Why economists are wrong about demand-side housing policy

For the first time, Millennials and Gen Z outnumber Baby Boomers at the ballot box. This demographic shift is significant, particularly in the context of housing policy. Younger Australians are facing an unprecedented housing crisis, and the need for effective solutions has never been more urgent at the upcoming federal election.

In response, both major parties are offering policies aimed at helping first-home buyers. Labor’s plan allows buyers to enter the market with a 5% deposit and no lender’s mortgage insurance, while the Coalition’s policy lets first-home buyers of new homes deduct the interest on mortgage payments from their income taxes.

As I often point out, these ‘demand-side’ measures have the same effect on the housing market as the tax concessions for property investors such as the capital gains tax concession and negative gearing for property investments. Economists sometimes make the point that these concessions incentivise investors building new homes to rent out which increases supply and therefore affordability. However, they do so by increasing demand for investment properties. They are fundamentally demand-side measures, the same as first home-buyer incentives. If more demand for housing was needed to increase supply, then the same argument in support of the investor concessions would apply to first home-buyer incentives. The only difference is that investor demand measures convert houses into rentals, instead of owner-occupied dwellings like first-home buyer incentives.

Economists lambasted the policies as ‘demand-side measures’ that won’t solve the housing crisis. They are only half right. These policies wouldn’t increase housing affordability, but they would increase home ownership, and that’s not nothing.

Neutral impact on prices

Assuming no change in supply conditions, the housing market is a zero-sum game: when renters gain the ability to buy a house, they increase demand for houses—but they leave their former rental property, now unoccupied and available to the market. That increases supply.

What confuses people here is that they think the ‘housing market’ is one market. It’s actually two markets: the housing market and the rental market. If you go onto a real estate website and find houses that people have put up to sell, there is no option for you to apply to rent the property. That is because it is not in the rental market, it is in the housing market. This is important because when you hear someone say that selling an investment property reduces supply, they are talking about supply in the rental market, not the housing market. In fact, this action increases supply in the housing market.

To illustrate the point, imagine you are a renter and you buy the house you live in. In this action you have:

1. Taken one house out of the rental property (less rental supply)

2. Taken one less renter from the rental market (less rental demand)

3. Created additional demand for house purchasing (more housing demand)

4. Brought a house into to the housing market (more housing supply)

These actions all cancel each other out and the net effect on house prices and rents is neutral, but there are now more home owners and fewer renters. In summary, the shift from renter to owner doesn’t change how much Australians are paying for housing, but it does change to whom we are paying and that’s important.

Why should we increase home ownership?

In Australian politics, it is taken as given that increasing home ownership is an egalitarian social policy, however this is not an obvious conclusion. In most Scandinavian and European countries that Australians hold up as the gold standard for egalitarian social policy, home ownership plays a tiny role in the housing system.

The reason home ownership is seen as egalitarian in Australia is because in those crucial few decades after the second world war when our welfare state was being established, successive Australian governments took it upon themselves to build massive amounts of homes and sell them to Australians at below-market prices. This brought home ownership up from 46% to 72% between 1947 and 1966. Once that was done, there was no political pressure to develop strong protections for renters or an adequate pension system, because few Australians rented, and most could reply on the capital gains and imputed rents (saving on rent you don’t have to pay because you own) from their home to fund their retirement. This made home ownership in Australia not just a lifestyle choice, but a financial necessity.

Decades later, not much has changed for renters and retirees, but governments are no longer building houses, and home ownership has become harder than it used to be.

Wealth inequality

Increasing homeownership can also help address the growing wealth inequality in Australia, which is largely driven by rising house prices and the unequal distribution of investment properties. As property values continue to rise, those who own homes receive capital gains which can be leveraged at the bank to take on more debt and accelerate wealth accumulation, while renters are left behind, unable to build equity. Demand-side measures that make more Australians homeowners could moderate the increase in wealth inequality, but the design of these policies matters, and in this respect, Labor and the Coalition’s housing policies could not be more different.

Because Australia’s income tax system is progressive, the Coalition’s tax deduction model delivers the biggest benefits to the wealthiest buyers. A high-income earner in the 45% tax bracket will save 45 cents on every dollar they deduct, while someone in the 37% bracket will only save 37 cents — for the same home, same mortgage, same payment. In short, the richer you are, the more money you’ll receive from this scheme. It is the very definition of a regressive tax policy. That’s why Peter Costello ruled it out when he was John Howard’s Treasurer. It would also only be available to people who could already afford a deposit who, arguably, don’t need any more help.

Labor’s approach however, which reduces the upfront cost of buying, makes it easier for people to become homeowners who were not otherwise going to be. This is more equitable for people on lower incomes and would help to moderate the rise in wealth inequality, but still doesn’t address the broader affordability issue.

The only solution to affordability is supply. That means increasing utilisation of existing stock, such as through vacancy taxes that convert short-term rentals like AirBnBs into long-term rentals and homes for first-home buyers, or replacing stamp duty with land tax so people aren’t financially punished for downsizing. It means updating zoning laws so homes can be built near underutilised infrastructure, and it means governments stepping in to build homes directly, especially for people locked out of the private market. On this front, the other half of Labor’s housing policy—building 100,000 new homes and selling them to first-home buyers—by working with the states to unlock new zoning capacity, is the only policy from either of the major parties on the table at this election that will increase not just home ownership, but also housing affordability.

Ray Newland is the Founder and Executive Director of the Youth Climate Policy Centre, and Chair of the Macquarie University Economics Society. He currently works in policy for the Electrical Trades Union of Australia, and is pursuing a Bachelor of Economics at Macquarie University.