What will happen to our younger generations if New Zealand doesn't change the way it taxes property and savings?
What will happen to income taxes and home ownership rates if we leave the retirement age at 65 and keep our pay-as-you-go and universal pension system? Can we keep growing our economy and have a socially healthy population if we 'set and forget' our current taxation and pension settings?
These are questions I have begun asking myself a lot lately. I returned to New Zealand in 2004 after 10 years overseas building a career to make sure my two daughters grew up in New Zealand and eventually raised their kids here. My dream is to help build a country (in my own little way) where I can watch my grandkids grow up here.
But I'm beginning to worry this may not be possible, given what has happened in the last decade and what our current bunch of politicians have been saying (and doing) lately. My nagging fear is that my children, and the many other youngish New Zealanders entering the workforce in the next 20 years, will decide that after-tax wages here are too low, that home ownership under their own steam is an unaffordable dream, and there are better options overseas.
My nagging fear is that I'll have to watch my grandkids grow up by facebook and Skype because they'll vote against this plainly unfair and crushing inter-generational transfer of wealth by emigrating. Or worse. But it was only a fear based on my general observations about what happened in our housing market and our economy in the last decade, coupled with an intuitive set of views about what might happen next.
These general concerns lacked any great underlying rigour or academic backing. My outlook fit into a small (but growing) general world view that the ageing and developed world faces an epic clash of the generations in coming decades as a generation of young and poor tenants rebel against an entrenched group of old and rich landlords. It was only a general and academically unsupported view.
Many have criticised it as the rant of a envious loud-mouth. Fair enough. Until now. Andrew Coleman at Motu Economic and Public Policy Research presented a paper this week in Auckland that provides some intellectual rigour behind these concerns. Coleman's paper, "Squeezed in and squeezed out: the effects of population ageing on the demand for housing." is presented below in full and can also be found here.
I have also interviewed Andrew Coleman and the unedited Youtube interview can be found below.
Coleman's conclusions are startling and liberating at the same time. They are startling because they are counter-intuitive to most people's views of the housing life cycle until now and liberating because they suggest a way forward that might stop or reverse the trends. He has modelled what happens to the home ownership rates of the young and the old in New Zealand as the population ages.
The paper demonstrates that the young face rising income taxes and will increasingly have to live in ever smaller rental properties, while the older generations stay in their large houses and invest in rental properties. This is counter-intuitive to the traditional 'life-cycle' that is assumed by policy makers and voters alike.
The assumption is that students leave home, graduate, rent, buy a house, start a family, raise that family, buy a bigger house, pay off the mortgage, kick out the kids, save for retirement, retire and then downsize to a smaller house or unit to free up cash. But Coleman's conclusions are that as the population ages and the inherent biases towards property investment keep driving house prices and saving behaviour, the young will be forced to stay renting and the old will stay in their big houses.
If this happens, New Zealand risks becoming ghettoised into two groups: apartment dwelling young and middle-aged renters and villa-dwelling old landlords. Either that or no one ever leaves home. The social costs would be corrosive. It would mean sicker, weaker families and a less cohesive, more transient population. Coleman's conclusions from the paper and the model are best expressed in the haiku that accompanies Motu's research papers: "The young pay taxes So the old live in mansions They wanted when young."
So why will this happen?
Coleman has set up a model that takes into account: * the forecast doubling in the proportion of the population over 65 to 25% by 2051, * the way choices about renting and buying are dominated by tax, retirement income expectations, healthcare expectations, interest rates, bank lending constraints and inflation, * an assumption that governments will run balanced budgets where the current pay-as-you-go universal pension system is unchanged, health care costs rise and income tax rates are increased as a result, and, * an assumed increase in house prices because of population growth and an inflexible housing supply.
The results are profoundly depressing if the retirement age is not delayed and taxes are allowed to rise to pay for higher healthcare and pension costs.
The outputs from the model are aligned closely with what has happened since 2000:
* the proportion of young people owning their own homes has fallen,
* the speed of those moving up the ladder to home ownership has slowed,
* bigger and higher quality housing is increasingly owned by older near-retirees,
* older New Zealanders are spending longer in larger houses rather than downsizing,
* older New Zealanders are choosing to invest more in rental property than other asset classes, in turn pushing up house prices and making home ownership for the young even more difficult in one of several negative feedback loops. One of the biggest drivers towards the "Apartment dwelling renters vs Villa-dwelling landlords" scenario is the taxation system that incentivises rental property ownership.
Capital gains in rental property are tax free and savings invested in housing do not have to pay high withholding taxes on interest, including the inflation component in interest. Coleman suggests a few things to close this widening gap, including:
* moving towards a taxation system that exempts the inflation component within interest earnings on savings, and,
* changing the current system of a universal pension at 65 to reduce the future tax increases. See the paper below and the interview. I welcome your thoughts and comments.
I think New Zealand needs to have a debate about our taxation system, our pension system and the looming clash of the generations if we do not change these systems.
Hopefully this paper from Andrew Coleman gets people thinking and talking. At the moment, the Prime Minister John Key has tried to shut down this debate by only tweaking the property taxation system in the budget and refusing to debate the idea of delaying the retirement age or changing pension entitlements.
His threat to resign if these things change has deliberately taken them out of the debate. If the main opposition party won't raise these issues, maybe both young and old people who worry about these trends should start the conversation themselves. Off we go.
Here is the Powerpoint presentation Andrew presented in Auckland on Tuesday. Grandma is My Landlord Long Version May 2010