Australia's Future Tax System

Consultation Paper

Section 10: Tax and transfer impacts on housing

Overview

Housing plays an integral role in Australian society. It provides a source of shelter and a base for people to participate in communities and the workforce. It is the largest store of the nation's wealth and a major source of retirement savings for home owners.

The tax-transfer system affects the housing market through a range of taxes, concessions and transfers, which in some cases are targeted at certain housing tenures or income levels. These aspects of the system influence the type of homes people live in, the way they save and invest, including for their retirement, and the affordability of housing. Through its treatment of housing, the tax-transfer system also delivers significant assistance to particular groups of Australians, which affects the overall equity of the tax-transfer system.

Consultation questions

Q10.1 What should be the objective of the tax-transfer system in respect of housing? Should there be assistance for housing over other assets or services? Should assistance be based on housing tenures? Should assistance be focused on people on low incomes? Should assistance differ between public and private tenants?

Q10.2 What role, if any, should the tax-transfer system play in respect of housing affordability? Should the tax-transfer system be used to influence housing supply and/or demand to improve housing affordability? What changes, if any, should be made to housing-related transfers that assist disadvantaged households to find housing?

Q10.3 Recognising the influence that some taxes and transfers have on the use of housing and residential land, what changes, if any, should be made to ensure the housing stock and residential land are used efficiently?

This section considers the impact of the tax-transfer system on housing. It outlines the taxes and transfers affecting housing and discusses their distributional effects by tenure type and income level. The impact of the tax-transfer system on housing affordability and the efficient use of the housing stock are then discussed.

10.1 Housing taxes and transfers

A wide range of taxes and transfers affect housing. While some of these reflect revenue raising objectives, many are designed to achieve social policy objectives, such as access to affordable housing, adequate retirement incomes or equity concerns.

It is difficult to discern the overall distributional outcomes of the tax-transfer system in relation to housing. This partly reflects the range of objectives for the system. It also reflects the complex ways in which tax-transfer policies interact with the housing market. In light of this complexity, the panel has commissioned new research on the impact of the tax-transfer system on housing.

Summary of key messages from submissions

Some submissions say that the tax-transfer system should tax housing concessionally in light of its social benefits and place in Australian society. Others take an alternative view, arguing on equity grounds that housing should be taxed more like other assets. Submissions emphasise the role the tax-transfer system plays in supporting access to affordable housing for low-income Australians.

The submissions contain mixed views about whether property owners are paying a 'fair share' of tax. Several submissions note that property is subject to many taxes across all levels of government and claim that this results in the sector being over taxed. Others claim that housing is treated favourably as an asset class within the income tax system.

The exemption of the principal residence from capital gains tax (CGT) is raised as an issue in a number of submissions. Many argue that the exemption encourages excess investment in housing. Similarly, a number of submissions question the land tax exemption for the family home, noting the significant narrowing of the potential tax base that the exemption creates and expressing concern about equity between owner-occupiers and renters.

Other submissions claim that private rental investment is advantaged relative to owner-occupiers due to interest deductibility and 'negative gearing'.

In terms of the transfer system, a number of submissions suggest that pensioners who own their own house are more favourably treated than people who do not. Several submissions argue that low-income renters receive payments that are too low and do not keep pace with growth in rents.

Some submissions suggest that 'negative gearing' for investors and the exemption from CGT for owner-occupiers benefit high-income Australians. Others argue that negative gearing supports the provision of affordable rental housing.

Size and distribution of housing taxes, subsidies and transfers

Snapshot of the housing market

In 2005-06, around 70 per cent of households lived in their own homes (Chart 10.1A). The rate of home ownership has remained stable over the past 40 years and is one of the highest in the OECD. Between 1995-96 and 2005-06, the proportion of owner-occupiers who owned their home outright declined.

Owners and buyers aged between 25 and 64 years have the highest incomes and are the wealthiest Australians, their wealth being six times higher than non-homeowners. Tenants of public housing have the lowest wealth and incomes (Chart 10.1B).

Chart 10.1: Overview of housing market(a)

A: Tenure of occupants
(1995-96 and 2005-06)

Chart 10.1: Overview of housing market - A: Tenure of occupants (1995-96 and 2005-06)

Source: ABS (2007c).

