Irish Mortgage Brokers Blog

We have long been critics of the taxation system in general, primarily on the basis that the tax base doesn’t make sense, it should be focused more on sustainable and easily interpreted taxation, Site Value Tax, taxes on any activity which takes away from another party (carbon taxes, pollution taxes etc.) and finally on consumption. The idea being to cut Government spending according to the cloth available rather than the current approach which is to tax until you find the money available to meet the budget.

Dan Mitchell of the Cato Institute has a video below which spells it out.

The aim of the new pensions framework is to deliver lasting security, equity, clarity and choice to the individual. To a degree we are taking on a system the Australians have used in which providing for your retirement is mandatory.

The aim is also to increase pension coverage, particularly among those who have traditionally had a lower level of uptake, as well as encouraging provision for retirement that is not reliant upon the state alone.

There is concept in finance of a ‘risk free rate’, and normally that is seen as being the rate of return on money by a sovereign entity (in our case it’s Ireland), so in a rational market it should always be the case that anything with an implicit state guarantee should pay far less than those without it, because those without it have to reward investors by offering more in order to attract them.

Oddly, in Ireland the institutions implicitly backed by the state are actually paying over the odds, and in effect that means a transfer is occurring from tax-payer to depositor, in short, we are being ripped off when our sovereign guarantee is not factored into pricing.

For example: Anglo Irish Bank are paying 3.1% for a demand account, this means you can take your money out whenever you want, BOI, AIB, INBS, NIB and many others are paying a mere 0.1% meaning that Anglo are paying a full 300 basis points or 3% more than competitors who are not state owned (albeit they are partially state owned). Rabo are paying 2% so what we are seeing from a deposit account perspective is that Rabo are a better institution in terms reliability than our own state is.

What a joke…. But it’s not so funny really.

Then we have An Post, an implicit state guarantee and you can lodge up to €120,000 with them and earn a TAX FREE rate of 3.23%, normally you’d have DIRT which would take 25% away from any deposit gains, but in this case you don’t, so in order to earn the equivalent elsewhere you would have to be making 4.31%. Again, this is an example of paying way over the odds for funds, the state should in fact be offering well below market rate levels of interest because their return is guaranteed in a way that no other institution can copy.

Are you angry? Don’t be, just make sure that you buy An Post savings bonds and instead make some profit on the errors made from on high, as a financial adviser I can’t believe this continues and nobody is pointing it out, in the USA bond income from Municipal Bonds is tax free, so you always make a ‘tax equivalent yield’ in which you show how much you’d have to make on a taxable bond in order to generate the same income it is as follows:

R(te) = R(tf)/(1- t)

Where: R(te) = taxable equivalent yield for the investor
R(tf) = return on tax-free investment (usually a municipal bond)
t = investor’s marginal tax rate

Bond income is taxed at your own rate of tax, we’ll assume that you had a good year and are on the marginal rate of 41%, and see what kind of yield you would need from any other bond to earn 3.23% after tax.

R(te) = 3.23/(1-.41) = 5.47%

So if you were to go out and buy a corporate or sovereign bond you would need to be earning 5.47% in order to just match the offering by An Post, and you wouldn’t get a return like that which is backed by a sovereign guarantee! (exception is perhaps a Greek bond).

So why are we paying so far over the odds?

That’s a question, I certainly don’t have the answer.

There is an interesting situation that we are seeing much more of lately, where people in negative equity or negligible equity are deciding that because they cannot now move up the ladder (which was the point in their initial purchase - as a stepping stone to trading up), they will instead rent out their home and then rent a house in the area they actually want to live.

While this is a working solution to a person in negative equity seeking mobility it can result in a tax liability that many people are not aware of, this is how it occurs, the portion of mortgage payment that goes against the capital is actually taxable, and if it is paid to the bank it doesn’t mean you don’t have to pay tax on it.

The finance act in 2009 brought about a change whereby only 75% of mortgage interest can be offset against Case 5 rental income as an expense, and this further exacerbates the situation even for those who have interest only loans!

However, we’ll demonstrate the position a person would find themselves in if they had a mortgage of €260,000 over 25yrs (costing €1,230 per month) and they rented the property out for c. €1,100.

Clients have told us they have gone ahead and done this, but that they don’t mind losing out on the €130 per month in order to live where they really want to be, that is when we have to explain the rest of the implication to them!

For a start, if you rent out your property within the first five years (if you didn’t pay stamp claiming First Time Buyer status) there can be a stamp duty clawback, but it doesn’t end there.

Within the €1,230 per month mortgage payment (TRS will no longer apply if you are renting the property out) there are two parts, €650 is interest and the remaining €580 is capital repayment. Only 75% of the €650 can be set off against the rent meaning that only €488 applies.

