Housing wealth holds the key to reducing income inequality

Much of the discussion about inequality in Australia assumes it is inherently a bad thing. Inequality is said to offend our commitment to a fair go, and if the gap between rich and poor starts to widen, academics, pressure groups and media pundits soon start demanding that government do something about it.

But whether inequality is unfair surely depends on how it arises. If one person works harder than another and ends up with more money, few would see this as unfair. What would be unfair is if the government equalised their incomes by taxing the industrious person to transfer his earnings to the lazy one.

Similarly, if somebody invests and accumulates a large sum, while another spends on riotous living and ends with nothing, the resulting wealth gap between them is hardly unfair. Rather, we might query the fairness of policies that tax the thrifty person to provide a retirement pension for the spendthrift.

The key question about inequality, therefore, is not how big the money gap is between people, but how they come by their riches in the first place. If you make your money honestly, most people would say you are entitled to it.

But what about cases where money just falls into someone's lap without them having to do anything? This is what has been happening to millions of households as a result of the housing boom. If you bought a house a few years ago in a desirable location in Sydney or Melbourne, you will now be sitting on a small fortune, but if you missed out, a home of your own may now seem out of reach.

How can this be fair? Those who have gained have done nothing to deserve it, yet they have made more money than most people could hope to save from a lifetime of earnings, and they appear to have squeezed younger and less prosperous buyers out of the market. Professor Julian Disney described this as a "poisoned legacy".

Before rushing to judgment, however, two points should be borne in mind. First, nobody loses money when home owners accumulate capital gains - nobody is being exploited. Second, we are at the peak of a boom and can expect housing to become more affordable in the future.

Nobody is exploited because historically, house prices tend to rise in line with incomes. Incomes, in turn, generally rise faster than the CPI, because economic growth translates into higher real wages. Because house prices track income growth, they generally rise faster than other commodity prices.

This explains how each generation of home owners has made real capital gains yet subsequent generations have still been able to afford to buy houses. The cost of a house (relative to household incomes) remains relatively constant over time, but its price (relative to CPI) keeps rising. Home owners are not ripping off the next generation; they are sharing in the proceeds of economic growth.

Sometimes, however, housing costs leap ahead of incomes, as is the case today. We are at the height of a boom fuelled by low interest rates and sustained economic growth. The median house price is now nine times the median income. This is much higher than normal, and can't last. Asset bubbles always burst, and this one will be no exception. Sooner or later, prices will readjust to incomes.

Is it a bad thing that home owners benefit from economic growth to accumulate wealth? Far from it. Assets bring financial security and independence. You might lose your job, and governments might change your eligibility for welfare benefits, but the financial security represented by housing is always there to fall back on.

With a house of their own, older people enjoy low housing costs and can trade down to realise an income flow in retirement. When they die, they can pass the asset to their children. In two or three generations, working families can build up substantial assets. It is not the welfare state, but rather mass home ownership that offers the best guarantee of personal security and social harmony.

Rather than bemoaning the spread of wealth to ordinary families, therefore, we need to focus on extending the opportunities for home ownership to more low-income households who are willing to work and to save. As Mark Latham said in 2002 (pdf, 121KB): "The only problem with the ownership revolution is that there are not enough owners."

Attempts to make home ownership more affordable by boosting purchasing power can be counter-productive. The $7000 first-home buyers' grant, for example, makes housing more - rather than less - expensive, because each recipient bids $7000 more than they could before, and prices rise accordingly. The only people who gain are owners whose capital gains increase at taxpayers' expense.

Tax breaks for home buyers do not help much either. The fact that capital gains on shares and other assets are taxed, but gains from domestic housing are not, encourages people to put more of their cash into their homes, and this pushes up prices. Similarly, investors are encouraged into housing by negative gearing and the partial capital gains tax exemption, and this too fuels the housing market. One in six taxpayers now owns an investment property, yet prices are way out of line with rental incomes.

A more effective way of making housing more affordable would be to increase supply. This means releasing more building land and easing current planning restrictions so supply can keep up with rising demand.

We should welcome the fact that ordinary families now own assets of high value that can be passed on to their children. Instead of fretting about wealth inequality, we should get on with extending the opportunity for even more families to start accumulating wealth by buying a house.