It is difficult to find many supporters of stamp duty on property transfers. A general consensus, at least among economists, is that replacing it with an annual land or property tax would be preferable. It is a more efficient tax, promotes mobility and will mean a better use of the housing stock. A significant problem has always been how to avoid double jeopardy – those that have paid stamp duty, particularly relatively recently, are reluctant to pay a land tax as well.

Moreover, stamp duty is like an addictive drug to State Government Treasurers, with its revenues supporting their expenditure habits by over $6 billion p.a. for the larger states. Shifting directly to an annual property tax on all residences to fill the revenue hole created by its abolition would incur the wrath of the electorate.

Removing stamp duty and only applying an annual property tax to properties which are subsequently transferred without stamp duty after that date would limit electoral backlash. But for state treasurers it would be like an addict going 'cold turkey'. Even though the long-run revenue from such property taxes can be set to be of the same value as would have been raised by stamp duty, the loss of current revenue would hurt a lot.

However, a solution to this transition problem is potentially at hand. Virtually any future stream of cash flows can be sold to investors who will pay up front for securities which provide guaranteed promises to those future cash flows. Of course, some such securities can be 'toxic' as the Global Financial Crisis showed, but well-designed products such as Australian Residential Mortgage Backed Securities create value for society.

The future stream of property tax revenues from properties on which it is to be levied is ideally suited to such securitisation. It is simply a matter of finding the most appropriate design of the securities, such that they appeal to investors (such as superannuation funds) and thus can be sold by governments to provide a substitute cash inflow for the stamp duty foregone.

To illustrate, suppose 100,000 properties worth $100 billion dollars in total (at an average price of $1 million) changed hands in 2018 without payment of stamp duty (which is assumed abolished). Had stamp duty been applied the government would have received (say) $6 billion (assuming an average duty of 6%). But that is no longer received, and instead the government will receive property tax on those properties forever at an annual tax rate of say 0.225 per cent. 

This would generate $0.225 billion property tax in 2018 and, if property prices did not change, the same amount each year ever after. At a discount rate of 3.75 per cent, the present value of this perpetuity is $6 billion. So, in principle (if 3.75 per cent was the yield investors required), this perpetuity could be sold in 2018 for $6 billion to replace the loss of stamp duty revenue. (A similar strategy would be adopted for 2019 and so on, until at some  me it is no longer needed).

Of course, that example is too simplistic.

First, governments would not want, nor likely be allowed, to sell future tax revenues for ever. They would also want  the ability to change the tax rates. Again, this hurdle is not too
hard to overcome. The future cash flows involved could be limited to some number of years (say 30) and specified as being calculated at some notional fixed property tax rate (eg the 0.225 per cent rate assumed above), while the government could retain flexibility to vary the actual property tax rate in the future. To the extent that there are legal impediment to 'selling' future tax revenues, some alternative structure could overcome this. For example, the government could commit to pay amounts equal to the specified future tax revenue into a special purpose vehicle which then issues the securities to investors.

Second, property values tend to increase over time, such that the stream of cash flows could be expected to move in line with property prices. That just makes the arithmetic a bit harder and creates an exposure of those securities to risk of fluctuations in property price inflation. Finding the best security design to make that risk acceptable to investors at the lowest required return is something at which the securitisation industry is well skilled. (Note that the long term, eg 30 year annuity style, securities created can be structured to appeal to superannuation funds and providers of retirement income products.)

The third complication is that ratings agencies might treat the revenue raised by such securitisation as different (ie as borrowing) from tax revenues and penalise the government for having a higher budget deficit, by downgrading its credit rating. It would be necessary to convince them that this transition from stamp duty to property tax is beneficial for the state (not a hard task) and that the calculation of the government’s credit rating should treat the securitisation revenues as equivalent to the tax revenues they are replacing for the life of the transition process. It may be that this would require issuing somewhat shorter term securities (eg 15 years), such that the property tax revenues cease to go to the security holders after that time and instead provide direct tax revenue to the government budget, enabling a shorter transition period.

Finally, this solution needs to get bi-partisan support, since it involves a long run structural change to the nature of state government finances. There would, undoubtedly, be differences between political parties on the precise details of how the transition is structured.

But establishing an independent advisory group from the  financial and property sectors to develop a mutually acceptable transition on process would seem to be an appropriate way to proceed.

Click here to read a more detailed outline of the proposal.

This article was originally published in the November 2017 edition of the REIA News.

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