Tax changes will affect house prices

The government has been considering aligning the top income tax rate with business and trust rates all at 30%, as part of the current overhaul of the tax system being headed by the Tax Working Group.

Westpac research economist Dominick Stephens says the rental property sector as a whole claims more in tax deductions than it pays in tax.

He says the price of property - both owner occupied and rental - partly reflects the tax benefits conferred upon the owner.

"If the tax benefits change, so will the price," he says.

Westpac used its Investment Value of Housing model based on a median property in New Zealand currently worth $350,000 to estimate the impact of potential changes to the tax system on house prices.

Stephens says tax reform would change both house prices and rents and it is hard to predict which would move most.

"We have assumed that one-third of the adjustment to a tax change would come about via higher rents and two thirds of the adjustment would come via lower house prices."

He says if the top rate of income tax was reduced to 30% then the house price of a median property would decrease by 13.60%, rent would rise by 6.80% and there would be a higher rate of home ownership.

"Bottom-end houses would experience the biggest price decline and there would be an increase in price dispersion between the top and bottom end."

He also says the annual cost of becoming a leveraged landlord would increase, resulting in higher rents.

Landlords receive a tax rebate for losses on their rental properties at their marginal rate of income tax.

Stephens says if the marginal rate of income tax changes, so does the size of the rebate.

"For example, consider a landlord who is taxed at 38% and loses $20,000 per annum from owning a rental property. At present they get a rebate of $7,200 each year (0.38 x $20,000).

"If the top rate of income tax were 30%, the rebate would be just $6,000 per year (0.3 x $2,000). The annual net cost of becoming a leveraged landlord would instantly increase by $1,200 so fewer people would be willing to do it."

He says less demand would cause house prices to fall and fewer willing landlords would mean higher rents.

"Lower house prices and higher rents would make home ownership both more attractive and affordable, so home ownership would be higher than if the tax changes remained unchanged."

Westpac has also made a prediction on the effects of potential property taxes to be brought in by the government.

Stephens says a land tax of 0.5% would reduce house prices by 4.40% and land tax of 0.5% combined with income tax of 30% would reduce house prices by 16.90%.

If a capital gains tax of 10% was introduced it would reduce house prices by 15.70% and risk free rate of return with tax applied on 6% of equity would reduce house prices the most significantly by between 26% and 34%.

There are no specific numbers for ringfencing but it is predicted that it would also reduce house prices.