The ins and outs of a land tax

The first blog in this series suggested John Key was a tinkerer who was consciously defaulting on his election promise to lower taxes.

In fairness when he made that promise the Government had significant surpluses and  a lot of fat in its expenditure as well with Labour's sundry pet projects wasting money. Now he has core expenditure, mostly welfare, burgeoning. He has found that the pets are hard to euthanize and he has also found new pets of his own out of the inevitable reality of politics, expediency and compromise.

Thus to honour his promise, he has to cut expenditure, sell assets, borrow or trick us into thinking we have had a tax cut while introducing new taxes.  He has found that the first two are not starters due to political realities, and he is already borrowing to save us from a terrible depression.

I would argue that nanny state riding to the rescue is the single largest changer of behaviour in society and the effect has been a stifling of the willingness to try and the creation of a dependency mindset. Key should be reducing the size of government, and thus taxes to force productivity and incomes.

Another way he could increase our after tax income is find ways to increase our pre tax income. This only comes from productivity so maybe he is tinkering with the tax system to rebalance the tax burden in favour of those who produce. Lower income taxes, higher consumption tax and wealth taxes do that. It is not rocket science.

To fund income tax cuts he has to find money somewhere else. Maybe he has a plan that is productivity based?

The second blog was simply to say we already have comprehensive property taxes, they are ignored by most and not policed by the IRD. Police what we have got and you would collect significant revenue. The taxes on property that we do have are ineffective due mostly to poor design.

In previous blogs I have said that to be successful as a government you need to raise taxes that are invisible, popular, simple to collect and calculate and comply with. Reality is such a tax doesn't exist. (Carbon tax excluded, which is a complete con, see previous blogs on global warming).

Back to the tax working group's proposals. There is absolutely not one single thing in their recommendations that is original, and worse, not one proposal that has not been tried before. As for the property proposals, all have failed to modify behaviour or even collect very much in tax (land taxes excluded). This blog is a review on land tax, the next blog is a review of past fiddling we have had with property and what happened as a result as history is a wonderful guide to the future.

The first substantial tax ever introduced in NZ was land tax. I don't know exactly when but I assume it was in the 1860s. By the time I was a thinking person, maybe the mid-1970s we still had land tax. It was thus one of the most enduring and successful taxes ever created. It was abolished in the mid to late 1980s. I recall one of my first jobs in the IRD was to issue land tax assessments, mind numbingly boring work.

It was successful for these reasons:

1) It was simple to police and comply with, the QV of the land is what it is, take that number multiply it by the rate and you have the amount due to be paid.

2) The tax base couldn't leave; high income earners and mobile capital can leave.

3) It taxed capital rather than people, and as capital was concentrated in the hands of a few it was in essence a progressive tax and the few that were worst hit were small in voting number.

Initially it was universal, all land was taxed. This is what the tax group proposes this time. By the time I was issuing such notices the top land tax rate was 2%. Yes, it too was in its design a progressive tax. So the more land holdings you had, not only did you pay more, the rate was higher. Like all progressive taxes it was avoided by breaking holdings up into trusts, companies etc. The tax did not change property investing behaviour in aggregate, and nor will any other tax on property.

The reason for this is because owning property is a deep seated security rug and in new countries like NZ that need for property is psychologically very strong. Our Forbearers left their homes due to oppression and landlessness. The drive to own land was very strong, and these in built fears and aspirations will not be shaken for a very long time.

Soon political pressure was brought to bear to abolish land tax on residential property that was owner occupied. Then on all residential properly as it was believed to be forcing rents up and hurting the poor. Then on farm land as the poor farmers were struggling to make a return. All that was left was commercial and industrial property as public land was always exempted. This tax, if introduced, will have to go the same way.

Taxing homes will not be acceptable. Farmers are a major political force and taxing farms won't be politically acceptable either so the rate will not be 0.5% on all property. It will be a higher rate on a smaller base. At least that is my bet when the political survivors of Polliegrad (Wellington) decide what they want to do.

