The triumphalism of housing-bubble denialists like Neil Appleby in Crikey‘s comments section yesterday is premature. After Australia’s home prices “fell only 5% or so in 2008”, our “remarkable housing recovery” was entirely due to government subsidies, which were levered up with debt and handed over to vendors (socialism for the propertied class), starting a new speculative spiral.

This is at least partly sustained by the presumption that if prices are driven too high and consequently fall back, taxpayers will cough up another subsidy in another effort to avert a financial crunch and recession. Even while prices continue to rise, industry representatives are not above asking for more buyers’ grants. Imagine what they’ll be demanding when prices fall.

And does anyone not see the moral hazard?

Each new subsidy pushes prices further out of proportion to disposable incomes, so that the eventual correction will be bigger. That’s not kicking the can down the road; it’s rolling the stone up the hill.

Given that price/income ratios must return to earth, and that governments are loath to allow the numerator (price) to fall, the only remaining option is to increase the denominator: disposable income.

The federal government can do this by cutting income tax at the bottom end — by raising the thresholds and/or cutting the bottom marginal rate (preferably to zero). Then it can replace the revenue by taxing capital gains at the full marginal rate with no exemptions and no grandfathering. The capital gains tax (CGT) would not greatly affect current prices. But, by reducing the attractiveness of capital gains relative to current income, it would reduce the tendency to form fresh speculative bubbles.

Alternatively, the states can achieve a similar effect by abolishing payroll tax, and replace the revenue by turning the existing property stamp duty into a CGT-like vendor duty.

While economists argue about whether the removal of payroll tax would create jobs, increase wages, or reduce consumer prices (actually it would do a bit of each), any of these possibilities would increase disposable income.

A further advantage of CGT, especially at state level, is that it gives the government an incentive to invest in infrastructure that raises property values, leading to taxable gains.  The result is that property owners receive gains they would not otherwise get. Better still, the gains are sustainable because they are driven by improvements in utility, not by debt-financed speculation.

Oh, yes, home owners will scream blue murder at any suggestion they pay tax on their capital gains — which they have done nothing to earn, and to which they therefore have no moral right. Apparently they’d rather let the taxman steal their hard-earned income or their opportunity to earn it. But I assure them that if they don’t somehow pay tax on their capital gains, they’ll end up making capital losses instead.

Choose your poison.