B: Income and wealth of occupants aged 25-64(b)
(2005-06)

Chart 10.1: Overview of housing market - B: Income and wealth of occupants aged 25-64 (2005-06)

Source: ABS (2007c).

  1. Owner refers to a household that owns the home outright. Buyer refers to a household with a mortgage.
  2. Older Australians are excluded from the comparison in Chart 10.1B to remove the influence of demographics. Older Australians are over-represented in the outright owner category. Similar to the results in the chart, older Australians who are home owners or home buyers have higher average wealth and incomes than non home owners.

The major taxes and transfers affecting housing are outlined in Table 10.1. Specific taxes on housing, such as stamp duty and land tax, are levied by the states. Local government rates affect both owner-occupied housing and private rental properties.

Owner-occupied housing is not subject to Australian government income tax, whereas private rental properties are subject to income tax as they are an income-generating asset. A range of transfers are provided by all levels of government.

Table 10.1: Major taxes and transfers relating to housing

  Owner-occupied Private landlord Private renter Public tenant
Taxes
Income tax
(Australian Government)
Exempt. Taxable. 50 per cent discount on capital gain. Costs deductible. n/a n/a
Stamp duty
(All States)
Taxable at progressive rates based on property value (some first home buyers exempt). Taxable at progressive rates based on property value. n/a n/a
Land tax
(All States except Northern Territory)
Exempt. Taxable based on land values. Deductible from income tax. Thresholds exclude many small-scale holdings. n/a n/a
Rates
(local governments)
Taxable, based on land values. Some exemptions. Taxable based on land values. n/a n/a
Transfers
Income support assets tests
(Australian Government)
House value not counted toward total assets. Home-owning couple subject to maximum rate threshold of $243,500. Property value counted toward total assets. Non-home-owning couple subject to maximum rate threshold of $368,000. Non-home-owning couple subject to maximum rate threshold of s $368,000.
Rent Assistance
(Australian Government)
n/a n/a Eligibility determined by access to other payments. Payment rate determined by rent (capped) and family circumstances. Not eligible.
First Home Saver Accounts
(Australian Government)
Savings of first home buyers receive Government contributions and preferred tax rates. Existing property owners ineligible. Savings of first home buyers receive Government contributions and preferred tax rates. Savings of first home buyers receive Government contributions and preferred tax rates.
First Home Owners Grant
(Australian and state governments, administered by States)
Until 30 June 2009, $14,000 grant for first home purchased — $21,000 if a newly constructed home. To revert to $7,000 from 1 July 2009. Not eligible. n/a n/a
Public housing
(Australian and State governments)
n/a n/a n/a Eligibility determined by income and other criteria indicating disadvantage. Recipients pay a rent, usually around 25 per cent of their income.
National Rental Affordability Scheme
(Australian and State governments)
n/a Eligible institutional investors receive $8,000 per dwelling rented to eligible tenants. Low to moderate income renters access a home at rent 20 per cent below market rates. n/a
Home purchase assistance
(State governments)
Includes direct lending, deposit and mortgage subsidies. Generally means-tested by income. n/a n/a n/a
Private rental assistance
(State governments)
n/a n/a Payments to help meet ongoing, bond or other rental costs. Generally means-tested by income. n/a

Owner-occupied housing

Owner-occupied housing is taxed more like a private good than an investment asset. That is, returns to owner-occupied housing, such as a capital gain or imputed rent (see Box 10.1) are not taxable and the holding costs (interest or maintenance) are not deductible. This tax treatment makes an investment in owner-occupied housing more favourable than other housing options. The Architecture paper suggests that the effective rate of tax on owner-occupied housing is also lower than the rate on bank deposits and ungeared share investments.

The taxation treatment of owner-occupied housing can affect two key decisions of individuals or households:

  • Their investment allocation decision. The closer the alignment in the taxation of owner-occupied housing and other investments, the smaller is the tax distortion when allocating capital.
  • Their retirement savings decision. An owner-occupied home is a way to save for retirement, as it reduces housing costs in retirement. Aligning the taxation of owner-occupied housing with superannuation will reduce tax distortions from the retirement savings decision.

