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Question:
Evaluate the system for the taxation of returns on property holdings (owner occupied or investment property). What is its effect on: - equity - housing prices - the economy?

 
Answer:
Evaluation of Taxation on Return of Holding Property:

In Australia, there are many factors affecting the system of taxation on the return of the property holdings. The properties are owner occupied and investment property. In this study, there is an evaluation of taxation system on the return of the property holdings in Australia. There are so many taxes affecting the holding property. States need to meet their budget challenges. The best way to meet the budget challenges in Australia, there should be imposition of property tax. The property tax is the most efficient tax. It is levying on property holdings (Becker, Jacob and Jacob 2013).

The tax base on return on holding property is growing fast. The state and territory government levy council rate that raises to $ & billion in a year. The annual levy rate is $ 2 for stable unimproved land value of $ 1000. The economic cost of a levy on capital gains or increase in the value of capital is low. This is due to the reason that the increase in capital is easily traceable. There is a reduction or elimination of stamp duties on property holdings and there is a long-term reform of taxation by levying tax on broad-based property. According to the Common Wealth treasury, stamp duty is not so efficient tax in Australia. The rising figure of stamp duty has huge effect on the economy and the job market. The ACT is replacing the revenue of stamp duty with a relatively higher rate of municipal. South Australia is ruling out the stamp duty and imposing taxes on land to the housing of owner-occupied. The main objective of the government is to abolish stamp duties and relying on efficient taxation to earn more revenue. The large tax-base of Australia is property. It is worth $ 8.31 trillion in 2014 (Crabtree 2013).

However, a levy on a property tax results a difficulties for those who are rich in asset but poor in income. The derivation of profit from the sale of property in Australia is under the taxable income for the citizens or for the foreigners. According to the Australian tax system, there are two groups for property investors. One type of investors builds the property to earn a rent for a long period of time. The other type sell the property when there arises any chance of capital gains or higher value of the property. The first type is the passive investors and the second type is the active investors. The active investor holds their profit from the sale of the asset in revenue account. Their income is under the regime of income tax. However, on the other hand the capital gain arises from the increase in the value of the capital for the passive investors goes into the account of capital. This gain in capital is under the regime of capital gain tax in Australia (Easthope 2014).

There is a tax concession for housing of owner occupied housing. The owner-occupied dwellings are free from the taxes. There may be a 100 percent discount from capital gain tax. However, the notional imputed rent of the owner-occupiers is not taxable. The owner-occupiers effectively avoid tax payment on the imputed rent by renting their dwellings to themselves. In the current situation of Australia, there is no taxation imposed for imputed rent and expenditure on earning imputed rent. There is no deduction of gains from capital such as mortgage interest by the owner-occupiers. Tax neutral benchmark has an impact on owner-occupied housing market (Harding 2013).

Impact of taxation on the equity:

Generally, if there is a derivation of income from the asset, there is also an inclusion of this asset or property driven income as the income tax. If the property is in capital account then there is an imposition of capital gain tax. If the owner’s income enters into the revenue account then there is an imposition of income tax. There is an indirect and direct rate of interest or return in the Australian property holding. Non-portfolio investment gives indirect interest. The interposing individual is holding interest 10% or more. If there is a capital gain, then asset has a relatively higher value. Therefore the shares and equity attach to this property is now have an increased value. Therefore, the gain is also increasing on the equity. Imposition of capital gain tax on the equity is earning relatively greater revenues to the government of Australia (Kelly et al.2013).

Same treatment is there for equity on property holdings as the capital gain taxation asset. The imposition of capital gain tax is on the increases value of the holding property. This gains arises due to cost of sale is greater than the cost of purchase. The holding of property or invest in it, has a capital gain. The equities related to property holding, is a popular liquid asset in Australia. There is charge on capital gains from the holding asset. In Australia, there is a collection of capital gain tax only on gains of capital. There is no separation of this tax from the income tax, gains from increasing the price of the investment or owner occupied property is a capital gain. Therefore, there is a inclusion of this property as a capital and increasing the value of this capital is a gain in the property. Therefore, there is an imposition of capital gain tax on the increasing value of the capital (McIntosh, Trubka and Newman 2015).

