Tuesday, November 20, 2018

Unpopular Economic Opinions

I was an illogical ideologue

I recall many heated political and economic discussions with Paul Frijters when I started my PhD. In retrospect, these would simply involve me rambling and him pulling me up questioning the logic of the next line of my argument. I realise now that “younger me” was happy to regurgitate arguments I liked no matter the logical coherence.

But now life is much harder. Being absolutely critical and logical means you don’t believe the same myths as your social groups. It makes you an outsider in the purest sense.

It is also career-destroying. Telling people comforting lies is how you make the big bucks, particularly as an economics consultant.

You can tax capital gains due to inflation

I’ve never understood the concern adjusting for inflation in the taxing of capital gains. The gain, inflation-adjusted or not, is simply a profit in the year it is realised. Businesses investing in new capital equipment don’t get to say “Yeah, but if I bought this machine today it would cost heaps more, so let me just deduct today’s price as an expense."

Brexit will not be an economic disaster 

If supply chains are so tightly integrated that the British economy will collapse, then it is in the political interests of countries at the other end of these supply chains to agree to reasonable trade conditions so that their countries don't also suffer. Indeed, most of the arguments for Remain are not economic ones. They look and sound like economics, but there is no economic reasoning.

Take this article, which suggests that the need for exports to conform to EU product standards is a scary big cost of Brexit. But by definition, all products currently exported to the EU conform to EU standards. This is a minor administrative change by any stretch of the imagination.

While it is certainly in the interests of the EU bureaucracy to make a Brexit as economically disruptive as possible in order to send a message to other countries, I think in reality this will be hard to do.

Also, calls for a second referendum seem pretty anti-democratic— "democracy is good, except when the stupid people vote for things I don't like".

Am I batshit mental?

Or is it batshit mental to pretend the solution to a problem of badly distributed access to resources won't require redistribution of access to those resources?

Yesterday’s ‘bottom-up’ is tomorrow’s ‘top-down’

Russ Roberts is an excellent interviewer and I thoroughly enjoy his Econtalk podcasts. But every time he talks about ‘bottom up’ solutions to organisational problems I immediately think “here comes tomorrow’s top-down rule that you are going to hate"!

Nobody is serious about higher wages

If you aren’t interested in unleashing enough government spending to decrease the unemployment rate to a number starting with a 3, or even 2, then you can't be that interested in increasing wages.

We were interested in this once. And being far richer than we were then, we could do an even better job today. If that’s what we wanted.

Micro-efficiency obsessions are macro-economically inefficient

With such huge macro-level inefficiency from under-utilised resources, we should stop debating the microeconomic efficiency of government spending so much.
  • NBN? Just do it. Spend on the best quality stuff now.
  • Airport rail? Just do it.
  • Clean our city rivers? Plant trees in the catchment and install stormwater filters now.
Just about anything, even digging holes and filling them in, is better than a 5%+ rate of unemployment with hundreds of thousands of underutilised workers.

High population growth is ideology hiding in economic jargon

Arguments from supporters of high population growth in Australia are that:
  • Immigrants are job-creators
  • Immigration offsets ageing
  • Immigration makes the country richer
Sounds like something our stagnant regional towns could do with more of!

Ignoring the practicalities of internal borders, all of these arguments also favour an “immigrants to the regions” policy. After all, Australian cities are a small global region. Why argue for “immigration to the Sydney region” and not “immigration to the Tamworth region”?

For some reason, this is philosophically wrong rather than impractical, and immigration boosters seem happy to turn their economic arguments 180 degrees when the location of immigration changes.

Also, if you want public support for immigration, don't insult everyone who has concerns about the past decade of record high levels. Has insulting someone ever been persuasive?

Tuesday, November 13, 2018

Bad economics of the stamp duty discourse

This is an expanded version of an article first published at The Conversation

Most think-tanks and policy groups in Australia think that a policy to swap ‘stamp duties for land value taxes’, or what I will call SD4LVT, is going to provide some impressive economic and housing benefits.

But layers of bad economics hide beneath the new populism of SD4LVT.

It is extremely frustrating to me that leading minds in Australian policy have smashed their heads together and decided that the best reform they can think of is to replace one good tax on property with another good tax on property that is less politically popular. It's like subbing off the best player on the field for the best player on the team? Why not sub off the worst player instead?

The better minds in this game don’t even think SD4LVT will have any effect on reducing housing prices or making housing at all more affordable, yet still put it forward as the ‘holy grail’ of state tax reform.