Many studies have tried to measure the size of the net subsidy (or tax) conferred on owner-occupied housing by its tax treatment. A common approach in Australian studies is to determine the amount of tax that households would pay if owner-occupied houses were taxed like investment properties. Using this approach, the Productivity Commission (2004) estimated an annual implicit subsidy for owner-occupied housing of $25 billion in 2003, reflecting the combined effects of the exemption from CGT ($10 billion), the non-taxation of imputed rent net of interest and other costs ($8 billion), and exemptions from land taxes ($7 billion). This equates to roughly $4,600 per dwelling per year. This estimate is similar to the results of Yates (2003), who found a $13 billion benefit from the exemption from capital gains and a $8 billion benefit from the non-taxation of imputed rents (net of other expenses).10

Box 10.1: What is imputed rent?

Imputed rent is the value housing provides to an owner-occupier and can be thought of as the benefit from not having to pay rent to reside in that dwelling. Imputed rent is not included as part of a person's assessable income for tax purposes.

Excluding imputed rent from income tax can be considered to be a tax expenditure (or subsidy) that provides an incentive to owner-occupation. If a person were to move out of their home into rental accommodation and let out their property at the same rental rate, their tax bill would increase even though their assets and income (after housing costs) are unchanged. This is because rental income is taxed, while imputed rental income is not.

The Australian Bureau of Statistics (ABS) estimates gross imputed rent for owner-occupied property as the amount that would be received if it were rented privately. Net imputed rent is derived as gross imputed rent less holding costs such as interest and maintenance. The 2005-06 results show that even though outright owners have lower cash income on average than home-buyers, their income is higher once adjusted for net imputed rent.

Table 10.2: ABS estimates of imputed rent ($ per week) (2005-06)

  Mean disposable
income(a)
Mean gross
imputed rent
Mean net
imputed rent
Mean disposable income
(including net imputed rent)(a)
Home owners
Outright 625 236 172 31
With mortgage 716 245 5 718
Renter
From market 603 0 7 608
From state authority 356 183 83 404
  1. Household equivalised incomes. Equivalised incomes take account of different household sizes and structures by identifying the amount needed to provide an equivalent standard of living to that of a single person.

Source: ABS (2008g).

A number of submissions suggest that not taxing owner-occupied housing benefits high-income Australians. Yates (2003) also analysed the distribution of the tax subsidy to owner occupied housing, as shown in Table 10.3. People on higher incomes benefit most from tax exemptions as they have high marginal tax rates and generally have more expensive houses, with higher imputed rents and larger capital gains. Low-income earners on a zero marginal rate may receive no benefit. As mortgage payments and other expenses are not deductible, the current system favours home owners more than home buyers. Apart from people in the 'lower middle' income quintile, the subsidy was found to be mildly regressive as it increases proportionally more than income.

Table 10.3: Tax benefit to owner-occupiers by income quintile (1999)(a)

  Income quintiles
  Bottom Lower middle Middle Upper middle Top
Outright owners     
Tax benefit ($) 0 2,100 2,500 4,600 8,800
as % of income 0 9 6 7 7
Home buyers     
Tax benefit ($) 0 400 100 500 2,100
as % of income 0 2 0 1 2
  1. The tax benefit was calculated as the sum of the tax that would otherwise be payable on imputed rent and the annual capital gain less interest costs. The personal tax rates used in the calculation were determined using half of the household income (before net income from the owner-occupied property).
  2. Yates (2003). The study uses Housing Survey data from ABS (2000).

As not all Australians are financially able to participate in owner-occupation, there is a further equity dimension arising from the tax exemption for owner-occupied housing. Unlike investments in other assets, such as shares or a bank deposit, it is not possible to buy a $1,000 stake in an owner-occupied house. The 15 to 20 per cent of people that never purchase a home tend to be much poorer than other Australians.

As outlined in Table 10.1, a range of other government programs provide direct assistance to owner-occupiers through grants or tax exemptions. First home buyers are the major recipients of this assistance. In 2006-07 this group received the majority of the $1.7 billion in exemptions from stamp duty and received around $1.0 billion through First Home Owners Grants. From 2008-09, they have access to First Home Savers Accounts, which will confer a transfer of $625 million over four years. These transfers are not targeted, other than the case of stamp duty reductions that are restricted through house values. In 2005-06, state governments provided home purchase assistance, of which $30 million was through interest rate assistance and other subsidies and $969 million was repayable direct lending. This assistance is generally means tested by income.

