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The Road to Hell is paved with good intentions.

No doubt many readers of this site are of the libertarian persuasion after reading scholarly tomes by Ayn Rand, or Karl Popper.

Not me, though. I simply observed governments in action, and compared them to the workings of the free market.

One interesting thing I have observed over the years is that even governments who present themselves as ‘friends’ of the free market get the political urge to regulate, with the purest of motives, to ‘help’ the market along.

Markets aren’t like that, though. Even the best intentioned meddling by governments have consequences that are undesirable. Consider the Australian government’s well intentioned meddling in the Australian property market… Australians, it must be said, have a long standing tradition of investing in property, rather then equities in private companies. It is a bit of a chicken-and-egg riddle as to whether or not investors were reacting to the tax code, or the tax code evolved to suit property investment.

The tax code in Australia has a provision known as ‘negative gearing’. What this basically means is that if I go to the bank and borrow money to invest, the interest on that loan is tax deductible.

In practice, banks much prefer to lend to people who use that money to invest on property rather then shares.

Hillary Bray takes up the story

Negative gearing is not being driven by the investment return on rental property. Returns are better in both the share market, and also in sticking the money in an investment bank account. Rental property investment is entirely driven by its beneficial tax treatment.

Having some method to encourage investment in housing is a good thing. However, the problem in Australia at the moment is that rental property investment is a consequence of the high rates of tax elsewhere in the system. The existence of a housing price bubble is evidence that the market is being driven by tax returns – not investment returns.

Negative gearing is tax effective because it allows people to lower their income to get below the top rate of tax threshold at the same time as they benefit from a capital gains tax levied at only half the top marginal rate.

The current housing price surge began almost as soon as the capital gains tax was lowered three years ago. …

As the Reserve Bank pointed out, these two incentives are being made even more extravagant by the treatment of depreciation for rental housing. As the bank asked out loud, why are there depreciation allowances for appreciating assets?

The Reserve Bank’s submission to the Productivity Commission’s inquiry into house prices is basically saying that the extraordinary increases in house prices are in fact being driven by the Government’s fiscal policy – by the current structure of the taxation system.

So as a result of successive Australian governments tinkering to help the property market along, the result has been to send housing prices through the roof; to the point where it is now difficult for ordinary wage and salary earners (read voters) to afford a house in Melbourne and Sydney.

No doubt if the government had abolished the negative gearing provisions of the tax code when it halved the capital gains tax there still would have been substantial rises in the property market; that is the natural result of cutting the taxation of appreciating assets. The effect of leaving negative gearing intact is the market’s self correcting mechanisms aren’t able to kick in.

I would quibble, though, with Hillary Bray’s contention that “Having some method to encourage investment in housing is a good thing.” I do not believe that the state should favour one form of investment over another- all it should do is provide a climate suitable for all sort of investment and let the market decide the best place for capital to go.

The State is NOT your friend, even when it’s trying to help you.

10 comments to The Road to Hell is paved with good intentions.

  • Andy Duncan

    A sort-of similar situation has evolved in the UK, over the last few decades, driven mainly by restrictive government planning laws instituted by the UK’s own quasi-communist government straight after WWII.

    In order to ‘help’ the public ‘keep the countryside’, the government created all sorts of ‘green belts’, ‘national parks’, and other ‘areas of outstanding natural beauty’, plus general planning laws everywhere else, which mean even the smallest extension to your house has to go through several planning committees, often only getting passed as a result of you being a councillor, knowing a councillor, or bribing a councillor (God forbid).

    Net result, a massive demand for houses, a severe under-supply, and hugely escalating property prices. Now virtually the entire middle class pours all of its assets, via mortgage repayments and other investments, into wealth-consuming housing rather than wealth-creating industry because the returns on increasing property prices have been spectacular, far outweighing the costs of housing maintenance on assets which just sit there doing nothing, except gradually falling apart, but also increasing massively in value.

    This has unbalanced the entire UK economy, leading for calls for ‘key’ (read: government) workers to be given government housing subsidies and preferences, keeping non-government poorer people living with their parents, and burdening the wealthier non-government people with huge mortgage repayments and the long-term fear that housing prices will at some point collapse destroying all of their savings.

    And collapse, I’m almost certain they will, because the government respects its own ‘green belts’ like a teenager respects his own bedroom. For despite having made most of us in the UK agree with planning laws and our ‘rights’ to stop other people building on their own land, in order to keep our own property prices up, its about to institute massive dezoning of green belts, to stimulate house building.

    Which is going to make some poor farmers, with land at £12 pounds an acre, millionaires overnight, as the restrictions are lifted on their land (especially, one suspects, if they know the local councillor involved), and in ‘areas of outstanding natural beauty’, such as the Chilterns, rich people’s properties are going to plummet in value as their wonderful countryside views are suddenly filled with acres of terraced, ramped, eye-sore ‘key’ worker sustainable social housing (unless of course, the rich people happen to be local councillors, and can push it on to the people over the hill).

