State Of It: Capital gains tax mooted by New Zealand Reserve Bank

April 15, 2015

Editorial by Selwyn Manning – Government’s ‘Market Will Correct It’ Ideology Exposed.

THE RESERVE BANK OF NEW ZEALAND has issued a public statement backing a capital gains tax (CGT) as a way of correcting an over-heated Auckland housing market. It is the most persuasive indicator so far that the Reserve Bank’s preferences are out-of-step with current Government policy.

Throughout 2014 and early 2015 Finance Minister Bill English ruled out a capital gains tax as a prudent policy response to Auckland’s problematic housing market. During the 2014 General Election, the Prime Minister also insisted a CGT was not needed and Labour’s backing of it as a Reserve Bank tool was ridiculed.

But today, in a speech to Rotorua’s Chamber of Commerce, the Reserve Bank’s deputy governor, Grant Spencer, laid bare the Reserve Bank’s thinking.

Spencer suggested a CGT is now needed to ease investor demand that is currently, in tandem with other factors, driving Auckland house prices up at unsustainable rates. (Ref. LiveNews.co.nz)Spencer underscored how attempts to cool the market, through increasing supply – medium to long term remedies that may lift the number of houses on the market, the unlocking of green fields land, and, an intention to break the back of local government bureaucracy through Resource Management Act reform – have proven to be problematic.

But Spencer’s message also suggests the Government must act on demand and roll out a response that is specifically designed to ease demand on Auckland’s current housing stock.

When reading Spencer’s Reserve Bank speech, it is clear, there now exists a significant risk to the New Zealand economy.

The Government’s reticence to address investor/speculator demand – whether it be foreign in origin or domestic – has permitted paper values to climb beyond real value and beyond sustainable limits. It reminds us of International Monetary Fund warnings that the New Zealand dollar was around 15 percent above true value and OECD cautions that Auckland’s house prices were bloated above comparative markets offshore.

Today, Grant Spencer said: “Irrespective of the mix of demand and supply-based factors, the longer the excess demand persists, the further prices will depart from their underlying fundamental determinants, and the greater the potential for a disruptive correction.”

That disruptive correction is economic-speak for a broad-based implosion of New Zealand’s domestic economy caused by an imbalance between Auckland and out-of-Auckland housing values and the negative effect such an occurrence will have on our banking system.

The situation exposes the Government to accusations that it places its ideology (that the market will correct itself) ahead of a pragmatic solution. The Government is also exposed to its lack of policy that connects to demand – or specifically investor demand.

The Government’s reticence to roll out a policy response to 2015’s economic environment is fast branding it (as one National Party contact suggested) a Cabinet that is tired, that resembles an end-of-the-run 12-year vintage government rather than the third-term reality.

The solution-vacuum has created an environment where investors, domestic or foreign, can make huge profits without attracting real and proportional taxation liability.

So what are the solutions to this reality check? In its 2015 Budget, the Government could address its demand-side policy vacuum by targeting a narrow but significant driver of housing demand – investors.

The Reserve Bank suggests a CGT is the best way to target this group – that targeting investors is preferable than implementing migration policies designed to restrict the purchasing power of immigrants. As Grant Spencer said today “there are practical difficulties in using migration policies to manage the housing cycle”.

It’s important to note here, Spencer’s comment does not rule out regulating against foreign-based investors (as the Australians do now – something Finance Minister Bill English indicated was on his peripheral vision), but suggests against easing back in migration, or applying time, location, and/or residency regulations against migrant investment. Spencer underscores a view that such a policy would, in isolation, no longer have the desired effect.

Rather, the Reserve Bank suggests the Government ought to plug the taxation-loop-hole that is currently being exploited. And that solution seems reasonable.

In short, the compelling logic of this debate urges the Government to put ideology aside, prevent investors from getting away with millions of dollars of untaxed profits – money that arguably is used to ratchet up Auckland prices in some sort of awful pyramid or Ponzi scheme, money (that once it is artificially acquired) is in part siphoned offshore leaving in its wake only risk and no-added-value to New Zealand economically.

Grant Spencer highlighted that policy responses to the problem, including increasing the supply of houses, and loan-to-value ratio restrictions (LVRs), have not and will not remove market pressures that push prices upward. Nor will these policies remove the risk of a collapse, or downward correction in house prices, occurring.

If you heed the Reserve Bank’s warning, then it is reasonable to argue that if the Government does not address the demand side of the problem, beyond the LVR (which penalises young New Zealanders while benefiting domestic and foreign investors), then the identifiable risks to the New Zealand economy and to our banking sector will intensify. The facts speak for themselves. Unprecedented demand is driving prices up. Investor demand is a dominant factor in the equation.

The market can no longer be left to correct itself. Intervention is required. Policy that opens greenfield land to fast-track construction in an attempt to increase supply is a medium and long-term remedy. It has failed to cool the intensifying demand for Auckland homes.

The Reserve Bank alludes to new apartment developments in Auckland as short-term remedies.

But again, this grouped together with legislation intended to liberalise Resource Management Act (RMA) compliance is problematic. Economically, for this strategy to have a broad beneficial impact, vast estates of prime high-value waterfront development will need to be fast-tracked.

This solution will clearly cause resistance among National Party’s constituents – a reality that will cause political inertia.

But then, the Auckland Council’s preference for apartment development along the city’s rail corridors will not cut it in measure to have a positive impact. Such remedies, in isolation, will fail to avert a looming economic crisis from occurring.

Today’s Reserve Bank statement indicates the risks born within this economic environment have intensified since the September 2014 General Election.

It’s a political dilemma for the Government.

The Reserve Bank warns that the longer these risks are left without remedy the “greater the potential for a disruptive correction”. Grant Spencer: “Since late 2014, housing market imbalances have become more accentuated, particularly in Auckland where the supply shortage is greatest, and house prices are particularly stretched, having increased by three times since the start of 2002.”

The Reserve Bank deputy governor said that with 60 percent of its lending in residential mortgages, the New Zealand banking system “could be put under severe pressure in such a downturn.

The resulting contraction in credit would amplify the impact to the domestic economy and financial system, making it more difficult to avoid a severe downturn”. For the record here are the salient quotes from Grant Spencer’s statement:

“The Reserve Bank would like to see fresh consideration of possible policy measures to address the tax-preferred status of housing, especially housing investment. “Investors are often setting the marginal market prices that are then applied to the full housing stock within a regional market. Indicators point to an increasing presence of investors in the Auckland market and this trend is no doubt being reinforced by the expectation of high rates of return based on untaxed capital gains.” Mr Spencer said that macro-prudential policy is a potential instrument to help restrain credit-based demand pressures and improve the resilience of bank balance sheets to a potential housing downturn. “The introduction of loan-to-value ratio restrictions (LVRs) in October 2013 helped to moderate housing market pressures despite strong net inward migration and the ongoing shortage of housing. The LVR restrictions have also improved the resilience of bank balance sheets. They will be removed or modified as market conditions allow. “Other macro-prudential options are being assessed, including in relation to investor lending. However, such tools are not a panacea – their impact is inevitably smaller than the main drivers of the current housing market imbalance.”

Conclusion: Now is the time for the Finance Minister and the Prime Minister to put ideology and political ‘gotcha moments’ aside and intervene, in the nation’s interest.

— Listen also to Selwyn Manning discussing this issue on FiveAA Australia.

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