A number of submissions note that owner-occupiers who receive pensions or allowances benefit through concessional treatment in assets tests. Assets tests reduce payments once assets exceed a certain threshold. Pensions are reduced by $1.50 for every $1,000 above the threshold, while allowances are stopped once assets exceed the threshold. For home owners the threshold is $124,500 lower than the threshold facing non-home owners. This provides a concessional treatment for home owners whose home is worth more than $124,500, with the extent of concessionality increasing in line with the home's value.

Private rental housing

Unlike owner-occupied housing, investment in residential property is taxed in the same way as other assets. However, as shown in Section 8 of the Architecture paper, the current system treats some types of returns (for example, capital gains) more favourably than others (for example, interest), and this effect can be accentuated through gearing.

The features of the tax system argued by many submissions to favour property investment — such as the interaction of 'negative gearing' with the CGT discount (see Box 6.8) — are available for other investments. However, these favourable features may be more prevalent for housing than other assets. For example, properties tend to be more highly geared than share investments, which may reflect the lower volatility of house prices.

The size of this tax benefit has not been studied as comprehensively for rental investment as for owner-occupied property. Abelson and Joyeux (2007) calculated the tax benefit to housing by netting tax paid from direct and implicit subsidies. They found that the net subsidy accruing to private rental housing was $400 million in 2004, compared to $6 billion for owner-occupied housing.11

Tax data provide some insights into the size and distribution of tax benefits for private rental investments. In 2005-06, total deductions exceeded rental income by $5 billion. Chart 10.2 shows that the majority of rental property investors who declare losses have a total income of less than $50,000.12 However, high-income earners who declare losses are over-represented compared to their share of the overall income distribution. Investors whose total income is below $50,000 have an average deduction of around $7,000, about half the deduction of investors who have a total income above $100,000. The distribution of tax benefits between investors and renters is considered in the following section.

Chart 10.2: Proportion of individuals with rental losses

By total income ($'000) (2005-06)

Chart 10.2: Proportion of individuals with rental losses - By total income ($'000) (2005-06)

  1. The 'Proportion declaring rental losses' is the proportion of people declaring losses whose income falls within the given range. 'Share in population' is the proportion of people who submit tax returns and whose income falls in the given range.

Source: ATO (2008).

Publicly-assisted housing

Some equity concerns for housing access are directly addressed by the tax-transfer system through programs such as Rent Assistance, the provision of public housing and the National Rental Affordability Scheme (NRAS).

Rent Assistance is a non-taxable income supplement paid by the Australian government. In 2007-08, around $2.3 billion was paid to 940,000 low to moderate income individuals and families who rent in the private rental market. Public housing is funded jointly by the Australian and state governments, at a cost of around $1.6 billion in 2006-07. The proportion of people in public housing has fallen from 6 per cent in 1995-96 to 5 per cent in 2005-06. From 2008-09 to 2011-12, the NRAS is expected to encourage the construction of 50,000 new rental properties that will be rented to low income and moderate income households at rates at least 20 per cent below market levels.

Housing related transfers are more tightly targeted than tax incentives. Around 76 per cent of public housing recipients are in the bottom 40 per cent of the income distribution. Eligibility for Rent Assistance is determined by access to income support or eligibility for more than the base rate of FTB Part A, both of which are means-tested. Reflecting the different means tests applied across the eligible payment types, the incomes of Rent Assistance recipients can vary significantly. As shown in Table 6.2, Rent Assistance will cease when a family with one child receiving FTB Part A has an income of $72,854, compared to $47,655 for a single pensioner and $26,762 for a single Newstart allowance recipient.

The targeting of housing assistance according to recipient's income and housing costs differs between public housing and Rent Assistance. For recipients of public housing, the payment made by a tenant is generally fixed at 25 per cent of their income and is not affected by the value of the property. This means the effective subsidy paid by the government is higher for higher priced homes and is lower for recipients on higher incomes. For the 71 per cent of recipients who receive the maximum amount of Rent Assistance, their subsidy remains flat when rents increase.

Consultation question

Q10.1 What should be the objective of the tax-transfer system in respect of housing? Should there be assistance for housing over other assets or services? Should assistance be based on housing tenures? Should assistance be focused on people on low incomes? Should assistance differ between public and private tenants?

