A comment on stamp duty
The NSW government is reportedly planning to phase out the stamp duty tax on real estate transactions. It has been widely applauded.
My view on this can be summarised as… meh.
Stamp duty brings the NSW government a lot of revenue—around half a billion dollars per month for the past decade, and nearly $10 billion in FY2020-21 (of which $7.9 billion came from residential property asset trades).
While the replacement land value tax (LVT) is a great tax, stamp duty is pretty good too. Given that the transition is likely to reduce revenues to the state by $2.5 billion per year for 5-10 years, is the $15-25 billion loss in revenue worth the benefits?
For example, for $25 billion you could increase the public housing stock by 50%, from about 125,000 to 190,000, providing an extra 65,000 households with dirt-cheap housing for life.
While there are many efficiency arguments in favour of LVT, the question is how big these are in practice.
The ACT has been ratcheting down stamp duty on property and increasing land taxes for a decade now. But since the start of the transition in 2012, housing prices have grown more than in Sydney, and the effect on turnover and “loosening up” the market is hard to see. Indeed, when the ACT introduced an over 65s stamp duty exemption in the hope of older households selling bigger homes and moving into new apartments, they found it was common to take advantage of that exemption to buy an even larger home. The benefit to doing that was to shield more funds from the age pension asset test.
So I have no issue with the proposed tax transition. My concerns are that the benefits are much, much, smaller than most people think, and the costs in terms of lost revenue, less automatic stabilisation from the tax system, and increasing investor churn with the resulting disruption to tenants, are larger than most people think.
To understand why I came to this view, while still being a strong proponent of land and resource taxation, please read an expanded version of an article first published at The Conversation back in 2018 that I have reposted below the break.
Most think tanks and policy groups in Australia think that a policy to swap ‘stamp duties for land value taxes’, or what I will call SD4LVT, is going to provide some impressive economic and housing benefits.
But layers of bad economics hide beneath the new populism of SD4LVT.
It is extremely frustrating to me that leading minds in Australian policy have smashed their heads together and decided that the best reform they can think of is to replace one good tax on property with another good tax on property that is less politically popular. It's like subbing off the best player on the field for the best player on the team? Why not sub off the worst player instead?
The better minds in this game don’t even think SD4LVT will have any effect on reducing housing prices or making housing at all more affordable, yet still put it forward as the ‘holy grail’ of state tax reform.
Is this some kind of joke?
The bad economics behind SD4LVT arises because four key points are missing or overlooked.
1. Price effects
The economic incidence of stamp duty is on the seller. This means that if you remove stamp duty, all else equal, prices will rise by exactly the amount of the duty. Good analysts know this, even if they rely on poor analysis by others that assumes stamp duty “increases the price that property buyers pay”. If the average home price is $500,000, and stamp duty is 5%, prices will immediately rise to $525,000 when you remove the duty.
But if you want to replace the same tax revenue from stamp duty with revenue from land value taxes, you could wind up inflating prices and inadvertently creating an economic transfer to property owners.
Imagine an example economy with:
Turnover of 1 house each year (a turnover rate of 5%)
Average rent of $25,000 per year (5% gross yield)
An average home price of $500,000
Land price component of $250,000 per house (total land value of $5 million)
Total stamp duty revenue of $25,000 per year.
To replace the $25,000 stamp duty revenue with a land value tax requires taxing all twenty homes at $1,250 per year each.
Whether the market price of homes rises or falls depends on whether buyers think the upfront present value of $1,250 per year is lower or higher than the $25,000 upfront stamp duty they would have paid. At a 5% capitalisation rate in this example, $1,250 per year in perpetuity is equivalent to $25,000 and the taxes replace each other perfectly with no price effect.
But what if turnover is half that, say 2.5%, which in this example would be where one house is sold every two years? Here, the total tax revenue to be replaced is $12,500, which equals just $625 per house in land tax.