 
Impact on the Owner-occupying Housing:

The affordability of rental housing or owner occupied property depends on the personal tax system through investment in rented properties, gains in capital and rate of interest. There is an exemption of owner occupied housing from the personal income and system of capital gain tax in Australia. There is also exclusion of owner occupied property tax from stamp duties on the transaction of housing, council rate and taxes on land in Australia. The price signals the resource availability, allocation and real preferences of the economy. Tax policies takes into account this signal of price, sets accordingly. However, current tax system takes into account the capital gain and benefits from the investment the property. There is a same discounting rate for rental housing and capital gains. This creates neutral treatment in the taxing system. This is a proposed reform. This is likely to change the demand of investors to invest in higher rent yielding properties and may likely to change the horizon of investment (Pawson and Milligan 2013).

Currently, there is a reduction in incentive for investors to invest in housing where capital gains are relatively large. According to the Reserve Bank of Australia and Productive Commission, the volatility in housing market may cause for the favorable tax setting system. In the following figure 1, there is graph showing the volatility in the investment in the housing property by the investors and owner-occupiers. There is a consideration of time from 1986 to 2009. Horizontal axis measures the time and the vertical axis measures the percentage growth throughout the years of the rate financing or investing of investors or owner-occupiers in the housing investment (Turnbull 2016). This graph shows that there are volatilities throughout the years for both investors and owner-occupiers. However, from the period of 2004 to 2009, there is stability in the investment for both the investors and owner-occupiers. The percentage change in investment is relatively low due to reformed taxation system. The changing or reformed rate of taxation has a negative impact on short and medium housing market. The investment returns in Australian hosing property depends on the gains from capital rather than yields from rent. Concession in capital gain tax and reduction in net losses from rental property results in reduction in investment in residential property (Obeng-Odoom 2014).   

volatility in investment in property holdings

Figure1: volatility in investment in property holdings

(Source: created by author)

In case of neutral taxation of investment on housings, there is a reduction of tax of tax on investors. However, highly geared investors face increase rate of tax. There is long-term effect of this reformed tax system. In the long term, there may have some impact of this reformed tax system on the potential investors and owner-occupiers. Current reduced tax rate works as a subsidy to the renters. It results in a lower pressure to the renters. There is a graph (figure 2) on real effective marginal tax rates on property on rent and the ratio of gearing. Here lie some assumptions. The marginal tax rate for individual is 31.5%. The rate of nominal return is 6%, the rate of inflation is 2.5% and there is an equal 50-50 percent distribution of returns to gains from capital and income from rent (Wood and Ong 2013). There is a holding of rental property for 7and half years. There is an avoidance of debt provider tax. Taking into account all these factors the graph shows difference between the real effective marginal tax rates on property in the current on-going approach and recommended approach. At high percentage of geared investment, real effective marginal tax rate is negative and low but positive for current and recommended approach respectively. At the middle of geared investment, the real effective marginal tax rates on rental are same for both the current and recommended approach. However, for no geared investment, real effective marginal tax rate is relatively higher for current approach than the recommended approach (Miller and Oats 2016).

Impact on the economy:

There is a concern among stakeholders that there is many chances and opportunity to the government of Australian government to improve the tax system. The stake and stockholders recognize the potentiality of the property holdings. Therefore, property tax reform is very crucial to the equity market and the Australian economy.  There is an expectation of abolition of stamp duties on conveyance. This stamp duty ensures a large amount of revenue to the government of Australia. Therefore, if there is an abolition of this tax, government of Australia needs to provide some other way out to ensure the same amount of revenue to stabilize its expenditure. Otherwise there is a amount of resources available to allocate in the remaining services (Krever and Mellor 2016).

According to the New South Wales Chamber, there is a need of new model named KPMG and this may replace the revenues earn from stamp duties on land taxes. The Chamber assesses the effect of the alternative tax on the property and its effect to the entire economy. The impact of taxation on property holdings and different measures of revenues is more on the poorest household. This increases the inequality in the wealth, income from the property and materialistic wellbeing. The ability for the taxation is totally depends upon the net wealth and asset possession by an individual. The impact of income tax and property tax has a same effect on the levy on the property. The most crucial fact is that, household having lower position in the income distribution, has the lower net asset or property. A property-based levy is progressive tax. Therefore, there is an expectation that, as the income from investment property increases, the investors should pay higher tax rate, as their property tax base increases. This definitely ensures the equity in the Australian economy. 25% government revenues come from the increase in the tax rate7.6% to the higher positioning household in the income and net wealth table. Property tax is the most efficient tax in the Australian economy. If government wants to earn more revenue, then it may impose higher rate of tax on investment in the property holdings than in any other taxes. The supply of property is inelastic (Hulse et al. 2012).

