Terry Baucher outlines a potential menu to rein in soaring house prices featuring the application of the thin capitalisation regime to investment property, and reintroduced and stricter LVR restrictions for all buyers except first home buyers

Terry Baucher outlines a potential menu to rein in soaring house prices featuring the application of the thin capitalisation regime to investment property, and reintroduced and stricter LVR restrictions for all buyers except first home buyers

By Terry Baucher*
(This article is part of Interest.co.nz's Election Series).

This election would be a good time for the politicians to stop kicking the tax can down the road. The torpor which in the past 30 years has settled over the issue of what we tax and how much we tax has resulted in growing income and wealth inequality, under-funded health services, underinvestment in infrastructure, an unsustainable superannuation policy, an increasingly stressed environment and most critical for many New Zealanders, seemingly uncontrollable housing prices.  

The accumulation of these matters means that whichever group of parties form the next government they will need to look beyond the immediate problem of responding to Covid-19 and start addressing these other issues. When it comes to housing although a capital gains tax (CGT) is often suggested maybe an alternative approach might be to restrict the supply of capital and generous tax deductions.

New Zealand is unique in that we do not have a comprehensive CGT, nor do we have any form of gift or estate tax. It's rare for any jurisdiction to effectively exempt such a large chunk of capital from the tax base. Consequently, for over 30 years overseas organisations such as the IMF and the OECD have been advising governments of both hues to introduce a CGT. The calls have been repeated so often that I imagine their tone is now at the “FFS! How many times do you need to be told?” stage.

But Jacinda Ardern ruled out a CGT during her leadership and both ACT and National opposed the Tax Working Group’s proposed CGT. Although the Greens are proposing a wealth tax this is presently opposed by its likely coalition partner, Labour. The most likely post-election scenario is there will be no CGT and there won't be a wealth tax either. Against this background, what measures could a government take to address the issues of wealth inequality and runaway house prices?

I suggest that tackling accelerating house prices involves not only increasing supply and removing planning restrictions, but also restricting the access of funds. It is apparent the present easy availability of credit is a huge factor in driving global property prices. This points to the Reserve Bank (RBNZ) re-imposing loan-to-value ratio (LVR) restrictions for all but first-time buyers.

First home buyers are still an important part of the housing market but LVRs aside, raising a deposit of 20% when median house prices in Auckland are racing towards one million dollars is a daunting task. With trillions of dollars of capital looking for a home, turning off the tap by increasing LVRs for investors and non-first home buyers seems the most effective way of slowing house prices and bringing some stability to that market. Based on last week’s Newshub Leader’s debate this would seem to be something both Labour and National could accept.  

I suggest LVRs for investors should be at least 50% and maybe even higher. If the RBNZ wanted to take the heat out of the market it could also consider whether LVRs of at least 30% apply to everyone except first home buyers. To head off commercial property inflation the RBNZ might even extend LVRs to commercial property although banks are naturally more cautious about lending in this sector.

In relation to actual tax measures that can be taken, the current government, introduced loss ring-fencing and extended the bright-line test (a de facto CGT) to property sales made within five years. But what else could be done?

One approach would be to apply the thin capitalisation regime to investment properties. At present, if a business such as Microsoft wanted to invest substantially in New Zealand, the interest deductions that it can claim on any debt funding provided are restricted if the debt to asset ratio exceeds 60%. Restrictions also apply to the interest rate that can be charged on the debt funding.  

Applying the thin capitalisation regime would tackle the ability of investors to use debt to leverage up their investments which is another way first home buyers can be priced out of the market. 

But more direct action could be taken to address a strange anomaly under our tax rules. At present interest deductions are, with the exception of the thin capitalisation rules, generally fully allowable if incurred in deriving gross income.

The deduction relates to the rental income that is being derived from the underlying property being financed. 

However, the economic returns from property are twofold: firstly, in the form of taxed rental income and secondly in untaxed capital growth. The present treatment therefore gives an allowable interest deduction for both taxed and untaxed gains. This generous treatment together with the banks willingness to lend freely practically makes property a one way bet. An interest restriction rule, whether it is in the form of thin capitalisation or some other means, seems to me to be both an equitable approach and a good means of putting a handbrake on housing prices.

