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For taking our nation’s most significant step to date in the shift from stamp duty to “property tax”, NSW Treasurer Dominic Perrottet is to be applauded.

For leveraging the impact of COVID-19 to that end, the NSW Treasurer has applied a political nous that is evident throughout the proposal he has brought forward. He has raised the bar for other states to follow.

However, many of the political compromises deemed necessary to get this tax reform transition on the road have long and short term consequences, economic and political both. Leaders in other Australian jurisdictions, feeling pressure to follow Perrottet’s lead and reform their own land tax regimes, would do well to consider those consequences before making their own moves.

Land tax (which Perrottet labels “property tax” to distinguish it from pre-existing NSW ‘land tax’) is all but universally accepted as economically and socially preferable to stamp duty, and the switch to it has long been advocated in this newspaper. Land tax is more equitable, more productive, more efficient. Reasons for supporting its adoption do not need reiterating.

Perrottet’s proposal is bold and brave. The idea of taking on additional debt by shifting from stamp duty to land tax in the current low interest rate environment is a good one. It stimulates by putting money in the hands of property buyers at a time of low interest rates. And the pay-off for the state taking on additional debt will be a better system in the long run.

The well-promoted long and public consultation period on the proposed tax reform is to be commended. Experience shows that reform instituted through such a transparent process is better designed, more effective and likely to endure.

This consultation may prove crucial in the long run, as some aspects of the proposed land tax are troubling.

Perrottet’s proposal is unnecessarily and inefficiently complex. For a land tax to do a better job than stamp duty, it must be well-designed. In matching the revenue raised by the unfair inefficient stamp duty it replaces, it should be applied at the lowest possible rate, to the broadest possible amount of land. It should not distinguish between how the land is used nor who owns the land.

It should not have a complicated system of tax-free thresholds or different rates. It should tax all the wealth held in land, not just some of it. Perrottet’s proposal fails on that count.

However, the most worrisome single design flaw in Perrottet’s proposal is the slow opt-in transition to the new tax. This is politically hard, administratively complicated, inefficient and unfair.

The slow transition process adopted in the ACT (where the economic benefits of a land tax are already evident) has seen land tax return as an issue at all subsequent elections.

This slow transition design flaw is to be instituted with an ‘opt-in’ system – allowing individuals to choose between stamp duty and land tax until some unspecified time in the future when the transition is completed. Yet this runs counter to individuals’ expectation that government put in place the best possible system, especially when the choice is difficult.

Asking people to choose which tax they want to pay in relationship to the most important asset that they will ever buy, one they may hold for 40 or more years, goes against good policy design.

People may ultimately have made the “wrong” choice because of future circumstances beyond their control. This will make for unhappy taxpayers and political repercussions. Better if government itself opt for the best system (a broad tax on the unimproved value of all land) and apply it simply and fairly and universally.

The “opt-in” transition paradoxically will in some cases worsen the “lock-in” effect of stamp duty it is intended to undermine. A landowner not paying any tax at current abode has the same incentive (as under the stamp duty regime) to remain in situ and avoid the tax.

Furthermore, “opt-in” is patently unfair. Many expensive homes will not trade in the near future and so their wealthy owners will pay no tax. Young families who opt-in will pay land tax each year.

Stamp duty currently accounts for about one-quarter of state revenue and pays for key state services such as hospitals, schools and bushfire prevention and response. Land tax will take up this role. Why should some people pay for these things and others not? This has always been a lead argument against stamp duty and for a broad-based tax. The unspecified and therefore probably long transition period of the opt-in model still leaves one group who pays for it all and another who pays nothing but receives the benefits.

Running a dual system is expensive, complicated and adds inflexibility. Imagine trying to adjust the rate of land tax mid-transition.

The best solution is to apply the same tax regime to everyone. A broad-based tax on the unimproved value of land applied to all land irrespective of use. Combined with a payment deferral system for asset-rich, income-poor households.

The flawed opt-in system, if politically unavoidable, would do less damage with a fixed-end time limit. After that point is reached, all land is switched to the land tax system. Perrottet’s proposal would be better to incorporate this.

However, from an economic perspective, the best outcome is achieved by moving all land onto a land tax system in one fell blow. I suspect the NSW Treasurer is aware of this. For the first few years after its swift and general implementation, such a regime could have low taxes, with increases scheduled to achieve revenue neutrality in five years. This would ease the tax burden on economic activity during the post-pandemic recovery and give people time to adapt. Overall, its effect would be stimulatory.

To offset the naysayers, this approach could incorporate a land tax credit for those who have paid stamp duty in the last, say, seven years. The credit would be worth 100 per cent of stamp duty paid yesterday, with a schedule declining towards zero backwards over time.

Moments where genuine tax reform is possible are rare. Once new systems are put in place they are hard to change. We need to get it right.

 

First published at the Australian Financial Review on Wednesday 18 November 2020.

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