Can removing stamp duty "free up" homes by encouraging retirees to downsize?

Not really. Even the very best outcome is to bring forward in time relocations that will happen with 100% certainty anyway.

A few things this week got me thinking again about stamp duty, the tax levied on buyers of property assets.

First was the NSW government enacting their policy of First Home Buyer Choice, whereby first home buyers can choose whether to pay the stamp duty on their purchase or an ongoing property tax. The two payment options are designed to have an equivalent present value, which makes the whole exercise quite strange in my view, especially since first-home buyers of property valued under $650,000 already pay no stamp duty, and buyers up to $800,000 get a heavily discounted rate.

Second was this tweet about how someone’s neighbour upsized to shield more of their wealth from the age pension asset test, which excluded the value of your home.

Cameron Murray @DrCameronMurray

"We need to reduce stamp duty so pensioners will downsize to free up housing for young people" Reality:

Stuart Watson @StuartG123a

@samanthamaiden Reminds me of my neighbours. Put their house on the market a year ago, I asked them why they were moving…to upsize the home so they could qualify for the age pension 🙄

What’s more interesting is that this exact problem was discovered in the ACT more than a decade back when they introduced the over-65s stamp duty discount. Policymakers there had hoped that older households would downsize, freeing up big homes for families. Instead, they upsized and bought their dream retirement estate, and in the process, poured more money into their residence to qualify for the public age pension. After just a couple of years the ACT capped the property value to which the discount applied to avoid this outcome.

Third was this article from the UK making a similar argument about how stamp duty stops older people living in big houses from downsizing.

It gums up the housing market and, by extension, the labour market. Mutually beneficial transactions, for example an older person in a big house trading places with a younger family in a smaller house, are disincentivised.

I’ve previously explained in detail why these ongoing economic concerns about stamp duty are overblown.

Today I want to focus on this last point about freeing up big houses with few old people in them to make space for large younger households.

How big are the plausible downsizing gains?

We need to think very clearly about this question. What do you actually get from encouraging more relocations of older households into smaller homes?

Remember, every retiree household will eventually downsize, with stamp duties or without. If they don’t do it before they die, death will be the ultimate time limit.

At best, encouraging more house trades can bring forward a small amount of housing reallocations that have a 100% of happening at some point in all cases.

Thinking about the question from a flow perspective in the simplest possible way to understand what is happening.

Imagine a crude and simple scenario where every homeowner household aged 60 and over has a large home they stay in until they die at age 80 on average. The population of households at each age from 60 to 80 is the same at 100 households each. But also, 10% of households want to downsize when they reach age 70 but none do it because of stamp duty. What happens when we go from stamp duty to no stamp duty in terms of “freeing up” housing for young people?

High stamp duty case

The current flow of large houses being freed up is 100 per year, being all the households that die at age 80. If stamp duty stops all transactions from happening before this time, then we get a flow of 100 per year, or 2,000 “freed up” homes over the next two decades.

No stamp duty case

Now, we remove stamp duty to encourage earlier downsizing. This encourages the 10% of households who wanted to downsize at age 70 to do it. So 10% of all households aged 70 to 79 who stayed in their home because of stamp duty sell and move, in addition to the remaining death downsizing at age 80.

In this first year, we have an additional flow of 100 homes sold by downsizers (10% of households at each age from 70-79) plus the flow of 100 at age 80 for a total of 200 that year.

In the second year, we have the 10% of households who reach age 70 downsize, plus the 90 remaining households who reach age 80 and die, for 100 “freed up” homes that year. In fact, we get 100 per year each year after the first.

In this scenario, we get the same 100 per year flow as in the high stamp duty case except for one year with 200. So over the next 20 years instead of 2,000 “freed up” homes, it is 2,100. After the first year, there is no change in the flow; years 2 to 21 are identical in both cases.

The very best outcome in this simple crude model is to bring forward by a few years a small fraction of inevitable relocations. It is not an ongoing solution whereby each year more and more housing will be freed up. It is at best a small once-off change. Because after that, every subsequent home that might look to be “freed up” by downsizing is actually offset by exactly one less home “freed up” by death.

Final comment

I see the main issue being that we allocate dwellings by price. Because households have different incomes and wealth, price allocation effectively becomes allocation by income and wealth.

I have no idea how reducing the cost of transacting changes of ownership is meant to reverse the tendencies in the property market to concentrate ownership.