House prices were already spiralling in 2004: Here’s what Howard and Costello did about it

Prime Minister John Howard and his treasurer, Peter Costello, shelved a report that proposed substantial changes to their own tax reforms to fix spiralling house prices, instead telling cabinet the reforms were largely a job for the states.

Documents released today by the National Archives from John Howard’s cabinet of 2004 reveal a report, the then Coalition government had commissioned into problems facing first home buyers recommended winding back capitals gains tax discounts and means-testing homebuyer grants, but Howard and Costello feared large property price swings and public anger if they tackled reforms.

Peter Costello, left, and John Howard – a joint submission from them on spiralling housing costs in 2004 in effect pushed off any contentious changes. Credit: Glen McCurtayne

After a surge in house prices across the country and a drop in the proportion of young people entering the property market, then-treasurer Costello had the Productivity Commission examine the housing sector.

In every capital city, prices had increased faster than wages, prompting a substantial increase in average mortgage sizes.

Between March 2002 and March 2004, Sydney’s median price for an established home jumped by 43 per cent, from $365,000 to $523,000. Melbourne’s median price rose by 27 per cent to $305,000, while in Brisbane it jumped 64 per cent.

In an eerie preview of current debates about housing, the cabinet was briefed in June 2004 on the commission’s recommendations to improve supply and demand.

They included getting states and territories to remove stamp duty and replace that revenue source through another impost such as a land tax. Twenty years on, the ACT is the only jurisdiction to have started to axe stamp duty.

The report recommended encouraging the states to release more land while improving planning laws to allow higher densities in sought-after parts of the nation’s major cities.

But the commission also called for a review of the tax system, particularly the Howard government’s 1999 change to capital gains tax, as soon as possible.

In a joint submission to the cabinet, Howard and Costello argued that most of the commission’s proposals were aimed at the states and territories.

In a sign of the political and economic issues involved, under a section entitled “sensitivities”, the two men noted that given the then “delicate stage” of “excess demand” for housing, the timing of any changes could influence property prices in the near term.

“That is, policy announcements that increase housing demand may provide a disproportionate boost to overall housing demand and prices, resulting in further declines in affordability,” they noted.

“In contrast, policies directed at curbing investor demand may result in a disproportionate decline in house prices in a short amount of time (investors fleeing the market), resulting in significant costs to household balance sheets and potentially serious impacts on the economy.”

The 1999 capital gains tax change had come from a business taxation review that argued it would encourage investors to sink money into the Australian sharemarket.

Instead, it was already apparent by 2004 that property investors were using the concession.

Australians continue to push up the price of the nation’s homes.Credit: Joe Armao

At the time, the Reserve Bank raised concerns about the combined impact of negative gearing and the capital gains tax concession.

The Productivity Commission noted negative gearing and the concession had “combined to magnify the attractiveness of investing in residential property during the recent upswing in house prices, thereby adding to price pressures”.

“Indeed … these changes have almost certainly contributed to the surge in investment in rental housing in the past few years,” it noted.

This aspect of the commission’s 300-page report, which said a review should specifically examine the concession and negative gearing, was not presented to the cabinet.

A short submission from the Treasury argued against the commission’s key findings on the capital gains tax concession, noting prices had climbed sharply in a range of other nations over recent years.

The Treasury claimed that if the concession was a driving force for the surge in house prices, then there should have been a similar lift in the sharemarket, which had been flat since 2000.

But the commission had said the concession could easily have different impacts on property and shares.

One of the commission’s biggest concerns about the concession was that it amplified upswings or downturns in economic activity.

The Treasury submission failed to acknowledge how the concession had changed the tax impact of landlords.

Before the tax change, landlords had usually declared net rental profits – in 1999-2000, they were almost $1 billion.

By the first full year of the capital gains change, landlords reported a net $1 billion of losses. In 2003-04, they had reached $2 billion before doubling the following year to $4 billion. Net rental losses would reach a record $10.5 billion in 2008-09.

In a draft media release put to the cabinet, Howard and Costello stood by the capital gains tax changes, saying “they had improved incentives to save and invest by introducing an internationally competitive capital gains tax regime”.

Cut through the noise of federal politics with news, views and expert analysis. Subscribers can sign up to our weekly Inside Politics newsletter.