With everything back on the table, what impact would a GST hike have on property?
I’ve been wondering what would happen if the government hiked the GST. Specifically, what impact would it have on the property market?
The new Turnbull government has set their sights on tax reform, and put everything back “on the table” (must be a big table) including raising the GST.
It’d be a gutsy move, but maybe it could be done. But what would it do to property prices?
Instinctively, you’d think it wouldn’t be great. There’s enough head-winds facing property at the moment. A tax-hike is the last thing we need.
But the truth is probably more complicated than that, and it’s true that a lot probably depends on what adjustment packages they bring in to help manage the transition.
I mean a tax hike on it’s own would hit households right in the back pocket, and that’d obviously take a bit of steam out of the housing market. But you can almost guarantee that a GST hike would be balanced out by income tax cuts or something else or the other, so the impact there isn’t entirely clear.
To my mind, the most likely channel of influence is through new house prices. New houses are liable for GST, so a GST hike goes straight to the price.
If we assume the cost of a constructed detached home is something like $300K (excluding land), then a 5% increase in the GST (from 10% to 15%) would add about $15K to construction costs.
That’s not nothing.
If we assume land costs $200K, then we’re looking at a 3% increase in the final price of bringing a new home to market.
This is kind of where it gets interesting though. Because the GST doesn’t apply to existing housing.
So while new housing has gone up by about 3% due to the GST, existing housing hasn’t.
But new housing and existing housing live in the same market. They are substitutes, more or less. You can live pretty much just as well in an old house as a new house.
And so I would say that the cost of new housing is one of the main factors influencing the price of existing housing.
And part of the reason why we’ve seen such strong price gains in existing housing over the past twenty years or so is that new housing supply has been held back.
We haven’t been building enough new houses – mostly because planning restrictions have tied up land, which has pushed land costs up.
And with a shortage of new housing coming to market, the housing market overall has been held in shortage, and the competitive pressures that this has created have bid up prices.
Price gains in the major cities have been in large part driven by a shortage of cheaper new housing coming to market.
And so if the GST goes up, the most likely scenario is that as the price of new housing goes up, more people will be attracted to existing housing.
Existing housing gets bid up, probably by a similar degree to new housing.
And so the most likely scenario is that a GST hike will increase existing house prices by 3%.
This will happen even though existing homes and existing home owners have not been directly affected by the GST.
For an existing home owner, it’s a windfall benefit. You will get all the compensation and adjustment perks that come with the GST hike, plus you’ll see 3% capital gain in your house.
You can’t quite lock that in though, because markets are complicated, and influences get messy over time.
Say for example house prices have started cooling, thanks to a tighter credit environment. If developers don’t think that the market will wear an increase in new house prices, they might decide they just have to absorb the GST hike themselves.
A GST hike in a market that is clearly cooling would be tough for developers. It’d hurt their margins.
That said, given we’re likely to be given plenty of warning about the hike coming in, they may get a big lift in the short term.
When the GST was originally introduced on 1 July 2000, people had plenty of warning that prices were about to go up by 10%. In anticipation we saw a lot of pull-forward of construction activity in the 12-months prior.
Dwelling commencements in the 99/00 financial year increased by 15% to 172K, before falling to a record low of 115K in 00/01. The year after, in 01/02, commencements rebounded back up to 165K.
So despite the chopping and changing, the commencement average over those three years was 150K, which was in line with the long-term averages.
From this it really looks like the GST didn’t affect overall activity as such, but had a big impact on the timing of that activity.
However, following the crash in 00/01, the Howard government introduced the first home owners grant to juice the construction market, and the rest is history.
Have the governments since Howard learnt that lesson? It wouldn’t surprise me if they hadn’t.
And so it wouldn’t surprise me if we saw something similar – some kind of concessions or grants on the demand side to kick things along a bit.
And so if there hasn’t been long-term damage to construction, it would just be a bonus for the new housing market – especially developers.
Anyway, this is all just a thought bubble until we know what is on the table, and we have a better sense of where the market is at.
And without taking a view as to whether the government should increase the GST, there are at least a couple of scenarios I can see where an increase in the GST ends up being a positive for property.
Should Turnbull increase the GST? What would it do to the housing market?