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?
Budget 2012: stealing from the future?
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 addiction by any other name…
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.”
Making sure we’re fixing, not getting another fix
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.
11 Comments
Ronan, you’re clearly looking for a clatter across the top of the head writing this kind of stuff. You want to introduce proper, sustainable taxation with respect to property? Sure why not go the whole way and advocate the banning of further one-off properties, the taxing septic tanks and charging for water. I know you reference The Field, but have you ever watched it? Property, the opium of the Irish masses … and you want to tax the collective fix. Shame on you! Sustainable taxes is the kind of nonesense those sober Germans do.
A clatter across the top of the head would mean someone (perhaps even someone with power) paid attention.
Yes, it would help build confidence in Irish property if a realistic long term property taxes was introduced and a big majority of parties in the Irish parliament agreed and voted for it.
What is introduced so far is not believable long term. It is to weak and by far not enough. Not believable long term.
Further, I would rather go for a property in 2016 at 60 % below peak price than a 50 % below peak price in 2012 with a doubtable tax deduction exception.
So we are waiting…and we will keep waiting, and keep our foreign direct investment in our pockets, until Ireland stop its property-fix and a believable property market are allowed to find its own feet.
is the “new 33% mortgage interest relief” a typo?
I read in the paper that the central bank was introducing limits on ltv and maybe banning variable interest rates, will this help or hinder the market
because the majority of those who have a mortgage in the 04 to 08 period are on tracker rates, the increase in mortgage interest relief doesn’t make too much of a difference and variable rates are quite low so not too much help for those either
Because the new loans issued today are for a small value, again I would say it won’t make a whole lot of difference to someone buying today or not
cost to the government can’t be too much, can it?
Hi kildon,
Yes, 33% is a typo, well spotted! Don’t worry the calculations are based off 30% relief.
My belief is that done well, both limits on LTV and banning variable interest rates are extremely good ideas, although there is by no means any unanimity about this, see for example:
http://www.irisheconomy.ie/index.php/2011/12/15/european-commission-report-on-ireland-december-2011/
A limit on LTV “done well” is one that doesn’t get swept away the next time house prices start increasing; there must surely be something short of a constitutional amendment that will do this! A ban on variable interest rates “done well” would be a requirement on banks to borrow long to lend long: if a bank wants to lend €200m in mortgages this year for 30 years, it should be required to go off to capital markets and borrow that amount over 30 years (and not 3 years). Thus, the default product is switched from a variable to a fixed. “Ban” might be too strong a word, but Ireland in the eurozone needs the protection from the effect on consumption of inappropriate interest rates that this would offer.
one of the most important things which needs to be done is to limit the borrowing power of individuals. In France, there is a maximum percentage of your NET income which a mortgage can be. This protects both the banks from being reckless and individuals from overstretching themselves. Of course, this doesn’t suit the developers or other vested interests, so will probably never happen here.
@Jeremy
In a fixed interest rate scenario, percentage of net income is very useful. In a variable interest rate scenario, it is less so – technically, net affordability in many cases was excellent right the way the bubble, but only because interest rates were unhealthily low.
Thanks for the comment,
Ronan.
@Ronan,
While I agree on the need for a property tax (most western nations have one) I disagree on your comments regarding a capital gains tax; few countries apply such a tax to principal private residences (PPR’s), for a very good reason.
The reason is that it severely inhibits labour mobility. Supposing I bought a house in Limerick in 1997 for 100k. Now say I’m offered a job in Waterford; I must either become a renter again in late middle age, or else I sell my Limerick house for 250k and buy a similar one in Waterford for the same price. The government would charge me 45k CGT on my supposed ‘gain’ of 150k. So I stay put. In other words, CGT on PPR’s becomes (in a normal environment of long-term moderate inflation) a massive transaction tax, far worse than stamp duty ever was. This would freeze the second-hand market as well as inhibiting labour mobility. Recent purchasers wouldn’t be able to move either, due to negative equity, so everyone would be stuck.
One last point: you speak about ‘levelling the playing field’, but there is a fundamental difference between a PPR and a rental property. A rental property investor can dispose of a property and reinvest the proceeds in a better-performing asset class, or just spend it on botox. A PPR, when sold, is almost always replaced (as a matter of necessity) with a purchase of another PPR; the seller doesn’t realize any net cash on the sale. This cycle continues until death, where the taxman can justifiably take a cut of the final accumulated capital gain via inheritance tax.
Hi Effo,
Thanks for the comment. I’m not unwavering on the CGT point but what you speak about towards the end applies both way. Because no net cash is realized when owner-occupiers switch properties, the price level of property will adjust down to reflect any CGT. The overall effect might look like it reduces gross wealth in an economy (all houses would be worth slightly less in this scenario) but it also reduces gross borrowing, so it’s about reducing balance sheet effects, not really net wealth.
Also, I’m not talking about a 100% CGT, so if you make a profit on a house you still have a war chest to bring with you, just a slightly smaller one (but so does everyone – hence prices adjusting downwards). Distinguishing between rental and owner-occupier properties is a dangerous game to start playing as it splits the market. For full labour mobility, you want people to be able to rent or buy any broad class of property in any part of the country.
R
Hi Ronan,
When it comes to labour mobility, it is not useful to compare an owner-occupier with a property investor. The valid comparison is between an owner-occupier who moves house for employment reasons and one who chooses not to move. In a CGT environment (or a high stamp-duty environment), the latter is clearly better off than the former. This introduces ‘friction’ to the labour market, and makes it less likely that people are matched to jobs in the most economically efficient manner.
You speak of a ‘war chest’, but in a like-for-like house swap, like the example above, the seller doesn’t have a ‘profit’ that allows him to trade up to a better house; in fact he would need to borrow extra money to pay the CGT just to maintain the same size/value of house.
Maybe we should just throw our keys in the letterbox and head for the hills. Ppl are struggling to pay bills and buy food and were supposed to come up with money to pay property tax. This is crazy!