Pearls and Irritations

Governments have raised expectations among voters anxious to see action on housing. There is no shortage of proposed policy solutions. But how do we sort the good from the bad? Many policy ideas sound good, but won’t do much in practice. Some will make housing affordability worse, drag on economic growth, or subtract from budget balances that are already in trouble. There are reforms that would make a big difference, but none is politically easy. If governments want to be seen as serious on housing affordability, they’re going to have to make some tough choices.  

The politics of property prices are shifting rapidly beneath the Turnbull Government. After declaring that housing affordability would be the centrepiece of next month’s federal budget, the Government is now backtracking.

This shift in rhetoric is not surprising. Despite all the talk of options on the table, the Government is yet to show that it’s serious about addressing housing affordability. Few proposals emanating from the Federal Government would make much difference. And some would make the problem worse.

The Federal Opposition announced its own housing strategy last week to capitalise on the Government’s indecision. While most of Labor’s ideas are sensible, not many will make housing much more affordable, with the exception of the previously announced reforms to negative gearing and the capital gains tax discount.

State and Commonwealth Governments have raised expectations among voters anxious to see action on housing. Governments now need something concrete to point to. There are reforms that would make a big difference, but none is politically easy. If governments want to be seen as serious on housing affordability, they’re going to have to make tough choices and avoid the temptation to do the easy (and stupid) things.

First, face up to the problem

The first step to making housing more affordable is to face up to the size of the problem. [See Part 1]

Australian house prices have more than doubled in real terms since the mid-1990s, far outstripping growth in household incomes. And while low interest rates make it relatively easy to service a loan today, slow wages growth is eroding the burden of the mortgage more slowly than in the past. Home ownership rates are falling, especially among the young and the poor. Without change, many young Australians could be locked out of the housing market.

Governments have long promised to improve housing affordability, yet all the while house prices have continued to rise. The politics are hard. More Australians own a house than are seeking to buy a house, and making housing more affordable means house prices will be lower than would otherwise be the case. And many people who live in the established middle suburbs don’t like the idea of more density in their neighbourhoods. If governments really want to make a difference, they need to explain why improving housing affordability matters – and why doing nothing will only make the problem worse.

There are no shortage of ideas to tackle housing affordability

There are many policy ideas around housing affordability. Most simply won’t have much effect. Some will make housing affordability worse, drag on economic growth, or subtract from budget balances that are already in trouble. A few will make a difference, but all of them are politically difficult.

While making the hard decisions, governments should also set realistic expectations. Although government policy can help, housing is unlikely to become much more affordable overnight. It took neglectful governments two decades to create Australia’s housing affordability crisis, and it will take just as long to improve matters. There are limits to what even a brave government can do.

Many ideas sound good, but they won’t make much difference

Many of the policy ideas on housing affordability sound good, but won’t do much in practice. They live in the north west of our diagram.

Treasurer Scott Morrison has shown great interest in “shared equity” schemes, which sound like a way for first-home buyers to clear the deposit hurdle, without significant costs to taxpayers. Although such schemes can have many variants, government would likely stump up some of the capital to purchase a home, and get its money back, and a share of any property price growth, when the property is sold. Such schemes already exist in Western Australia and South Australia, where government lenders have issued thousands of loans for people to purchase their own home.

There is some evidence that these schemes increase home ownership rates. Yet they are unlikely to make much of a difference to housing affordability, at least not without big public subsidies. Only one in five loans approved by the WA lender in 2015-16 were genuine shared-equity loans. Most were low-deposit loans to borrowers, some of who may have borrowed from a commercial bank.

Treasurer Morrison is also keen on a ‘bond aggregator’ for the social housing sector. The Government would borrow on behalf of community housing providers, and on-lend to the providers — giving them access to cheaper and longer-term finance. While this may help to boost the supply of social housing, a substantial increase in the stock is unlikely unless there are additional large public subsidies to cover the costs of providing housing at below market rents.

Restricting foreign investment in housing may have some impact on house prices, but again only at the margin. Treasury research suggests foreign investment has not been a major contributor to recent growth in house prices. Of course the Government should ensure that foreign investment rules are being followed; there are reports that foreign investment rules are still being broken, despite a recent crackdown.

Increasing taxes on foreign investment in housing, as several state governments have already done, and the Federal Opposition has now proposed, may be a sensible way to raise revenue but is unlikely to hit house prices unless the tax hikes are very big.

Taxing vacant dwellings, a policy recently announced by the Federal Opposition and the Victorian Labor Government, sounds attractive, but will be difficult to administer. Accountants are likely to be able to fit most vacant homes within one of the exemptions for those temporarily overseas, holiday homes and those who need a city unit for work purposes. A similar tax introduced in Vancouver this year is yet to show that it has overcome these challenges.

