If you haven’t read The Opportunities Party tax policy yet, you are probably unaware that they are proposing a tax on imputed rent as a core part of their tax policy, to ‘fix’ the housing market.
I have to start this article by saying I don’t hate Gareth Morgan – in fact, I rather like him. He embodies a lot of the values that this blog is about, and is clearly schooled on the impact of a number of problems affecting NZ, such as social inequality driven by the seemingly interminable house price inflation. He’s also got this sort of gruff demeanour that makes you think that he’s a worker or a farmer rather than a former banker.
The next thing to consider is that I have barely a scrap on Gareth Morgan in terms of economic credibility. I run a small motel on the Kapiti coast, which I must openly admit is a few magic beans short of having worked for decades in the castle in the cloud that is the finance industry. None of my children have started a successful publicly listed company yet, although I would hope that if I finally get off my bachelor butt and conjure up some children they would not feel unobliged to do so.
However, this article is likely to be read as the first of a number of broadsides that I launch at The Opportunities Party, not because I disagree with his values (you can only refer to them as ‘his’ values, because all their website videos show that this is a cult of personality, not yet a political party), but because I disagree with his approach to solving the problems he outlines.
A few years ago, amongst my ever-dwindling circle of friends, I threw out the prediction that property would one day become an unattractive investment class, not just because interest rates would go up and drown all the mugs, but chiefly because rising house prices would eventually trigger politicians to step in and introduce some seriously punitive measures to punish the runaway market and the hidden conductors behind it. Such an asset class, subject to uncertain future legislation, could barely be considered to be a wise long term investment (except in specific circumstances, and of course there are always specific circumstances).
Those predictions appear to have begun to find their shape in the body of a man named Gareth. Keep in mind that we operate in an MMP democracy – to tilt the joust in Parliament, Gareth doesn’t need to get a majority, he just needs 5% or even just an electorate seat. Once he gets a seat or so under his belt, it wouldn’t be too hard to sway a majority party under stress to buy into some of his key reforms (although political parties not wanting to risk life and limb might well steer clear of him).
So, without further ado (we’ve had an unusual amount of ado already), here is my analysis of the Tax on Imputed Rent (henceforward referred to as TOIR).
What is Imputed Rent?
Gareth gives three scenarios of how property ‘income’ would get taxed in his taxation policy document, available to download on The Opportunities Party website:
“So consider 3 scenarios. You have $300,000, you put it in the bank and pay tax on the interest income you receive each year. At the end of the term you get your $300,000 back. Alternatively you buy a house and rent it out. You pay tax on the rent received, and at the end you sell your house and get your $300,000 back again. So far very similar scenarios. Now thirdly you buy a house and you live in it. At the end of the term you sell the house and get your $300,000 back again.
“The difference with the third scenario is you have received a benefit from living in the house for all those years, but no tax has been paid on that annual benefit of ‘free’ accommodation. Here’s the anomaly, it’s called imputed rent and if we’re interested in our tax regime being fair and not influencing how people invest their money, then we need to charge tax on imputed rent each year.”
What Gareth refers to as an ‘anomaly’ is simply the overall benefit that one receives for a lifetime of hard work, namely, that once you fully own your home, you get to live in your own home without the bank breathing down your neck.
To answer the question above, imputed rent is a hypothetical amount you would have paid if you were tenanting your home, rather than owning it out right.
Say for example you own a house in Karori. After 35 years as a teacher you’ve finally paid off the last of your mortgage. The average rent for a house in your neighbourhood would be $400 per week. So your imputed rent is $400 per week.
No, you didn’t pay yourself anything. You didn’t receive any actual income. It’s just a hypothetical figure. That’s the problem with a tax on imputed rent. It taxes imaginary income. It’s not enough that you still have to pay rates. Now you have to pay tax on an income you would have received if you rented your house (which you didn’t).
Ok, So How Is a Tax On Imputed Rent (TOIR) Calculated?
Oh boy.
How I would love to answer this question with an actual real world example.
Unfortunately, The Opportunities Party tax policy document provides no detail whatsoever on how this tax actually will be calculated, including the payment dates and even the actual percentage rate required.
We’re not even sure whether the TOIR would be calculated at a special flat rate, or whether it would simply be applied at your current income rate. The latter option is probably more fair, but a hell of a lot more complicated.
So all in all, how can we deduce the economic effect of a future tax on imaginary income whose parameters have not yet been defined?
Let’s follow on from the above scenario. Having paid off your house in Karori, you’re now approaching retirement, and you’ve scaled back your working hours. You personal income tax rate is 17.5%.
To fulfil your obligations under the TOIR, you would simply pay 17.5% of the hypothetical rent amount we mentioned above to the government on a regular basis. Yes, that’s an extra $70 per week or $3,640 per annum for owning your own home. (More or less like doubling your rates.)
It’s not clear if the tax will be collected on a weekly basis, or whether a bill will simply arrive in the mail out of the blue asking for thousands of dollars (“surprise tax”).
Bet you wish you thought of that when you were diligently paying off your mortgage.
