Will the proposed Stamp Duty reforms make property more affordable?

Finance & Fury Podcast

Welcome to Finance and Fury. A few weeks ago we went through the NZ government tasking the RBNZ with looking at property prices with monetary policy.

1. in that episode, we went through why it probably isn’t going to really work well – politically the perception is that the Government is trying – but for the CB to make housing affordable through monetary policy, their only real recourse is to increase interest rates which would potentially put many households into default – leaving to an oversupply in property and property prices dropping – but this may not actually create ‘affordability’ – it would create people who have declared bankruptcy, who then have a hard time getting another loan, plus it may lower the household incomes – affordability of property is the price of property measured against the average household income
2. what was mentioned in this episode is that the central bank has basically said as much – and would refer back policy tips for governments to try and implement – this is the other end of the spectrum on the fiscal policy side – such as changes to the taxation system – this brings us back to today’s topic – and this is one of the proposals that the NSW government has when looking at property affordability –
3. Major changes may be coming down the pike in NSW for stamp duty reforms – may set the example for other states to follow

This episode – we will look at the proposal to remove stamp duty and replace this with a form of property tax – in other words, pay less upfront tax and replace this with an ongoing tax

1. We will also look at some examples of how this would work
2. Most of the information from this episode is from the consultation papers, bot with NSW treasury and a few private

To start with - this proposal is nothing new – one paper I was looking at went back to 1996, another to 2016 –

1. Because if anyone was politically/policy aware back in around the 2000s – the proposal was that with the introduction of GST at the federal level, it was meant to be the replacement of stamp duty charged by the states – so the GST gets introduced, then the states remove stamp duty
2. As is with governments – don’t like to forego revenues – so GST was a double win for the states – keep collecting stamp duty and then get a distribution from the federal level through GST – which is distributed between the states

Before we get into the details of this proposal – let’s start at the beginning - What is stamp duty –

1. Tax you pay on the transfer of an asset – stamp duty is triggered by a property transaction and levied on the sale price
2. Stamp duty is also referred as a transfer duty, as it is a transaction-based tax paid on the transfer of property, both residential and commercial.
   1. The tax is paid by the purchaser of the property, based on the sale price – includes the price of the land and the building on it – essentially the market value
   2. Stamp duty has a progressive tax structure - the tax rate increases as the purchase price increases.
3. first introduced in England back in 1694 under an act to help raise revenue to fight against the French towards the end of the Nine years’ war
   1. As an English colony this tradition carried – NSW introduced Stamp Duty 1865
4. Stamp duty makes up a large chunk of every states revenues – NSW has a revenue of just under $32b
   4. Transfer duty - $8bn or 25% of the total revenue, land tax was about $4.6bn or 14.4% - but in total the NSW government makes around 40% of their revenues from property, in the form of transfers or ongoing land tax – note that this land tax is not rates – which are levied and collected by the local councils
   5. Interesting – one paper I looked at called Fundamental principles of stamp duty – had the revenues of NSW back in 1995 - $2.6bn was the stamp duty collection – but this made up around 43% of the state’s revenue back then – today this tax, whilst it has increased by $5.4bn, makes up about 18% less as a share of the total revenue - additional taxes have been introduced since, such as on gambling, other state levies, which have helped to reduce the portion
   6. NSW has some history in reforming Stamp Duty - From 1 July 2016, the NSW government abolished transfer duty on the sale of business assets, including intellectual property, goodwill and statutory licences.

Why is NSW looking at this proposal –

1. The major reason is that over the past 156 years, stamp duty on property has become a large upfront barrier to entry to getting into the property market – not only getting into the property market, but moving from a current property into a new one -
2. Since the 1990s - Property prices have grown, especially around the greater Sydney area – but on top of this, the tax rate of stamp duty has also grown – creating a compounding effect of the barrier to entry for property
   1. Initially the stamp duty rate was 0.5% - but on average now it is around 4% in NSW based on the average property price – it is a tried system – but on average it is about 4% - increase of about 8 times
   2. In the past 30 years, the average earnings over households in NSW have trebled, but the average house prices have increased around five times, and average stamp duty on dwellings has increased more than seven times – there is a problem here –
   3. With the compounding factors of higher prices, requiring more of a deposit savings, as well as costs to stamp duty, homeownership has declined, from around 70% in the 1990s to around 64% today
3. To get into the property market – you have to personally cover the stamp duty – save for your 20% plus the stamp duty costs
   2. One of the studies done has estimated that stamp duty can add 2.5 years for an average worker to save enough to get into the property market – this is based on the average household saving 15% of their income on a deposit
   3. Goes without say that stamp duty has massively increases the transaction costs for getting into property – In 2009 NSW stamp duty revenue was 137% of the ABS measure of ownership transfer costs. By 2018, stamp duty was 384% of ownership transfer costs
4. Economists also suggest that stamp duty can also hurt economic spending for the population - A review of nine recent studies of the Australian tax system indicates that each additional dollar of residential stamp duty revenue lowers living standards by about 90 cents. For stamp duty on commercial property, the impact is even higher, with an economic cost of $1.00 for every dollar of revenue raised.
   1. So, on average, almost every dollar raised in stamp duty has 100% economic cost – reducing consumer spending and GDP

But let’s be clear – the Government are not acting purely out of the goodness of their hearts for this change – they are looking to replace an upfront tax with an ongoing tax – in the form of a property tax

1. We already have a Land tax - which is an annual tax paid on the ‘unimproved’ value of land
2. We also already have rates – which is also based upon the unimproved value of land – however at the moment – land tax isn’t paid by many people in NSW – the numbers:
   3. For stamp duty – figure of about $8bn at the state level, with an average rates bill of $1,050 in NSW and 3m households, revenues by the councils of about $3.2bn, but for land tax there is a $4.7 billion revenue that is generated from about 180,000 land tax payers – this is an average annual land tax bill of about $26,000 per tax payer
   4. Focusing on properties, rather than the people who pay land tax, about 260,000 out of 3 million residential properties in NSW (about 8.5 per cent) are subject to land tax - then among commercial properties only about a quarter are subject to land tax
3. a smaller number of people pay land tax – why? It has a high tax-free threshold, and there are many large exemptions, including the principal place of residence and farms.