Such a move would complicate the tax system. The first draft of the ring-fencing rules eventually introduced last year were so complicated they were considered unworkable and then redrafted entirely. An alternative and simpler approach would be to remove the loss ring-fencing rules and allow interest deductions in full, but the eventual property disposal would be taxable. In other words, an investor can get the value of the deductions now in exchange for a future tax liability.  

Whether a government will have the courage to take strong measures relating to capital taxation remains to be seen. A cynic might say that the chances of that at present are relatively low. However, there is an increasing likelihood that an attempt to kick the capital taxation can further down the road might just see the can rebound and hit the kicker. Which would definitely be a “FFS!” moment.


*Terry Baucher is director of tax advisory firm Baucher Consulting.  

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57 Comments

29
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We somehow need to solve our obsession with property investment - I don't think your average kiwi realises how weird our views are with property. Perhaps they need to go and live overseas? (and not Australia as they appear to be just as bad...) Its like we're a bunch of meth addicts who don't realise they're sick. And the only way to wake them up will be a near death experience so they can see the harm they're doing to those around them.

23
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Most realise how sick the 'meth' is making them and the country, but as long as they get to sell their product to someone else at a higher price, they don't care.

18
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True. And not many realize how our unbalanced economy, overly reliant on parasitic speculation in housing, is becoming more and more fragile because of that.

19
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I don't want to be here anymore and have decided to plan my exit. Ths country is not for the likes of me. It is only for the rich and old. Adrian Orr and Jacinda have destroyed my future chances of living here happily. What's the point? Oz, Canada or UK bound.

12
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If I were young and skilled, I would not stick around for sure. I cannot blame you.

Canada is definitely a bad alternative to NZ. The country's virtue-signaling left and status quo-obsessed right can't make the tough choices to solve productivity stagnation, low wages and housing speculation.
Their best minds end up heading south for higher pay, affordable living and better career prospects, so the government uses mass migration from lower-wage countries to duct-tape over the country's real issues.

Sound familiar?

http://d3n8a8pro7vhmx.cloudfront.net/livingwageforfamilies/legacy_url/12...
https://financialpost.com/opinion/government-is-why-housing-in-canada-is...

Agree. But implementing this proposal would make a world of difference I suspect. Send an email with the link to your local candidates - particularly the LAB one as it looks like they will get back in. However, send it to the NAT one as well and tell them you'll commit your party vote to whatever party it is that takes up this proposal.

Your not alone, tradies packing up for Aussie now . They’re starting to rehire in the mines, an their infer structure projects will up an going while NZ has a committee to talk about it .

I came to the same conclusions as you Andy about 1 year ago. Landed a job in Aussie from New Zealand very easily via skype interviews, and had 3 offers in less than a month. I've saved 5x more in Aussie than I could with 1 year in NZ, and can honestly say you've got a nothing to lose. My only regret is I didnt do it sooner! Apply for a Aussie bank acc and TFN from NZ once you have proof of a job offer - saves a lot of time and effort once you land. Best of luck!

It totally depends on what career and experience you have, and which cities you're moving between.
I've run the numbers and am better off in Wellington than Sydney/Melbourne. Other Aus cities are cheaper but don't have the same roles available.
For some people it would work, for others not.

One less renter!

You picked the three countries that have the same stuffed up restrictive housing laws as NZ (due to the origins of the UK Planning regulations and being part of the same commonwealth legal system.)

It would only make sense to go to any country if your skillset can by way of higher-income leverage you past any inequity the laws might impose on you otherwise, so your net discretionary income is higher.

The clue is to first look at the median income to housing multiple as this gives you an idea of how much (or less) discretionary income you will have leftover after housing costs, to live life, make other investments, etc.

All the countries you mention going to, have very poor median income to housing multiples.

Looks like auctions are the dominant way to sell again . Will it be slowed down, I don't think so. It's being used to inject new money into the system.

The problem is that we don't have enough alternative investment options. Our stock market is tiny. We have almost been taught that we must get on the housing ladder, at almost any cost. If we continue down this route, a million dollar house will become the average in not too many years, and many young people will need to literally win lotto if they want to buy a house outright.

