In July, the State Government announced plans to reform how land tax is paid in South Australia.
Under these changes, it will no longer be possible for property owners to set up complex ownership structures to avoid paying tax on the aggregated value of their properties.
The reforms would bring South Australia into line with land tax arrangements in Victoria and New South Wales.
The reforms have met resistance from some lobby groups, who say the changes will ‘devastate the SA property market’, and landholders will raise rents to pass on the additional tax burden.
Others have claimed that the reforms will push up land prices in the city, putting pressure on rates and disincentivising investment in the CBD.
In considering these reforms, it is important that economic implications are properly understood.
It is unlikely that the reforms will lead to an increase in property prices, and relatedly, the cost of rental accommodation.
In all probability, landholders will bear the full cost of the tax, at least in the foreseeable future.
Unlike many household goods, rental accommodation is not a cost plus business where producers simply add a profit margin to their materials and other expenses.
The price of rental accommodation is set by supply and demand forces very much outside of the control of individual landlords.
The supply of rental accommodation in South Australia is what economists call ‘inelastic’. This means that the flow of rental accommodation into or out of the market is not particularly responsive to changes in rent levels.
The more inelastic the supply of a product, the smaller will be the impact on the market price of an increase in the cost of supplying it.
It is useful to look at markets where supply levels are more elastic, for example, the production of beef cattle.
A drought may cause a significant increase in production costs for the farmer because, say, expensive imported feed is required. A natural response in this situation might be to reduce the number of animals in the farmer’s care.
As shoppers we witness the impacts of drought and other adverse natural phenomena on market prices. Reduced production leads to scarcity which in turns puts upward pressure on prices.
The rental accommodation market functions in a very different way. When faced with an increase in the cost of providing rental accommodation, landholders are unable to reduce ‘production’ in the way that farmers can.
They might consider withdrawing their rental property from the market, but their choices are limited. They can move into the property, which is unlikely if they already have a primary residence.
They could sell it, with the likelihood that the buyer either places it back into the rental market, or moves into it, thereby releasing their former property back into the market.
Theoretically, they could leave it empty, though they would incur a significant opportunity cost in the process.
The limited ability of landholders to respond to an increase in the cost of providing rental accommodation by reducing supply is a fundamental feature of the market.
Certainly in the short to medium term – counted in some years – the rational response to an increase in landholding costs resulting from the proposed reforms will be to retain ownership and continue to charge rent at levels the market is prepared to pay.
The claim that the new land tax arrangements will make rental accommodation less affordable is highly questionable.
South Australians would be much better off, including renters, if investors focussed on productive uses for their capital rather than exploiting anachronistic tax loopholes.
James Atkinson is a senior consultant at SGS Economic and Planning.
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