GST on rent

In an excellent article from Brian Fallow, the idea that GST could be applied to rent is brought up.

I agree with this 100%.  By not taxing rent we are distorting incentives regarding the investment in housing – after all, rent is a form of consumption and should be captured by a tax on consumption.  (Note:  I haven’t been clear enough that the “revenue neutrality of the tax” is very important – this only makes sense if we are cutting more distortionary taxes as a result (eg income taxes).)

However, I would go a step further.  We should be taxing the rental equivalent of ALL properties with GST – as the rental equivalent (when you own a house) is consumption.  Now remember this doesn’t just impact on renters, it depends on the incidence of tax.  As a result, it will lead to lower net of tax returns to property investors – net returns that are more closely related to the relevant net returns among other asset classes!!

Part of the reason that New Zealand has overinvested in housing is because of favourable tax treatment.  A clean up of GST in regards to the housing market, combined with a revenue neutral increase in GST rates, would have a big impact on the housing market.

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  • Miguel Sanchez

    I haven’t studied GST since 5th form economics, but my instinct is that this would swing things too far in the other direction – creating a massive tax disadvantage for housing, which is no more defensible than having a tax advantage. Remember that GST is a tax on value-added – a retailer collects and pays GST on the goods that they sell, and they receive a GST rebate on the cost of supplying those goods. Otherwise, the same items would be taxed over and over at every stage of the supply chain.

    Now, apply that to housing. What’s the cost of supplying the housing ‘service’ that the seller could claim a rebate on? Well, one example is that we could tax the sale of an existing home (new homes are already subject to GST), and rebate the seller for what they originally paid for it. Hmmm… a tax on the difference between what they paid for an asset and what they sold it for… is that not just a capital gains tax?

    Rentals are just as problematic. Strictly speaking, if rents are going to incur GST then the landlord should get a rebate for the cost of providing the service. If we take that cost to be their mortgage repayment… we already have a system that encourages negative gearing, which is effectively negative value-added. So we potentially end up with a system where the IRD pays property investors a net GST rebate as a reward for leveraging themselves up to the eyeballs!

  • @Miguel Sanchez

    Hi Miguel,

    “Strictly speaking, if rents are going to incur GST then the landlord should get a rebate for the cost of providing the service. If we take that cost to be their mortgage repayment… we already have a system that encourages negative gearing, which is effectively negative value-added. So we potentially end up with a system where the IRD pays property investors a net GST rebate as a reward for leveraging themselves up to the eyeballs!”

    This only occurs if we also have a GST rate on the mortgage payment to start with.

    GST falls on the final transaction – the rental transaction between the renter and the landlord. When the landlord is charged GST on the inputs they pay a rebate, yes. But at the moment they don’t get charged GST on these inputs, and so the point is mute.

    Remember, a GST rebate is someone being rebated GST – we wouldn’t set up a system where we pay people to make a loss, we’ve already got income taxes for that 😉

    Same argument holds with the rental equivalent.

    The point of the rebate is to make sure that the good or service is only taxed once on the value chain, the tax will never be negative.

  • Miguel Sanchez

    “This only occurs if we also have a GST rate on the mortgage payment to start with.”

    Yes – which is what Brian Fallow is arguing for (hence the title of his column). If you tax rents only, then it’s not a value-added tax and shouldn’t rightly be called GST.

    Oh, and GST does NOT fall on the final transaction – it’s collected at every stage in the supply chain, based on the value added at each stage.

  • @Miguel Sanchez

    Indeed.

    But we can split the points here in order to think about GST.

    First, when it is only on rent, then there is no refund.

    Secondly, when we pop it on the interest for an investor as well there is a refund of the GST paid on investment – but not the GST that gets paid from the rental service. This is exactly how we want it to be, as we only want the “rental service” to be effectively taxed once.

    In this case, as long as demand is not perfectly inelastic, some of the incidence of tax will fall on the landowner.

    Furthermore, there is no incentive to “excessively leverage” beyond what we have now – as the GST refund is ONLY on GST that is paid, as you said it is a rebate.

  • Miguel Sanchez

    Just on the last point in your first post: as I said, new homes already incur GST when they’re sold. If you then charge GST on the flow of services they provide over their lifetime then you really are taxing the same thing twice. Existing homes may be a different matter, but then we don’t backdate GST payments for goods that were bought before 1987 either.

