The role of property tax incentives schemes in creating the property bubble

Steerpike

Hi all. Have not been in here for some time, so forgive me if I'm going over ground that was recently discussed. I know there's a mega-long thead going on at the mo about the bubble, but I haven't had time to read it all, and if it deals with the pumping up of the market by tax incentive properties. So bear with me. The following is from the Gombeen Nation blog:

In light of RTE revelations on TDs' spending splurge last Paddy's Day,
Gombeen Man was intriqued by Bertie's recent words on the Irish economy. Not for the first time.

Warning of dark days ahead as our false economy slows down - due in large part to his Government's steroidal pumping-up of the property market through tax breaks - it is timely to examine the phenomenon that was the Celtic Tiger before it finally leaves for fresher, meatier pickings.

The earlier part of this country's economic success was largely down to EU financial input in the form of funding and a general opening up of Irish society and attitudes thanks to involvement with the rest of Europe. For instance, we now have contraceptives... unthinkable in the 80s. We now have divorce.

Another factor was the work of the IDA in bringing investment here, by making our Gombeen land the ideal place for multinationals to set-up under a low corporate-tax regime, and use the location to process global profits in a "business-friendly" environment. This, make no mistake - along with the fact that we are an English-speaking nation - is why the multinationals operate in, and through, here. Whatever about the ethics of it all, we do, however, now have employment for anyone who wants it.

The problem is, this Government kept the tax-break idea going by applying it to construction in Ireland long after it was necessary. This took the from of tax shelters for the building of holiday homes, hotels, and houses and apartments in "designated areas". While there might have been some argument for state intervention (isn't that supposedly the bane of enterprise and business) when things were depressed, there was none for continuing with it when the economy took off.

Loathe to see their friends in the construction industry go short of the latest helicopters to transport their semi-literate arses in, the Government kept these tax shelters going right through the height of the property boom. Individuals who benefited were mostly those already propertied and well-off, by allowing them to write off rental income from all investment properties by means of Section 23 tax schemes.

The result? Middle-aged, middle-class (upper echelons now, I think) people diverted money into the schemes, at a time of low bank interest rates, and pushed up prices to astronomical levels. Many properties were not even let out, but were bought purely for capital appreciation - which thankfully, has come to a belated end. The others, in the form of buy-to-lets, were let to hard-working young people, many of them building the investment properties they now rent. Another consequence is that many young people - single, cohabiting, and trying to bring up families - are now locked into 40-year mortgages on small, overpriced, shoddily built apartments.

Thank you Fianna Fail. But let's be honest - would things have been any different had there been a coalition led by the other side of Irish Civil War politics?

Probably not. Pity there's no opposition in this country.

Glenbhoy

Steerpike wrote: »

[Loathe to see their friends in the construction industry go short of the latest helicopters to transport their semi-literate arses in

Whilst I agree with many of your points I don't see the need for that comment.

That aside, I believe there are several other important points:
1. In 1998, Peter Bacon issued a report recommending that mortgage interest be made non-deductible for taxation purposes, this was in order to cool the buy-to-let frenzy, this decison was reversed in 2001 when house prices started to cool down (ostensibly the reason given was to free up rental accommodation).
2. Circa 1998 cgt on development land had been 40%, that years finance act allowed for a special incentive to reduce such cgt to 20% for a very limited time only, after which it would revert to 40%, what happened, well, of course this was extended and eventually done away with - obviously the fact that this time period was not going to be enforced was well flagged to interested parties.
3. The govt liasing with the central bank could easily have enforced stricter lending to reserve ratios for the retail banks, but didn't want to interfere in the market - although I think that the ECB said that even though govts had no controlover interest rates, there were plenty of other means of controlling asset bubbles. They could also have enforced certain affordability ratios, and encouraged the banks to accurately assess applicant incomes.
4. Mortgage interest relief should not be at the ridiculous levels it currently is as compared with rental reliefs - neither should actually exist, but there is no rationale for having one option (which is not accessible for many low income people anyway) incentivised to such an extent.
5. Taxes could have been levied on second homes and so, stamp duty should have been amended years ago........

Afuera

I strongly agree with all your points Glenbhoy, except this one I am still not sure of.

Glenbhoy wrote: »

3. The govt liasing with the central bank could easily have enforced stricter lending to reserve ratios for the retail banks, but didn't want to interfere in the market - although I think that the ECB said that even though govts had no controlover interest rates, there were plenty of other means of controlling asset bubbles. They could also have enforced certain affordability ratios, and encouraged the banks to accurately assess applicant incomes.

While they could have forced our local banks to be more conservative, I still think that other banks from the EU would have been able to lend in our market. These would have been beyond the reach of the Irish central bank.

Also, I think that our weak tenants rights are a major factor that leave people with little options but to buy in the end. Lack of security of tenure being the major failing in the rental market as it stands. There probably would not have been such a mad scramble to get on the ladder during the boom if there were real alternatives.

Glenbhoy

Afuera wrote: »

I strongly agree with all your points Glenbhoy, except this one I am still not sure of.


While they could have forced our local banks to be more conservative, I still think that other banks from the EU would have been able to lend in our market. These would have been beyond the reach of the Irish central bank.

Also, I think that our weak tenants rights are a major factor that leave people with little options but to buy in the end. Lack of security of tenure being the major failing in the rental market as it stands. There probably would not have been such a mad scramble to get on the ladder during the boom if there were real alternatives.

Good point about tenancy rights.

The rest of the EU banks tend to be much, much more conservative than ourselves and our anglosaxon neighbours so that wouldn't really be an issue (I think), also it's much more complicated to secure titles on properties in other jurisdictions for banks, so banks tend to operated in their own legal environment mostly (afaik), see the michael lynn saga - where banks are going to really struggle to obtain any value for the foreign properties.
I spent a short while in one of the banks checking out affordability ratios, income verification procedures and at that stage there was a genuine fear of the central bank clamping down on these areas, it never happened unfortunately.

Afuera

Glenbhoy wrote: »

The rest of the EU banks tend to be much, much more conservative than ourselves and our anglosaxon neighbours so that wouldn't really be an issue (I think), also it's much more complicated to secure titles on properties in other jurisdictions for banks, so banks tend to operated in their own legal environment mostly (afaik), see the michael lynn saga - where banks are going to really struggle to obtain any value for the foreign properties.

Some of the Spanish banks have very loose lending as well (e.g. 50 year mortgages) and many, such as Santander Bank and BBVA, have had pretty agressive campaigns to increase their market share. If there was a gap in the Irish market, where the local Irish banks had their hands tied by our central bank, I wouldn't have been surprised to see some of these move into our market. It's kind of academic though at this stage because the Irish central bank never even made a proper attempt to limit the wreckless lending in the first place.

You're right through about the problems securing titles in foreign jurisdictions. It may have swung the whole risk-reward profile in favour of leaving the local Irish banks deal with their own market and kept other banks away.

Glenbhoy wrote: »

I spent a short while in one of the banks checking out affordability ratios, income verification procedures and at that stage there was a genuine fear of the central bank clamping down on these areas, it never happened unfortunately.

I think when it was discovered that EBS were blatantly ignoring the central banks recommendations anyway, and the lack of repercussions that followed that discovery, just how little clout our central bank really has. I'm under the impression that it is out of choice rather than design though as it is easier for them to issue a few warnings now and again to cover their back rather than actively police the financial institutions.