Home ownership has become much less affordable. It is a major source of inequality both between generations and within generations. Housing cannot become more affordable without bringing down house prices relative to incomes. Labor’s tax proposals are intended to do just this. But is this the right time? House prices are allegedly falling already, and will further price reductions undermine the economy?
The first recommendation in the Grattan Institute’s report on Housing Affordability (published less than a year ago) was that “The Commonwealth Government should limit negative gearing and reduce the capital gains tax discount”. Exactly what the Labor Party is now proposing, but the Coalition Government is trying to run a big scare campaign that these proposals will severely damage a falling housing market and the economy. So, who is right?
The starting point for this discussion must be that home ownership has become much less affordable for young couples who traditionally in Australia have always expected to own their own home.
As the Grattan Institute puts it:
It’s been a perfect storm of rising incomes and falling interest rates, rapid migration, tax and welfare settings feeding demand, and planning rules restricting supply. As a result, house prices more than doubled in real terms over the past 20 years. The strains are most acute in Sydney and Melbourne. Since 2012, house prices have risen 50 per cent in Melbourne, and 70 per cent in Sydney.
What is perhaps most worrying is that house prices have increased much more rapidly than incomes. Consequently, housing affordability has declined. Thus, according to the Grattan Institute:
Average prices have increased from around 2-3 times average disposable incomes in the 1980s and early 1990s, to around 5 times more recently. Median prices have increased from around 4 times median incomes in the early 1990s to more than 7 times today (and more than 8 times in Sydney).
Furthermore, the rate of price increase in the cheapest quintile of homes has been even bigger.
Since the Grattan Institute report was written it has been widely reported that house prices have started to fall, especially in Sydney. According to CoreLogic which monitors sales data, national dwelling prices have declined by 6.1 per cent since October 2017. However, this CoreLogic measure is affected by changes in the mix of dwellings, and CoreLogic has itself attributed the downturn to the most expensive segments of the market.
Instead, according to the ABS, which measures price changes with no change in the mix, house prices for Australia on average increased by 1.8 per cent over the course of 2018, and on average by as much as 3.6 per cent in Sydney. Either way, whatever the measure, the most recent market experience, does not alter the conclusion that home ownership is much less affordable today, than it has been for all previous generations of Australians.
Lower home ownership and its consequences
Home ownership has traditionally been part of the Australian dream. From the 1950s to the early 1980s, home ownership rates in Australia hovered around 70 per cent. However, that is now changing.
Mostly it is young people and lower-income people who have been affected. Older people who attained the goal of home ownership under very different conditions, are watching their wealth grow instead. But this fall in housing affordability is now showing up in lower rates of home ownership. Thus, the Grattan Institute has found that “between 1981 and 2016, home-ownership rates among 25-34 year-olds fell from more than 60 per cent to 45 per cent”. The percentage fall for those aged 35-44 has been of the same order of magnitude, and even for those aged 45-54 the home-ownership rate has fallen by around 10 percentage points since 1991. On the other hand, for those people aged 65 and over, their home-ownership rate has continued to remain high at over 80 per cent.
Young people are living with their parents longer, and starting their families later as it now takes around 9 to 10 years for an average household to save a 20 per cent deposit for a typical dwelling, compared to 6 years in the early 1990s. Increasingly, those who do manage to purchase home in a location where they aspire to live, are relying on support from their parents and friends. Thus the share of first-home buyers receiving assistance from family or friends has risen from around 6½ per cent in the 1970s to around 14 per cent in the period 2011-15, and is now almost certainly even higher.
The irony is that parents who own their own home can readily take out a mortgage, the proceeds of which are then passed to their children as the deposit on their first home. But not everyone has rich parents, and home ownership is becoming increasingly unequal – a big turnaround from 35 years ago when all income groups had similar home-ownership rates.
Spatial inequality is therefore also growing and major cities are increasingly geographically divided as home-ownership in preferred locations becomes unaffordable. Young people with less income and education are increasingly concentrated in the fringe suburbs, while the job growth is concentrated in the city centre.
This loss of amenity may also be risking our sense of community. Home ownership provides greater security of tenure, and strong communities are typically reliant on the engagement of home owners.
How to improve housing affordability
A little recognised fact is that it is impossible to improve housing affordability without reducing the gap between house prices and incomes. A rapid increase in incomes, and particularly low-incomes, seems most unlikely. Therefore, if we want to improve housing affordability it is imperative to reduce house prices – at least over time.
The problem is that reducing house prices inevitably reduces existing home-owners’ wealth, and there are many more existing home-owners than there are aspirants to home-ownership. But surely Australia is better than this. Do we want a society where the (mostly older) “haves” deliberately act to prevent young aspirants from sharing the Australian dream?
Negative gearing particularly favours investment in low- yielding assets, such as housing, where the prospective returns are mostly in the form of capital gains. In addition, this tax inducement in favour of investment in rental housing is further augmented by an excessive 50 per cent rate of capital gains tax discount. Given the now much lower rate of inflation, compared to when this discount was introduced, this discount should be only 25 per cent, as proposed by Labor, if we want to tax all real capital gains, as we should.
Together negative gearing and the excessive 50 per cent discount for capital gains tax have acted to push up investor demand for housing, and thus housing prices, making it more difficult for first-home buyers to enter the market.
Labor’s proposals to limit access to negative gearing to new homes and existing investments and to lower the capital gains tax discount to 25 per cent will reduce investment demand for existing dwellings, and thus help lower house prices over time. The question is however, how much impact will these proposals have on the housing market and how quickly? Will they devastate the market, as the Coalition claims, or will there be a useful market correction to make home-ownership more affordable over time?
In my view, the latter is the much more likely outcome, and for the following reasons I consider that any fall in housing prices will be quite manageable.
First, the main reason why house prices have risen so much is a shortage of supply. This mainly reflects the impact of zoning laws which has limited the supply of housing where people most want to live. This shortage of supply will continue to put a floor under dwelling prices. To the extent that investors withdraw, and prices adjust downwards, this investor demand will be replaced by first-home buyers who will then be enabled to purchase a home. Indeed, CoreLogic (cited earlier) has already noted that the lower valuation dwellings have benefited from higher demand from first home buyers, which is shifting demand in favour of lower priced dwellings.
Second, housing prices, especially for the most expensive dwellings, rose to a level where they were clearly over-valued relative to underlying demand. This has been a general feature of the last decade since the Global Financial Crisis, as asset values have generally risen much more than the demand for the services provided by those assets. Thus, a market correction in both financial markets and housing markets, and some decline in these asset prices has been highly probable.
Third, it is clear that the Reserve Bank will act to support these markets, if necessary, by lowering interest rates, thus helping to restore buyer demand.
Fourth, because Labor’s policy for negative gearing will ‘grandfather’ existing investments, investors will be encouraged to hang on to their existing properties, and that will slow the market impact. In addition, as the policy will not apply to new dwellings it will not stop investors purchasing new dwellings.
In sum, therefore, I suggest that Labor’s tax policies on negative gearing and capital gains will improve the fairness and efficiency of the tax system and raise additional revenue which can be spent on improving government services, including the equality of access to those services. The impact on the housing market would, however, be only modest with the Grattan Institute modelling showing that housing prices would be roughly 2 per cent lower than otherwise. But even this modest impact will help make home ownership more affordable.
However, to really achieve the goal nation’s goals for home ownership, governments will need to intervene to ensure that our cities can adapt to the increasing population by allowing increases in their density in the inner and middle-distance suburbs. While some present residents might see such changes in zoning laws as interfering with their quality of life, it would be more than offset by the improvement in well-being for an increasing number of people who are presently missing out.
Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.