The government has asked for bold proposals. Maybe it’s time to consider taxing the family home
- Written by Peter Siminski, Professor of Economics, University of Technology Sydney
The Australian government has “an appetite to be bold and ambitious” in its economic reform agenda. And tax reform is on the menu at its much-publicised reform roundtable, to be held next week.
Here, we serve some food for thought – the taxation of owner-occupied housing. This may seem distasteful, but there are some strong arguments for doing so.
Tax breaks for owner-occupied housing are very large
The size of tax concessions for owner-occupied housing is similar to that of superannuation, and much larger than for investment property. Treasury estimates it forgoes more than A$50 billion per year by exempting owner-occupied housing from capital gains tax (CGT).
There is also no tax on the rental value of owner-occupied housing, although we did tax such “imputed rental income” (what a homeowner would pay in rent) briefly between 1915 and 1923.
Owner-occupied housing exacerbates inequality
Australia prides itself on being a fair society. In reality, we are near the middle among developed countries on standard measures of income inequality. But such statistics ignore the income that owner-occupiers derive from their homes.
In a new paper, we see what happens to income inequality if owner-occupied housing income is included. This non-cash housing income refers to the imputed rent and unrealised capital gains on the property.
When these are included in the income measure, inequality is higher, and it increases more strongly over time. The effect is large enough to shift Australia’s inequality from 16th to tenth highest amongst OECD countries (though we haven’t conducted the same exercise for other countries).
Unsurprisingly, outright home owners are much better off than renters when income from the home is counted. They have an average income 86% higher than the average income of renters – compared with 34% higher if housing income is ignored, as it usually is.
Australia’s progressive tax system is largely a mirage
Income taxes reduce inequality because the tax rate is higher for people with higher incomes. That is what is meant by a “progressive” tax system.
Our paper finds that this changes greatly when income from owner-occupied housing is included. The income tax system reduces inequality by a lot less (about 40.5% less) if we include such housing income. Because this income is tax-free, the average tax rate for the rich is much lower than it seems. So the tax system is less progressive than it appears to be.
The same is true for government pensions and benefits. They also reduce inequality, since they are targeted to people with limited means.
But housing wealth is excluded from the pension assets test, so pensions are not as as targeted as they appear to be. Repeating the exercise above, we find the effect of pensions and benefits on inequality is 18.9% smaller when housing income is included.
Overall, the combined impact of income taxes and pensions/benefits on inequality is 26.7% lower when we include income from the family home.
Favourable tax treatment is built into house prices
These tax concessions may also increase house prices and encourage inefficient allocation of resources. Income from investing in owner-occupied housing is tax-free, while all other investments attract tax. So Australians plough their money into their home instead of other, more economically productive, investments. These funds could instead be invested into private firms (directly or through the stock market), stimulating entrepreneurial activity and lifting productivity, wages and profits.
While stamp duty is typically payable on home purchases, the value of the income tax exemption is much larger. That lifts demand for housing, and hence housing prices. We know of no recent studies that have estimated the size of this effect, but it is likely to be large and therefore make the move into home ownership more difficult.
The absence of recent studies may be because taxing owner-occupied housing is not seen as a politically viable option. Much more attention has been placed on the much smaller tax concessions for investment property income.
Most people would be better off
The Australian community as a whole would benefit from a reduced incentive to invest in housing because it would lead to increased investment in productive activities.
In terms of who would benefit most, renters stand out as obvious beneficiaries, since the tax burden would shift towards homeowners. But a progressive tax on housing could also benefit owners of modest homes, as part of a broader redesign of the tax system.
There is a temptation to equate a new tax with more total tax. This depends on the design. But it is certainly possible to implement a progressive tax on housing wealth, perhaps combined with an income tax cut, which could leave most people better off.
How would this look in practice?
There are many policy options for more fairly incorporating owner-occupied housing in the tax system. We do not make a specific proposal here, but options include:
a broad-based land tax would go a long way to addressing the issue, and should be on the government’s agenda. This is an economically efficient tax that is advocated by many economists
an explicit tax on owner-occupied housing wealth is also justifiable, since it is the only large asset that generates income that is not taxed
a broader wealth tax could also be considered.
We also believe there is a strong case for reconsidering the exemption of housing from the pension assets test. Many wealthy retirees benefit from public pensions, which are funded by taxes on the incomes of younger workers and renters.
Too important to be squeamish
We should have a national conversation on whether the current tax treatment of owner-occupied housing is sensible. Moving away from complete exemption would open up opportunities for reduced reliance on income taxes and more food on the table for renters, and owners of modest homes.
Will the reform roundtable etiquette permit consideration of reforming the taxation of owner-occupied housing? This is an important and much neglected consideration in assessing the overall fairness and efficiency of the tax system.
Authors: Peter Siminski, Professor of Economics, University of Technology Sydney
