Reforms to land tax and why local governments should care

Summary

This briefing examines the rationale for transitioning from stamp duty to land taxes and highlights the issues for local government. It draws on the experience of the ACT which, in 2012, embarked on a 20-year tax reform program, abolishing stamp duties and insurance taxes, and replacing the revenue by increasing general rates for all landowners.

Briefing in full

Briefing in full

Introduced to NSW in 1865, stamp duty has remained relatively unchanged for more than 150 years.

In 2018-19, the NSW Government raised about $7 billion, or 24 per cent of annual tax revenue, from stamp duties – making it the State’s second largest source of tax revenue. Only Victoria raises more as a share of state tax revenue.

The pattern is similar in other high growth states. On average, states raise 22 per cent of tax revenue from transfer duty. The proportion has steadily increased from 16 per cent following the introduction of the GST in 2000, up to 19 per cent at the time of the Henry Tax Review in 2010, and then up 26 per cent in 2015 to 2018.

Australia is one of very few countries around the world to have such a heavy reliance on stamp duty on property transfers as a source of tax revenue.

The NSW Government, in their consultation paper on the proposed changes to the property tax, argues that stamp duty has well and truly served its purpose. While stamp duty was fit-for-purpose when house prices were lower relative to income and moving around regularly was rare, the amount of duty homebuyers pay has increased dramatically faster than home prices or incomes in practice. The paper argues that stamp duty has a direct impact on people’s ability to live where they want and when they want to move. Many people often stay in homes that do not necessarily suit their family or lifestyle circumstances because of the large upfront transaction cost of buying a property, which includes stamp duty.

The NSW Government maintains that abolishing stamp duty could remove tens of thousands of dollars from the up-front cost of home purchase, and place downward pressure on home prices over the longer term, making housing more affordable for all. It is forecast that the proposed changes could inject $11 billion into the economy over four years – providing much-needed stimulus – while also delivering a very significant economic reform to the state’s economy.

The Grattan Institute, in its submission to the NSW Productivity Commission review of state taxes, noted that NSW has one of Australia’s least efficient tax systems, with each dollar of revenue raised costing the economy 30 cents.

In 2020, the NSW Productivity Commission Review of Federal Financial Relations concluded that a broad-based land tax would be more efficient and equitable than stamp duty, and recommended that the NSW Government should replace stamp duty with a broad-based land tax. The Review suggested that the transition should be managed with the support of detailed distributional and financial modelling, and public communication and consultation, to ensure that the transition is fair, efficient, and minimises the amount of revenue foregone.

The differences between stamp duty and land tax

Stamp duty is triggered by a property transaction and levied on the sale price. Revenue collection from stamp duty shifts the costs of infrastructure and essential services onto those who are buying and selling property. Stamp duty is also volatile as it depends on growth rates and market activity.

A land value tax is an ad valorem (according to value) levy on the unimproved value of land which ignores the value of any improvements such as buildings or personal property. The value of land is, however, a measure of the benefits accruing to landowners in particular locations arising from investments in infrastructure and essential services, amenity and access to markets.

Several tax reviews have recommended shifting to a broad-based land value tax

Over the past two decades there have been several tax reviews which have laid the groundwork for understanding the advantages of recurrent land value taxation over stamp duties on property transfers (Harvey et al, 2001; IPART 2008; Henry 2010; Lambert 2011, Australian Government’s Productivity Commission 2017; NSW Government 2020).

Most notably, the Henry Tax Review of the Australian tax system (conducted in 2010) concluded that there is no place for stamp duty in a modern Australian tax system and put the abolition of stamp duties at the top of state/territory tax reform agendas. The key differences between land taxes and stamp duties are:

• Land is an efficient tax base because it is immobile; unlike labour or capital, it cannot move to escape tax, and therefore has the potential to be an efficient tax base for the states, one capable of delivering significant and sustainable revenues. This means that economic growth would be higher if governments raised more revenue from land and less revenue from other more volatile tax bases.
• Stamp duties on the transfer of commercial and residential land (and buildings) are a significant source of state tax revenue. Stamp duties are inefficient taxes because they are affected by market volatility. As a tax on transferring land, they discourage land from changing hands. Stamp duties are also an inequitable way of taxing land and improvements, as the tax falls on those who need to move.
• Existing land taxes are narrow, which make them less efficient and fair than they could be. Levying higher taxes on larger holdings discourages investment in land by institutional investors in rental housing. Since owner-occupied housing is exempt, land tax on residential investment properties is probably passed through to renters as higher rents.
• Stamp duties on conveyances are inconsistent with the needs of a modern tax system. Land tax needs to be reformed by broadening the base, which would provide a reliable and stable source of revenue to state governments. Land tax rates should be based on the value of a given property, so that the tax does not discriminate between different owners or uses of land.

