NZ’s Distortionary Tax System Contributes to Housing Crisis

May 9, 2017

NZ has one of the most distortionary tax environments for housing of any country in the OECD.

It wasn’t always this way. But new research from Andrew Coleman, an Affiliate of Motu Economic and Public Policy Research, argues that tax changes made in 1989 to retirement saving accounts are a hidden factor behind the current housing crisis.

“Most countries think it is important that people can invest in assets that are taxed in a similar way to their own homes,” said Dr Coleman. “If housing is taxed less than other assets, people have incentives to buy bigger houses, and they will pay more to live close to jobs, the centre of town, or beaches. The result is artificially high housing prices – exactly what we have now.”

One way to avoid this situation is to have a neutral income tax system. If a government wants to do this, it has to tax the rent you get from your own home and apply a capital gains tax to all assets including housing.

An alternative method is to tax retirement savings accounts on a similar basis to housing. This method has been used in many countries around the world for many years. It was used in New Zealand until 1989 too, when the government raised taxes on retirement savings but didn’t raise taxes on housing.

“This created a whole new set of distortions and helped create the unbalanced housing market we have today,” said Dr Coleman. “It has encouraged people to increase the size of their houses by 25 percent, and New Zealand now has some of the largest new houses in the world. We’re also paying perhaps twice as much for land as we should in areas where there is significant transport congestion.”

“Higher land prices are a boon for baby-boomers like me,” said Dr Coleman. “But this advantage is offset by large costs imposed on all younger generations. It’s particularly hard on first home owners with low equity and renters. It even leads to higher per capita debt for Kiwis.”

Fortunately, there may be a solution. It isn’t a quick fix, and it won’t fix all the problems in the housing market. But if the Government wants to correct the tax problem it could do what other countries do and change the tax settings on retirement savings accounts such as KiwiSaver.

“For the last 25 years, New Zealand has been the odd country out by taxing retirement saving accounts on an income basis rather than an expenditure basis. It might have looked like a good idea back then, but with the benefit of hindsight perhaps it is time to reconsider New Zealand’s great income tax experiment,” said Dr Coleman.

The study, Housing, the ‘Great Income Tax Experiment’, and the intergenerational consequences of the lease by Andrew Coleman has also been published by the University of Otago.