So your €1,100 rent minus €488 is the ‘profit’ you are deemed to have made which amounts to €612 per month and at c. 45%(ish) tax that means you’d have to pay Revenue €274 per month in tax on top of the €130 difference that it takes to make up the full payment.

This means that the monthly cost is actually around €400 (and this is made up of after tax income - so the gross cost is higher again- of course, we can advise people so that this doesn’t happen but often people don’t seek advice in advance and that means that even with our help they are facing a tax liability, for that reason we would hope that if you are considering this that you call first!

Other expenses that have to be considered are changing your home insurance to reflect that it isn’t a primary home any more, then there is the NPPR tax (non-principle private residence), as well as PRTB requirements.

If you have any questions call us, the main thing is to ensure that you don’t find yourself in this situation if you can’t sell your current home and want to move elsewhere!

In the first clip, James Galbraith (son of the famous JK), economics professor at University of Texas, discusses whether a new tax on big banks is justified. Ken Bentsen, of the Securities Industry & Financial Markets Association, and Mark Calabria, of the Cato Institute, share their insight as well.

In the second clip Mark Walsh, of ‘Left Jab,’ and Dan Mitchell, of the Cato Institute, discuss taxing banks based on their risk to the system.

I think that the introduction of postcodes will usher in the foundation for property tax, and that the gains to be had from postal efficiency are not at the heart of the move toward a comprehensive postcode system.

Just to give the background to this post, the Sunday Tribune reported:

Residents in Dublin’s coveted D4 addresses have only two years left until their exclusive postcode is renamed by the Department of Communications, as plans for the new postcode system are finalised by Minister Eamon Ryan. The department plans to issue tenders for the system by Easter, but a delay has meant the code will not be in place until the end of 2011, and not early next year as planned.

Under the new coding system, areas such as Dublin 4 and Dublin 6 will be renamed under a new six-digit system, such as D04123 and D06123. However Labour’s spokeswoman for Communications, Energy and Natural Re­sources, Liz McManus, said the latest estimates for the new system show it will cost a minimum of €40m.

McManus has also said businesses will suffer further financial hardships as they will be forced to change their address records and data.”This is not the time to be implementing this system, and it appears to be nothing more than a vanity project for the minister.”

What does this have to do with Property Tax?…

In the budget speech Lenihan alluded to the coming tax on property, this quote is verbatim ‘In the Renewed Programme for Government we have accepted the recommendations of the Commission on Taxation on the need for a property tax. Considerable ground work will need to be done before a Site Valuation Tax can be introduced. Work will shortly begin on the registration of ownership and the valuation of land‘ (emphasis mine).

The idea of a ‘Site Valuation Tax’ means that a property isn’t taxed on what it will sell for, rather it is taxed based on the value of the site it sits upon, essentially the footprint of the property, and this is where Liz McManus is missing the point - if we have comprehensive postcodes breaking areas down into small parcels then you can start to apply a site value with meaning.

I like to use myself as an example, I live in Donnycarney in Dublin 5, suffice to say the value of the site I live on is nowhere near as valuable as the sites of my not to distant neighbours in Beaumont or Raheny, so you couldn’t have a site value tax for ‘Dublin 5′, but if that were to change, and instead my postal code was me and every house within 100 metres then it would make absolute sense to value them all the same (from a ’site’ perspective).

It would also mean that maintaining a national database on property site values would be far more simple, without them you would have to figure out the actual transactions in an area, see if it was comparable or not and test for proximity and other factors, it would be a quagmire. However, with smaller parcels you can use the average for surrounding parcels as well as transactions and other measures to get a really accurate non-distorting site value (there would be marginal distortion such as where a less-desirable neighbourhood meets a desirable - my own neighbourhood being a case in point where Donnycarney borders Clontarf, it would be important to have some small tinkering to take account for circumstances, but by and large huge tracts of land could have a common postcode and broadly common value).

Far from postcodes being a ‘vanity project’ they are fundamental to a rationally and well working database that can be used to get a letter to you, but also to impose a property tax.

Doubt it? O.k., then be cynical with me for a moment and ask ‘Do we have a badly functioning postal service where letters are regularly lost?’ (if you are in debt collection you might believe that to be the case!), do we need to get post to people quicker than we used to? And with the new codes, will it speed up the process or increase efficiency? Is the post office going to do away with half of their work force due to some new found efficiency? And most importantly, in a year where every expenditure going is being slashed, would €40m not make one hell of a difference to some pertinent project?

Unless you have your eyes closed then the push for postcodes ought to be screaming out the obvious at this stage…. postcodes = property tax.

We don’t need a better postal system, we won’t get to send letters for less due to postcodes. In terms of function, I have tested it several times, it works, really well actually, in fact, if you get an envelope and write on it ‘Karl Deeter, Dublin’ I’ll still get it. That’s how good it is, fact, so why all the effort to re-invent the wheel? Unless it’s really about something else?

