A little knowledge might be a dangerous thing, but its complete absence is far worse. At a workshop in Dublin recently, councillors and planners discussed how local authorities could ensure that developers put forward decent proposals. Most of the councillors seemed to feel that they had little control over the projects which went ahead and, in particular, their density. This was because, if the developer had paid a lot for the piece of land, they felt morally obliged to allow rather more units to be built there than they would like so that the sale price of each individual unit was not excessive.
How wrong they were. The price of the site has nothing to do with the prices at which the houses or shops built actually sell. A developer cannot just say “I paid €1 million for this site but the planners have only given me permission for ten houses rather than the twenty I wanted. This means that the land for each house will cost €100,000 rather than the €50,000 I was expecting. I’ll have to put the price of each house up by €50,000 to compensate.”
It’s true that some developers might think like that, but they are not going to be able to jack up their price by €50,000 unless they can find buyers who are happy to pay that amount more for the extra garden. No, it’s the market that decides what prices the houses will fetch and a developer’s heartfelt wish to recover his costs has no bearing on these prices at all.
If the developer makes a loss, he’ll offer less the next time he buys a piece of land. Councillors have no obligation to make his speculation profitable, although, perhaps, he knows from experience that they will.
The little knowledge that the councillors at the seminar lacked was something economists have known for almost 200 years. It was in 1817 that David Ricardo pointed out that a 'tax on rent would affect rent only; it would fall wholly on landlords and could not be shifted to any class of consumers'. In other words, if a government imposes a tax on rents, there is no way that landlords can increase the amount their tenants have to pay to compensate since rents, like house prices, are set by the market. Higher taxes just mean that the market value of rental properties will drop.
This leads to a useful thought. One of the reasons that first-time buyers are having to take out such huge mortgages is that they are competing for properties with people from their parents’ generation who already own their own houses and are buying others to rent.
At the moment, investors letting property can set the interest they pay on their borrowings against the rental income they declare for tax. But suppose the tax situation reverted to that of between 1998 and 2002 and this relief was withdrawn for all deals made after a certain date. The effect would be to reduce the amount that would-be landlords could afford to pay after that date, and hence their ability to compete with young couples. The price of entry-level houses would drop.
Who would lose out? Not the would-be investors, as they would still get the same financial return. Nor the young couples, as they would need to borrow less. Only the developers would be out-of-pocket together with anyone who had bought an entry-level house recently and found that they needed to sell it.
The blunt truth is that the only effect that the tax relief currently granted on interest payments is having is adding to the profit being made by landowners when they sell their fields to developers. Did Charlie McCreevy realise this when he restored the interest-paid tax concession in 2002? Does Brian Cowen realise it now?
McCreevy restored the tax relief because the number of new apartments and houses being constructed had dropped markedly because landowners and developers with land banks were playing their trump card and refusing to sell or develop at the prices they were being offered. They could do this only because the supply of development land is effectively a monopoly. They then lobbied hard saying that the new restrictions were damaging the building industry. The government caved in as all governments have done in similar situations. What it should have done was to introduce an annual tax on land zoned for development to force the owners to develop it or sell it to someone who would.
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