If we capitalise the perpetual cost of $625 per year at 5% we get a present value of only $12,500, which is half the stamp duty rate. A new buyer can now pay $512,500 for the house plus $625 per year in land tax and be equally as well off as paying $500,000 for the house plus $25,000 upfront in stamp duty. The net effect in this case is a land price increase from $250,000 to $262,500, or 5%.
If this situation happened nationally in Australia, that would be nearly a $200 billion economic transfer to landowners, which would completely offset the value of their new land tax obligations.
In short, replacing stamp duty revenue with land tax will increase prices if the capitalisation rate is higher than the turnover rate, and decrease prices if the opposite holds. Price effects are ambiguous for SD4LVT.
2. Asset churn
Taxing capital gains only happens when a transaction is made that realises gains. Thus, it is a transaction tax, just like stamp duty, though the size of the tax is related to historical changes to property values rather than current values.
Many in the housing discourse, such as the Grattan Institute, want to increase transaction taxes on housing by increasing capital gains taxes and expanding their scope to apply to owner-occupiers. At the same time, they want to decrease transaction taxes on housing by eliminating stamp duty because apparently transaction taxes stop people relocating.
Somehow abolishing a transaction tax in the form stamp duty is good because it reduces the cost of owner-occupiers relocating, but then putting back a large transaction tax in the form of a capital gains tax specifically on owner-occupiers is also good. Huh?
There are two problems with the ‘transaction costs impede household mobility and are bad’ view. The first is the simplest. People who relocate for work generally don’t buy and sell houses to accommodate that move.
Moving for work is not a common reason for buying a home, regardless of age, which might reflect a view by some households that work is a temporary reason for moving and therefore not sufficient to commit to homeownership.
Thus, the effect of stamp duty on reducing housing turnover is likely to fall mostly on investors, who make up nearly half of housing transactions and can easily time their decisions. Transaction taxes make it more expensive for people to quickly buy and sell and deters speculative buying that seeks only to capitalise on short bursts of capital growth before selling, which itself fuels the capital growth and accentuates the bust. Many investors fall in this category, and many homeowners also make their location and purchase decisions based on expectations of capital gains rather than housing need. Go on, ask new homebuyers about property prices. See if they bought where they did for housing need or capital growth?
The evidence on stamp duty deterring moving shows pretty clearly that moving for work is unaffected, as the below plot shows, with the main effect being from people making 'short moves' by relocating less than 10km. Indeed, the best evidence on turnover effects estimates only the size of the short-term shock as people adjust to the new price equilibrium.
In terms of the claim lower stamp duty helps more efficiently use the stock of dwellings, as it reduces the costs to older people downsizing, freeing up large homes for families, the evidence here is the opposite. When the ACT scrapped stamp duty for over-65s, the retirees who utilised the exemption bought bigger homes, rather than smaller ones, requiring them to implement a low value cap on the exemption. After all, the distribution of home ownership is not driven by housing need, but primarily by wealth. Reducing the cost of redistributing housing by wealth will not suddenly make housing ownership less unequal. Regardless, turnover as a whole seems relatively unaffected by stamp duties. The early 2000s boom also saw massive stamp duty increases yet turnover shot up dramatically. The role of stamp duty in determining these patterns of housing turnover is tiny compared to other factors.
Indeed, if you want people to move more frequently for a lower cost then implement a ‘moving house subsidy’, which could also apply to renters. It would also help renters forced to move unnecessarily due to investor turnover (yes, stamp duty also reduces undesirable moves for renters).
Second, taxing capital gains on owner-occupied housing will be a far bigger transaction tax than stamp duty for most homeowners. Stamp duties are typically around 5% of the property price. For a homeowner who bought a home prior to 2012 in Sydney or Melbourne, their home has appreciated in value about 50%, or to put it another way, 33% of the current price is capital gain.