The Henry Tax Review estimated that 26 per cent of owner-occupiers across the nation have remained in the same property for at least 20 years. Over that period, property owners have benefitted from the services provided by the state and a once-in-a-lifetime land price windfall, yet they have contributed very little towards the cost of essential services and critical infrastructure via the property taxation system. Conversely, those who move more frequently (for whatever reason) have paid far more than their fair share through stamp duties. In addition, broad-based property taxes deliver more stable revenues because they are not affected by market volatility.

To date, the ACT is the only jurisdiction to have commenced the transition away from stamp duty (as discussed below).

The rationale for reform

In 2019, Prosper Australia – an independent economic research institute based in Melbourne – undertook a study to determine what is standing in the way of this ‘tax switch’ from stamp duty to land tax. Their study noted that:

• Stamp duty is the ‘pantomime villain of tax reform’ blamed for everything from expensive housing to unemployment to traffic congestion. Staggering estimates of its economic costs suggest an incredible dividend from its potential abolition.
• Land value tax is the obvious replacement. Borne by the same property owners, administratively simple, unavoidable and perfectly economically efficient, it finds favour with economists and progressives alike. It is “the least bad tax” (Milton Friedman) and a “no-brainer” (Martin Wolf). The economic case for it is “simple, and almost undeniable”.

Prosper Australia maintains that ‘Stamp duty now has few friends in the Australian policy debate, and land value tax no principled objectors’ and that ‘there is near-consensus across the academic, political, business, and community sectors that the former should be replaced by the latter.’

What is standing in the way of these reforms?

Prosper Australia identified several impediments to these reforms, including:

• The development of a policy package attractive enough to convert the ‘duty’ into a political opportunity. Long-term economic gains versus short-term political gains are never easy for politicians, and the inequity of the current stamp duties versus the efficiency gains do not appeal much to the general public. Something more compelling is required to ‘sell’ the change.
• There are political difficulties inherent in both forms of taxation. Duty is paid once, at a time of liquidity and is seemingly voluntary, since it is contingent on a choice of purchase. In contrast, land value tax is recurrent, unavoidable and taxes an economic rent that may not match cash flow. This ‘asymmetry’ between the two taxes poses a significant challenge for reform.
• Replacing stamp duty with a full land tax would impact adversely on recent purchasers. While there are a variety of ways around this problem, politicians will not commit to a reform process without assurances about the fairness of the pathway. This reticence was made clear in the entrenched opposition toward proposed changes to negative gearing and capital gains taxes during the 2019 federal election.

Designing the transition

Prosper Australia maintains that there are at least six distinct issues of principle or politics to be addressed in any transition process:

• double taxation of recent buyers
• potential impacts on asset values
• liquidity problems for the asset-rich cash-poor
• some future buyers being made worse off
• budget impacts from lost revenue
• other political difficulties relating to the unpopularity of new taxes, and the nature of recurrent property taxes.

Prosper Australia also maintains that characterising the transition as a policy or political problem with objectives, options, impacts, and trade-offs can help in moving towards consensus over the best model – or can at least make clearer the inherent tensions involved in each choice.

Transitional policy options include the three basic models suggested by the Henry Tax Review:

• Switch-on-sale: a full grandfathering model where current property owners are exempted from the new land tax until sale.
• Credit: applying the new land tax to all properties but granting some or all current property owners’ credit that can be used in lieu of cash payments.
• Gradual transition: phasing out stamp duty and phasing in land tax over time, as in the ACT since 2012.

Prosper Australia suggests several complementary policies, including:

• A phase-in to full land tax rates or ‘tax holiday’ (other than as part of a gradual transition).
• An opt-out option for future buyers to choose between paying land tax or stamp duty.
• ‘Internally funding’ the costs of these various concessions via higher land tax rates to make the reform package revenue-neutral over a defined period.
• Allowing deferral of land tax either on a restricted eligibility basis (e.g. means-testing) or for taxpayers more broadly.

The ACT’s approach

In 2011-12, the ACT Government undertook a Tax Review which recommended a phase-out and phase-in approach to replacing stamp duties and insurance taxes with increased Land Value Tax (LVT) over 10 years, with additional ‘credit’ for recent buyers providing in effect a full exemption from the replacement LVT for up to 10 years of this transitional period.

In 2012, the ACT Government announced that it would embark on a 20-year tax reform, abolishing stamp duties and insurance taxes and replacing the revenue by increasing general rates for all landowners. The ACT Government stated that in making these reforms it was seeking to achieve greater revenue predictability, efficiency, and equity. It also promised that the reforms would be revenue neutral, reassuring residents it was not a tax grab.