10.2 Impact on housing affordability

Access to affordable housing is a long-standing issue for the community and policy makers. Recent growth in housing prices has resulted in significant wealth gains for owners of residential property, but has also led to widespread concerns about falling affordability for home buyers and renters.

Summary of key messages from submissions

Submissions from developers and the construction industry argue that taxes are an important contributor to high housing prices in Australia. GST, developer charges and stamp duties are claimed to have contributed to price growth over the past 10 years. One submission argues that 35 per cent of the cost of broad-acre development in north-west Sydney is attributable to these taxes and charges. Developers express concern about a lack of transparency in the way they have been derived. Local government bodies argue that developer charges are consistent with the beneficiary principle of equity and encourage the efficient consumption of goods and the efficient use of resources.

Other submissions suggest that tax plays relatively little role, arguing that recent low affordability is attributable to economic fundamentals which have raised demand, and institutional arrangements which have constrained supply.

A number of submissions claim that 'negative gearing' has reduced housing affordability by causing speculation in the housing market. Several submissions propose restricting negative gearing or directing it so that it promotes the supply of affordable housing. The housing industry argues for the retention of negative gearing on the grounds, among others, that the temporary removal of negative gearing lead to an increase in rents in 1987.

Some submissions take the view that investors have enjoyed systemic tax advantages and that this has decreased affordability for owner-occupiers.

A range of submissions also stress the impact of stamp duty on the up-front costs of home-buyers.

Submissions raise concerns about housing affordability for low-income renters, citing the level of Rent Assistance compared to the costs of renting and the variation in rents experienced by people in different parts of the country.

What is housing affordability?

There is significant community concern about the affordability of housing. This reflects the importance of adequate housing in enabling people to participate in the workforce, raise a family and engage in a local community. At its most basic level, affordable housing involves access to an adequate level of housing for Australians, regardless of their means.

There are many other objectives for housing affordability, reflected in the range of ways it is measured. Some measures record the residual disposable income of households after deducting their housing costs. This can indicate if a household enters housing poverty, whether through rising housing costs or falling income. Some measures indicate the ease of access to owner-occupied housing, often focusing on first home buyers. These include the 'deposit gap', which records the difference between typical house prices and the maximum mortgage available on a typical household income. Other measures suggest housing becomes unaffordable when housing costs exceed a certain proportion of income, with 30 per cent of income frequently cited.

Using measures of housing affordability to make comparisons between people or over time can be problematic. For example, high-income earners may be able to spend more than 30 per cent of their income on housing costs and still be able to achieve a level of consumption regarded as adequate.13 Comparisons of housing costs between renters and mortgage payers is difficult because all rent is an expense, but part of a mortgage repayment represents saving (through principal repayment). Increasing real incomes over time also confound comparisons. A household devoting 47 per cent of their income to housing costs in 2007 could afford the same level of non-housing consumption as a household in 1996 devoting 30 per cent of their income to housing costs.

Chart 10.3 shows income-share measures of housing affordability for home buyers and renters. These have been falling and are at their lowest level since 1990-91. The decline in housing affordability for home buyers reflects strong growth in house prices and increases in interest rates from their lows of 2001. Chart 10.3 does not reflect the significant reductions in interest rates and slight falls in house prices that have occurred since June 2008.

Chart 10.3: Changes in housing affordability (1988 to 2008)

A: Repayments on the median house as a share of household income

Chart 10.3: Changes in housing affordability (1988 to 2008) - A: Repayments on the median house as a share of household income

Source: RBA (unpublished).

B: Rents as a share of average weekly earnings

Chart 10.3: Changes in housing affordability (1988 to 2008) - B: Rents as a share of average weekly earnings

Source: Real Estate Institute of Australia (2008) and ABS (2008c).

House prices have increased by 54 per cent in real terms since 2000. Though real rental growth over the same period has been lower (17 per cent), rents are now growing strongly. Strong rental or price growth in a market is a sign that demand is outstripping supply.