If a capital gains tax applied to their sale, the tax rate as a proportion of the current value would be:
Capital gain (33%) x Marginal tax rate (45%) = 14%
This is triple the stamp duty for most properties. Even if the capital gains tax was discounted 50%, the nearly 80% of homeowners who bought prior to 2012 would still have much higher transaction costs from capital gains taxes than from stamp duties.
In effect, stamp duties are taxing some of the capital gains during a boom that would otherwise accrue to homeowners, particularly owner-occupiers who are exempt from the capital gains tax. This seems like a good thing to me.
So while stamp duties are often claimed to be economically costly because they deter households relocating, their main effect is actually reducing investor churn, which is a good thing for property market stability. Additionally, the costs of relocating are probably less than the costs from other property transaction taxes that opponents of stamp duty support.
3. Tax revenue stability
Another concern in the discourse is that “stamp duty revenues are much more volatile than other taxes.” During a boom, revenues rise more than proportionally to prices since they depend on prices and turnover. Vice-versa in a bust.
If I was to think in the abstract about what sort of taxes are good macro-economically, I would say those that are pro-cyclical, meaning they automatically increase tax revenues during an economic boom, and decrease them in a bust. On this metric stamp duty is a terrific tax to help stabilise the economy, which is even more useful in Australia as our economic cycles are closely tied to the housing market.
The land value tax that many propose to replace stamp duty would have smaller automatic stabiliser characteristics, meaning the tax system as a whole would be less stabilising.
From what I can tell the call for more stable tax revenues is not driven by economic reasoning at all. At best it appears to rest on some kind of political preference for state governments not to be involved in macroeconomic objectives.
4. Wrong assumptions
The metrics of economic disaster caused by stamp duties are usually derived from economic analysis using computational general equilibrium (CGE) models of the macroeconomy. Sounds fancy.
You might have even seen a chart similar to the one below, with stamp duties presented as having massive flow-on economy-wide costs compared to other taxes. In this example, stamp duty is apparently forty times more economically costly per dollar of revenue than council rates, which are also levied on property values.
As you might have guessed, this is absolute nonsense. CGE models cannot account for transaction taxes because, wait for it, there are no transactions in these models. It’s true. Look it up.
But that hasn’t stopped many economists. Instead of using a better tool for the job, they simply invent a different thing that they pretend is stamp duty and put that into a CGE model.
Rather than a transaction tax that is incident on the seller, and therefore incident on land values, a tax on the production of new buildings is assumed instead (p125).
conveyancing stamp duties are modelled as a tax on investment in residential and commercial structures
Against all the evidence they assume that stamp duty is not a tax whose economic incidence is on land. Instead, they assume that stamp duties raise the cost of housing to all buyers and renters. In addition, the model assumption requires that stamp duties also raise the cost of building new houses without affecting land prices, leading to reduced new housing construction in general. Garbage in, garbage out.
It’s hard to explain in plain English what is going on in these models. My best explanation is that the model says that stamp duty forces every new home to be built with an additional extension on the house, where the construction cost of the extension is the same as the stamp duty. But then as soon as it is built, the extension is immediately demolished, yet somehow the buyer is forced to pay for it. Meanwhile, all the other households in the economy are somehow forced to also pay more to occupy their existing houses, as if they were now renting non-existent home extensions.
If that sounds crazy, that’s because it is. There is no actual economic evidence of broad economy-wide costs of stamp duties. Just garbage inventions that don’t look anything like stamp duties.
Stamp duties don’t increase the cost of housing. They do reduce asset churn by investors and speculators, which is desirable for price stability, and the apparent economic costs from reducing household mobility are overblown. The ‘revenue instability’ of stamp duties is actually a huge positive for the economy as a whole, and the economic analysis that has underpinned the talk of the high economy-wide costs of stamp duty is simply made up.
All of this is true. Yet SD4LVT is the apparently the holy grail of Australian tax policy. Our best policy wonks want politicians to use up the precious political capital to swap one very good property taxes for another very good but electorally unpopular one, for no net economic gain.