Have your say: Westpac forecasts 16.9% house price fall on tax changes

Westpac has forecast a 14% fall in the median house price and a 7% rise in the rent on such a house if the government reduces the top income tax rate to 30% from 38%, as is likely to be recommended by the Tax Working Group. A 'politically plausible' combination of a 0.5% land tax and drop in the top tax rate could cut property prices 16.9% and raise rents 8.4%, Westpac forecast. Property investors had bid up prices over the last 10 years to ensure tax losses on properties so as to avoid paying the top 38% tax rate put in place by the last Labour government. Without the differential in tax rates between corporate, trust and income tax rates, prices were likely to fall, Westpac economists Brendan O'Donovan and Dominick Stephens said in a research report titled: 'Tax and House prices'

High-income landlords can swap their taxable labour income for tax-free capital gain income. Unsurprisingly, many do. Ownership of New Zealand rental properties is skewed towards high income working-age people, and the sector as a whole claims more in tax deductions than it pays in tax. The price of a property "“ both owner occupied and rental "“ partly reflects the tax benefits conferred upon the owner. If the tax benefit changes, so will the price.

Westpac's economists said it based its forecast on the changes suggested by the Tax Working Group and used a model that assumed one third of the adjustment would come in the form of higher rents and two thirds in the form of lower house prices.

Landlords receive a tax rebate for losses on their rental properties at their marginal rate of income tax. If the marginal rate of income tax changes, so does the size of the rebate. For example, consider a landlord who is taxed at 38% and loses $20,000 per annum from owning a rental property. At present, s/he gets a rebate of $7,200 each year (0.38x$20,000). If the top rate of income tax were 30%, the rebate would be just $6,000 per year (0.3*$20,000). The annual net cost of becoming a leveraged landlord would instantly increase by $1,200, so fewer people would be willing to do it. Less demand would cause house prices to fall. Fewer willing landlords would mean higher rents. Lower house prices and higher rents would make home ownership both more attractive and more affordable, so home ownership would be higher than if taxes remained unchanged.

Westpac pointed out any change in the top income tax rate to 30% from 38% would encourage savings in bank deposits and investments in businesses.

Leveraged landlords are the "marginal buyer" in most segments of the New Zealand housing market, so they determine the price. However, it is useful to note that a change in income tax would also affect debt-free owner occupiers. Lower income tax means less tax on interest income or dividends. This would increase the incentive to save via bank deposits, shares, or business ownership rather than by owning a bigger/better house. So demand for property would fall.

Westpac also forecast a 4.4% fall in house prices and a 2.2% increase in rents if a 0.5% land tax was put in place. A capital gains tax of 10% would cut property prices 15.7% and lift rents 7.8%, while a 'Deemed Rate of Return' tax of 6% on equity in rental property would cut prices by between 26% and 35% and lift rents by between 13 to 17%. A 'politically plausible scenario' of a 0.5% land tax and income tax set at 30% would produce a combined 16.9% fall in house prices and an 8.4% rise in rents, Westpac forecast. However, it said the positive effects for New Zealand's economic growth rate was likely to improve the sustainable rate of capital gains on property, partially offsetting the one-off hits from such tax changes, Westpac forecast

If New Zealand's sustainable rate of economic growth were to rise, it is reasonable to assume that the sustainable rate of capital gain on housing would increase. (A "rule-of-thumb" says that the real capital gain on land should, on average over time, equal real economic growth). Our baseline scenario assumes 2.5% sustainable real capital gain. To completely offset the price-negative impact of the tax changes in the combined land and income tax scenario, the rate of sustainable real capital gain would need to lift to 3.1%, assuming no change in average mortgage rates. We think that's a bit of a stretch.

My view This report will kick off a real debate. Now the proverbial is hitting the fan of political reality as the property investors who (largely) backed National will bay for the status quo. I hope John Key doesn't listen to the outrage too closely. I'm not hopeful. Your view? We welcome your comments, insights and questions in the comments section below.

The full report is below Tax and House Prices