Immigration and tax breaks for investment in residential property are being cited as the underlying causes of steep increases in the cost of housing over the past decade.

New Zealand now boasts one of the highest rates of home unaffordability in the world as a result of prices rising far faster than incomes, and the government's Savings Working Group blames that squarely on the policies of successive governments.

Although "the favourable tax treatment of property investment" accounted for about 50% of house price increases between 2001 and 2007, the working group said, there was also strong evidence that rapid swings in immigration brought about price-rise "shocks".

There was a sharp spike in immigration in 2001, 2002 and 2003 and, said working group committee member Dr Andrew Coleman, it appeared that property prices did not fall anywhere near as greatly when immigration fell again.

The report added that there was little evidence that immigration boosted local incomes. In fact, the need to build roads and schools meant that net migration contributed to the national deficit.

"Migration is another issue that the government should investigate further," the working group said. "There are indications that high immigration rates have pushed up government spending, house prices and business borrowing, and prevented necessary adjustments to the economy."

Coleman said the working group was not anti-immigration, but called on the government to investigate limits in the future, something Immigration Minister Dr Jonathan Coleman does not seem inclined to consider.

In a statement to the Sunday Star-Times, Coleman said: "Department of Labour research shows there is no strong link between immigration and house prices and migrants provide a net gain to the New Zealand economy of around $1.9 billion a year. If migration stopped today, the economy would contract by 10% over 10 years."

The working group also laid down the challenge to the government on the subsidies to property investors, calling for fairer taxation of interest income by taxing "real" interest after inflation is deducted from returns.

If $1000 invested earned 7% interest and inflation was 5%, the investor would pay tax on $50 of real returns.

The flipside would be that borrowers could claim only "real" borrowing costs as a business expense. A mortgage of 7% taken out to buy a rental property, for example, in a 2% inflation environment, would be considered a 5% mortgage when calculating tax deductions.

At the moment, those who have cash in the bank – including many retired people – are taxed regardless of the impact of inflation, said working group chairman Kerry McDonald. He called on the government to do the right thing by older voters, many of whom rely on the interest they get from bank deposits and interest-paying investments.

"In the absence of indexation, the New Zealand government will continue to impose significantly penal tax rates on lenders and offer significant tax subsidies to borrowers," said the working group. This was not the kind of policy to deliver social equity in housing or to rein in New Zealand's addiction to borrowing money from overseas.

But although the government seems to be ruling out curbing migration swings, Finance Minister Bill English has not ruled out indexation.

The effect of the tax subsidies may be inflated in New Zealand, which is one of the few countries where there is no capital gains tax. Other countries also offer lower tax retirement savings schemes.

- © Fairfax NZ News