The transition model adopted by the ACT Government was a gradual phase-out and phase-in over a 20-year period, but it did not adopt the recent-buyer exemption/credit recommendation of its Tax Review. Thus, all properties of a given value and type in the ACT pay the same rate of Land Value Tax regardless of when they were bought, but with separate progressive rate scales applying to residential investors, owner-occupiers, apartments, commercial land, and farmland. The ACT Government justified these changes by arguing that, unlike in other states and territories, rates in the ACT fund more than just municipal services (such as rubbish collection and local roads) but also fund health, education, housing and community services, public transport, and police and emergency services. The risk for the ACT with such a long timeframe for implementation is that a future government may discontinue the reform process. So far, that has not happened.

Prosper Australia has undertaken two reviews of the ACT’s transition from stamp duties to land tax both of which conclude that the reforms are achieving all three objectives of revenue predictability, efficiency, and equity. Government revenue has been far more stable and predictable. While it is difficult to demonstrate efficiency empirically, the shift away from volatile and inefficient stamp duties and the abolition of insurance duties toward land taxes is resulting in annual increases in the ACT’s Gross State Product. At the same time the reforms have remained roughly revenue neutral. In relation to equity, the number of first home buyers has risen, and the incidence of taxation is shifting from people who buy and sell houses to those who monopolise high value and high quantities of land .

The NSW proposal

The NSW Government’s Consultation Paper proposes that:

• The property tax would consist of a fixed amount plus a rate applied to the unimproved land value of an individual property, and not aggregate landholdings, similar to council rates.
• Buyers could choose to pay the property tax at the time of purchase. It would replace stamp duty and (where applicable) land tax. Once a property is subject to the property tax, subsequent owners must pay the property tax.
• There will be no double taxation. If stamp duty has already been paid, then it will not be necessary to pay the property tax.
• Residential owner-occupied and primary production properties would pay lower rates than residential investment properties, which in turn would pay lower rates than commercial properties.
• Price thresholds would limit the number of properties initially eligible for transition to keep revenue and debt impacts within reasonable levels, while ensuring that over 80 per cent of residential properties are eligible to opt-in from day one.
• Protections would apply so that the property tax does not result in rent increases without a tenant’s agreement. A hardship scheme would recognise that taxpayers’ financial situations can change over time and ensure that no one facing hardship needs to sell their home to meet property tax liabilities.
• In the short term, the proposed model will reduce the NSW Government’s revenue. Over the longer term, the property tax would be revenue neutral, collecting the same amount of revenue as stamp duty and land tax.

Comment: issues for local government

These tax reforms have been mooted for over a decade, but as Prosper Australia notes: ‘It is difficult to think of any other reform for which expert opinion and the forces of politics are so firmly in opposition.’ And, ‘If this reform is to proceed the politics must be accepted for what it is, and the policy design process must work around that – not the other way around’.

As the NSW Productivity Commission’s review noted, the transition must be carefully managed with financial modelling, and public communication and consultation, to ensure that the transition is fair, efficient, and that the need for such reforms is better understood.

While the details of the NSW proposal are yet to be worked out, problems will arise with exempting current owners from land tax until the property is next sold because it entails a massive and unavoidable loss of tax revenue over a transition period potentially lasting for generations.

Prosper Australia recommends a model that includes the immediate abolition of stamp duty, partial credit for past duty paid for current property owners, gradated introduction of a land value tax via a short phase-in period, a limited-time ‘opt-out’ option for new buyers, and revenue losses from the transition to be funded by a temporarily higher land tax rate, and with the overall transition period to be revenue neutral.

The issues of concern to local government include the way in which the land tax will be administered alongside council rates, especially how the unimproved values are to be calculated and reviewed over time. The State needs to clearly define that the land tax is a state tax which must be collected separately from council rates.

The land value tax will also impact on developer contributions, infrastructure contributions, and windfall gains and value capture arising from rezoning. These matters require further consideration.

Related LGiU briefing:

• A time to change: major development contributions planning reform, which provides a high-level overview for local government on key areas of reform being pursued by the NSW Government.

 

For more information on this briefing contact LGiU Australia by emailing mzierke@sgsep.com.au

 

Resources

George, H. (1879, reprint 2017) Progress and Poverty. An inquiry into the cause of industrial depressions and of increase of want with increase of wealth … The Remedy, in Peddle, F.K. and Peirce, W.S. (eds) The Annotated Works of Henry George, Volume II Progress and Poverty, Co-published by Fairleigh Dickinson University Press, Maryland, and Robert Schalkenbach Foundation, New York.

Harvey (2001) Review of state business taxes — Full report, State Business Tax Review Committee, February, The Victorian Department of Treasury and Finance.

Prosper Australia (2020) Understanding Land Tax and Why Planners Should Care About It.  Presentation to PIA NSW, November.

Tully, J. (1980) A discourse on property: John Locke and his adversaries, Cambridge University Press, UK.