Other ideas involve big risks to the budget or the economy

While the ideas discussed so far won’t do much to make housing more affordable, they won’t do much harm either. Several other ideas in the south west of our diagram are less benign: they involve big risks to either the budget or the economy.

The Turnbull Government is reportedly still considering allowing people to use their superannuation to buy their first house. Politicians are understandably attracted to any policy that appears to help first homebuyers build a deposit. Unlike the various first homebuyers’ grants, which cost billions each year, letting first homebuyers cash out their super would not hurt the budget bottom line – at least in the short run. But as we wrote in 2015, such a change would push up house prices, leave many people with less to retire on, and cost taxpayers in the long run. Alternatives that allow first homebuyers to withdraw only voluntary super contributions are less foolish, but are unlikely to make much difference to housing affordability.

The Government is reportedly considering providing incentives to encourage seniors to downsize their homes, thereby freeing up larger homes for younger Australians. This idea, too, should be rejected. Research shows that downsizing is primarily motivated by lifestyle preferences and relationship changes. These considerations dwarf the financial trade-offs between having more cash to spend, but less Age Pension. According to surveys, no more than 15 per cent of downsizers are motivated by financial gain. Stamp duty costs (which are analogous to the threat of losing pension entitlements) were a barrier for only about 5 per cent of those thinking about downsizing. A study that compared downsizing by those who do and don’t qualify for a pension suggests that the financial considerations prevent at most one in four pensioners from downsizing. Most of the incentives would go to households that would have downsized anyway. As the Productivity Commission found, these incentives have a material budget cost, and distort the housing market by adding even more to the long-term tax and welfare incentives to own a home.

The Government should also resist the temptation to push people to the regions. Since Federation, State and Commonwealth governments have tried to lure people, trade and business away from capital cities. It has consistently proved an expensive policy failure. Despite government policies of decentralisation, the trend to city-centred growth has accelerated in the past decade. Half of all jobs growth in Melbourne and Sydney is now within a 2km radius of the city centres, reflecting the rapid growth of jobs in services industries where physical proximity really matters. In the unlikely event that government policy actually succeeded in encouraging more people to live in regional areas, it could reduce house prices in the major cities, but it would also slow growth in incomes.

The Government should also tread carefully when it comes to curbing immigration, as proposed by former prime minister Tony Abbott. Slowing immigration would have a big impact on house prices. Australia’s resident population is increasing by about 350,000 a year, and over half of this due to immigration. But curbing migration could also slow growth in incomes. Recent Productivity Commission modelling concluded that continuing Australia’s approach of taking younger, skilled migrants could result in GDP per person being up to 7 per cent higher in 2060 than if there was zero net migration.

There are reforms that would make a difference, but none is easy

So governments need to focus on the policies in the top right of our diagram: policies that will make a material difference to affordability, but won’t substantially drag on the economy or the budget. Everything in this category is politically difficult.

Given the allocation of federal responsibilities, the Commonwealth can primarily intervene to reduce demand. States have more ability to boost supply through land use planning and zoning laws, and greenfield land release. They can also make renting more attractive by reforming state land taxes and residential tenancy laws. Both levels of government can improve access by making better decisions about which transport infrastructure to build, and then introducing congestion charges.

The Commonwealth should reduce unnecessary demand for housing

The Commonwealth government could materially reduce housing demand – which would have an immediate impact on prices.

The most obvious opportunity is to reduce the capital gains tax discount and abolish negative gearing. The effect on property prices would be modest – they would be roughly 2 per cent lower than otherwise – but would-be homeowners would benefit. There would be economic benefits too. Current arrangements distort investment decisions and make housing markets more volatile. Reform would boost the budget bottom line by around $5 billion a year. Contrary to urban myth, rents wouldn’t change much, nor would housing markets collapse. If phased in, the reforms would be easier to sell politically and would dissuade investors from rushing to sell property before the changes come into force. An alternative flagged by the government – limiting the number of properties a person could negatively gear – would be much less effective because few people negatively gear multiple properties.

The government should also include the value of the family home above some threshold – such as $500,000 – in the Age Pension assets test. This would encourage a few more senior Australians to downsize to more appropriate housing. More importantly, it would make pension arrangements fairer, and contribute up to $7 billion a year to the budget.

Making owner-occupied housing liable for capital gains tax could also reduce demand and improve the budget bottom line. But such a change might have unintended consequences. It would discourage people from moving house since home sales would trigger liability to pay capital gains tax. Young purchasers would be tempted to choose oversized housing to reduce the number of home moves they make over a lifetime. It would be difficult to resist calls to allow deduction of interest payments (given taxation of the gains), which would wipe out most of the benefit to the budget.

The States should boost supply

Affordability would improve much more if the States did the heavy policy lifting over a number of years to increase supply.

