Evaluation Of Taxation Of Return Assessment Answer

Answer:

Introduction

This report discusses effect of taxation on return from property holding in an economy. The economy Effect of taxation on equity and housing prices are analysed. Taxation on property return affects the economy. Property tax is a source of income of government. Hence, if property tax increases, tax revenue increases. Property tax is regarded as cost of capital (Norregaard 2013). When, government increases the property tax, cost of capital increases. Therefore, reduction in property tax increases the capital investment. As the capital investment increases, industry develops and the more jobs are created. On the other hand reduction in tax revenue decreases government spending. The mixed effect of property tax on economy is discussed in this report in the Australian context.

Property tax depends on the value of the property at a certain point of time. Different types of property valuation methods are used in different jurisdiction. Decrease in property value reduces the tax bill. Furthermore, property tax bill varies according to the usage of property such as residential use, commercial use, vacant land etc. In some areas the real estate tax bill is calculated on current value (Burkhauser et al. 2015). Therefore, the tax bill changes as the value of the property changes overtime. Generally, local government collects property taxes. Hence, property tax law is formed based on local economic structure.

Evaluation the system of taxation on property holding returns

  • Assessment of taxation on owner occupied property

Land is considered as property in the economy. As land is inelastic in supply, effect of price on supply is low. Therefore, imposing tax on land does not impact much on behaviour of land suppliers. In case of owner occupied land, it is easier to identify the actual tax payer. The return on land is considered as economic rent. Land tax in Australia is charged to the owner of land. As opined by Jacobs and Berry and Dalton (2013), the utility of house is different from the land. Land taxes differ across different states of Australia.


Land Tax in New South Wales

Tax Base, (AUD)

Tax rate 

Up to 412,000

AUD 100

412,000 -2,519,000

1.6% on band over ADU412,000

Over 2,519,000

25 on all value over ADU 2,519,000

 

Land tax in Victoria (2009-2014)

Tax Base, (AUD)

Tax rate 

Up to 250,000 

0%

250,000 – 600,000 

0.20% on band over 250,000

600,000 – 1,000,000 

0.50% on the band over 600,000

1,000,000 – 1,800,000 

0.80% on the band over 1,000,000 

1,800,000 – 3,000,000 

1.30% on band over 1,800,000 

Over 3,000,000

2.25% on all value over 3,000,000

 

Land tax (2014-15) in Australian territory for residential properties

TAX BASE, AUD

TAX RATE

Up to 75,000

0.41%

75,000 – 150,000

0.48% on band over 75,000

150,000 – 275,000

0.61% on band over 150,000

Over 275,000

1.23% on all value over 275,000

Figure:  Land Tax rate in different territory of Australia

(Source: Ato.gov.au, 2016)

Unlike land, a house gives service to the occupiers. Thus, VAT can be imposed on the services of house. In the view of Whiteford (2014), the value of houses fluctuate overtime just like share values. Hence, the home ownership can be considered as saving. As the owner occupied property has characteristics of both investment and consumption, it needs to be taxed from the two ends. If there is decrease in value of land, the land owner may suffer from capital loss, if the land tax would have been declared before. However, in practical, the value of land is non-decreasing as its supply is naturally fixed. Hence, use of land is not likely to be changed after windfall loss. Slack and Bird (2014) cited that, there is externality effect on owner’s land. If there is external development besides a land, the value of the concerned land increases. In this case, the value of the land increases due to community efforts rather than individual effort. Tax collected from the land thus includes the benefits accrued by the landowner.

Assessment of taxation on investment property

Investment property is the property, which is purchased in the motive of profit earning. Rental income is a source of income from investment property. Rental income is taxable at the time of receiving it during a given period. Sale of rental property comes under capital gain or loss. Capital gain on investment property is liable for tax. In Australia, the investment property, building renovation due to profit motive and property used in business are taxed as capital gains tax or goods and service tax (Australia I.C.O.M.O.S. 2015).

During the calculation of tax on the capital gain, cost of financing the acquisition and end use of the property needs to be considered. The capital gain from selling property gets tax exemption if gained amount is reinvested in an asset. The amount of tax depends on the time of selling investment property. During valuation of capital gain, difference between initial purchase price of the property and selling price renovation cost and transfer costs are considered (Coffee et al. 2013). Capital gain tax in Australia is calculated by using CGT method and Indexation method etc. Net capital gain is calculated by subtracting total capital loss and any CGT discount from total capital gain during a year (Ato.gov.au, 2016). In Australia, the capital gains tax is charged at standard income tax rate.

In the capital gains tax method, capital gain is calculated by deducting cots base from the fair market value of property. The cost base includes acquisition cost of property, incidental expenses of purchase and sale of property and property improvement cost. Cost base cannot be calculated if the property is sold within one year of purchase (Elia et al. 2013). The property indexation method depends on date of purchasing property. There are two criteria of measuring capital gains in Australia.

  • If residents have acquired the property after 21 September in 1999, the discount capital gain or unindexed capital gain is decreased by 50%. Therefore, the capital gain, which is taxable, is 50% of the cost base.
  • The cost base of the assets, which were acquired before 21 September 1999, was indexed as per fluctuation of the CPI in Australia.