This new property tax will not be land tax, or replace land tax or rates – it will be on top of these

1. There will be some changes compared to land tax as it currently stands - The property tax would apply to each individual property, unlike land tax which is based on an owner’s aggregate value of landholdings
2. But here is where the proposal is looking at two options –
   1. Tax based on the unimproved land values – which is how council rates are determined
   2. Property tax based on the market value of property – including the value of the land, buildings and improvements
   3. Is similar to rates vs stamp duty – rates are based upon the current unimproved land value – stamp duty is based on the market value of sale – I think it will likely be based on the unimproved land value – the council already does this each year – takes more work to try and calculate the market value – plus, it may cost too much on an ongoing basis
   4. It is estimated that the economic benefit of the reform would be approximately halved if the property tax were based on market values instead of unimproved land values.

The reform framework –

5. Buyers will be given a choice of which tax to pay – anyone buying a new property will be able to do the sums themselves
   1. Pay upfront or pay on an ongoing basis
   2. Pros and cons for each situation – if you plan to move homes regularly, or live somewhere for a few years before upscaling, it may make more sense to take the annual tax rather than paying for stamp duty -or if you plan to buy your forever home where you will live in it for decades, it may be actually cheaper
6. Property tax will be an annual tax on land value – the tax structure will likely be similar to rates, where it is based on the land value
   1. There will be a fixed amount plus a rate applied to the unimproved land value of an individual property
   2. The rates – depends on the type of property – four types, owner-occupied residential property, investment property, primary production (farmland) and commercial –
   3. All of these properties need to currently pay stamp duty if they are purchases – but only investment properties or commercial properties are liable to pay land tax, if they are above the minimum threshold – what are the rates:
      1. Owner occupied: $500 + 0.3% of the unimproved land value
      2. Investment property: $1,500 + 1% of the unimproved land value

• Farmland: $0 + 0.3% of the unimproved land value

2. Commercial property: $0 + 2.6% of the unimproved land value

7. If you are not buying a new property, there is no change to your current situation
   1. If you already own a property and have paid stamp duty, then you will not have to pay the potential property tax
   2. There will be window in which new purchases of property can make a choice, to receive a rebate of their stamp duty and to pay the ongoing property tax
8. First time home buyers – the existing stamp duty concessions for FHB could be replaced with a grant of up to $25k

Looking at some examples –

1. In 2020, the average unimproved land value for residential property across all of NSW is around $437,500
2. Using the indicative property tax rates, the average residential property in NSW would be subject to an owner-occupied property tax of $1,812 per annum
3. For metropolitan NSW the average residential land value is around $630,400 - corresponding owner-occupied property tax would be $2,391 per annum
4. In comparison – let’s say there is 40% premium for the total values – taking the market values to $612,500 and $882,560 respectively –
   12. Stamp duty on these properties would be $22,897 and $35,052 – this represents paying for 12.6 years and 14.6 years upfront in stamp duty when compared to the ongoing tax for that is estimated
   13. The other thing to consider is that over the years, the unimproved land value of the property is likely to rise – hence the present value of stamp duty may not seem as bad
   14. Assuming that the average land value grows by 3% p.a. – takes the break evens down to 11 years and 13 years – so shaves about 1 and a bit years off – but they key consideration is the long term holding of a property
   15. If you plan to own the property for 20+ years, or retire into it – it may actually be better to still pay for the stamp duty
5. Investment property – Say you buy a residential investment property in metropolitan NSW – the fixed fee plus 1% is about $7,804 p.a. – the stamp duty payable on property at the market rate = $35,052 – about 4.5 years of the annual ongoing tax
   1. Effects on investment property – make it less viable form a cashflow perspective – additional costs – rates, land tax, annual tax – rents would need to go up to cover this

Will this do any good?

1. The government has forecasts that in the medium term, the property tax would create a revenue neutral situation –
2. Currently, there are about 200,000 property transactions each year paying stamp duty. A long-run transition to a system where around 3.5 million properties pay an annual property tax would allow the Government to recover the revenue lost in the early years.
3. From an economic perspective - Based on the current model, the proposed reforms could inject $11 billion back into the economy over the first four years, putting money back into the pockets of the people of NSW
   1. However – this may actually have a long term negative effect on consumer spending – when accounting for the increasd ongoing costs for households for holding property, this may initially inject $11bn in the economy over 4 years, but what about the annual opportunity cost for the money going into this ongoing property tax?
   2. Issue with models, impossible to accurately predict anything – especially when considering that it is all assumptions based and assuming that the money saved on stamp duty will be spent in the economy – as opposed to going towards a deposit or helping to cover the debt
   3. One big assumption is that the removal of stamp duty is that it has the capacity to increase household turnover – reducing the upfront transaction costs
      1. The Reserve Bank has noted housing turnover is positively related with household retail spending, particularly on durable goods such as furniture, home appliances and electrical or electronic devices, and renovation activity as new owners might choose to modify homes to suit their needs or existing owners add value before listing
   4. From an affordability point of view – trading the here and now for ongoing costs
      1. Residential – need to consider the pros and cons
      2. For investments – it may be better in some cases if the property is going to be long term hold – to pay stamp duty

In summary – the NSW Government views - Stamp duty is an inefficient and volatile tax that puts a barrier to entry for people getting into the property market

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