Westpac: Tax change would cut home prices

Photo / Chris Skelton

Some of the tax changes under consideration would reduce house prices and raise rents, but they would also increase home ownership, Westpac economists say.

Their conclusions are based on a mathematic model which derives what a property investor would pay for a house based on such variables as rent, tax rates, interest rates, maintenance costs and long-run expectations for inflation and capital gains.

They assume property investors are the marginal buyers who determine prices in most segments of the housing market.

"Houses not already taken by debt-free owner-occupiers are worth most to investors because they get better tax breaks than owner-occupiers with high debt."

Their conclusions also rest on a rule-of-thumb assumption that one-third of the adjustment to a tax change would come through higher rents and two-thirds through lower house prices.

How much lower depends on the tax change.

One change considered by the tax working group chaired by Professor Bob Buckle would cut the top personal tax rate from 38 per cent to 30 per cent.

For a median property (now worth about $350,000) that would reduce its value by almost 14 per cent, the Westpac economists calculate.

That is because landlords normally pay more in deductible expenses and mortgage interest than they receive in rent, and they can use those tax losses to shelter other income, such as salary.

The tax working group has found that ownership of rental properties is skewed towards high-income people of working age, and that the sector as a whole claims more in tax deductions than it pays in tax.

Some of the cost of reducing the tax benefit of owning a rental property would be recovered by higher rents; Westpac estimates they would rise about 8.7 per cent if the top income tax rate were cut to 30 per cent.

Another option under consideration is a tax on the unimproved value of land. The economists estimate a land tax of 0.5 per cent would cut the value of land by 11 per cent.

As land represents about 40 per cent of the value of the median house, that would cut house prices by 4.4 per cent, and on the basis of the assumed two-for-one burden sharing raise rents 2.2 per cent.

The combination of a cut to the top income tax rate and the introduction of a land tax (to replace the lost revenue) would cut house prices by just under 17 per cent and raise rents by 8.4 per cent, Westpac reckons.

All these options, by making houses cheaper and renting dearer, are expected to boost home ownership.

Another option under consideration is to apply the risk-free return method to rental properties.

Instead of taxing rents and allowing deductions for the expenses incurred in the course of earning rental income, owners of rental properties would be deemed to have earned 6 per cent on the net equity in their property and be taxed on that.

The impact would depend on how leveraged the investment is, but in all cases would be high, cutting the value of the house (to an investor) by anything from 26 per cent, for those who are debt free, to 34 per cent for someone 100 per cent leveraged.

A capital gains tax on rental properties would reduce their tax advantage and thus reduce prices - by 15.7 per cent - and raise rents by 7.8 per cent, the economists say.

They regard the capital gains tax option as unlikely, not least because of the impact on tenants, who tend to have low incomes.