In order to control housing prices there are a few things that can easily stop the problem of raising prices decoupled from incomes:
1) Control land prices by creating a set of rules that should set a cap for how much land can be sold per sqm.
2) Regulate the real estate services sector in a way agent incomes do not depend on the price or number of the properties they sell (right now it works as giving incentives to police for number of fines they issue)
3) Introduce a tax to properties that remain closed in high density areas.

30
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Or we could just decide that we're trading houses like consumption items and include land prices in the CPI. Boomfa! No more 10+ % rises in property values as it would look like we have runaway inflation.

Of course! Too obvious though, so that is off the table for starters.
After all. Housing isn't a Consumption Item (sarc/off). It's a Kiwis right to Wealth and Riches via Capital Appreciation. None of this making a pile out of doing a day job well. So let's just stick to looking at the ever-decreasing cost of financing that asset in the CPI shall we? Much better for all.

The problem is that they would introduce this too late when house prices are conveniently falling from bubble levels. Then we get inflation in everything else disguised.

Some countries do this, however didn't stop housing bubbles like in Spain, instead it helps money laundering since sales prices are reported with lower than the real price and part of the payment is done under the table. This is the reason why Spain used to have the largest amount of 500 euro notes in the eurozone.

That and a pretty healthy blackmarket in Ibiza each summer ;)

The LVT matter needs to be shot, not kicked. Edit: That said, no point in shooting something that is already dead.

There is a solution but it's very inelegant. Foist all social housing financial obligations onto local councils (as many other countries already do), they will be forced to increase council rates/taxes substantially or open up development to new dwellings (as distributing the tax burden over more dwellings reduces taxes each would pay.)

13
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Here's my proposal, and it's a doozy: A land tax that scales with each residential property or title you have an interest in. Thinking as follows:

1x property: 0%
2x properties: Base rate
3x properties: Base rate x2
and so on, and at whatever base rate is needed.

Not sure how you'd apply it at an individual level or how it would work with Trusts, but we need something along those lines that doesn't punish family home owners, but with strong disincentives for portfolio-building in residential real estate. I used to think denying interest rate deductions for property investors would solve the problem but people will still and buy property that would be otherwise available to owner occupiers, which doesn't work when supply mechanisms are broken and a multi-generational shortage arises. It's unworkable but the status quo isn't exactly beer and skittles either.

Good thought, but....where there are 'rules' there is an army of accountants and lawyers who will find the loopholes.
What causes residential property price 'inflation' is the availability of debt. Without that, the whole merry-go-round stops.
Will that involve new 'rules'? Sure. But the RBNZ oversees the banks that make the loans, and if they are stringent enough, and punish malfeasance, that will work.
The problem? The RBNZ is the biggest player in the game we already have. So chances of reform? Nil.
Tragically for our country, only a financial catastrophe; one big enough to be remembered for 50 years or more; as the rural reforms of the '80s are, is going to fix this mess.

Yes, you're really tooling around the edges as long as Govts are happy to keep prices stable through inefficient land management and the RBNZ has the printers going 'brrrr' overtime. But something needs to be done. I've just had a squizz at houses in Brisbane. I could offload my first home bought a year ago and move there to a nicer house and be almost mortgage free in a couple of years, as opposed to taking on an $800K mortgage to get four bedrooms in Auckland while trying to raise a family. It just doesn't add up anymore.

I read this article and think the reason our housing market is like this is because its been controlled by the RBNZ and house prices will never deflate because the buying power of the dollar to buy the property devalues monthly and the RBNZ controls this by inflation. Since 1971 currency worldwide has been devaluing as its only backed by peoples confidence nothing else. No government has fixed the issue in the past and wont in the future as all that happens is RBNZ prints more worthless pieces of paper called money. This is only going to get worse because debt is growing so fast. Interest rates will not be the major player in the next 3 - 5 years inflation will be and its going to be increasing quickly.

It's interesting to consider that inflation might be just around the corner, but I wonder as a complete layman if the modern world just doesn't work that way.
For inflation, we need money supply and scarcity of resources.
House prices and rents - yes absolutely scarce and inflating steadily.
Reliable tradesmen - scarce and inflating.
Imports from cheap manufacturing countries - no scarcity.
Local production and food - some scarcity but only when immigration doesn't provide the needed low-wage workers.

