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Why the government is right to subsidise first-time buyers

The government is not giving a grant to first-time homeowners in order to make them more affordable. Every economic and political correspondent should print this out on an A2 sheet and stick it above their bed.

The purpose of the grant (or any subsidy) is to increase the supply. In the economic jargon, this is ‘moving the supply curve to the right’. And subsidising new housing by five percent should have that effect, and reasonably fast.

So what happens is this: the government brings in their homebuyers’ grant. Homebuyers go looking at houses, including houses that were previously out of their price range. It also gives homebuyers a top-up to their deposit, so they can purchase sooner than they might have otherwise. They make purchases that they would not have made previously. That is obviously a good thing for the lucky homebuyers. But that is not the point of the grant.

The point of the grant is that the price of houses will go up. As a result, the builder will want to build new houses. Not only will the builder want to build new houses, but the banks and investors will want to back him because they have greater confidence. This results in increased supply.

This increase in supply is the overwhelming reason why the government is giving a grant to buyers of new housing.

There are alternatives the government could consider to do the same thing. But none of them is very attractive. They are:

– The government could give the developer of the houses a grant directly. This would avoid an increase in house prices, but it would mean that the developer could sell the houses to whomever he or she wants. This is likely to favour large landowners and foreign investors. For political reasons, the government wants to avoid this. And of course, nobody likes giving free money to property developers.

– The government could cut the taxes on development. It could do this by cutting VAT, or cutting development levies paid to local authorities. The problem with this is that the government has to make up for the lost VAT or it has to give extra subsidies to the local authorities (because the local authorities will incur real costs in opening up land. On the other hand, when you give the purchaser the subsidy, the subsidy mostly pays for itself, because the increased supply generates tax revenue of its own – in the form of VAT and income tax for the inputs into the houses -.

– The government could cut the cost of development. This could be done under government influence by reducing the building standards. But then the housing won’t be as spacious (spacious accommodation is more flexible than small accommodation as household needs change) and it won’t be as warm during the cold months, so there are additional long-term costs. There are other ways to cut costs without impacting on quality, but they tend to depend on there being a vibrant sector and a reasonable amount of activity to get them to kick off. And the whole problem is that no one is building anything.

– The government could cut the cost of development land. This is a very good idea, but it turns out to be very difficult to do in practice, for political and other reasons. ¬†The government doesn’t seem to be able to make it happen. If building activity increased, perhaps it would help. It might seem attractive to carry out projects that would open up new development land, such as building metros and train lines if there were a vibrant building scene.

– The government could build houses itself. This could get the government in big trouble, because it now has to meet the entire cost of building the houses. By contrast, the buyers’ grant only requires a five percent subsidy to houses, and so for the same money, you can get twenty times more houses built. And we need a lot of houses. (Personally I think these are underestimates; if we had 100,000 new homes in Dublin tomorrow, I think they would all be full by next year).

РThe government could rejuvenate unused housing. This is a good idea, but it is very bitty. It depends on a lot of transactions happening in order to make a relatively small number of new homes available. Each house renovated is unique and requires special attention, including financing, planning advice and architectural considerations.  Building new homes, by contrast, is something that can be organised on a large scale.

And of course, the above alternatives would also mean that first-time buyers would not be in any stronger a position in the market. They would still be competing on a level playing pitch with investors and trader-downers.

So the government has found the least-bad of all the subsidy models. It has something targeted at first-time buyers, important voters who seem like worthy people. It is low-cost because of the extra revenue generated by increased supply. The whole thing will be a stimulus and will help kick off other activities that might help increase the supply.

It’s not perfect, of course. The only benefit for renters, for instance, is indirect. First-time buyers will hopefully vacate rental accommodation to move into their shiny new houses and apartments. This should reduce demand a little, but it won’t really add any new rental supply.

And of course, this is all very slow. If a developer decides to build apartments today, it will most likely be three years before any of them will be occupied, even if he doesn’t meet any significant planning or financial obstacles.

So the government is finally addressing mediume-term housing supply. Unfortunately, the short-term issues remain. There will still be a shortage this time next year, and the rental market will get worse before it gets better. Long term issues also need to be addressed. We need to do projects to open up new building land to provide for growth in the second half of the next decade. Otherwise we are going to end up back in the same mess again.

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