Economist says rate of 15 per cent could knock nearly a quarter off what an investor would pay.

A capital gains tax would reduce the price it is rational for an investor to pay for a property by as much as 23 per cent, Westpac economists say.

The bank's chief economist, Dominick Stephens, said he put Labour's policy of a capital gains tax levied at 15 per cent upon realisation into a model designed to estimate what it was rational for an investor to pay for a property based on today's rents, today's longer-term interest rates, a reasonable expectation for long-term capital gain and an estimate of the cost of maintaining the property.

"We calculate that a 15 per cent capital gains tax would reduce the value to an investor of a given property by 23 per cent if rents remained unchanged. Even if we assume a 10 per cent lift in rents, the loss in net present value of the house to a landlord is still 15 per cent," Stephens said.

"But while the net present value of the asset drops immediately if the tax situation moves against the asset, what actually happens to asset prices is another question altogether. My view is that upon the introduction of a capital gains tax house prices could well fall, so long as other conditions weren't conducive to rapid house price increases. For example in today's environment they could well fall slightly."


The OECD's latest Economic Outlook report says New Zealand house prices are 66 per cent overvalued based on the long-run average ratio of house prices to rents, making them the most overvalued among 31 developed countries.

Relative to incomes they are 30 per cent overvalued, a margin exceeded only by Belgium.

Stephens said there was a popular myth that house prices never fell but at worst would go sideways while the fundamentals like rents caught up.

"There is no historical experience to back that up whatsoever. House prices fell in the early 1990s, 1998, 2001 and 2008," he said.

"They have halved in Japan. They fell a good 30 per cent in the US."

Stephens suspects the myth of a ratchet under nominal house prices dates from the 1970s when consumer price inflation was very high and though house prices halved in real terms they were basically flat in nominal terms.

"But the experience since 1992 when inflation reached low single digits and stayed there has actually been that house prices go up and down."

In common with economists at ANZ and the Treasury he supports a capital gains tax.


"It will help right the current misallocation of resources to land-based economic activities, and would lift the rate of home ownership. Other useful measures would include lowering the rate of income tax and reducing the rate of inflation."

Meanwhile, fresh research from the Reserve Bank has raised its estimate of the impact curbs on new mortgage lending at high loan-to-value ratios (LVRs) have had.

A model based on past relationships among market variables indicates that six months into the regime house prices are 3.3 per cent lower than they would have been without it, mortgage debt 1 per cent lower, mortgage approvals 12 per cent lower and house sales 26 per cent lower. Earlier the bank estimated the impact on house price inflation as a reduction of 2.5 percentage points.

The modelling, by Reserve Bank economist Gael Price, also allows for the strength of net migration flows and economic activity since the LVR restrictions were introduced, offset by rising interest rates. Because of the time lags involved, house price inflation and mortgage credit growth should both decline further, compared with the no-LVR counterfactual, given the drop in market activity which has already occurred.

But the impact of the LVR regime is expected to wane: "As participants grow accustomed to the new policy environment it is possible housing market activity could rebound somewhat, leading to smaller effects over the first year than those implied by the analysis in this paper."