The Implications on Tax Efficiency
“It is not a capital gains tax; it is far more efficient and fair than that.”
I never thought I’d say this, given the sort of rampant rorting I saw over in Australia over the Capital Gains Tax regime, but God, give me a Capital Gains Tax over a TOIR any day of the week.
Who Does a Tax on Imputed Rent Punish?
This is the interesting thing about a TOIR, as far as residential property is concerned. It doesn’t punish everybody who owns property in the housing market. It doesn’t punish investors, who use negative gearing to force up the cost of properties in the first place (except insofar as the TOIR may force a crash in the housing market overall). It doesn’t punish speculators, who generally buy and sell property in a short space of time. It only punishes homeowners, arguably the most innocent and downright hardworking of all the aforementioned groups.
It may be that if this law comes into being, that the ‘Kiwi dream’ of owning a freehold house quickly becomes tainted.
How might property owners wriggle out of a tax on imputed rent?
Property investors are notoriously shifty. And therein lies the problem – I can conceive of no way in which such a ‘tax’ could ever be enforced without massive amounts of administrative costs, huge and cumbersome administrative infrastructure to support the limitless number of appeals that a person might make against such a system, as well as numerous enforcement dramas while the tax is ‘phased in’.
Here are some fairly obvious examples of ways in which homeowners might attempt to wriggle out of the TOIR coir.
By arguing that the imputed rent they ‘would’ pay on their property does not reflect the market. I can practically envisage this one area adding a whole branch of specialisation and billions in fees to the legal and accounting industries
By bumping the mortgage back up on your home so that you technically have very little equity in your home and so only have to pay TOIR on the value of the asset minus the debt
By doing a ‘switcheroo’ with a property investor friend or even just a company, nominally transferring ownership of title over to another entity, so that you can claim that you do, in fact, pay rent, even if you pay it to yourself, or a mate, or a company you own directly or indirectly (don’t forget that NZ abolished the gifting regime so these transfers would now be far easier than previously)
By subletting their home and claiming that all (or part) of their home actually is rented, perhaps by convincing their kids to come live with them.
And then some. The reality is the examples are merely just the fringe of the mullet when it comes to me brainstorming how I would get out of it in those circumstances. There are forces in property who are far more devious than me, and I would never presume to pit myself against their collective problem solving intelligence.
This Means People Will Go More Into Debt
The second most scariest thing of all for me (the most scary thing we’ll come to in a sec) is that this sort of strategy would lead people to take second and perhaps third mortgages on their homes just to reduce the cost of their TOIR.
Because he’s planning to tax the property based on equity, the logical thing to do, as a homeowner, would be to go more into debt (as far as the banks will allow, in a newly uncertain market), in order to minimise the actual amount of equity being taxed.
This provides a disincentive for outright home ownership. People will have the incentive to remortgage their homes up to their waist, neck, forehead or higher.
What is the tax on imputed rent other than a recipe for mass indebtedness?
In terms of administration costs, ahem, I don’t mean to sound defeatist, but I don’t see how TOIR could be considered ‘efficient’. All of the laws and foundations of the tax are still unwritten, and it’s already the bloody election year. Let alone the turgid body of case law that would rise up. You’d probably need one enforcement official for every three property owning taxpayers.
The Prospect of Economic Collapse
“We’re not looking for a 40% fall in house prices.”
Oh okay, that’s all right then. How much were you looking for? Just 38%?
The truth is, even Mr Morgan doesn’t know exactly how far house prices would drop. Bit of a shame, really, because the throngs of Kiwi families who would be forced to declare bankruptcy would probably like to know in advance. Even so, the fact a 40% drop in house prices is being casually contemplated by what I can only presume is one day to become a serious political party is a sign that all is not right on the nut farm.
This one could go either way. I can envisage either one of two options resulting as a result of this TOP TOIR policy.
Either it has no effect on property prices. Bupkiss. The majority of homes simply travel from the people who owned them to investors who rent them out.
Or, and I have to say, much more likely, this policy could create a ‘few teething problems’ as far as property ownership is concerned, leading to total economic collapse.
The Impact on Business Funding
In the same document, Gareth talks about ‘deem(ing) a minimum rate of return on all productive assets’. As far as I am concerned, this is a challenging proposition because it goes right to the heart of some of the most fundamental questions of Austrian school economics and seeks to enshrine them in legislation and case law.
Essentially, Gareth Morgan will be asking the IRD and if not, the courts, to define exactly what does and doesn’t count as a productive asset. Is a spade a productive asset? What about a kid’s spade, for digging sandcastles? And by extension, do I have to show a ‘minimum rate of return’ on my kid’s sandcastle spade in order to show that imputed rent may not be charged against it? Wait – don’t answer that now, you’ll deprive the legal profession of about fifty million clients. But good on him for raising the question.