Effect of taxation on equity

Capital gains from stocks and mutual funds are taxed if the income is generated in short term. Long term return from equity is not taxed. Implication of tax is not applicable at the time of investment in shares. Tax is imposed at the time of sale of assets (Crowe 2013). As the public investment is mobilised in the economy for investment in different sectors, it is exempted from tax. However, income generated from sale of assets is liable to be taxed as if it is capital gain. In Australian economy, the repayment for mortgage on housing loan is liable to be taxed (Baranska 2013). The interest earned from the investment property is tax deductible. Equity is taxed if it is used for funding the purchase of investment property.

Loan to value ratio and debt service ratio are used in evaluating the effect on equity. Investment in different types of property has different types of risks and values. Therefore, the loan to value ratio differs for different types of assets (Shi and Jou and Tripe 2014). Banks of Australia accepts up to 80% loan to value ratio for residential property and 60-70% for the commercial properties. If the borrower takes a mortgage insurance policy, the lender generally accepts a higher LVR (Chung 2016). The value of equity is therefore calculated as follows. If for example, the current value of property is $800,000 and the mortgage on home is $450,000, then the value of equity on property is $800,000 - $450,000 = $350,000. Now, if the investor finds an investment, which is worth of $500,000, the investor would try to get a loan of same worth.

Now the LVR for the investor = ($450,000 + $500,000)/ ($800,000 + $500,000) = 73.08%. As the maximum criteria for the LVR is 80%, the investor will pass in the security criteria. Therefore, the bank may grant the loan to the investor for purchasing the investment property using the equity. The return on equity falls under the capital gains tax (LeBlanc and Matthews and Mellbye 2013). Hence, the standard income tax rate is applicable for the equity. Dividends on equity of a company fall under the corporation tax in Australia. The corporation tax rate in Australia is 28.50%, which is effective from 2015. Moreover, the tax on capital gain depends on whether the property is held on capital account or revenue account. If the property is included in the revenue account, the gains from disposal are calculated with the income of the owner (Peng and Chen 2016). The tax rate on income would be as per owner’s tax rate. If the property is held in capital account, the net capital gain is added with the income of the owner and taxed according to the owner’s tax rate.

Effect on housing prices

The housing price in Australia is influenced by the increasing value and cost of the assets. As investment in house is a source of income, return from investment property determines the demand for house (Sim and Krause and Winson-Geideman 2015). The housing prices in Australia have increased at 7% per year. The rising housing price in Australia can be explained by Stock flow model.

Figure: Residential property prices in Australia

(Source: abc.net.au, 2016)

Figure: Growth in housing prices in Australia

(Source: rba.gov.au, 2015)

Stock flow model

According to the stock flow model, demand for housing property is negatively related to the user cost of acquiring the property and property price (rba.gov.au, 2015). However, demand for housing is positively related to rent. There are other factors such as permanent income of the households; availability of credit etc affects the housing demand. The user cost of house ownership depends on real interest rate, asset depreciation and appreciation of housing price. Differences in tax structure for owner occupied and investment property also influence the demand for housing (Forrest 2013). 

Figure: Relation between the property price and property demand

(Source: created by author)

In the short run, the demand for housing changes frequently compared to supply of house. The demand pull inflation raises the price of the house In Australia. Increasing access of credit in Australia is the cause of increasing demand and prices of housing. Despite increasing rent, the demand for housing is rising in Australia, as the income of the people has increased substantially over the years (Randolph and Pinnegar and Tice 2013). However, there is a fall in residential property prices in Australia from 2015 to 2016.

Figure: changes in housing price in Australia

(Source: abs.gov.au, 2016)

Effect on Australian economy

According to the recommendation of tax review committee, the government of Australia can impose levy of 0.2% on unimproved value of property or may impose 0.1% on value of improvement on annual basis (abc.net.au, 2015). As per reporting, the actual amount of tax on property would be more than the average payment by the residents of the capital city. The report says that imposition of tax would raise the levy by $7bn at the current property price. According to Ferrero (2015), property tax is unavoidable. It is an inevitable part of spending for home owner, as property tax is wealth tax. Property, which is in use, gives service to the user and therefore is liable for GST tax in Australia. There is little impact of property tax on savings and incentive to work. Property tax is a significant source of earning of states. Moreover, property such as building and land is immobile in nature and the demand for real estate is rising with population growth (Paris 2013). Therefore, the prices of property tend to rise. People cannot shift immediately to avoid property taxes. Thus, property tax remains good source of revenue of state government.

States and Australian territory on purchase of property levy stamp duty in Australia. Stamp duty rises with increase in property price (Ferrero 2015). Increase in stamp duties discourages people to purchase property and restricts the efficient use of property such as land and buildings. Grattan Institute of Australia has suggested that, the revenue of the States may increase if stamp duty can be abolished. Increase in revenues is beneficial for state, as it can use the revenue in improvement of society (Cesa‐Bianch, Cespedes and Rebucci 2015). Investment in property increases capital of the economy, which is further used in any productive purpose.

