The NBR reports research by Westpac economists showing that cutting income tax will lead to lower house prices:

A reduction in the top rate of tax to 30 percent would see house prices fall 13.6 percent and rents rise 6.8 percent, the Westpac economists estimated.

This is because of our fairly generous rebates for the losses from investment properties:

Landlords received a tax rebate for losses on their rental properties at their marginal rate of income tax. If the marginal rate of income tax changed, so would the size of the rebate.

If I had the time I’d work out what the actual impact on the government’s books would be – if anyone has the figures, please drop a note in the comments. Also, an interesting note on land tax:

A land tax of 0.5 percent was estimated to cause house prices to fall 4.4 percent and rents to rise 2.2 percent. The fall in house prices was based on the median house, for which land made up 40 percent of the value. Land values were estimated to fall 11 percent.

Put them together, and you get:

Under a land tax of 0.5 percent combined with income tax of 30 percent house prices would fall 16.9 percent and rents rise 8.4 percent. The Westpac economists said such a combined approach was “politically plausible”.

Politically plausible, but not necessarily the best scenario for New Zealand. If Australia’s federal government cuts their business tax rate, New Zealand businesses will be left in a less competitive position internationally, and will be more likely to move to Australia, taking their profits and jobs with them. We ought to be aiming for a 25% business tax rate in 2010 – 2011. Because, as Bill English used to say “Us Kiwis can beat those Aussies!”.

Interest.co.nz has the details of papers put up by Motu economist Arthur Grimes and Deloitte partner Mike Shaw to the Tax Working Group’s final conference in Wellington on Tuesday, detailing the pros and cons of a land tax. Here’s my responses to the pros and cons:

Pros:

* Brings in property to tax base. NZ has relatively low property taxes compared to other countries.

This is certainly true – the large burden of our tax base is on low-middle income wage earners. Spreading that tax burden will help the economy no end.

* Progressive tax hits richest hardest and hits those with most children least, as they have less land

Goodo, if you’re into that sort of thing. Not really much of a pro.

* Hits Maori and Pacific Island communities least

Again, good if you’re into that sort of thing – wonder how a land tax would affect Maori land though? Would National do a deal with Tainui or Ngai Tahu.

* Likely to cause rental property investors to rethink

Which is of course one of the problems we have – the $213 billion invested in rental property is 5 times what we’ve got invested in stock market. Because of LAQCs, this investment stock represents a tax “loss” of $500m (in credits). Why not just abolish LAQCs then? Probably not an election-winning strategy, although $500m could easily go towards lowering the top tax rate in compensation.

* Very cheap to administer

Excellent – all those tax law students hoping to work on land tax law should therefore re-think their careers at the IRD…

* No avoidance or evasion

No wine boxes then. Again, tax law students – start studying something useful.

* Land is immobile so no danger of assets ‘fleeing’ tax

Also good – one thing we struggle with in New Zealand is keeping our businesses onshore. Lowering company tax will help that.

* Per hectare threshold reduces hit on farmers and foresters

This would also be good – it would make little sense to cut company tax, then load more tax on productive sectors of the New Zealand economy – agriculture and forestry.

* Threshold cleaner and easier to administer than exceptions

Again, this is a pro – a “clean” tax cuts bureaucracy, and makes the IRD a little less bastard like.

* Discourages land-banking property developers from sitting on land

Good – that should mean lower house prices for first time home owners, if you’re into that.

* Less borrowing for property investment and lower overseas debt

Whoah there… less borrowing for property investment doesn’t mean less borrowing everywhere. It does mean that what is borrowed could be put into productive assets though, but this isn’t really a pro.

Cons

* 0.5% land tax could reduce land values by as much as 15%

Ouch. Pretty much a big election loser there… so that pretty much rules out the Government.

* House prices (land and buildings) could fall by 4-8%

Double ouch. Perhaps we could make the Grammar zone cover all of New Zealand to compensate?

* House price falls depends whether tax is deductible, level of real interest rates, other local body rates

Owww… lower house prices mean lower rates Bills. That’s actually a pro in my book.

* Retired households hit hardest

An incentive to move into rest homes perhaps? Here’s a sharemarket tip: if land tax is introduced, by shares in Metlifecare, Ryman, BUPA and Oceania Group. Not really a con in my books.

* Young homeowners with little equity, low discretionary income hit relatively harder

Now this is a big con, particularly at a time when housing affordability is down. However, is it really that important that everyone own their own home?

Overall, I would say conditionally that the pros of land tax outweigh the cons. I say conditionally because:

• The Government ought to reduce income and business tax and the same time as introducing any land tax – not using land tax just to generate more tax revenue. That means we’re still going to have to cut spending to sustainable levels.
• It’ll hurt house and land prices, something many small businesses depend on for equity, and “mum and dad” investors for their retirement. Although that is a long-term pro, as it will encourage New Zealanders to stop depending on housing to become wealthy, and put their capital to much better use.

Update: Big fail on rates there. Mea culpa. The issue is whether land tax increases average house prices and push up rates. So again, likely to make the government unelectable.