I see where he is coming from, however. In a nutshell, he is talking about ‘malinvestment’, an important concept that, if we isolate it to the case of property rather than attempting to define what is and isn’t included in the phrase ‘all productive assets’, means the fact that under times of deceptively low interest rates, people tend to invest in crappy assets (such as houses) that yield a very low cash-on-cash return. If money weren’t put into this asset class, it could go into better asset classes, such as buying businesses, stocks, etc.
Basically, in the world Mr Morgan sees, dumb old bankers are approving loans against houses, which they deem to be a ‘safe’ gamble, rather than throwing funds into an endless array of internet startups.
But this presumption is not entirely fair. I’ve worked with finance brokers. I know first hand that often times entrepreneurs use the equity in their own property to secure loans against their businesses, and that banks are often made much more comfortable by the idea that the entrepreneur has some equity to begin with to secure a second mortgage.
So the problem of malinvestment is not as simple as ‘either’ business ‘or’ property. Often times, business owners buy a property first, pay down part of the mortgage, then secure a second mortgage backed by their home to finance their startup or business expansion.
A crash in property prices, if it does anything at all, will more likely lead to cutbacks in bank lending criteria for businesses. Which in turn could lead to an economic shutdown. We then get to experience the opposite of the ‘trickledown’ effect – the ‘noose effect’ – and I’m afraid the less you have to begin with, the more you get strangled, as businesses disappear, jobs disappear, and your home gets taken away from you.
If property prices crash, banks would simply call in their debts. First they’d declare you insolvent and seize your home (provided the laws allow them), then after that they’d say fuck you to your startup idea as well. Nobody’d loan startup capital to a person with poor credit, even if you can fairly point the finger and claim it was stinking old Gareth’s fault.
It is for all of these reasons that I am tempted to propose renaming The Opportunities Party “Captain Crunch and The Credit Crunch Party”.
‘NOT ONE ADDITIONAL DOLLAR OF TAX WILL BE COLLECTED’
You’re damn right about that. When the economy crashes it will be so hard for the Government or anyone else to squeeze a dollar out of a NZ citizen that the $5 note will become merely a rumour from a time long past.
Conclusion
Gareth Morgan may be wearing an iron suit on policy, but he’s wearing a bikini on detail.
More questions remain. Does it apply strictly to residential property, or could it apply also to commercial? Is that guy really serious when he says he’d apply some sort of TOIR to every single asset class? Could the owner of a factory be charged TOIR for failing to lease the factory during an economic slowdown? In which case, shouldn’t we be a bit more precious about voting for policies that could lead to a slowdown in the first place?
Above all else, what will the disastrous TOIR mean for the Kiwi bach?
The TOIR exists for the purpose of punishing low returning assets. Perhaps no asset offers worse returns than the classic Kiwi lifestyle holiday home.
We’ve seen from the last financial crisis that baches are vulnerable young things. Over 14,000 baches were listed on the market during the GFC with only 600 selling during that time. The reason why? When your family business goes through tough times, what’s the first thing you want to liquidate?
Would the TOIR apply directly to a bach ‘asset’? Even though it’s not an asset but basically a cost centre?
If so, what would stop people from trying to offload them on the market en masse? Would this mean that an important part of our culture (well, a questionable cultural luxury anyway) would disappear down the drain?
What impact would this have on coastal towns around NZ?
I’m not precisely sure but I expect that demand for wrecking balls will go up.
I admit, of course, the above questions are somewhat tongue-in-cheek. The price of Kiwi baches ought barely to be a speckle of spittle in my vituperative rant when compared with the huge globule of saliva I secrete on the topic of the innumerable hardworking, home-owning Kiwis who will have their costs of owning a home forced up, at the same time as their home value plummets and their loan stays the same.
But it does throw up an important point. The downstream effects of the TOIR appear not to have been properly considered – and certainly haven’t been explained in common sense terms on The Opportunities Party website. And this is policy number one on his website.
Because politicians don’t always spell out the fine print and Gareth’s policies in particular need some unpacking, I’ve decided to take matters into my own hands and fill in the blanks on his missing tax policy outcomes. These were taken from the TOP website – but my additions are in italics below.
“Our tax policy will:
a. Make the system fairer by kicking sand of the face of anyone paying off a mortgage or anyone who has worked their whole life to pay off their home;
b. Make housing more affordable over time by crashing the housing market;
c. Lead to more sustainable investment of capital (everyone’s savings) by eliminating the equity used to fund a huge proportion of new business startups and forcing the banks to reevaluate whether or not they should even lend money against a home (and since when did capital get defined as “everyone’s savings”?);
d. Make capital more readily available for productive businesses that create jobs and pay wages by causing the biggest home grown credit crunch in NZ national history;
e. Encourage a lot more “trickle down” from those who have stockpiled wealth courtesy of this loophole by punishing homeowners and letting property investors off the hook;
f. Reduce New Zealand’s reliance on foreign investment and debt to finance our growth by making us the scariest country on earth to invest.
That was fun! I should do this for every political party.
Like I said, I don’t hate Gareth Morgan, I think he’s good value and he’s got his heart in the right place.
But the best thing that can be said about his policies is that they would create a fun market for speculators.
