Houses of cards

House prices are notoriously volatile, but that hasn't stopped state governments acquiring what many say is a dangerous addiction to the tax revenue associated with high property prices. Any slump puts pressure on the Budget, but calls for reform have mostly fallen on deaf ears.

By JASON WALLS

This year’s Victorian state election coincides with a massive 16 per cent boom in property prices, with the median house price in Melbourne hitting a record $630,000 in June.

This is good news for the state’s coffers. Property tax is a significant source of revenue, representing 42.5 per cent of total taxation and 13.5 per cent of total revenue last financial year – nearly $7 billion.

The vast bulk of property tax comes from land transfer (or stamp) duty, which is collected in direct proportion to property values and steadily increases over time, so generally state governments forecast a smaller total tax take than actually eventuates.

But in the two years out of the past 10 in which the housing market contracted, the government was blindsided, recording the decade’s two largest shortfalls between predicted taxation revenue and actual takings.

In 2009, when the market contracted by 4.5 per cent, the then Labor government raked in $663 million less in tax revenue than it had forecast in the previous year’s budget. And under the Coalition in 2012, when the market shrank by nearly 5 per cent, the figure was $478 million.

This year’s budget estimates (revised marginally downward in last week’s update) predict steadily rising income from property tax over the next four-year term, predicated on the assumption of a compliant housing market. But given the poor track record in predicting housing market downturns on both sides of politics, there seems little reason to put much faith in this rosy outlook.

Whether Melbourne is in the midst of a housing “bubble” has been the subject of much debate, but prices can’t keep rising forever, and any contraction of the market could put a serious dent in the spending commitments of whichever party forms government in November.

A guessing game

Prof Jakob Madsen holds the Xiaokei Yang Chair in Business and Economics at Monash University and he says the housing market is notoriously unpredictable, with the most recent contraction in 2012 coming “out of the blue”.

“It’s incredibly difficult to say anything about house prices in the short term,” he says.

“We cannot explain changes in house prices from one quarter to another by a model, we cannot do it. Models are really bad at picking that up and that’s because it’s psychology that drives a lot of the housing market. It’s the same as the stock market, the stock market is by and large driven by psychology and emotions and so on, and it’s a bit the same in the housing market in the short term.”

Prof Madsen is among those unconvinced that the housing market is due for an imminent crash based on the assumption that the market is overvalued, as has been suggested by some, but that doesn’t mean it will all be smooth sailing.

“I don't think there's going to be a crash in the Australian housing market, we cannot expect that,” he says.

“However I do think that we are going into a stable to declining housing market and that suggests that there'll be pressure on revenue.”

Prof Madsen says that in the short term, the biggest driver of house prices is the availability of credit, but once again it’s not easy to make solid predictions.

“It is a bit of a guessing game. When it comes to credit, that’s 100 per cent a guessing game,” he says.

“In the future we can expect a constant decline [in growth] in house prices the next four years, but there’s [also] definitely a risk that we can see the housing market fall.”

An unhealthy addiction

In 2010, the Henry Tax Review recommended replacing stamp duty with an increased annual land tax which it said “could provide an alternative and more stable source of revenue for the states”.

“Stamp duties on conveyances are inconsistent with the needs of a modern tax system,” it said.

“While a significant source of State tax revenue, they are volatile and highly inefficient and should be replaced with a more efficient means of raising revenue.”

Chair of Urban and Regional Planning and Policy at the University of Sydney Prof Peter Phibbs says this is not a radical idea (the ACT government having begun the process in 2012), calling stamp duty a “classically inefficient tax”.

“Every taxation review I can remember probably suggested an alternative,” he says.

“One of the problems is it discourages people moving, it adds to what we call the transactional cost of moving, and moving is a good thing.

“[If people] change jobs and they want to move they should be able to.”

But the hit to state budgets (stamp duty currently earns the Government $32,000 on a median $630,000 home with every sale) would have to be offset, and replacing it with an annual land tax would result in a short term decline in revenue.

Prof Phibbs says state governments have become “addicted to house price escalation”.

“It becomes a bit of a honey pot for government, the way that it’s run at the moment, in that governments do really well out of house prices,” he says.

“You probably wouldn’t introduce it at the top of a boom.”

When it comes to the main roadblock to the abolition of stamp duties Prof Phibbs is unequivocal.

“Politics,” he says.

“It’s changing a system and you’re telling someone that you’re replacing a tax [which] for a lot of people they can’t see, or they see it but it’s at a time when they’re participating in a very expensive property transaction so they just think it’s part of the property deal.”

“Whereas if they’re getting a bill every year that says ‘land tax’, there’s just some concern that people would react against it.”

The blind leading the blind

Apart from a 22 per cent lift in property prices in 2010, current growth rates are as high as they’ve been in a decade. The last time growth hit 16 per cent was in 2002, and it eased in the following years before contracting by 2 per cent in 2005. During this time, property tax revenues fell in line with the market before bouncing back in 2006 when the market recovered.

In the 2002 Budget, then treasurer John Brumby had warned against over-reliance on property taxes as a source of revenue.

“Some state taxes are sourced from tax bases which are particularly volatile, hence tax revenue from these sources is subject to substantial annual variation. Stamp duty on land transfers and mortgages are clear examples of this,” he wrote. (Mr Brumby went on to abolish stamp duties on mortgages in 2004.)

Despite this circumspection, when it came time to hand down his 2004 Budget, Mr Brumby still predicted $90 million more in tax revenue than actually eventuated after the housing market collapsed the following year.

But hindsight is 20:20, and due to the volatility of the market, Prof Madsen says it’s almost inevitable that governments won’t see a crash coming.

“The other thing we cannot explain is why house prices have gone up so strongly over the last 12 years, 15 years, in Melbourne,” he says.

“We cannot explain it, there’s just a lot of things we just can’t explain … it’s very difficult, so we cannot blame the government for not predicting the downfall in tax revenues.”

The likelihood of the boom continuing unabated for the next four years is unpredictable at best, and if growth slows or the market contracts, the Victorian government could find itself several hundred million dollars per year out of pocket.

Neither of the major parties responded to requests for comment, but Greens leader and finance spokesman Greg Barber said his party backed the Henry review’s recommendations.

“We support the Henry review recommendations, in fact I think we are the only party who do,” he said.

“Victoria went a small step down the road of removing regressive taxes when we took the fire services levy off insurance policies and put it on land. All parties in the Parliament supported that, so there is hope for reform.”