Is this some kind of joke?

The bad economics behind SD4LVT arises because four key points are missing or overlooked.

1. Price effects

The economic incidence of stamp duty is on the seller. This means that if you remove stamp duty, all else equal, prices will rise by exactly the amount of the duty. Good analysts know this, even if they rely on poor analysis by others that assumes stamp duty “increases the price that property buyers pay”. If the average home price is $500,000, and stamp duty is 5%, prices will immediately rise to $525,000 when you remove the duty.

But if you want to replace the same tax revenue from stamp duty with revenue from land value taxes, you could wind up inflating prices and inadvertently creating an economic transfer to property owners.

Imagine an example economy with:
  • 20 houses 
  • Turnover of 1 house each year (a turnover rate of 5%) 
  • Average rent of $25,000 per year (5% gross yield) 
  • An average home price of $500,000 
  • Land price component of $250,000 per house (total land value of $5 million) 
  • Total stamp duty revenue of $25,000 per year. 
To replace the $25,000 stamp duty revenue with a land value tax requires taxing all twenty homes at $1,250 per year each.

Whether the market price of homes rises or falls depends on whether buyers think the upfront present value of $1,250 per year is lower or higher than the $25,000 upfront stamp duty they would have paid. At a 5% capitalisation rate in this example, $1,250 per year in perpetuity is equivalent to $25,000 and the taxes replace each other perfectly with no price effect.

But what if turnover is half that, say 2.5%, which in this example would be where one house is sold every two years? Here, the total tax revenue to be replaced is $12,500, which equals just $625 per house in land tax.

If we capitalise the perpetual cost of $625 per year at 5% we get a present value of only $12,500, which is half the stamp duty rate. A new buyer can now pay $512,500 for the house plus $625 per year in land tax and be equally as well off as paying $500,000 for the house plus $25,000 upfront in stamp duty. The net effect in this case is a land price increase from $250,000 to $262,500, or 5%.

If this situation happened nationally in Australia, that would be nearly a $200 billion economic transfer to landowners, which would completely offset the value of their new land tax obligations.

In short, replacing stamp duty revenue with land tax will increase prices if the capitalisation rate is higher than the turnover rate, and decrease prices if the opposite holds. Price effects are ambiguous for SD4LVT.

2. Asset churn

Taxing capital gains only happens when a transaction is made that realises gains. Thus, it is a transaction tax, just like stamp duty, though the size of the tax is related to historical changes to property values rather than current values.

Many in the housing discourse, such as the Grattan Institute, want to increase transaction taxes on housing by increasing capital gains taxes and expanding their scope to apply to owner-occupiers. At the same time, they want to decrease transaction taxes on housing by eliminating stamp duty because apparently transaction taxes stop people relocating.

Somehow abolishing a transaction tax in the form stamp duty is good because it reduces the cost of owner-occupiers relocating, but then putting back a large transaction tax in the form of a capital gains tax specifically on owner-occupiers is also good. Huh?

There are two problems with the ‘transaction costs impede household mobility and are bad’ view. First is the simplest. People who relocate for work generally don’t buy and sell houses to accommodate that move. 
Moving for work is not a common reason for buying a home, regardless of age, which might reflect a view by some households that work is a temporary reason for moving and therefore not sufficient to commit to homeownership.
Thus, the effect of stamp duty on reducing housing turnover is likely to fall mostly on investors, who make up nearly half of housing transactions and can easily time their decisions. Transaction taxes make it more expensive for people to quickly buy and sell and deters speculative buying that seeks only to capitalise on short bursts of capital growth before selling, which itself fuels the capital growth and accentuates the bust. Many investors fall in this category, and many homeowners also make their location and purchase decisions based on expectations of capital gains rather than housing need. Go on, ask new homebuyers about property prices. See if they bought where they did for housing need or capital growth?

The evidence on stamp duty deterring moving shows pretty clearly that moving for work is unaffected, as the below plot shows, with the main effect being from people making 'short moves' by relocating less than 10km. Indeed, the best evidence on turnover effects estimates only the size of the short-term shock as people adjust to the new price equilibrium.

In terms of the claim lower stamp duty helps more efficiently use the stock of dwellings, as it reduces the costs to older people down-sizing, freeing up large homes for families, the evidence here is the opposite. When the ACT scrapped stamp duty for over-65s, the retirees who utilised the exemption bought bigger homes, rather than smaller ones, requiring them to implement a low value-cap on the exemption. After all, the distribution of home ownership is not driven by housing need, but primarily by wealth. Reducing the cost of redistributing housing by wealth will not suddenly make housing ownership less unequal. 

