Remedy applied in colonial New Zealand fairest way to stem property inflation without undermining growth

The housing market in Auckland is experiencing one of the largest booms in its history. While it has enriched homeowners and speculators, it has had dramatic effects for businesses and landless families who find it exceedingly difficult to afford a place to live, work or operate. The scale of the rapid increase in property prices poses a significant risk to the stability of the entire New Zealand economy.

Much of the analysis of Auckland's housing problem points to a simple, yet expensive, solution: increase the supply. Others have argued we should consider banning foreign investments, introduce a capital gains tax or further extend Auckland's already impressive urban sprawl.

The main problem with these arguments is they misunderstand the role of land in the crisis. Unlike houses or genuine capital, land does not depreciate or require maintenance. Instead, land value stems more from public expenditures on infrastructure (such as roads, schools or railway stations) in its vicinity and the entrepreneurship and effort of local workers and businesses.

While land can be used more or less efficiently, the supply of well-located sites is fixed and the only response to increasing demand is a price increase.

Advertisement

While we have tended to look for new and innovative ways to address the problem, the answer might be found in New Zealand's history. In the late 1800s, New Zealand governments sought a way to prevent the formation of a landed aristocracy.

In his quest for solutions, Sir George Grey corresponded with, and even met personally, the philosophers and economists John Stewart Mill and Henry George.

Both Mill and George observed that unequal access to land is the root cause of persistent inequality (as economic growth translates into higher rents) and that land speculation lies at the heart of boom and bust cycles. George's solution was to abolish economically harmful taxes on labour and businesses and instead introduce a single tax falling on unimproved land values.

Grey made the decision in 1879. After its final confirmation in 1891, the land tax was, for several years, the largest source of government revenue and arguably an important factor contributing to New Zealand's once famed egalitarian character.

Unfortunately, over the course of the 20th century, the tax, in the face of immense pressures from various groups of vested interest, was radically weakened and finally abolished in 1991. Currently, council rates remain the only (and arguably modest) mechanism through which the public recovers some part of the rising land values.

However, unlike ordinary council rates, a land value tax (LVT) would not penalise anyone for constructing houses or factories. It would be simply a cost of owning a unique type of asset, the supply of which can be neither increased nor decreased.

Thus, it could bring in a decrease in prices (and speculation) as the owners of unproductive sites might feel compelled to sell or lease them to those willing to use them productively.

As taxing land could increase its availability to workers and businesses, LVT could result in new economic opportunities and jobs - a trend that could be reinforced by lowering the current fiscal burdens imposed on effort and entrepreneurship. Encouraging more efficient use of land is not only beneficial to economic growth and housing affordability, but also has a potential to substantially lower the costs of public infrastructure and to significantly reduce the burden on the natural environment caused by urban sprawl.

LVT, either in the form of a national tax or a replacement of council rates, would be a transparent and efficient alternative to our current taxes which are not only burdensome on businesses and families but are also difficult and expensive to administer and enforce. It is impossible to hide land in a tax haven and hence taxing it can be done cheaply and using publicly available information.

While LVT might persuade some modest-income earners to sell their valuable properties, most workers and homeowners would get net benefits from a reduction in taxes falling on their income and consumption (GST). Additionally, part of the revenue from LVT could fund a citizen's dividend.

Given the multiple problems stemming from Auckland's housing crisis, an LVT stands out as the best-rounded of the policy options on the table. Not only would it address house price inflation, it could also result in a more efficient use of land, mitigate urban sprawl, lower the burden on the natural environment and reduce the risk of real estate bubbles; all without undermining the foundations of economic growth.

Zbigniew Dumienski and Nicholas Ross Smith are lecturers in politics at the University of Auckland. Dumienski was a finalist in the Treasury's best economic essay competition this year with an article containing ideas expressed here.