Therefore, charging higher price does not shift the investors from invest in it. There is no shift of this property to any other places or country to avoid the taxation. Therefore, if the investors want to have benefit of capital gains, then there is enforcement of the levy on property holdings. It is evident that all the taxes are causing for lower economic growth. However, some taxes have a lower effect than other taxes. Broad based property taxes are one of the most efficient taxes. The reason for this is it does not discourage someone to investing in property holdings. However, property levy would result in relatively greater government revenue though it has an impact of distributive equity in this field (Cui 2014).

the real effective marginal rate

Figure 2: the real effective marginal rate

(Source: created by author)

There is an implicit subsidy for sustaining a non-neutral treatment of tax. Lower tax rate is advantageous to the renters. However, this tax rate is not transparent and well directed to improve the purchasing or renting affordability of investors. Providing sufficient amount of subsidy results in increase in the availability of housing for rent, however, there is a reduction in the welfare of the tenants. Property owners sell to reduce the security of their tenure. In contrast, in case of negative geared, proposed tax system is more effective and justified means for low-income investors (Cao et al. 2015.).

While considering the overall in impact of taxation system on holding properties, the reform will results in the tax system that is not very effective on the changing the prices of property holdings toward a desired level (Almy 2014).

 
Reference:

Almy, R., 2014. Valuation and Assessment of Immovable Property. OECD Working Papers on Fiscal Federalism, (19), p.0_1.

Becker, B., Jacob, M. and Jacob, M., 2013. Payout taxes and the allocation of investment. Journal of Financial Economics, 107(1), pp.1-24.

Cao, L., Hosking, A., Kouparitsas, M., Mullaly, D., Rimmer, X., Shi, Q., Stark, W. and Wende, S., 2015. Understanding the economy-wide efficiency and incidence of major Australian taxes. Treasury WP, 1.

Crabtree, L., 2013. Decolonising property: exploring ethics, land, and time, through housing interventions in contemporary Australia. Environment and Planning D: Society and Space, 31(1), pp.99-115.

Cui, W., 2014. Taxing indirect transfers: Improving an instrument for stemming tax and legal base erosion. Virginia Tax Review, 33(4).

Easthope, H., 2014. Making a rental property home. Housing Studies, 29(5), pp.579-596.

Harding, M., 2013. Taxation of Dividend, Interest, and Capital Gain Income.

Hulse, K., Burke, T., Ralston, L. and Stone, W., 2012. The Australian private rental sector: changes and challenges. Australian Journal of Political Science, 35(1), pp.99-110.

Kelly, J.F., Hunter, J., Harrison, C. and Donegan, P., 2013. Renovating housing policy. Grattan Institute, Melbourne.

Krever, R. and Mellor, P., 2016. Australia, GAARs–A Key Element of Tax Systems in the Post-BEPS Tax World. GAARs–A Key Element of Tax Systems in the Post-BEPS Tax World (Amsterdam: IBFD, 2016), pp.45-64.

McIntosh, J., Trubka, R. and Newman, P., 2015. Tax Increment Financing framework for integrated transit and urban renewal projects in car-dependent cities. Urban Policy and Research, 33(1), pp.37-60.

Miller, A. and Oats, L., 2016. Principles of international taxation. Bloomsbury Publishing.

Obeng-Odoom, F., 2014. Urban property taxation, revenue generation and redistribution in a frontier oil city. Cities, 36, pp.58-64.

Pawson, H. and Milligan, V., 2013. New dawn or chimera? Can institutional financing transform rental housing?. International Journal of Housing Policy, 13(4), pp.335-357.

Turnbull, S., 2016. The Role of Law in Transitioning to a Sustainable Economy. Available at SSRN 2816914.

Wood, G.A. and Ong, R., 2013. When and why do landlords retain property investments?. Urban Studies, 50(16), pp.3243-3261.

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