Will hiking CGT solve the housing crisis?
No. It could make it worse.
Australia is running out of money. The budget recently blew out by $57 billion and economists have pointed at runaway spending as driving Australia’s stubbornly high inflation.
The high spending – and reticence to cut it – has led the government to look for more ways to raise money.
The Senate is investigating whether to hike capital gains tax by reducing or eliminating the long-term capital gains tax discount. The government has been coy about this, seemingly flying a kite to see how people react. At present, the focus appears to be on how the CGT discount applies to housing.
Proponents of higher CGT have claimed that it will help first home buyers by ‘forcing’ investors to sell or driving investors from the market. However, the proponents of higher CGT are wrong.
Hiking CGT will backfire and will not help with the housing crisis.
Construction
Higher CGT will deter construction. This is very clear because investors – especially developers – are rational value maximizers. They care about the after tax returns on an investment. If the returns are below that of listed investors, they will pivot their resources. Thus, if the already low returns to property development are reduced even further, fewer developments will occur. At a time when we are struggling to build enough houses, higher CGT will make the supply problem worse not better.
What if we just allow the discount for new builds, and remove it for existing stock? That will make the hike marginally less bad. But it will not solve the problem this is because developers need to sell stock. Buyers will clearly consider the CGT that applies to them. So, the buyer will factor that into the price they are willing to pay. Now, some might think that this would reduce house prices. For a very short period, it might. But, developers will see the lower profits, shelve marginal construction, and supply will shift down. So, no, only allowing the hike for new builds will not solve the problem.
Housing stock
Hiking CGT will also reduce the amount of stock available for sale. This is a problem as it means that people will need to rent for longer. The reason this will happen is that people will lose up to half their equity as soon as they sell.
Let’s put some numbers on this. Suppose you buy a property for $100. It increases at the rate of inflation (say 3%) for 10 years and it is now worth $134. This is a terrible return as the a levered investment in the S&P500 would achieve significant more. But, suppose the investor has that $34 in equity now. If they sell, the equity falls to $18 if they are on the highest marginal tax rate. That is, their equity nearly halves. It is obvious that an investor would not sell as they will see their gains erased. The highest the CGT rate the fewer sales will occur.
The net result is that there will be less housing stock available to buy. This might force people to rent for longer. It could also (ironically) support house prices due to supply ratcheting down. Or phrased differently, the price at which an investor is willing to sell is now higher than it would otherwise have been.
Revenue
What then about revenue? Hiking CGT rates is sometimes seen as a revenue raising exercise. If we ignore cause-and-effect, the logic looks superficially clear: higher tax rates mean higher revenue, right? Wrong. Because hiking CGT will, as indicated above, reduce transaction volumes. Lower transaction volumes mean less capital gains tax intake and less stamp duty.
To put this in context, the UK hiked capital gains tax rates to 24%. Notably, this is below Australia’s capital gains tax rates currently. Capital gains tax revenue then ell by 10%. This was due to a combination of people leaving and fewer transactions.
To use another example: California was considering a ballot initiative to impose a one-off 5% wealth tax. As a result, $1 trillion in wealth left California before the initiative was even decided on and despite resistance from Governor Newsom. The result is less revenue and less money reinvested in the economy.
Where does it leave us
The overall result is that hiking CGT rates is not a solution to the housing crisis. It risks making the situation worse and reducing government revenue. The spin around hiking CGT rates does not stand up to scrutiny.