Housing affordability — major drivers of recent trends

In its review of first home ownership, the Productivity Commission (2004) considered that demand factors were the 'dominant' source of widespread price growth. Increased access to housing credit had been an important factor fuelling demand, reflecting:

  • the long-run implications of financial market deregulation, which has reduced constraints on borrowing and, through competition among lenders, led to smaller interest rate spreads on lending; and
  • lower and more stable inflation over the past 15 years, which has meant that interest rates have been both lower and more predictable than over the previous 20 years.

Both of these factors allow households to borrow larger amounts.

Household income growth has also supported housing price growth. Real household incomes have grown by around 40 per cent over the past 15 years, having been essentially flat over the previous 15 years. General employment growth has also played a role, with the unemployment rate around a 30 year low.

Among other demand factors, immigration has recently grown strongly in response to skill shortages in the economy, which has contributed significantly to housing demand.

In contrast, the national supply of new housing has fallen since 2004-05. The reduction has been driven largely by the Sydney market, with supply stable across the rest of Australia. However, the fact that the national rental vacancy rate in 2007 was at its lowest level since data first became available in 1980, indicates that supply is not responding sufficiently to meet strong demand. Factors influencing the level of housing supply may include delays in approval processes, land release and zoning policies, and infrastructure charges levied on developers.

The increase in the price of housing also reflects an improvement in the quality of the housing stock. The average size of a newly constructed house has increased from 130 square metres in 1970-71 to 240 square metres in 2006-07.

Impact of tax and transfers

Recent policy changes

The most significant changes to tax and transfer settings for housing include the changes to CGT in 1999; increased infrastructure charges; the introduction of the GST on housing and the First Home Owners Scheme; as well as changes in rates, land taxes and stamp duty conveyancing.

The introduction of the 50 per cent discount for capital gains in 1999 is more favourable for assets that experience strong capital growth than the indexation system it replaced. Tax settings that favourably treat capital gains can magnify cyclical price volatility by encouraging investment targeted at capital gains rather than income flows. In its report on First Home Ownership, the Productivity Commission (2004) states that 'these changes have almost certainly contributed to the surge in investment in rental housing in the past few years'. Since 2004, the share of investment activity in the overall housing market has returned to the average level of the 1990s.

Several submissions by property developers cite increasing infrastructure charges as a driver of declining housing affordability. Infrastructure charges are the payments made by property developers for the various services that local and state governments provide to land sold for residential property. These charges vary considerably by jurisdiction and can include payment for access to types of economic and social infrastructure — such as roads, water, sewerage and community centres.

Section 3.4 notes that a role of user charges is to facilitate efficient allocation of goods and services by ensuring that the cost of providing them is passed to the user. In the case of infrastructure charges, this would encourage development in areas where it is most valued and at least cost. However, excessive infrastructure charges can act like a tax on development and reduce the supply of dwellings. There is mixed evidence about the significance of infrastructure charges. The Productivity Commission (2008a) showed local infrastructure charges at the aggregate level increasing at around one per cent per annum in real terms in NSW between 2000-06. The Housing Industry Association (in Productivity Commission (2008a)) showed local infrastructure charges in Sydney more than doubling in real terms to $50,000 from the mid-1990s to 2007.

The GST was introduced on 1 July 2000 and is levied on new housing through input taxation. The Australian Treasury (Productivity Commission 2004) estimated that the introduction of the GST increased house prices by 5.5 per cent. Changes to stamp duty and land tax have been relatively small in comparison to the overall increase in house prices. As noted in several submissions, stamp duty can affect affordability by significantly increasing the up-front cost for purchasers who have small deposits. However, as noted in the Architecture paper, stamp duties are likely to push down house prices received by sellers, an effect that would be reversed if they were removed.

Ongoing tax and transfer impacts

The tax treatment of owner-occupied housing has a variable effect on affordability over a person's lifecycle (Box 10.2). For owners with low equity, cash costs of purchasing a house are higher than they would be under an investment-style tax as interest payments are not deductible for owner-occupied housing. However, as principal repayments are made and houses increase in value, the tax treatment of owner-occupied housing becomes more favourable. For retired people with low or no private income, excluding housing-related earnings from income tax may not provide a concession as they may not otherwise pay tax. However, Age Pension recipients who own their own house benefit from the preferential treatment that owner-occupied housing confers through the asset test for the pension. Owner-occupied housing also reduces financial risk in retirement as it provides insurance against movements in rental prices to which private renters are exposed.