Regardless, turnover as a whole seems relatively unaffected by stamp duties. The early 2000s boom also saw massive stamp duty increases yet turnover shot up dramatically. The role of stamp duty in these patterns of housing turnover is tiny compared to other factors.

Indeed, if you want people to move more frequently for a lower cost then implement a ‘moving house subsidy’, which could also apply to renters. It would also help renters forced to move unnecessarily due to investor turnover (yes, stamp duty also reduces undesirable moves for renters).

Second, taxing capital gains on owner-occupied housing will be a far bigger transaction tax than stamp duty for most homeowners. Stamp duties are typically around 5% of the property price. For a homeowner who bought a home prior to 2012 in Sydney or Melbourne, their home has appreciated in value about 50%, or to put it another way, 33% of the current price is capital gain.

If a capital gains tax applied to their sale, the tax rate as a proportion of the current value would be:

Capital gain (33%) x Marginal tax rate (45%) = 14%

This is triple the stamp duty for most properties. Even if the capital gains tax was discounted 50%, the nearly 80% of homeowners who bought prior to 2012 would still have much higher transaction costs from capital gains taxes than from stamp duties.

In effect, stamp duties are taxing some of the capital gains during a boom that would otherwise accrue to homeowners, particularly owner-occupiers who are exempt from the capital gains tax. This seems like a good thing to me.

So while stamp duties are often claimed to be economically costly because they deter households relocating, their main effect is actually reducing investor churn, which is a good thing for property market stability. Additionally, the costs of relocating are probably less than the costs from other property transaction taxes that opponents of stamp duty support.

3. Tax revenue stability 

Another concern in the discourse is that “stamp duty revenues are much more volatile than other taxes.” During a boom, revenues rise more than proportionally to prices since they depend on prices and turnover. Vice-versa in a bust.

If I was to think in the abstract about what sort of taxes are good macro-economically, I would say those that are pro-cyclical, meaning they automatically increase tax revenues during an economic boom, and decrease them in a bust. On this metric stamp duty is a terrific tax to help stabilise the economy, which is even more useful in Australia as our economic cycles are closely tied to the housing market.

The land value tax that many propose to replace stamp duty would have smaller automatic stabiliser characteristics, meaning the tax system as a whole would be less stabilising.

From what I can tell the call for more stable tax revenues is not driven by economic reasoning at all. At best it appears to rest on some kind of political preference for state governments not to be involved in macroeconomic objectives.

4. Wrong assumptions 

The metrics of economic disaster caused by stamp duties are usually derived from economic analysis using computational general equilibrium (CGE) models of the macroeconomy. Sounds fancy.

You might have even seen a chart similar to the one below, with stamp duties presented as having massive flow-on economy-wide costs compared to other taxes. In this example, stamp duty is apparently forty times more economically costly per dollar of revenue than council rates, which are also levied on property values.

As you might have guessed, this is absolute nonsense. CGE models cannot account for transaction taxes because, wait for it, there are no transactions in these models. It’s true. Look it up.

But that hasn’t stopped many economists. Instead of using a better tool for the job, they simply invent a different thing that they pretend is stamp duty and put that into a CGE model.

Rather than a transaction tax that is incident on the seller, and therefore incident on land values, a key layer of bad economic analysis assumed this instead (p125).
conveyancing stamp duties are modelled as a tax on investment in residential and commercial structures
Against all the evidence they assume that stamp duty is not a tax whose economic incidence is on land. Instead, they assume that stamp duties raise the cost of housing to all buyers and renters. In addition, the model assumption requires that stamp duties also raise the cost of building new houses without affecting land prices, leading to reduced new housing construction in general. Garbage in, garbage out.

It’s hard to explain in plain English what is going on in these models. My best explanation is that the model says that stamp duty forces every new home to be built with an additional extension on the house, where the construction cost of the extension is the same as the stamp duty. But then as soon as it is built, the extension is immediately demolished, yet somehow the buyer is forced to pay for it. Meanwhile, all the other households in the economy are somehow forced to also pay more to occupy their existing houses, as if they were now renting non-existent home extensions. 

If that sounds crazy, that’s because it is. There is no actual economic evidence of broad economy-wide costs of stamp duties. Just garbage inventions that don’t look anything like stamp duties.