  • Miguel Sanchez

    OK, let me make it clearer with mathy symbols and stuff. Property investors already have an incentive to aggrange their affairs so that (interest on mortgage) > (rent collected). So if you apply GST to both legs then you get (GST rebate on interest payments) > (GST paid on rent collected). Happy days for property speculators! And if you apply it to rents only (or even imputed rents), then it’s not a value-added tax, and actually puts housing at a disadvantage to all other goods and services.

  • @Miguel Sanchez

    I agree that, insofar as new house construction is taxed with GST, this would be a double tax. But in that case, construction firms should be able to get a rebate then we should tax people based on consumption.

    Furthermore, new housing stock isn’t the sole determinant of the consumption value of the housing stock – additions and alterations add value, and have to be captured.

    @Miguel Sanchez

    “Property investors already have an incentive to aggrange their affairs so that (interest on mortgage) > (rent collected). So if you apply GST to both legs then you get (GST rebate on interest payments) > (GST paid on rent collected)”

    But this does not imply that they would want to leverage themselves up anymore. As when we look at the cost and benefit the GST rebate and cost wash out, just leaving us with just the GST paid on rent collected!

    “And if you apply it to rents only (or even imputed rents), then it’s not a value-added tax, and actually puts housing as a disadvantage to all other goods and services”

    In this case we are taxing the consumption value of the property. In every other industry the consumption value of their product is taxed. As a result, I do not think it puts property at a relevant disadvantage.

  • @Miguel Sanchez

    Note. I would say that I agree with you that, if a the tax is already being implemented further up the value chain we don’t need it at the end. Would that be a fair representation?

    My main concern in that case is transparency – I like my consumption tax to only be on consumption, so that we can see where it falls out. However, is there are significant transaction costs of doing so I can see why we might not.

    However, on the issue of property speculation I do not agree – as ultimately, the tax still falls on consumption it doesn’t matter if the interest GST is netted out.

  • Miguel Sanchez

    @Matt Nolan

    It doesn’t imply that property investors will want to leverage themselves up any more. But neither does it imply that they will leverage up any less, which was Brian’s argument for taxing it.

    “In every other industry the consumption value of their product is taxed.”

    Not strictly true – for example, when you buy a car you pay GST at the time of purchase, not on the flow of services that you consume over the years. (And if like me you bought before 1987 you pay no GST at all.)

    If in turn you rent out that car, yes you incur GST on the rental payment, but you also get a rebate on your expenses. And if you rent it out at below cost, then net net you’ll get a GST rebate that offsets a fraction of your losses. The problem is that you’d never run a rental car company that way – but you can do it with housing, since you’re counting on a capital gain at the end of the investment. Solution? A capital gains tax seems more appropriate than GST.

  • @Miguel Sanchez

    “It doesn’t imply that property investors will want to leverage themselves up any more. But neither does it imply that they will leverage up any less, which was Brian’s argument for taxing it.”

    I see. Well I agree with you on that bit – it does not imply that they will leverage less – unless we think that the lower rate of return (from the change in the treatment of rents) will lead to lower levels of leverage, which is a bit indirect.

    “when you buy a car you pay GST at the time of purchase, not on the flow of services that you consume over the years”

    True.

    “A capital gains tax seems more appropriate than GST.”

    A capital gains tax is the answer insofar as we are taxing income. However, if we are looking at taxing consumption then we need to make sure that this tax is appropriately set up as well. I see the CGT and GST issues as separate in this sense – apart from the underlying idea of revenue neutrality and a revenue target.

  • Miguel Sanchez

    Cool, I think we’re on the same page now. And your last distinction is important: I don’t think we should be looking at a consumption tax at all, because I don’t believe that the problem is on the consumption side of the equation (and I don’t think that Brian Fallow really believes that punishing home ownership is the answer). The real problem is the incentive for landlords to leverage up, effectively subsidise renters by accepting low yields, and live off the capital gains, i.e. it’s the seller’s behaviour that we need to change. A consumption tax just doesn’t hit the right spot.

  • Spider_Pig

    I thought we hadn’t overinvested in property?

    http://www.tvhe.co.nz/2009/06/03/the-myth-of-over-investment-in-housing/