Jeremy Kronick is a senior policy analyst at the C.D. Howe Institute.
Last week, a new tax introduced by the B.C. government came into effect with the goal of slowing down the unrelenting increases in Vancouver-area house prices. The additional 15-per-cent transfer tax specifically targets foreign nationals looking to buy real estate.
We must ask whether it will meet its stated objective of making Vancouver housing more affordable for the so-called middle class and, perhaps more important, what are its unintended consequences?
Whether or not Vancouver housing prices fall – or their increase moderates – as a result of this tax depends on a host of factors. There are many different possible reactions by foreign buyers.
I'll focus on three possible scenarios.
In the first, foreign buyers accept the higher tax as the cost of doing business, leading to little or no change in sales volumes, though with likely decreases to property values. In this case, the government now has additional tax revenue to spend on increasing the supply of housing and related infrastructure. This is the golden scenario for the B.C. government and the public, though not necessarily for current homeowners.
In the second scenario, foreigners adjust and spend more on a lower value part of the housing market. Before the tax change, B.C. residents payed a 1-per-cent tax on the first $200,000 worth of their real estate purchase, 2 per cent on the remaining value between $200,000 and $2-million and 3 per cent above $2-million. So a jump to 15 per cent is significant. However, if as suggested, the bulk of Vancouver purchases by foreigners are in this luxury market, i.e. above $2-million, they may simply readjust where they spend in Vancouver.
What does this mean? If foreign nationals continue to believe Vancouver real estate is a good investment, they may move into the cheaper portion of the market between $200,000 and $2-million, and deal with the additional, though lower – at least in absolute terms – cost of the tax. If this occurs, there may be little housing affordability relief as some relatively more affordable housing increases in price, and tax revenues are lower than expected.
In the final scenario, and one that is concerning to Torontonians and perhaps many other Ontarians, the capital foreign buyers earmarked for Vancouver's housing market simply shifts location. There are many examples, including in Toronto, of increased land transfer taxes causing depressed sales volumes, which suggests that people are sensitive to this form of tax increase and will look to park their money in lower tax areas. Should the effect of this tax cause a shift in capital eastward, house prices will surely rise further in Toronto on account of increased demand. What happens then?
The Ontario government can choose to not raise the current transfer tax, allowing house prices to continue to increase. The hope for the government in this case is that the 10 per cent of real estate purchases in Vancouver made by foreign nationals are not those simply looking to avoid scrutiny at home. The hope would be that the 10 per cent includes at least some immigrants who are on their way to becoming citizens but are not there yet, or are foreign parents purchasing homes for their student children causing them to be more likely to stay after graduation – generally a good thing for an economy.
If Ontario does choose to follow in Vancouver's footsteps, foreign nationals could again accept the tax, giving the Ontario government more tax revenue to spend on policies boosting housing supply, should it so wish. Or they could readjust their spending patterns to lower-value homes, potentially causing reduced affordability for houses below the luxury price range. It would be Vancouver's story all over again.
However, what is concerning is what happens if capital leaves completely.
Foreigners have many other options for investment. If foreigners start to worry about taxes hurting their return on investment in Canada, they will be more likely to spend in other countries. And while this may be a good thing for the overheated housing markets in Vancouver and Toronto, it may not be for Canada in general. Canada remains very dependent on foreign capital to finance its current account deficit of $62-billion a year, or 3.5 per cent of gross domestic product. We should beware the risk we run of reducing this flow by making foreign capital less welcome.
At the end of the day, the impact of the tax on foreign housing purchases in Vancouver remains to be seen. Perhaps it will work out exactly as planned in that city. However, what is playing out in Vancouver could well have unintended consequences across the country, not all of them happy.