In sum

Stamp duties don’t increase the cost of housing. They do reduce asset churn by investors and speculators, which is desirable for price stability, and the apparent economic costs from reducing household mobility are overblown. The ‘revenue instability’ of stamp duties is actually a huge positive for the economy as a whole, and the economic analysis that has underpinned the talk of the high economy-wide costs of stamp duty is simply made up.

All of this is true. Yet SD4LVT is the apparently the holy grail of Australian tax policy. Our best policy wonks want politicians to use up the precious political capital to swap one very good property taxes for another very good but electorally unpopular one, for no net economic gain.

Sunday, November 11, 2018

A housing jubilee and lottery to solve affordability

People fuss over housing being expensive without ever really thinking about what their ideal world would be. My ideal world is one where everyone has the benefits of outright homeownership—few ongoing housing costs with tenure security.

One way to get those desirable social outcomes is for everyone to own their own home outright. This can be done with the stroke of a pen. Simply convert all the current residential rental leases to land titles, transferring homes from landlords to tenants, then write-off all the existing housing debt (or shift it to the central bank’s balance sheet and adjust the interest to zero).

After this housing jubilee, all homeowners will become debt-free and all tenants will become debt-free owners.

Any other vacant and under-construction homes would be nationalised and given away in a lottery to anyone who missed out by not being a tenant at the time of the switch. Holiday rental housing stock can be exempt from the Jubilee if evidence is provided that the home has been used for holiday letting in the past year.

The whole jubilee could be enacted by Christmas and our housing affordability problems would vanish.

To maintain the affordability benefits of the jubilee the government can periodically give away homes to anyone who does not have one to allow for changes to population, household formation, and age distribution. It can also redo the jubilee every couple of decades.

A public agency can build new homes at a bunch of different locations across all the major cities and towns, just like a private developer. Or it can purchase them from developers, get them through inclusionary zoning, use homes that end up at the public trustee, or get homes into the system in a variety of other ways. But instead of selling them they are given away.

My preference for how to do this in practice is a housing lottery. Anyone who wants a house and doesn’t have one would go through a screening process, then if found eligible, would get a ticket for a lottery for a new home in their preferred location. Every Saturday night, to great fanfare, the lottery would be drawn. Perhaps as many as 1,000 homes per week could be drawn nationally, broken down into regional sub-lotteries of local housing to qualifying local lottery entrants. Ideally, there could be statistical targets on the number of homes needed for the system so that the typical entrant, for example, is expected to win the lottery within a year of first entering.

The total cost of producing 50,000 new homes a year is about $15 billion. This could be funded ten times over by simply tightening up existing tax loopholes and existing giveaways.

Alternatively, and perhaps more practically, those homes transferred for free in the jubilee can be lifetime leases rather than perpetual freehold titles. This means that when people in these homes die or move to old-age care, the house re-enters the system to be given to someone else. If their children don’t have a home, which is unlikely, since they would have themselves been eligible for a free home, they can inherit the lease for their lifetime. Otherwise, the house re-enters the system to be given to someone else. There can also be controls on sub-letting or selling free homes back into the private market.

Alongside this system, the private market can continue to function as people sell and repurchase as they choose, though if they do sell they can then enter the lottery if they choose.

You might think this is radical. But in fact we do exactly this in healthcare.

We spend over $100 billion per year to provide health and hospital care for free to anyone who needs it, no questions asked. Politicians quite often even brag about how much they are going to spend on the health system. Imagine if they also wanted to brag about how many new homes they built to give away!

In healthcare though we have a system of medical professionals who decide on health needs, rather than a ‘medical procedure lottery’ which would be totally inappropriate. I personally think a lottery adds excitement to the whole process. It also adds fairness, as the homes won’t ever be exactly equal in terms of locational and quality attributes, so if luck determines who gets the slightly better homes, then so be it.

The only role for bureaucratic assessments will be to ensure eligibility to enter the housing lottery in a certain location. We could foster a system of professional ‘housing general practitioners’ who assess whether the person entering the lottery is eligible (they don’t already own property) and their need based on age, family size, and location preferences.

This is absolutely doable. If we can spend $50 billion on submarines we can do this. If we can spend $100 billion per year on free healthcare, we can do this. If can give away $30 billion per in superannuation tax discounts for the richest households, we can do this.

If this idea is too radical for you, perhaps consider whether you actually want affordable housing for all.