But if we take them for the moment at their word, what are the economic consequences in reality? My view is it will have limited impact on residential property prices. It will force the sale of some expensive real estate occupied by cash poor occupants, mostly the old, and top end real estate might take a bit of a hit. Yuppies with high debt and expensive homes might end up with negative equity. But houses worth up to, say $1m, will not be affected significantly.

They will turnover in response to supply and demand as they always have, and the supply continues to be compressed due to the Resource Management Act and looks set to continue on in the meantime. The demand side is in aggregate driven by birth rates, demographics and migration flows.

Certainly the introduction of a new tax changes the value equation for migrants and thus might have an impact. Residential rents respond to supply and demand and this tax will not force up rents. This said, the rental stock might decline with landlords selling. But wake up. Just because a house is sold doesn't mean it disappears. It then becomes part of the owner occupied stock and demand falls in a line with supply.

This said prices might fall if landlords start to bail out en-mass, as housing affordability is a major problem in NZ. We have some of the least affordable housing relative to income in the world. So if owner-occupiers wish to buy, affordability has to improve meaning incomes have to rise, interest rates have to fall or remain low or housing prices have to fall. So when the economists' say property prices will fall they have already given up on the alternative of low interest rates and higher income. Interesting what a basket case we have become.

Farm prices will fall. Farmers are lucky to make between 2 and 4% income on the value of their land holdings, so a tax of .5% is significant.  Most farmers have debt and some are as result only just viable, and only get by because the banks keep lending to them on the value of their land. Most of the big four banks have excessive relative exposure to NZ farm land and much of the debt is troublesome as the underlying asset, the farm, can't service debt even at 5%pa.

Do the maths, a dairy farm with more than 50% debt on its land will incur more interest than it makes. So if farm land is included, farm land will fall in value due to forced sales, and will most likely bring on a substantial banking crisis and perhaps even a full blown depression. The alternative is that land prices hold up, but this will only occur if inbound foreign investors buy up our farms thus accelerating the foreign ownership of our nation.

So my bet is farm land and owner occupied homes will be exempted, but residential rental property and commercial property will be included. And as a result, to raise the target revenue to fund significant tax cuts on income, it will be at 1%. Commercial landlords will pass it on to  their tenants - most leases are net leases - meaning the tenant pays anyway, and all other leases as they come up for review will be amended to pass it on.

This said, occupancy costs are now almost at the maximum business can bear and remain viable so it is possible that the existence of a land tax will suppress rent reviews and future growth prospects of commercial property. With residential rentals, the landlords will have to absorb it and despite the tax cuts elsewhere, voting habits will change and due to MMP even small changes in voting habits change governments.

Highly geared landlords may well be forced to sell and this might for a short time dampen the property market. But in reality this will be driven as I said by demographics and migration. And one final prediction, Maori land will be exempt as well. Another step toward separation of Maori from the rest of us. Ultimately they will regret what they wish for.

So how do you manage your exposure to land tax and practically register your opposition to its introduction at the same time?

Land tax is assessed on the QV of land. Whenever QV revalues your property you have a right to object. You can request a new valuation at any time, but you do have to pay for it.

So at the very least object to every single revaluation of your property assets from now on, the lower the value the less you pay. The more objections filed, the more likely QV is just to accept your objections if well made out, as the thought of 1m objections proceeding to a review process is just incomprehensible. Imagine also if 1m property owners requested a revaluation downwards of their properties right now. That would be a pretty good feel for whether the public supports a reintroduction of land tax.

But before you do this, be careful what you wish for. Productivity has to be encouraged, and thus tax on income has to be reduced. Some form of compensating wealth tax needs to be considered, but frankly a capital gains tax would be better. Go back and read my 20/20/ 20 tax plan as the recipe for rebalancing the economy to production and saving rather than consumption and dependency. If the rates are the same, and low, avoidance is impossible, acceptance and compliance is easier.

 Next blog: Other repealed and forgotten property taxes.