Housing affordability is in the spotlight again. This is unsurprising.
Since the beginning of the 21st century, house prices have increased by 165%. Over the same period, the general price level has increased by 71.2% and income per capita has increased by 122%. As a result, housing has become more expensive and purchasing a home has become more difficult for average Australians.
What can improve this situation? In our research, we study the role of stamp duty on housing market outcomes.
The inefficiency of stamp duty
There are two main problems with stamp duty. First, it exacerbates credit constraints by making it more difficult for budget-constrained households to purchase a home.
For these households, who may already struggle to save for the downpayment, the added cost of stamp duty raises the upfront expense of buying property, making homeownership even less attainable. This cost is partly mitigated in some Australian states, with first-time home buyers exempt from stamp duty under some conditions.
Second, stamp duty discourages mobility after a home is purchased. Once households have bought a home, the high cost of stamp duty acts as a disincentive to move, even if their housing needs or preferences change. This creates inefficiencies in the housing market, as people may remain in homes that no longer suit their circumstances to avoid the financial burden of moving.
These problems are becoming more severe over time. To understand why, first, note that stamp duty is a progressive tax; the marginal rate increases with the price of the home.
Furthermore, as house prices have increased, in much of Australia, there has been little change in the stamp duty schedule. The ACT is the only real exception to this rule, where there has been a steady decline in the importance of stamp duty and a shift towards land tax.
Second, there has been a significant increase in house prices in most of Australia. This combination has generated, on average, an increase in the tax burden associated with purchasing a property. This greater tax burden is reflected in a decline in household mobility.
Modelling the welfare cost
We develop an economic model that captures the two primary reasons households may move home. First, they may relocate to a home that offers a different size or quality. This type of move involves a significant shift in price to reflect the change in the home’s attributes.
Second, households may move to a home with a similar price but with different characteristics, such as a change in layout, location, or features that better suit their lifestyle or preferences.
These moves often reflect a change in preferences or what we describe as a housing mismatch shock. Over time, a household’s needs evolve. Younger, growing families may have the need for more bedrooms. An older household may prefer to downsize and live in a single-storey home. Workers may change jobs, a home closer to their new work location may be preferred.
We use the Household Income and Labour Dynamics in Australia (HILDA) database to study the prevalence of housing mismatch shocks. Using data on the change in the value of homes that a person lives in and their self-professed reasons for moving, we are able to estimate the probability that a housing preference shock occurs. This is a key ingredient that helps our model match the data and turns out to be important for measuring welfare changes.
Using this economic model, we can estimate the effect on key economic variables when stamp duty is removed, Budget balance is maintained by assuming an introduction of either a consumption tax or a recurring property tax.
Overall, we find that removing stamp duty only has a small impact on the homeownership rate. In our different model experiments, we find that removing stamp duty raises the homeownership rate by between 1 – 2 percentage points. The effects on house prices will also be moderate.
This does not mean reforming stamp duty is not worth doing. We find that if stamp duty was to be replaced with either a property tax or a consumption tax, households would be able to move more frequently and this would reduce housing mismatch. As a result, households would be better off in terms of welfare.
For future generations, the preferred policy would be to replace stamp duty with a property tax. The property tax in our model is similar to a land tax and our result aligns with a broad body of literature asserting that land taxes are generally non-distortionary in comparison to other forms of taxation.
Challenges and options
Replacing stamp duty with a property tax may be challenging. Current homeowners who have already paid a large cost upfront in the form of stamp duty would resist the idea of being asked to pay again a recurring property tax.
In our model, the majority of existing homeowners would prefer replacing stamp duty with a consumption tax. Hence, there is an implicit tension between what is good for the economy in the long run versus what is popular in the short run.
With a consumption tax, both homeowners and renters are taxed to recover the lost revenue from eliminating stamp duty. With a property tax, only homeowners bear this burden. Over two-thirds of the population own a home and would prefer the consumption tax.
One option to address homeowners’ resistance could be to allow new homebuyers the choice between paying stamp duty or opting for an annual property tax. This approach was implemented briefly by New South Wales (NSW) for first home buyers, but has since closed.
Another approach, as seen in the Australian Capital Territory (ACT), is to gradually phase in a land tax while reducing stamp duty over time. This spreads the impact and allows for a smoother transition to a new tax system.
A final approach would be to provide people who have recently paid stamp duty a tax credit that reduces or eliminates their property tax burden for some time.
Fixing the housing crisis?
Our results confirm some of the previous literature: stamp duty is an inefficient tax. Removing stamp duty and replacing it with an alternative tax system will improve societal welfare.
However, there is a tension. While replacing stamp duty with a property tax provides the best outcome for future generations, replacing stamp duty with a consumption tax will be preferred by current households. It is not a panacea for the housing crisis, as reforming stamp duty will have only a modest effect on house prices and homeownership.
Citation: Cho, Yunho, Li, May & Uren, Lawrence, (2024), Housing Mismatch and Welfare Effects of Stamp Duty, Austaxpolicy: Tax and Transfer Policy Blog.
Yunho Cho is an Associate Professor at the Institute for Social and Economic Research at Jinan University and completed his Ph.D. in economics at the University of Melbourne.
May Li is a Senior Lecturer at the University of Melbourne and completed her Ph.D. in Economics at the University of Texas in Austin.
Lawrence Uren serves as a Senior Lecturer within the Department of Economics at the University of Melbourne, and completed his doctoral studies in economics at Princeton University.