A staggering failure of Economics 101

It’s not often that you find out about developments in the Aussie housing market from Canadian ex-finance-ministers, but Garth Turner ran an interesting piece yesterday about Senator Nick Xenophon’s proposals to make housing “more affordable”. In short, he says “we tried that and it backfired”: 

I confess. Once I thought like you. I even supported realtors years ago when they cooked up this scheme to allow kids to dip into their retirement funds to buy a first home. At the time we were in a steep recession with real estate plunging and the economy in a funk. So, I voted in our Parliament for a temporary program to create the Home Buyer’s Plan in order to stabilize the market and try to revitalize the home-building business. It worked, kinda. Then subsequent governments (a) made the plan permanent and (b) doubled the amount people can suck out of their registered savings.

Now, Nick, we’re reaping the bitter harvest sown when that dumbass legislation passed. Allowing first-time buyers to remove tax-free money to buy a modest home they could not otherwise afford, then restore it to their long-term retirement savings makes perfect sense in theory. In practice and experience, just the opposite.

Meanwhile in San Francisco, the Board of Supervisors is proposing a Singapore-style flipper tax on people who sell houses within four years of buying them. The tax would range from 24% on sales within one year to 14% for sales between four and five years after the purchase. 

And back in Australia, people are fighting tooth and nail to preserve the generous “negative gearing” tax breaks that allow homeowners to tax-deduct the entirety of any losses on their investment properties (interest expenses over rental income). The negative gearing laws have been around since the mid-eighties; they’re a major reason why housing is such a popular investment in Australia; and they’re widely considered a third rail in Aussie politics.

There’s something about the housing market that makes people forget everything they learned in Econ 101. 

On first principles, if you want to reduce the price of a thing, you either need to decrease demand for the thing or increase supply of the thing. All three policy measures up the top of this post would do the exact opposite, no matter how well-intentioned they are. 

First: letting people tap their retirement funds to pay for a house. This typically gets dressed up as a “benefit for first homeowners”, but here’s what happens: if all first home buyers _can_ tap their retirement funds, all of them will. And they won’t just tap the funds; they’ll use them as part of their 20% deposit, letting them leverage up the money four times. 

End result: the demand for houses increases (because people can pay more for them), but the supply doesn’t change. So prices go up, and homebuyers end up in more debt than they would have had without the policy change. (First-home-buyers’ grants, occasionally nicknamed “first-home-sellers’ grants”, have the same end result.) 

Second: flipper taxes. Again, the legislators have forgotten that if you want to bring house prices down, you need to encourage sellers. Flipper taxes do the opposite: they motivate potential sellers to keep their houses off the market until they reach the five-year mark, but they don’t do anything to stop buyers. 

Singapore’s experience with a flipper tax is worth examining. They introduced the “ABSD” tax in 2011, and jacked up the rate in January 2013. Since 2011, residential house prices have gone up, not down; and industrial property prices skyrocketed because the flip tax only covered residential property. 

Third: negative gearing and other tax incentives for homeowners. By now, you can probably figure this out yourself: tax incentives encourage people to buy; and more people buying means prices go up. 

Home ownership is not necessarily a bad thing. But policy-makers across the world seem to have a blind spot when it comes to house price policy, and they love implementing policies that are dressed up as “keeping houses affordable” but end up making houses unaffordable. Someone with an Econ 101-grade education should probably step in at some point and explain the unintended consequences of these policies.