Factor in growing inequality - the desires of the wealthy are seldom scarce except for housing, holiday homes and access to premium locations.
The needs of the poor are sometimes scarce but their ability to pay is only getting tighter.

Overall I can only see inflation (except for housing, assets) when the government determines new ways to put money into the hands of the unwealthy that doesn't go directly to their landlord.

To me the root cause of the problem lies with how much the banks will lend into residential property. It's them that control the price, so controlling the banks urge to poor in the money is key. Nothing to do with land availability or perhaps even immigration.
Not going to happen is it. Turkeys voting for Christmas stuff.

This resonates with me too. Terry is a Tax guy, so perhaps the wrong one to answer or comment, but I've always thought that a much more nuanced RWA regime for lenders could be the key. The 'Risk' weighting for various lending destinations could be juggled: it's plain absurd that the 'safe as houses' loan book is not sub-classed into the obvious: first or subsequent home, bach, investment property, and so on, and substantially differing Weightings then applied to these sub-classes. That would then act to incentivise (say) FHB lending, and dis-incentivise other lending comparatively. Plus, as a side benefit, it would more precisely disclose the scale and nature of actual bank lending. Could probably be done by lunchtime tomorrow if within standard RBNZ legislation and powers. No doubt, commenters will put me right if this already applies......

Yes, it could be done by the RBNZ, I think with/without government approval. But then I assume the current risk weighting is based on an actuarial calculation? If so, you probably can't 'jimmy' it to suit another purpose.

Tax it like this so we don’t burden productive farms and small business while encouraging efficient use of housing stock and land.

https://d3n8a8pro7vhmx.cloudfront.net/garethmorgan/pages/2959/attachment...

Why don’t they just extend bright lines to 10 years or indefinitely... legislation already there and easy to understand.. 33% tax non-negotiable. Can’t reduce to PAYE rate. Leave all other capital alone

Because
1. You'll end up with less and less houses being sold.
2. 33% tax on inflation over 10 years is unfair. Most countries with CGT have lower tax rates or allow an inflation adjustment.

How is it any less fair than withholding tax on term deposits at 33%?

That's also unfair.

The message for TD is to get that cash out and use it.

and because 3) it depends on a Realised Gain - i.e. an actual sale...... - that's why #1 in RefactorNZ's comment is one result. Properties are simply held, and other ways to obtain the return (leasing, lending, etc) come in to play.

Whereas if t'were applied to Unrealised (i.e. mark-to-market) gains, watch out below.....

Imminently sensible!!!!!!

Any party that really wants to represent the interests of owner-occupying homeowners (whether first or second or retirement/last home buyers) ought to be implementing this.

How our politicians could stop kicking the housing tax can down the road....

May be by kicking the politicians.....

Politicians are not going to touch the property market, its called having a vested interest. Its all talk to get votes and then no action. Society as a whole has been sliding towards the chiasm that separates the haves from the have nots for decades, it has nothing to do with house prices really. Take the USA for example, the top 1% over there have more wealth than the bottom 50% combined. The situation just gets worse and worse every year because enough is never enough for those at the top until there is a revolution. Your wasting your time if you think politicians are going to fix the problem for you, the only way to fix the problem is making decisions to sort it out yourself.

a) Supply - Free up or remove RMA - there should be no zoning or density restrictions as long as environmental effects as set by national standards are complied with

b) Financing - Ban recourse mortgages. Its a free ride for the banks and skews investment towards overly secure housing. NZ'ers need to be welcomed to take business risks.

c) Demand - Have a population growth strategy aimed at maximising net welfare (wellbeing) gains per capita, taking into account gdp/capita growth & externalities

d) We could do with a comprehensive capital, capital gains or wealth tax but at a minimum
i) require local government to rate on land value only
ii) consider whether additional central government land tax can be justified

Agreed, the current RMA has serious issues.

Ban recourse mortgages??? WTF??? You take a risk, you should be responsible if the risk goes bad. People should not be able to gain the benefits of taking a risk without suffering the penalties if the risk does not pan out. The US a decade ago demonstrated quite clearly just how stoopid it can be when there are non-recourse mortgages.

