New rules will not reduce house prices in Auckland, they will merely decide how to apportion profits of sales.

Most mornings I listen to Morning Report on Radio New Zealand. Of late they have taken to torturing me with nonsense about house prices in Auckland. Monday's announcement of a new capital gains tax on investment properties caused an outpouring of ignorance so great that I can no longer resist my lecturing tendency.

Two mistakes that pollute thinking about Auckland house prices make people misunderstand this new tax.

The first mistake is that high prices are regrettable. High prices are bad news for buyers, of course. But for every buyer, there is a seller. The loss to the buyer is perfectly offset by the gain to the seller. Similarly, if prices were lower, the gains to buyers would be perfectly offset by the losses to sellers. Either way, society - that is, everyone taken together - is no better or worse off.

Lower prices benefit society only when they cause consumption to increase. To see why, start with a Big Mac Meal.


These cost $9. If you buy a Big Mac Meal you must value it at least a little higher than $9, otherwise you wouldn't buy it. Suppose you would be willing to pay $10 for a Big Mac Meal that costs you $9. Then your consumer-surplus, as economists call it, is $1. And suppose it cost McDonald's $8 to provide you with that $9 meal. Then its "producer surplus" is $1. Altogether, your purchase makes society $2 better off.

Now suppose the price of a Big Mac Meal falls to $8. Your consumer-surplus rises to $2 and McDonald's producer-surplus falls to zero. Society may seem to be no better off. But that isn't quite right.

As prices fall, more people are willing to buy. Consider someone willing to pay $8.50 for a Big Mac Meal. When the price was $9 he did not buy one and therefore got no consumer-surplus. Now that the price is $8, he does buy a Big Mac Meal and enjoys 50 cents of consumer-surplus. The extra consumption created by a lower price creates extra consumer-surplus. Society is better off.

But falling prices don't have this beneficial effect when supply is fixed. If McDonald's could not increase its production of burgers, changes in price would merely reapportion gains between McDonald's and consumers of the fixed number of burgers.

The same goes for the Auckland housing market. Growth in supply is severely restricted by planning laws. So lower prices cannot create the benefit of increased consumption. In fact, given that supply can hardly increase, rapidly rising property prices are welcome.

Again, consider another case. Imagine flooding drove thousands of people from their homes. Demand for hotel rooms just outside the affected area would go through the roof. Hoteliers seeking to profit from the flood would put their prices up.

This may look like immoral profiteering but it is socially useful.

Families would squeeze into one room rather than renting two, thereby leaving a room free for another family who would otherwise be out in the cold. People with alternatives to staying in a now exorbitantly priced hotel, such as staying with friends, would take that option, leaving the room free for a family with no such alternative. People whose jobs allowed them to leave the city for cheaper hotel rooms elsewhere would do so, leaving local hotel rooms free for people who need them.


In short, rising hotel prices during a flood-induced spike in demand helps rooms go to those who value them most.

Similarly, as demand to live in Auckland drives up prices, better use is made of the limited space available. For example, owners who don't much care for Auckland sell their now valuable homes and move somewhere cheaper, being replaced by people from outside Auckland who value living here enough to pay the price. And people choose to live in smaller spaces, thus freeing up space for others. In short, prices that rise with demand help to get the best allocation of residents to the fixed number of residences.

The second popular mistake is that prices are being driven up by property investors. But demand to invest in Auckland property depends on demand to live here. If fewer people wanted to live in Auckland, rents would decline and investors would be unwilling to pay as much for properties.

The money going into the Auckland property market ultimately comes from what residents pay - either in the purchase price of owner-occupied homes or in rents. Investors in existing properties are ineffectual intermediaries, profiting when supply unexpectedly declines or demand unexpectedly increases and losing when the opposites happen.

That's why the Government's new capital gains tax will not reduce prices. It affects neither the supply of housing in Auckland nor demand to live here.

This tax is not a way of reducing house prices but a way of divvying up the proceeds of a protection racket. Mafia protect a client's business by threatening to murder those who compete with him. In return for this service, the mafia take a percentage of their client's profits.

Politicians protect property owners from competition. They do not threaten to murder people who want to build new houses. Instead, they pass planning laws that prevent property development or make it so expensive that it becomes unprofitable.

All the benefit of this regulatory favour now goes to the owners of existing property. No mafioso would charge nothing for his protection, and nor will politicians.

The Prime Minister expects his new tax to raise about $420 million over the next five years, which can be used to buy votes with increased government spending, for example, on pensions and Gold Passes for wealthy, property-owning 65-year-olds.

The political beauty of it is that those who ultimately pay the price for this protect-and-tax racket - young people who would benefit from an increased supply of housing - can be passed off as the intended beneficiaries.

Jamie Whyte is a former leader of the Act Party and is managing director of
Whyte & Associates