IN BUDGET 2012, Minister Noonan announced a range of measures designed to stimulate the property market. Most were largely unexpected changes to the tax treatment of property in Ireland. But will we look back at these measures in five years and smile or shake our heads?
Two principal moves in the Budget have the feel of desperation about them: a philosophy of “if we can steal demand from 2014 and cram it in to 2012, we will”. For example, the Government has increased Capital Gains Tax from 25% to 30%, but made an exemption for commercial property purchased in 2012 and 2013 (once it’s held for seven years or more).
Would-be residential property purchasers have even less time to move: tax relief for owner-occupiers has been extended for 2012 but is cut after that. The Mortgage Interest Relief scheme will continue into 2012 and at an increased rate of 25% for first-time buyers and 15% for other (residential) buyers. From 2013, there will be no mortgage interest relief.
The fact that mortgage interest relief for homeowners who bought between 2004 and 2008 (i.e. the bulk of those in negative equity) has been increased to 30% is an almost entirely unrelated measure. The move on bubble-era mortgages is one about alleviating the debt burden (if only slightly), rather than one about stimulating demand (if only temporarily).
To see this, the graph below shows the monthly mortgage payment in 2014 for the same property (the average house) bought in different circumstances. The first two are the 35-year 100% tracker mortgage, enjoying a 2% interest rate in 2014 and with the old 20% mortgage interest relief [MIR] and the new 33% mortgage interest relief. The monthly mortgage repayment for that boom-time buyer will fall from about €970 to just under €850, a welcome relief to boom-time borrowers no doubt (albeit one that has to be funded by other taxpayers or more borrowing).
Mortgage repayment in 2014 for various mortgage set-ups on the same property
The third bar shown is the 2012 buyer, where prices have fallen by 50% and instead of a 100%, 35-year, tracker mortgage, the borrower faces a 90% LTV, 30-year variable interest rate of 5% and mortgage interest relief of 25%. Their repayment is just over €650. The final buyer (say 2014) enjoys prices 60% below peak but no mortgage interest relief. The state has imposed a maximum loan-to-value of 80% but other than that, she enjoys the same borrowing circumstances as someone in 2012: 30-year mortgage and a 5% variable rate. Her repayment is lower again: just below €650.
The preservation of tax-incentive properties (such as Section 23) in Budget 2012 where annual income is less than €100,000 is basically cut from the same cloth: a debt burden measure, not a market stimulant. (The generosity shown to these investors will be funded by a surcharge on those tax-relief investors with an income of more than €100,000, who are now subject to a surcharge of 5%.)
Stamp duty on residential property was reduced to 1% (below €1,000,000 and 2% on the balance) a year ago. That has been preserved this year and effectively extended to commercial property, where a flat rate of 2% now applies.
An economically literate medical professional will know this type of behaviour immediately: it is addiction. Ireland is addicted to property. And not in the romantic historical we way like to think… “It’s a whole post-Famine thing. Sure didn’t you watch The Field? We could never rent long-term here.”
No, Ireland’s addiction to real estate is quite modern and quite easy to explain. A 2004 paper in the Central Bank’s Financial Stability Report highlighted that actual cost of owning housing was negative for the bulk of the period 1976-2003. The most significant contributory factor was that the capital gain went untaxed: with any other asset, if you bought it at £10,000 and sold it 20 years later at £110,000, there would be tax liable on the £100,000 profit. If capital gains tax of 20% had applied to housing, this would have cooled down house prices as the war-chest you bring to your next deal is £80,000, not £100,000.
But it’s not just untaxed capital gains in isolation. Ireland has the most generous tax treatment of property in the developed world. A 2006 report by the OECD highlighted this: Ireland was the only country that both allowed owner-occupiers tax deductions for mortgage interest payments AND did not tax property values, capital gains or imputed rents.
In fact, the only tax there was on property was stamp duty. And that’s now effectively gone (or at least down to 1%). And the Government has extended tax relief, an integral part of the problem. After an intervention-fuelled bubble, the response has been to intervene more. This is just like the addict who says “Honestly, if I can get just one more hit, then I’ll be fine. Honest.”
The litmus test for any measure is whether it creates a healthier property market in the medium-term, not in the short-term. As is the case with any textbook bubble, there is a real danger that property prices will overshoot on the way down. On its own, that might not sound too bad if you don’t own property right now. However, overshooting means that prices have to recover at some point and the way people form their expectations about house prices, extrapolating from the past, means that overshooting dramatically increases the likelihood of another bubble down the line.
But just because there is the danger of overshooting does not mean any measure will do. The two key ingredients in the property market are confidence and finance. Neither is in abundant supply at the moment, but making borrowing unsustainably cheap – by bullying banks about the variable interest rates and then offering tax deductions on those rates – is not the way to get around this. The solution lies in the rather more boring rebuilding confidence and finance.
Offering borrowers certainty is one solid way of rebuilding confidence. General macroeconomic confidence aside, this should be certainty about how much they can borrow (a legal maximum loan-to-value would do the trick), and what their tax burden will be. On the latter, the worst possible idea is to introduce a €100 flat charge and then “see where it ends up” in five years’ time. A far better idea is to announce early in 2012 what the property tax burden will be from 2017 into the future and how the country is going to get there.
But borrowers are just one half of the equation. Lenders also matter (particularly if the taxpayer owns the bulk of them). Pleading in one ear with the banks to lend more is pointless if you’re shouting at them in the other ear to stop lending (which the Government is doing with the stress tests which require them to deleverage, i.e. lend less). It’s even more pointless if you’re also giving them a clatter across the top of the head for trying to get their mortgage interest rates back to sustainable levels (probably about 6%).
A time of crisis is, as I’ve said before, a time of opportunity. With so many in negative equity (i.e. no capital gains ever likely), never has there been a better time to introduce full capital gains tax for residential property and level the playing field between productive investment and property investment. Similarly, a silly if affordable €100 charge per household is probably the best setting in which to introduce a fair and efficient annual property tax. The huge parliamentary majority enjoyed by the current government means they have the power to wean Ireland off its addiction, generating greater tax revenues in the process, once and for all.
Ronan Lyons is an Irish economist based at Oxford University, and runs the Economic Research unit at Daft.ie. You can read more articles on his blog.
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