The "tax cuts for landlords" canard
People who may or may not know better aren't telling it straight when it comes to interest deductibility.
What’s this “tax cut for landlords” business that I keep hearing about?
The coalition government promised to restore interest deductibility for residential property investors. This allows them to deduct mortgage interest expenses from their taxable rental income This is in line with general taxation principles for most businesses.
Will all landlords benefit from the move?
No. The extent to which landlords benefit depends on their individual financial situations, such as the size of their mortgage and the interest rates they pay. Those with mortgages will be able to deduct their interest costs when working out their taxable income. Landlords without mortgages (for example, Christopher Luxon) will see no benefit from this policy change.
Does this mean landlords are getting a tax cut?
No, landlords are not receiving a tax cut. Restoring interest deductibility allows landlords to deduct mortgage interest expenses from their taxable rental income, aligning with standard business practices. This deduction acknowledges that interest is a legitimate business expense, ensuring landlords are taxed on their true net income.
But they’ll be paying less tax won’t they?
Yes, many landlords will pay less tax as a result of restoring interest deductibility, but this does not equate to a tax cut in the traditional sense. It is instead recognition of the cost of financing business operations, ensuring taxes are assessed on true economic income. That is why it is a standard feature in most tax systems.
Isn’t that just a semantic quibble?
It may seem that way, especially to those unfamiliar with tax details. However, the distinction is crucial. Calling it a "tax cut for landlords" has Trump-like, populist appeal but implies undue favouritism. In reality, landlords are currently subjected to unfair treatment, and the reform will simply restore equal tax treatment, aligning them with other businesses.
So it’s not for the benefit of all landlords and it’s also not really a tax cut?
Correct. The restored interest deductibility is not universally beneficial for all landlords. Nor is it a tax cut in the traditional sense.
So how come Labour and fellow travellers keep calling it a tax cut?
Politics, mostly.
And to be fair, ignorance in at least some cases. Many people, especially those who have only ever earned salaries or wages, do not understand how business expenses and tax deductions work. The lack of understanding makes easy work for populists on the left, who are able to capitalise on unfamiliarity with basic tax principles to craft a simple, if misleading, narrative.
If it’s so simple, why can’t landlords already deduct interest?
They always could. The ability for residential property investors to deduct mortgage interest expenses was removed by the previous government as part of a policy aimed at reducing property speculation and cooling the housing market. The removal of this deductibility was intended to increase tax revenues and make housing more affordable by discouraging investment-driven demand.
Did removal of deductibility achieve those aims?
There is no evidence that it reduced property speculation or increased housing affordability. It did increase financial pressure on landlords. This often led to higher rents as landlords sought to offset the increased tax burden, passing costs onto tenants.
The reduced profitability of rental properties may have also discouraged investment in the rental market, potentially exacerbating housing shortages and deterring renovations to make existing rentals nicer.
Does that mean restoring deductibility will result in decreased rents?
Probably not. When interest deductibility was removed, landlords faced higher tax liabilities. In many cases these were passed on to tenants in increased rents. By restoring deductibility, landlords' tax burdens are reduced, alleviating some of the financial pressures that led to rent hikes. This could slow the pace of rent increases or (at best) stabilise rents.
It is unlikely to result in a significant decrease in rental prices.
Why not?
Rental prices are primarily driven by supply and demand. However, you also need to account for psychological factors and adjusted expectations. Tenants generally expect rents to rise in response to increased costs and may accept these hikes. Landlords also feel more justified in imposing them.
When costs decrease or savings occur, landlords are less likely to lower rents in response, because they adjust their expectations to maintain higher profitability, and tenants do not typically expect or demand rent reductions in the same way they anticipate increases. This results in landlords retaining the benefits of cost savings without passing them on to tenants.
Any other examples of this in action?
Yes. When the Labour government boosted student allowances by $50.00 a week in 2018, students reported that landlords were preemptively raised rents, specifically citing the extra cash students would receive. This was surprising to people who thought that the rental market operated purely on supply and demand principles, but was unsurprising to people who have an understanding of the world beyond Econ 101.
Is there a fancy economics term for all this?
It’s called asymmetric price transmission. It refers to the way prices respond differently to increased costs than they do to decreased costs. In general, prices tend to rise quickly and significantly when costs increase but fall more slowly and less fully when costs decrease. It most commonly occurs often in markets where sellers have some degree of market power.
This includes - but is not limited to - the rental market in terms of constrained supply.
But that doesn’t seem fair
It may not seem fair. You may even go so far as to say that it seems unfair. However, it shows how important it is to consider both market forces and behavioural economics in the rental market.
Does the world always accord with subjective claims of fairness?
Research is ongoing, but the current theory from the world’s leading scientists seems to be that the world is not always fair. Consequently, policies designed with fairness in mind may not always yield outcomes that align with those intentions. This means it can be a good idea to design policies according to their likely consequences rather than just the desired outcomes.
Okay, so how much will tax revenues be reduced as a result?
The restoration of full interest deductibility for landlords will reduce tax revenues by $2.9 billion over four years. This cost is $800 million higher than originally planned due to an accelerated implementation agreed upon by National and Act.
Is that material in the scheme of things?
The $2.9 billion cost of restoring full interest deductibility for landlords over four years is significant but manageable in New Zealand's overall fiscal context. It’s a fraction of the total budget. However, it is notable given the deficit and overall economic pressures, the government will need to balance this policy with its broader fiscal strategy to get debt under control.
Can you explain this in rugby terms?
The team is trailing by 27 points. Banning interest deductibility is like cheating to get a penalty kick. At best it closes the gap by 3 points, which is noticeable but not game-changing move.
Allowing interest to be deducted means playing fairly according to accepted standards of conduct but missing out on the 3 points as a result. The team needs to find other ways to make up the difference.
Okay, but is the reduced revenue going to mean reduced services?
Only if the government can’t find cuts in non-essential services. For example, the scrapped Auckland Light Rail project was estimated to cost up to $29.2 billion. Compared to that, the $2.9 billion of reduced revenue (over four years) is relatively small.
So tell me what’s going on in a nutshell?
Allowing residential property investors to deduct interest as a cost of business corrects an artificial imbalance introduced by the previous government as part of a failed attempt to make housing more affordable. Correcting the imbalance is not a tax cut in the conventional sense of the word, though it will mean a noticeable but not material decrease in state revenues.
Reverting to normal tax principles will alleviate some financial pressure on landlords. This will possibly slow rent increases, though it is unlikely to decrease rents significantly. The chances that anyone will learn any kind of lesson from that is quite slim.
House prices rose the most in 2021 due to lockdowns and very low interest rates.