the economy.

It is akin to firing a shotgun at a sparrow in a crowded street. The collateral damage can be enormous.

Monetary policy is a very blunt instrument when trying to rein in such a situation.

Owning your own home is an integral part of the New Zealand psyche, although arguably, this ideal is changing for a variety of reasons.

The origins of this core value are indeterminable, but probably relate back to the desire to own property that was held by many new migrants.

The trading of residential property for speculative purposes is less desirable.

The value of any asset is determined by supply and demand. The aggregate demand for housing in a society is derived from the overall level of incomes, the availability and cost of financing, and population growth.

The Auckland property boom in the mid-1990s has been attributed to the influx of wealthy immigrants.

But equally as important, if not more so, was the increased availability of low-deposit finance following financial deregulation.

Much of this finance came from overseas. In using this source of money banks were encouraged by the relatively high interest rates in New Zealand and the poor aggregate savings record of New Zealanders.

This situation contributed to the rise of the New Zealand dollar over this period.

Eventually this rise in housing prices took on a life of its own and people started treating residential property as a speculative investment rather than as a place to live.

The lack of a capital gains tax on such activity made such speculation more lucrative than other investment opportunities.

This surge in prices was eventually curtailed by a change in immigration patterns, tight monetary policy and the fact that property prices began to exceed the grasp of many lower and average-income earners, resulting in a decline in first-home ownership.

As mentioned previously, the use of monetary policy to rein in such a situation is a blunt approach that can cause major collateral damage.

Higher interest rates strengthen the exchange rate, making exports less competitive and imports more attractive for New Zealand consumers. Business expansion is hindered by higher debt servicing costs.

Other regions not experiencing a property boom are, nevertheless, lumbered with higher interest rates.

For example, during the property excesses in Auckland and some other centres during the 1990s, median prices in some other parts of the country actually declined.

The decline in these areas was probably partly due to the higher interest rates.

The allure of untaxed profits on residential property means funds are channelled into what is essentially a non-productive investment.

This often means that other more productive but less lucrative investments are ignored.

The focus on housing probably partly explains why the New Zealand sharemarket has languished during much of the past decade, compared with its overseas counterparts. This has had major implications for New Zealand's economic growth.

It would be a wasted lesson if this experience was repeated.

Rather than using monetary policy to rein in such a situation, other approaches need to be considered.

One such approach could be the introduction of a residential capital gains tax. The introduction of such a tax could use a comprehensive initial Government valuation of residential properties as a starting point.

The details of such a tax would need to be thrashed-out, but they would need to take into account such factors as allowing for the cost of home improvements and the effects of inflation.

At present, the introduction or even consideration of such a measure would be political suicide. But a second-term Government may be more amenable to the idea.

Unless the problem of speculative activity in residential property is addressed, the New Zealand economy will continue to suffer from what is a major distortion in investment patterns.

A home is a place to live rather than a productive asset that generates saleable goods and services in its own right.

It provides a degree of security and stability. It can also be a means of enforced savings.

Widespread speculative activity in such a market denies access to the benefits of home ownership to many lower and middle-income families.

* Peter Lyons, an economics teacher, is doing research into international studies at Otago University.