Box 10.2: Treatment of owner-occupied housing over a lifecycle

Owner-occupied housing is treated differently to private rental housing for the calculation of income tax, stamp duty and land tax, and assets test of the Age Pension. Chart 10.4 illustrates the impact of the different treatment over a lifecycle, by comparing owner-occupied treatment to private rental property treatment for these taxes and transfers. A positive amount indicates owner-occupied housing receives a more favourable treatment (less tax and/or a larger transfer payment) at that point in the person's life.

Chart 10.4: Tax-transfer treatment of owner-occupied housing compared to investment housing over a lifecycle

Real annual benefit (or cost) by age of owner

Chart 10.4: Tax-transfer treatment of owner-occupied housing compared to investment housing over a lifecycle - Real annual benefit (or cost) by age of owner

Note: Assumes: a 30 year old purchases a new home with a price of $380,000. The mortgage is 80 per cent of the home's value, with an interest rate of 8 per cent and a 30 year repayment period. Initial income is $65,000, which increases at 4 per cent per year until retirement at age 65 years. The home's value is assumed to increase at 4 per cent per year in line with wage growth. Imputed rent is equal to 4.5 per cent of the value of the home. Schedules from NSW are used for the calculation of stamp duty and land tax. In retirement, the person's only assets are their home and their superannuation. Their superannuation is saved through compulsory 9 per cent contributions, with earnings of 7 per cent per year. All payments and schedules that are currently indexed to inflation, such as pension asset test thresholds, increase by 2.5 per cent. The Age Pension and income tax schedules increase in line with wage growth at 4 per cent. The house is not sold, so a capital gain event is not triggered. Were a sale to occur at age 85 years, for example, the additional benefit to the home owner of the CGT exemption would be around $215,000 (in 2008 dollars).

Source: Australian Treasury estimates.

As noted by several submissions, housing subsidies have the potential to adversely affect affordability if they increase prices. If housing supply is not fully responsive, concessional treatment of both owner-occupied and private rental investment can lead to higher prices. Several Australian studies find the responsiveness of supply to housing prices to be relatively low (Berger-Thomson and Ellis 2004), which suggests that a generous tax treatment is likely to cause higher prices than would otherwise be the case.

A number of submissions suggest that tax advantages for private rental investment lead to higher house prices. In the long-run, their potential effect on house prices depends on the extent of tax-advantaged investment relative to the total market. A significant and growing number of investors engage in 'negative gearing'. However, around half of investors are likely to receive limited tax advantage due to low levels of gearing and low personal tax rates. Further, the share of private investors in the overall property market (around 22 per cent) constrains their capacity to influence prices in the long term.

To the extent that any tax advantages to private investors are shared with their tenants through lower rents, this could improve housing affordability. The potential gain to a particular tenant would depend on the size of a landlord's tax advantage, which will be higher for landlords with higher incomes. Wood and Watson (2001) showed that higher income investors tend to own more expensive rental properties, and that the rental yield for the most valuable 10 per cent of properties was 5.9 per cent, compared to 9 per cent on the cheapest 10 per cent of properties. This suggests that the scope for sharing of any tax advantages to boost housing affordability is greatest for those who rent more expensive properties.

Similarly, the imposition of land tax on investors is likely to be shared with tenants through higher rents. If land tax were levied on all residential properties, it would tend to reduce the price level of housing. However, as owner-occupiers are exempt, their property valuations would be largely unaffected, which is likely to support the price level (though perhaps less so for housing types dominated by investors). If house prices are not affected, rents have to be higher than otherwise to maintain the after-tax return to investment. In this way, a majority of the impact of land tax on investors is likely to be borne by tenants.

The housing affordability outcomes for transfer recipients can differ significantly depending on how assistance is delivered. As public housing tenants' rental payments are determined in proportion to their income, less than one per cent have housing costs that exceed the 30 per cent of income affordability benchmark. For Rent Assistance recipients, around 36 per cent have rental payments that exceed 30 per cent of their income. Chart 10.5 shows that this varies considerably depending on which payment they receive.

Chart 10.5: Proportion of Rent Assistance recipients with rents exceeding
30 per cent of their income (June 2008)

Chart 10.5: Proportion of Rent Assistance recipients with rents exceeding 30 per cent of their income (June 2008)

Source: FaHCSIA estimates.

