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The confrontation over Victoria’s Social and Affordable Housing Levy may have been short lived when the proposed levy was quickly dropped after conniptions by the property lobby but the shibboleth that property taxes represent a large proportion of the cost of buying a house is economic propaganda that just won’t die.

The Housing Industry Association’s Fiona Nield rolled out what has become standard spin from the property industry – that government taxes represent 38 per cent of the price of a new home built in Victoria.

The implication is twofold: first, that government charges are passed on via sellers to buyers; and relatedly, that removing taxes would reduce the price of housing.

Says Ms Nield: “Any new tax has to be passed on in higher costs, and: “The tax needs to be passed on in higher house prices.”

The HIA would like you to believe that if a house that sells for the median price of $775,000, more than $294,000 goes to the government in taxes and charges.

We did a back of the envelope calculation to see how the HIA’s claim stacks up. We included all the government taxes such as stamp duty, land tax, rates, infrastructure contributions and development levies on that median price of $775,000. The total was $150,355 – for a rate of 19.4 per cent – well short of the HIA’s 38 per cent. In fact almost $145,000 short. (More on this below)

What is going on? Where does the “38 per cent of a new home build” figure come from? By including all the costs that developers face, which is rather misleading.

The 38 per cent figure comes from a 2019 economic report by The Centre for International Economics commissioned by the HIA. It uses a tax summation approach: all the taxes and charges on land are added up and compared to the market price of a new dwelling.

The HIA has included in its 38 per cent figure what is called regulatory costs. These are the rules and regulations that increase costs for the developer, but do not create more revenue for the government – things like assumed “costs” of planning rules and complying with the building code.

To quantify “excessive land price,” economists assume a counterfactual land market in which developers are allowed to build whatever they want, wherever they want. This counterfactual is then used as a benchmark to determine that land prices are “excessive.”

What the developer regards as “regulatory costs” ensure that the negative effects of new development on the surrounding community are reflected in the price – and not shifted on to everyone else to pay. The biggest regulatory cost is “excessive land price” due to restrictive zoning.

To quantify “excessive land price,” economists assume a counterfactual land market in which developers are allowed to build whatever they want, wherever they want. This counterfactual is then used as a benchmark to determine that land prices are “excessive.”

Any aggregate long-run costs due to land market failure are hand waved away. Any positive externalities generated by the planning regulation are ignored (as these are also reflected in land price).

This kind of esoteric economic modelling is a long way from what an ordinary person would consider a tax or government charge.

The HIA’s claim around taxes also plays into our basic intuition that taxes always raise the price of goods and services. However, when it comes to taxing land and housing, it is just not that simple.

Economists have long studied who ends up bearing the cost of a tax. A tax can result in lower wages, smaller profits, higher prices and/or reduced demand. Who pays depends on who has the market power, what level of competition exists, and how easy it is to avoid the tax by changing behaviour. The technical term is tax incidence.

Consider a tax on apples and a tax on fuel. I can easily buy a pear instead of an apple and thus avoid the tax, but I can’t avoid a fuel tax if I want to drive my car. Fuel suppliers are therefore able to pass on a new tax. This is a key argument for imposing a carbon tax: as the cost of fossil fuels rises, the more cost-effective and urgent it becomes to find a less carbon intensive, and therefore cheaper, alternative to fossil fuels.

Sometimes a tax can be passed through to the end buyer, but this depends on the level of competition. The housing market is a competitive market. If one builder decides to absorb a new tax by accepting a lower profit margin, this makes it difficult for his competitors to pass on the entire tax to a buyer.

Before you can build a house, you need somewhere to build it. The price of land responds to taxes in a unique, and truly counterintuitive way: taxes on land reduce the price of land. This is because land has no cost of production. The price of land isn’t determined by the price of widgets and whatnots required to make it. It is just there – finite, immoveable.

On the other hand, taxes on produced goods or services do increase the cost of production.

Here’s one way to think about it: owning land confers a bundle of rights. If the location of the land is within easy reach of lots of jobs or customers, is really picturesque, or is in the catchment area of a high performing public school, that land will cost more. As a landowner you do not produce these amenities, but land ownership guarantees you exclusive access or control. If others want that location they have to buy from you; you have a monopoly.

When a developer makes an offer on a piece of land, they work backwards. First they estimate how much they can sell a new home for, then they subtract their costs – design and build costs, marketing, taxes and a reasonable profit.

Here’s another way to think about it: when a developer makes an offer on a piece of land, they work backwards. First they estimate how much they can sell a new home for, then they subtract their costs – design and build costs, marketing, taxes and a reasonable profit.

What is left over is the amount they can afford to pay for the land. If taxes go up, costs go up, reducing what is left over to be spent on land. Taxes go down, costs go down, there’s more left over to pay for land.

Taxes on land mean that a portion of what the buyer would otherwise pay to a land seller goes to the public purse to pay for community amenities such as hospitals, roads and schools.

Hence taxes on land often have the effect of reducing land prices. Remove them and the benefit does not flow through to new homebuyers, but to existing landholders who are in a position to sell.

Research shows that taxes and charges on development don’t immediately show up in the price paid for housing. Instead government charges influence the location, quantity and style of new homes over the longer term.

What are “regulatory costs”?

Regulatory costs include:

  • residual in raw land price – that is, zoned scarcity of residential land
  • finance charge: land holding – interest costs on holding land due to planning delays
  • developer’s margin (uncertainty) – compensation for planning delay risk
  • GST and SD costs– due to delays and uncertainty created by planning

Excessive land price:

  • This assumes that without planning zones, or less restrictive planning zones, land would be cheaper. Another way to think about this is that it assumes a counterfactual land market in which developers are allowed to build whatever they want, wherever they want
  • Even if there were no zoning constraints, rezoning farmland would not put downward price pressure on existing residential land

Planning delays and inefficiencies:

  • Includes added finance charges for holding land while waiting for planning approvals.
  • Delays and uncertainties in paying SD & GST – “cascading costs”

Cascading costs:

– Regulatory costs on variable resources are essentially inefficiencies in the planning system.

  • Regulatory costs on variable resources are essentially inefficiencies in the planning system.
  • Apart from directly adding to developer finance costs, these costs impact the GST collected on development and (via their impact on the final transfer price), the stamp duty paid by the purchaser. These “cascading tax costs” are calculated.
  •  Regulatory costs on land (the fixed resource) inflate the price the developer pays for raw land and therefore most statutory taxes that follow. The cascading effect on taxes due to zoning IS NOT calculated

Emily Sims, Prosper Australia

Research and policy manager at Prosper Australia More by Emily Sims, Prosper Australia

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  1. This article is very flawed. To develop land, the developer has to pay for the wholesale broad acre land, background investor profits, planning costs and fees, land division costs and fees, construction of roads and services mains and connections to house allotments, usually a storm water basin / lakes, playgrounds, gyms, public open space and landscaping, off site road and services upgrades, holding costs of borrowed finance, land division period rates and taxes …all ahead of building a house. All of these costs form a component of the cost of a house and land package. These are the costs of making the land allotment that a home owner buys. To say that making new land for housing has no intrinsic cost is grossly incorrect.

    1. What you are identifying are housing production costs. Land at its most elemental level costs nothing to produce. The production costs you mention are accounted for in the residual. If taxes increase (or any of the costs you list) there is less residual so the price offered for land is lower. Also, supply is spurred into action as land taxes increase, undermining the market power that some land bankers and developers enjoy. That makes it harder for that tax to be passed on.