Effect on society

According to World Economic forum report, taxation on housing has mixed impact on consumer spending. Taxes on main dwelling have negative impact on household expenditure. Taxes on residential property have no significant impact on household expenditure. When mortgage debt burden increases, the household reduces their savings. As an impact, total disposable income of individual decreases. Fall in disposable income decreases consumer goods demand of people. Therefore, it may affect the aggregate demand of the economy (weforum.org, 2015). Decrease in consumer spending is regarded as short run cost in the economy. Lower property tax rate encourages the urbanisation in the economy. Rapid pace of urbanisation has positive externality on the surrounding land.

Effect of fiscal policy on housing market

Fiscal policy of the government can affect the housing market in terms of demand and housing prices. Taxation on property is fiscal policy of the government. Market analysts have predicted that due to effect of Brexit, Australian real estate market will gain from foreign investment. Global investors find it is risky to invest in UK and European market due to after effect of Brexit. Therefore, they tend to invest more in Australian real estate market. Chung (2016) argued that, government fiscal policy may be counter effective in this case. NSW government has taken decision to impose 4% stamp duty on the purchase of residential property by foreign investors. Furthermore, 0.75 % land tax would be imposed on the foreign investor, who owns a residential real estate in Australia. This surcharge is more in Victoria, which is 1.5% to make the real estate market costlier (news.com.au, 2016). This government policy may discourage foreign investment in domestic housing market in Australia. Reduction in tax cut has positive effect on demand for housing. However, it has negative effect on property investors. Cut in housing prices reduces the capital gain on investment property. Due to lowering interest rate, the revenue of the government has decreased from $8.4 billion during 2011-12 to $3.7 billion in 2013-14 (theaustralian.com.au, 2016).   

Supply of housing depends on availability of land, cost of construction, profit of the developer and other infrastructure cost such as water, sewerage and transport facility. Demand for housing depends on number of households searching for land, location, transport, income of the households etc. If the government increases the spending to provide better social infrastructure, demand for housing tends to rise.

Explanation of circular flow of income

Circular flow is a concept, where activities of different economic agents are linked through a circular flow. Main agents of the circular flow are producer, households, goods market and factor market.

Figure: circular flow of income

(Source: created by author)

Investment property such as land, commercial premises comes from households. Property sold to the commercial firm, banks or government earns capital gains and rent. Government impose tax using fiscal policy on the rental income. Tax revenue is thus received by government. The tax revenue is further used in economic development. The investment properties are used by different organisation for productive purpose. Final produced goods are received by households through product market. On the other hand banks play important role of resource mobilisation in this sector. Household saves money in banks. Banks mobilise the saving across the economy. A household goes to the bank for getting loan to invest in property. In return, the borrower pays interest rate to the bank. In this way, different agents in the economy are linked with each other.

Recommendation

Property tax has effect on consumption behaviour of people. In one hand, it is source of revenue to the local government. A better way of property taxation is comparison of property tax with market value of property and not with the GDP of the economy. Inequality in property tax rate decreases the revenue. Property valuation is a complex issue. Therefore, appropriate tax on property needs proper infrastructure. Due to inelasticity of the supply of property and growing demand for land and building, the property price in Australia has growing trend. Demand for supply is growing for residential and commercial purpose. Property tax has both equity and efficiency implications. Therefore, it can be recommended that for proper taxation, property identification, collection of revenue and enforcement are needed. Tax payer may support the government in the context of tax payment if they can feel that they receive required service for property tax from the local government.

Conclusion

The report has analysed the implication of property tax and its impact on Australian economy. Two types of property such as owner occupied and residential property are evaluated here. Land tax differs across different state of Australia. Different land tax has mentioned in the report. CGT method and Indexation method are used in calculation of capital gain tax in Australia. Capital gain in Australia is taxed according to the standard income tax rate. Taxation on equity has been discussed in the report. Housing price in Australia has a growing trend. As property tax base increases, price of housing increases.  Rising housing prices has not much impact on property demand. However, hike in stamp duty has negative impact on property demand.

References

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Ato.gov.au. (2016). Property used in running a business | Australian Taxation Office. [online] Available at: https://www.ato.gov.au/General/property/property-used-in-running-a-business/ [Accessed 18 Aug. 2016].

Ato.gov.au. (2016). Working out your net capital gain or loss | Australian Taxation Office. [online] Available at: https://www.ato.gov.au/General/Capital-gains-tax/Working-out-your-capital-gain-or-loss/Working-out-your-net-capital-gain-or-loss/ [Accessed 17 Aug. 2016].

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Baranska, A., 2013. Real estate mass appraisal in selected countries–functioning systems and proposed solutions. Real Estate Management and Valuation, 21(3), pp.35-42.

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Cesa‐Bianchi, A., Cespedes, L.F. and Rebucci, A., 2015. Global liquidity, house prices, and the macroeconomy: Evidence from advanced and emerging economies. Journal of Money, Credit and Banking, 47(S1), pp.301-335.

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Jacobs, K., Berry, M. and Dalton, T., 2013. ‘A dead and broken system?’:‘insider’views of the future role of Australian public housing.International Journal of Housing Policy, 13(2), pp.183-201.

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