Could changes in 1989 to New Zealand’s tax treatment of retirement savings plausibly explain a significant portion of the subsequent sharp rise in New Zealand house prices?

Andrew Coleman made the case that it could to a LEANZ audience in Wellington this week. He was careful not to argue that it did.

He said other relevant factors were operating. These included higher per capita incomes along with lower inflation and lower real interest rates. No one has been able to unscramble their effects empirically with meaningful precision.

The New Zealand Initiative has always emphasised in addition the role of restrictive land zoning. Rising land prices have contributed far more to house price inflation since 1989 than rising dwelling construction costs.

In support, I have pointed my finger at the Resource Management Act 1991. Its key feature is a strong bias against development and a constitutionally-disgraceful disrespect for property rights. Massive price differentials have been found across planning boundaries.

Coleman’s case that the change in retirement tax was potentially important is rigorously made in Motu Working Paper 17-09, May 2017.

Its starting point is 1989. The then government put the taxation of retirement savings on the same basis as the taxation of interest income. Previously it had been tax preferred, much like the tax treatment of owner-occupied housing.

An unintended effect was to induce New Zealanders to invest more in dwellings and less in retirement savings. Coleman calculates that this potentially increased desired house sizes by 25%. It also made it potentially worthwhile to pay roughly 50% more for a property in a desirable location than under a neutral tax system.

These are one-off effects. They don’t explain ongoing property price inflation. Coleman estimates that subsequent lower real interest rates could have increased real land values for properties in desirable locations by at least 60% since the 1990s.

No contending tax structure would have stopped such rises. Not even a capital gains tax.

Coleman laments the intergenerational inequity of the current situation, as does The Initiative.

There are many options for making tax system more neutral between capital investments. For example, taxes on owner-occupied housing could be increased or taxes on retirement savings reduced. He comments that retirement savings are commonly tax favoured in most OECD countries.

Coleman wants a more open-minded and better-informed tax debate about these tax structure choices. Commendably, he has led by example.