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Replacing the current stamp duty or conveyance duty on the transfer of property and the narrow base land tax with an annual property tax would be a fairer tax and it would increase the productive use of available property. The reform would provide Australian state (and territory) governments with a more stable and predictable source of revenue.

To reduce tax redistribution effects of the reform relative to the current taxes, and to enhance political acceptance, alternative ‘details in the design’ of the reform proposal are described and evaluated. These include the tax base, the tax rate and transition options for the replacement property tax.

Why Reform?

Stamp duty on the transfer of housing and commercial property is paid only when property is sold and bought. The duty can be avoided by continued ownership.

The stamp duty provides an additional cost and barrier to property owners shifting their choice of property when circumstances change, including location of employment, family demographics, incomes and business opportunities. Additional reallocation of the ownership of residential and commercial property from lower value to higher value uses and users would be a key efficiency gain in replacing the current stamp duty with an annual property tax which is independent of property transfers.

The transfer tax is extremely unfair. Those who change property ownership more frequently than the average pay more tax over their life cycle than those who hold onto the same property for longer than the average. Yet, both benefit from state provided education, health and so forth funded by the taxes. For those who hold properties for around the average of between 15 and 20 years, the reform proposal means no change in tax paid over the life cycle, and a more productive economy.

Property asset prices are unlikely to change with an aggregate revenue neutral reform package (see appendix of my working paper for details).

Tax Base and Tax Rate Options

As is often the case with tax reform, trade-offs will be required across efficiency, equity and simplicity; assuming an aggregate revenue neutral reform.

National productivity gains and simplicity point to a land tax base and a flat rate for the replacement annual tax for all types of property. On the other hand, such a reform will have redistribution effects given the replaced stamp duty has an improved property tax base and a progressive rate schedule, and the current land tax on commercial and rental property has a progressive rate.

Redistribution effects of the reform package relative to the current taxes can be reduced by using improved property as the base rather than land, and/or a progressive tax rate schedule rather than a flat rate. Equity should be considered in the wider context of all taxes, including the progressive income tax. Relative to a land base and flat rate, either an improved property base or a progressive rate schedule induce some distortions to decisions, but lesser distortions with much smaller costs than the current taxes to be replaced.

Arguably, a revenue neutral reform package with similar equity effects would involve a lower rate for owner occupied property for which only stamp duty is replaced and a higher rate for rental property and commercial property for which both stamp duty and the current land tax would be replaced. Also, the turnover rate is higher for rental and commercial property. Rates for the annual property tax could vary between the states and territories for reasons of revenue and equity.

Some Transition Options

A one-off switch from the current taxes to the replacement annual property tax can be seen by many as a form of double taxation for recent buyers who have just paid stamp duty and then face the replacement tax. Several transition options to reduce the double taxation are available.

One option is a revenue neutral gradual phase down of the stamp duty rate to be replaced and phase up of the new annual property tax, with the Australian Capital Territory (ACT) example of a 20-year adjustment period. Another option is to provide credit for recent payment of stamp duty as a credit against the annual property tax, for example 50 per cent for last year, 40 per cent for two years back, and zero after five years. The former has the advantage of revenue neutral, but it takes many years to reap the efficiency gains. By contrast, the credit option reaps efficiency gains, but comes at a short-term revenue cost that could be offset by a slightly higher annual property tax rate.

Provision should be offered for those with liquidity problems to carry-forward the replacement annual tax as now is available for local government rates. These people include the ‘asset rich and income poor’ and those with unexpected health problems and unemployment. Funds carried forward would be indexed to the government borrowing rate for revenue neutral and equity.

Concluding Observation

A number of alternative details or design options in an annual property tax replacement for the current unfair and distorting stamp duty and narrow base land tax are available. The political and social choice among the options requires evaluation of the trade-offs of efficiency gains and simplicity versus the redistribution effects of the replacement option relative to the taxes to be replaced.

 

This blog post is based on John Freebairn’s recent working paper, ‘Reforming state taxes on property’ (TTPI Working Paper 6/2020).

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