Stamp Duty Reform: Benefits and Challenges

Executive summary

Property tax reform is gathering momentum. The NSW government recently published a progress paper providing more detail about its reform intentions including the results of its public consultation process. The next step for NSW is to assess feedback on the progress paper and provide an update later in the year. It now joins the ACT as the only two jurisdictions in Australia intent on replacing transfer (stamp) duty with land tax.

Against this backdrop it is timely to take a step back and reassess the economic benefits and challenges of transfer duty reform using the most recently available data[1]. The report also discusses the equity distortions created by transfer duty and why they are an important consideration.

This report highlights the distortions that transfer duty imposes on mobility and prices in the housing market. It also discusses the challenges faced by jurisdictions wanting to phase it out in preference of a broad-based land tax using a model that analyses the link between dwelling prices, the number of transfers and transfer duty revenue.

Key findings

Mobility will increase if transfer duty is reduced or removed.

• Transfer duty imposes a high cost on households that move residence. For example, a household that bought the Sydney’s median priced house four times over the past 20 years would have paid more than 10 times the amount of duty than a household making only one purchase at the start of this period.
• Australian jurisdictions are 40% more sensitive to duty than many European OECD countries and would gain substantial benefits from the increase in mobility removal of duty would provide, including more efficient use of housing stock and improved labour productivity.
• Removing transfer duty in favour of a broad-based land tax will likely lift dwelling prices in the short-term as the removal of transfer duty is capitalised into prices. However, if lenders fully capitalise the cost of the replacement land tax into loan serviceability criteria, the price impact from removing duty may be negligible. Data shows dwelling prices and the number of transfers both rose in the ACT during the transition period.

States and territories with the highest effective rate of transfer duty have the most to gain from reform.

• VIC has Australia’s largest effective rate of transfer duty. In contrast, the ACT has the lowest effective rate of duty after nearly a decade of transitioning to a broad-based land tax. Consequently, the economic loss from transfer duty in the ACT is the equal lowest of any jurisdiction with the NT.
• Adjustments to transfer duty regimes by the states have not kept pace with rising house prices, resulting in a revenue windfall that is difficult to replace. Surging house price growth without adjusting the duty regime results in stronger revenue growth and a higher effective land tax than necessary. In NSW, a 5% per annum average rise in dwelling prices over 20 years would generate 2.2 times the amount of duty revenue than if prices had risen by only 2% per annum.

Jurisdictions wanting to reform their property tax regime by replacing duty with a broad-based land tax face several challenges.

• The aim of transitioning from transfer duty to land tax is not to increase revenue per se, and this paper demonstrates the transition can be achieved in a revenue neutral way.
• A short phase out period costs taxpayers less and provides more certainty about the revenue to be replaced, while a long transition costs taxpayers more with less revenue certainty.
• Home buyers purchasing property just before the reform commences may need to be compensated and this could cause a large fall in revenue.
• Broadening the tax base also means an additional tax burden falls on households who own their home with no mortgage and investors, many of whom probably paid duty many years ago. A broad-based land tax imposes an additional cost on households that on average would be around 75% of current municipal rates. However, this will be offset by the likely positive short-term impact on prices from removing duty.
• Phasing in a broad-based land tax using just new transactions would take on average around 23 years provided all new buyers decided to pay the tax in preference to transfer duty assuming 4.4% of properties turnover each year.

A range of options are available to policy makers to help speed up any transition and to help address equity issues raised as part of the reform.

• A short phase out period can help by limiting the impact of house price growth on the cost of transition. For example, a substitute revenue neutral broad-based land tax would need to be 0.02ppts higher in NSW (0.45%) under a 20-year transition, assuming 5% per annum price growth, compared with a shorter 5-year transition (0.43%).
• Crediting back those households who recently paid duty over at least a 5-year payback period will not result in a cut to the substituted land tax revenue.
• Asset rich and cash poor retirees could be allowed to defer some, or all their land tax liability until the property is sold.
• Retirees and low-income earners could also be paid a rebate on the land tax liability. A similar rebate is already in place to support these cohorts meet municipal rates expenses.
• A progressive replacement land tax could be designed with the distribution of duty in mind when estimating it on the unimproved value of the land.
• The cost to landlords of a new replacement land tax is unlikely to be passed on to tenants, but it may be legislated to make this unlawful during a rental agreement. Property investors typically have a relative short property ownership period compared to owner-occupiers and the additional turnover generated by the removal of transfer duty may disrupt rental agreements and tenure for tenants if some protection is not put in place.

[1] The analysis in this paper is primarily focused on residential property.