Growth... that should be a four letter word, at least in terms of people. Productivity growth, that is superb. What the world should be turning towards is long term sustainability, not short term growth.

So a limited liability company is ok & can walk away from debts, but house purchasers should always have a mortgage debt around their neck???

No way - this is simple and straight out risk distortion. It should be a level playing field.

Its no wonder banks only want to lend on housing & business loans are hard to come by.

We want productive use of capital and that comes with a risk.

Those limited liability companies also pay higher interest rates, in part due to the higher risk of them walking away from debts.

The bank takes a risk.

Good luck with those ideas...

It's highly unlikely to be adopted - and even if it was, the net gain would be small or nothing as capital gains tax would likely be legally avoided thtough like kind exchanges i.e. 'trading up'

If you want to stop house price appreciation you have to look at
- Restrict foreign buyers and cash from buying NZ homes as rules are different overseas and could circumvent the system here
- Set debt to income ratios, this limits available leverage
- Stop subsidising Akl rentals - especially those that were sold HNZ properties... this limits rental incomes being subsidised by the govt, and lets market forces take over
- Limit LVR's
- Limit Interest only loans
-

Tax can't solve every thing.
Reduce demand. Set a target population and work to it.

Good piece. Although didn't mention the necessity of the government taking on a role of building houses and selling at no profit as per the 1950s.
The things the author mentions in the article may limit future price rises but they won't result in 3 bedroom houses in Auckland selling for less than 600k...

If the OECD would be as vocal on NZ's draconian superannuation savings system, being a TTE system rather than more sensible and incentivising EET system it used to be in NZ (and consistent with the USA, Canada, Australia and UK structures). Then people would be more accepting of a CGT for property which currently is the only vehicle that can achieve for a reasonable retirement sum for the average person.

There is a *HUGE* difference between a capital gains tax and a wealth tax.

I strongly support a capital gains tax, and would remove many of the typical exemptions that some parties would enact so as to get popular support. A gain in wealth is income, and should be treated as such.

A wealth tax on the other hand, penalizes the prudent saver. Taxing capital gains equivalent to income, this is intelligent and appropriate. Taxing saved wages (which was already taxed prior to accruing in savings) is inane. You wish to see unintended consequences, see what happens when you tax savings. I know that my savings will depart to another country if this happens.

Yes a wealth tax as proposed by the Greens is nothing more than a robin hood tax

I mean seriously?! they are straying far from their niche...

The gov absolutely does not want to reign in house prices. That is what their whole current policy of ridiculously low interest rates is...to increase investment in houses and all the economic trickle-down that happens, especially during these upending economic times. That is their policy. Like it or not. They have no intention of stopping this train.

Now living in the Czech Republic after purchasing a house in 2018. The biggest kick was the 4% property transfer tax. 4% of the market value or purchase price - whichever is higher. The Czech's scrapped it in April of this year. However, they still have nominal levies based on the size of the property and location. Interestingly, we don't pay Rates or council tax.
http://www.ecovislegal.cz/en/czech-legal-news/tax-framework-for-real-est...

BTW: the transfer tax could not be borrowed. Essentially 4% extra to be paid 3 months after settlement. I'm now wondering why the government scrapped it..perhaps the election?

The solution to the housing crisis is very simple. Reduce net migration to zero for several years. The country needs a few empty houses to put downward pressure on both house prices and rents.

This is about the only comment on this page that makes any sense. It's a simple supply and demand equation. Supply will always meet demand but there is a very long lag due to the length of time to provide new product (at least 2-3 years for anything of scale and 3-5 years for larger developments).

As a side note, the funny thing about Kiwibuild is that no government or private organisation could ever bring the number of houses to the market that labour promised, in that period of time. Its just not physically possible due to the consenting process alone.

Last time I looked there were ~70K empty houses in Auckland and Christchurch combined - doesn't seem to have had much of an effect on prices. There is no solution to house price appreciation realistically - the cheaper they become the easier for investors to buy them, the more expensive they become - the easier for investors to leverage. Only way is to limit the number of houses per investor. Good luck with that!!

Pretty easy really. Just make it so that investors can't leverage off existing property to raise deposit. If investors want more property, come up with the cash deposit and also make it high, say 50%, then see what happens.