Several submissions note that the value of public housing and Rent Assistance transfers can vary significantly by time and location. Public housing tenants are insulated from the effect of house price movements. However, as their assistance is generally tied to a specific dwelling, they may be exposed to significantly higher costs if they need to move. In contrast, Rent Assistance is indexed to CPI, so housing affordability for recipients decreases when growth in rent outpaces general inflation. Over the past five years, rents have increased by around 7.3 per cent per year, compared to CPI growth of 3.1 per cent per year. Further, the contribution of Rent Assistance to housing affordability outcomes is affected by the significant regional variation of rental costs. For example, the maximum Rent Assistance payment represents 24 per cent of the median rent in Adelaide but only 13 per cent of the median rent in Darwin.

Consultation question

Q10.2 What role, if any, should the tax-transfer system play in respect of housing affordability? Should the tax-transfer system be used to influence housing supply and/or demand to improve housing affordability? What changes, if any, should be made to housing-related transfers that assist disadvantaged households to find housing?

10.3 Impact of specific taxes and transfers on the efficient use of the housing stock and residential land

Several taxes and transfers affect the way people live or invest in housing. There may be scope to modify these taxes to encourage more effective use of the existing housing stock.

Summary of key messages from submissions

A number of submissions express a view that the exemptions from land tax, including for owner-occupied housing, result in an unfair distribution of the tax burden and make the tax base less efficient than it otherwise could be.

Many submissions highlight that stamp duty discourages people from relocating and argue that it is unfair and inefficient. Several submissions, estimating the efficiency costs of different state taxes identify stamp duty as one of the least efficient taxes and land tax among the most efficient. Many submissions propose abolishing stamp duty, with some proposing to replace it with a modified land tax.

Several submissions argue that some tax settings have adverse behavioural outcomes in the housing sector. A number of submissions suggest that land tax encourages high-value commercial development of land. One argues that the tax-free status of owner-occupied housing encourages habitual renovation.

Efficiency impact of different taxes and transfers

The Architecture paper notes that stamp duty, land tax and the concessional treatment of owner-occupied housing in means tests for income support can affect the use of the housing stock. Stamp duties may encourage people to live in one house when they would prefer to live in another, by discouraging transactions and relocation. Stamp duties may also lead to over investment in large dwellings, by encouraging people to renovate and discouraging downsizing.

The concessional treatment of owner-occupied housing in the assets test for income support can also create this type of 'lock-in' effect and encourage people to store their wealth in housing. The assets testing of owner-occupied housing effectively values a person's home at $124,500, irrespective of its actual value. It encourages people to store wealth in their house to access income support. The assessability of capital withdrawn from the home through relocation to a lower value property (or by way of a reverse mortgage) also discourages downsizing.

Several features of the tax system can lead to a tax advantaged treatment of certain classes of investors. Most states levying land tax use progressive schedules, which discourage larger holdings of land. This may discourage participation in the market by institutional investors. In addition, as argued by several submissions, 'negative gearing' and the favourable treatment of capital gains are likely to lead to lower rental returns than would otherwise be the case. These tax advantages are not available to all investors, such as superannuation funds, which cannot borrow and companies which are not eligible for the CGT discount (see Box 6.8). Faced with lower rents, such investors may be discouraged from investing in the housing market.

In its final report, Review of State Taxation, IPART (2008) suggests that one long term reform option for property tax is to reduce reliance on stamp duty and increase the use of land tax. It notes that such reform would need to address the potential impact on different taxpayers, as land tax can adversely affect people who have high property values but low incomes.

Consultation question

Q10.3 Recognising the influence that some taxes and transfers have on the use of housing and residential land, what changes, if any, should be made to ensure the housing stock and residential land are used efficiently?


10 The estimates of tax advantage in the paragraph are not necessarily indicative of revenue raised from the hypothetical alternative tax settings. This is because the alternative settings would likely lead to significant behavioural responses by tax payers, which are not accounted for in the estimates.

11 This study used the income benchmark to measure their subsidy, which differs from the approach used by the Productivity Commission (2004) and Yates (2003).

12 Total income is the sum of all assessable income, but does not include any deductions.

13 For this reason, some measures focus only on housing costs for households in the bottom 40 per cent of the income distribution.