The middle rings of Australia’s large capital cities generally have good infrastructure, and good access to city centres where most of the new jobs are being created. These cities are sparsely populated relative to other large cities in the developed world outside the United States. Grattan research shows that people want more townhouses and semi-detached dwellings in established suburbs.

Current rules make it reasonably easy to build apartments in the CBD and to develop new housing estates on the fringes of the major cities – so that is what we’re getting. But the rules make it very difficult to subdivide and create extra residences in the middle rings of the capital cities, up to 20 kilometres out of the CBD. Population density in the middle rings has hardly changed in the past 30 years yet urban infill could supply a lot of the new housing needed.

State and local governments need to change planning laws and practice to make it easier to subdivide in middle ring suburbs. They also need to increase density along transport corridors, which would both boost housing supply and use existing transport infrastructure better.

Increasing supply will only restore housing affordability slowly. Migration increased substantially from about 2006, so that Australia’s population increased by around 350,000 per year, rather than the 220,000 per year as was typical in the previous decade. Dwelling construction did not match demand, particularly in NSW. It increased by about 30 per cent in the past four years, but it is still only keeping pace with current population growth. Several years of construction – probably at even faster rates than currently – will be needed to erode the large backlog that accumulated between 2006 and 2014, estimated to be a shortage of about 200,000 dwellings.

This is primarily a State government problem. While the Commonwealth Government can release some of the limited stock of Commonwealth land, it does not directly control planning rules. It could provide incentives to state and local governments to increase the supply of housing in good locations, but its budget will struggle to provide incentives sufficiently large to overcome the reluctance of a State government that is not motivated to take on the political difficulties anyway.

State tax reforms would help

State governments should also abolish stamp duties and replace them with a general property tax, as the ACT Government is doing. Stamp duties on the transfer of property are among the most inefficient taxes. They discourage people from moving to better jobs, or to housing that better suits their needs. Abolishing stamp duties would encourage people to move as their circumstances change, making more efficient use of the housing stock. This would mainly improve economic growth rather than housing affordability. But it’s a big prize: a national shift from stamp duties to a broad-based property tax could add up to $9 billion a year to gross domestic product.

Reform of progressive state land taxes, which levy a higher rate of land tax if a person owns more investment property, could improve conditions for renters, because institutional investors would be more likely to offer long-term leases to renters seeking greater certainty.

Such tax reforms might be encouraged if the Commonwealth provided incentive payments to the States, which would reflect how Commonwealth revenues will ultimately benefit from the increased economic growth. A recent COAG agreement to encourage states to enact economic reforms is a step in the right direction, but more needs to be done.

Improving infrastructure would also help

Governments need to improve transport networks by using existing transport infrastructure more efficiently and building more effective transport projects. This will make fringe suburbs a more attractive alternative to established suburbs closer to CBDs, limiting price increases in inner suburbs.

First, the Commonwealth Government should work with states on the possibility of introducing congestion charging to ensure existing roads are used more efficiently. A congestion charge needs to discourage only a small proportion of people from driving to enable a big increase in traffic speed.

Second, governments need to improve transport infrastructure investment decision-making. Governments have tended to favour projects in swing states and marginal seats, rather than projects with the highest benefit-cost ratios. Governments should only commit money to a transport infrastructure project if Infrastructure Australia or another independent body has assessed it as high priority, and the business case has been tabled in Parliament.

Remember, failing to act will have consequences

Housing affordability has vexed Australian governments for two decades, as politicians have tried to appease aspiring first homebuyers without upsetting existing homeowners. Governments have eschewed the hard choices that would actually make a difference, preferring policies that were cosmetic but politically painless.

Inaction will further reduce home ownership, increase inequality, dampen economic growth, and increase the risks of an economic downturn. The public has figured out that there is a real problem. Unless governments improve reality rather than appearances, public trust in political institutions will continue to fall. Pretending there are easy answers will only make things worse.

John Daley is Chief Executive Officer of Grattan Institute. John is one of Australia’s leading public policy thinkers, with 25 years experience in the public, private and university sectors. He has worked for ANZ and McKinsey in a career that also includes expertise in law, finance, education, and workers compensation. 

Brendan Coates is a fellow at Grattan Institute. Brendan’s research focuses on tax reform, economic and budget policy, retirement incomes and superannuation, transport infrastructure, cities and housing. Before Grattan, Brendan worked with the World Bank in Indonesia, and prior to that, he undertook a number of roles with the Australian Treasury, including as part of the Treasury’s China Policy Unit.   

Trent Wiltshire is an associate at Grattan Institute. Trent joined Grattan Institute in July 2015 after four years as an economist at the Reserve Bank of Australia. Trent holds a Master of Public Policy and Management from the University of Melbourne, a Bachelor of Commerce/Law with Honours in Economics from Monash University.

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