Canadian real estate has been the ideal tax shelter, but that might change soon. Generation Squeeze, a Vancouver-led non-profit advocating for Millennials, released its Solutions Lab report. The CMHC-funded (but independent) study has four suggestions for improving housing affordability. Today we’re going to dive into its most controversial proposal stirring debate — a progressive tax on home equity.
A Progressive Surtax On Canadian Real Estate
A progressive (and deferrable) tax for housing is like income taxes, but with property. The higher the value of the home, the higher the rate of taxes are paid on the additional value. The idea is to add friction to growth, or have society share the wealth created. In this case, they’re suggesting the surtax applies to the home value over $1 million. Don’t have a $1 million home? Then you don’t pay a surtax.
Not clear? Let’s work through a quick example from the organization. In one scenario, they use a surtax of 0.2% on values from $1 to $1.5 million, 0.5% for $1.5 to $2 million, and 1.0% above $2 million. Remember, this is an example. The actual rate would require various impact models from the government first.
Using this example, a homeowner with a $1.2 million home would only pay a surtax on the top $200,000. At the 0.2% rate, that works out to $400 for that year. Pretty easy, right?
Progressive tax rates are lost on some people, though. Let’s do a $2 million example. The first $1 million gets no surtax, just the last half. The first $500,000 above $1 million is taxed at 0.2% ($1,000), and the remaining $500,000 at 0.5% ($3,500). In this case, the owner would owe $3,500 on the surtax. It gets more steep as the home gets more expensive.
The Surtax Is Just A Progressive Property Tax
The home equity surtax is just a progressive property tax, and acts that way. Think of property taxes like inflation. When inflation is too low, there’s little incentive to keep money flowing. As a result, this can create capital hoarding and inefficiency. If inflation is too high, it devalues money too fast, leading to a different kind of inefficiency. But when inflation is just right, it keeps capital moving at a fair rate without big penalties.
Municipalities should be tying carrying costs with incomes. That’s the goal of the surtax, or higher property taxes. If home prices become too cost-prohibitive to own, people no longer buy them. As a result, home prices slow in growth as more productive areas of the economy become more attractive to invest in.
Taxing housing too low can mean high home prices that absorb all investment capital. Take Vancouver for example. The City is one of the most expensive in the world, and happens to have one of the lowest tax rates. A million dollar home pays about $2,920 in taxes in the City of Vancouver. Compare that to Austin, a similar-sized city to Vancouver with a bigger GDP. A $150,000 home in Austin has a property tax bill of $3,415 per year. Obviously people find it more palatable to see home prices rise in Vancouver than Austin.
Regions with higher property taxes provide friction for fast home price growth. In Austin, they have to act quickly if speculators show up and send prices soaring. If they don’t, residents with a home will be priced out. In contrast, Vancouver encourages high home prices, since higher prices have a minimal cost. The only people who get screwed are young people, who don’t already own. Suckers.
Adopting a progressive surtax should provide the same sort of idea. It increases carrying costs, lowering the incentive to drive up home prices forever. As home prices rise, the profitability of allocating more towards housing is diminished. This only applies to homes over $1 million, so don’t expect it to make housing affordable. It should however slow down home prices from soaring too fast.
Very Few Households Would Pay The Surtax
The group chose $1,000,000 to start the surtax because they’re a part of the Illuminati, and it’s their lucky number. Kidding! Just trying to see if you’re paying attention. The real reason is this is high enough to only impact a small share of Canadians. Fewer than 9% of households have homes worth over $1 million. Most of those that do are located in BC and Ontario, largely in Vancouver or Toronto. It’s a good starting point, and unlikely to punish many.
The Ability To Defer The Surtax Is Risky
Sounds good, right? The study includes risks such as political fallout and jurisdictional tax risks. However, it misses out on behavioral risks that result in additional price inefficiencies. In particular, a deferral adds considerable risk to the policy.
A key part of the tax suggestion is a deferral component, so no one is unfairly punished. Unfortunately, this means there’s no immediate impact on carrying costs. Deferrals remove the motivation or connection of tying income to home prices. If it becomes popular, the cost will just be passed to the next buyer.
The deferral component also suggests charging a “fair” interest, citing BC’s deferral program. In BC, property tax deferrals have an interest rate capped at 2%. Suppose the interest paid is 2% (or less), while inflation is 4.5%. A million-dollar homeowner’s liability is devalued, and the stakeholder shares it.
Too wordy? It means taxpayers subsidize the deferrals of millionaire homeowners. If rates are anchored lower for stimulus, it becomes an extra driver of inequality.
Lastly, the liabilities can stack up. If home prices fail to increase while the costs of deferred taxes build-up, it can eat away at equity. It’s not an obvious problem when home prices rise by $20k per month. However, the Bank of Canada (BoC) ideally stops trying to drive record demand for housing. Failing that, their printer eventually runs out of ink.
Taxing home equity sounds like a radical idea. Paying your property taxes? Not so much. In Canada, nearly every tax policy around housing is designed to inflate its value. The property surtax might provide price growth friction, but it also risks making the market more inefficient.
A more perplexing issue here is why have a property surtax, anyway? The BoC’s easy monetary policy has been driving record home sales, but they say low rates are needed. Its research shows low rates drive home prices higher, but they publicly state it improves affordability. Their research shows low rates increase inequality, but the BoC says “low for long” might help. Let’s keep driving record home sales, home prices, and create more inequality. But we might be able to improve it with a few more policy layers? It seems like like just raising interest rates would fix a lot of the issues around housing affordability.
The solution is like asking someone to punch you in the face, to stop someone else from punching you in the stomach. It might work. After all, it’s more difficult to reach your stomach if you fall over. But why not just directly address the person punching you in the gut?