    It’s a complete mess, and if all these planning laws to ‘help’ us hadn’t been instituted in the 1940s, we’d have ‘natural’ house prices, probably much greater contentment with a good housing supply, a greater reliance on flexible renting rather than burdensome mortgages, a far greater investment in productive industry, rather than static housing, and a country where people didn’t feel so much they had the government-backed ‘right’ to inflict their selfish views on the property rights of other people.

    Yes, we’d have ‘built over’ more of the countryside, but we’re going to anyway, so why not do it in a natural way over generations, as they did prior to the 1940s, rather than the hodge-podge chaotic way we’re about to do it now, with massive dollops of corruption and central government Whitehall stupidity thrown in for good measure.

    The government is not your friend. Unless of course you’re a councillor, or a farmer with lots of low-priced land near a conurbation, and you can make a few quid from all of this, on the side.

  • Of course, the Sydney property market is the only one I know that makes the London market look sane….

  • toolkien

    Just another example of the notion that for every ying there is a yang. When the government interferes in the market for Good (do they ever interfere for Bad?) they simply move the Good from one to another, offset by a Bad somewhere else that is conveniently ignored (until they decide to shine the spotlight on the Bad, blaming some private sector source, and set about with more interference).

    I guess it’s another way of looking at the ‘Law of Unintended Consequences’. The Government can’t make more Good than the capicity of the individuals and resources that make up a particular State. They can only shift it around, and when they channel Good in one direction, they channel Bad in another, and then is slapped with a label of unintended consequences as if that makes it o.k. and is merely an oversight. Whoops! They are then guilty of stupidity for not seeing the consequences of their actions, or they are liars if they knew of them, but assume that those who carry the burden are either too weak to fight, or are too unaware of the burdens that await them (e.g. National Debts – see Boomer Generation Retirements).

  • Rob Read

    Toolkien you have hit upon the problem with regulation.

    The State’s coercion can only provide a transfer i.e. a zero sum gain, so if I win then you lose.

    Free trade is a win-win game, I win, you win; as we both exchange goods for those we value more.

  • Rob –

    I’d be interested in the economic/philosophical underpinnings behind that statement (that the state can only provide zero-sum outcomes).

    I believe in the existence of market failure (the underprovision/overprovision of goods that benefit/disadvantage people other than the economic agents involved in their purchase).

    I also believe in the existence and prevalence of government failure (that a large proportion of attempts by governments to solve market failure make things worse, through inefficiency, corruption and unintended consequences).

    But unless you believe *all* examples of government attempts to address market failure will necessarily fail (or dispute the existence of market failure), there doesn’t seem to be a sound argument that all state activity is zero-sum.

  • I believe in the existence of market failure (the underprovision/overprovision of goods that benefit/disadvantage people other than the economic agents involved in their purchase).

    If I buy a loaf of bread from a baker, we are both the “economic agents involved in that purchase”. Perhaps you’d like to explain what possible interest “people other than” the baker and I have in that transaction. By what right do they assert a benefit or bemoan a disadvantage?

  • Note where I say “goods that benefit/disadvantage people other than the economic agents involved”.

    A loaf of bread is not one. A fuming, unsealed vat of noxious chemicals, an unsilenceable boombox, or a bulldozer purchased to clear rubbish off land that I own but that others overlook, all might be. Perhaps you can see why.

  • It is certainly odd to categorise these externalities (positive and negative) as “market failures”. In the direct case of damage to property, if this can be demonstrated, the law can uphold your property rights without any government regulation.

    The problem with considering externalities is that people tend to assume wideranging but non-existent “rights” over other people’s property which entitle them to redress over supposed disadvantages. You don’t have a “right to silence” or a “right to a view”. Instead of asserting a “right not to be exposed to noxious fumes” demand redress for the damage to your property by the presence of such fumes.

  • The “rights” question depends on your philosophical approach to property: I’m working purely on utilitarian grounds here (whether or not I have any rights over my neighbour’s property, if he uses it as a rubbish dump then this will reduce my quality of life…).

    Property rights may well be important enough that we should ignore the non-maximisation of overall utility in such cases. However, this would be an example of the free market being the best overall system *despite not maximising utility compared to alternatives in all cases*, rather than because it always works better.

  • Yet if you imagine that you are entitled to some redress for your neighbour’s use of his site as a rubbish tip you implicitly assert a right to that property: a right to frame acceptable uses for it. If his site is a good site for a rubbish dump, you might have taken that into account before buying your site.

    Your argument is based on false premises. Firstly that the goal of “maximised overall utility” is so compelling that anything short of such a “perfect” outcome is a failure. But the old cliche holds: The best is the enemy of the good. Secondly that there exists some magic alternative to the market which does maximise overall utility.

    However, this would be an example of the free market being the best overall system *despite not maximising utility compared to alternatives in all cases*, rather than because it always works better

    That rather depends on what you mean by “always works better”. There are plenty of people who benefit in a rigged market, cartels, monopolies and those receiving subsidies. It stands to reason that they would be at a “disadvantage”, at least initially, operating in a freer market. The point about the market is that it is better than any other system in general and not for every specific transaction.