There was an interesting talk given by CFA Ireland on the topic of Islamic Finance and Sharia compliant financial products. The long and short of it is that there are no retail Islamic finance products widely available in Ireland at present, there are two or three Sukuks domiciled here.

So what can a Muslim living in Ireland do in order to remain Sharia compliant? The good news is that a person can essentially engineer their own Islamic Finance products at home, and this is perhaps the reason that there has not been a bigger uptake or creation of strictly Islamic products in both the west and in predominantly Muslim countries, even in Pakistan the uptake on Islamic Finance products is only c. 5%.

Part of the reason is that Islamic Finance products often come with a ‘Faith Premium’ which means the cost of being Muslim is significant if you choose to use products that are in strict compliance with your religion. It is important to note that it is in the area of ‘interest’ or ‘usury’ that Islamic Finance distinctly differs with run of the mill finance, usury is forbidden in the Qu’ran.

However, many Islamic Finance products can be engineered at home so we will look at them now.

1: Current Account that pays interest - In a current account or indeed, any interest paying account you can easily get around the usury laws by taking any interest and giving it to charity, using and utilising only our own money.

2: Mortgages - This is a little harder, but essentially you would need to rent and stay renting until such time as you can buy with cash. Having said that, with rents at all time lows and vacancies at all time highs it could be a good time to negotiate a ten year lease and start saving as much as you can so that you can afford the price of a house at the end of that time.

3: Investment - Equities are fairly compliant already, you can receive dividend which is a share of profit, and the values can go up, that is a market transaction, it is only when the element of usury enters that you have issues, so you could buy equities but not via a margin account. Equally, there are certain things that are banned such as alcohol company stocks etc. so it is important to look at any fund and consider the underlying stock if you want to invest via managed funds.

The fact that Ireland has an increasing Muslim population is without doubt, people often (mistakenly) think of Muslims as being from only Arab states, in fact, much of the northern half of the African demographic is primarily Islamic, that means people of all varieties be they black, or north African arab, equally, many of the emigrants from former Yugoslavia are Muslim, as are many Filipinos and Indonesians living here so the chances are that there are many more Muslims in Ireland than the average person easily realises, and this diversity in our national make up means there are new requirements in many services including finance.

The question is whether it warrants a specifically Islamic Finance approach and that is really the rock upon which potential business models here may perish because in the absence of a ready made product, many of the Sharia compliant concepts can be home made.

Islam internationally: Green - Sunni, Blue - Shia

I called Fred Harrison in connection with a book review I had done for the national broker associations magazine ‘The Professional Insurance Broker’, I wanted to send him on a copy, what was meant to be a quick hello/goodbye turned into a fascinating chat on the topic of property taxes.

Something that we are seeing more of lately is a debate where the public sector are demonized - often for merely existing - and portrayed as being ‘wasteful’ and bloated. Bob Frank in the US said something to me before that stuck in my head, that ‘the serious waste occurs in the private sector, the public sector don’t go around buying hummers and other pointless trophies, the ‘waste’ in the public sector however, is found in the way that they budget and perform versus the private sector’.

I think that is profound, the public sector don’t waste in the same manner and it is important to remember that in any debate. However, when it comes to running a tight budget the private sector is head and shoulders above the public sector, and that is where the concept of ‘waste’ comes into play. This inherent dilemma was solved in a sentence (for me anyway!) yesterday.

‘The public sector must capture the gains the public sector creates and take it away from land speculators, bankers and anybody else who tries to capitalise their work’. Simple and yet genius. We shouldn’t be using the tax and transfer system via wages, it would make far better sense to let people keep what they earn and instead tax them on the services received and infrastructure used, property tax with services tax and a few other simple concepts would achieve this, and perhaps we might (if this was embraced) end up with a tax system that people understand!

The focus is all wrong, we shouldn’t concern ourselves with the public sector being over or underpaid, rather, their income should be a reflection of the services rendered and then spread that accordingly, that is how any business works, you don’t set your income based on what you reckon you want whether the money is there or not, you set it based upon what actual money is in the account, and that needs to be determined by a system where the reward comes from the service. How crazy is it, when you actually think about it, to tax me or you on our actual job earnings in order to pay for a road outside of your house? They are totally unconnected concepts and events.

The idea of changing the way that we collect taxes is a central theme in Fred Harrison’s work and he works on data sets going back over 200 years to prove that land and property have been central themes in financial crises since modern economies began. If his thesis is correct, a change in the manner in which we collect taxes would make a huge difference to this, and it seems to be largely backed up by well thought out research, TCD’s Constantin Gurdgiev did an excellent paper on the topic recently.

I won’t get into the minutiae of property tax (I’ve done that too many times in the past!), what I will talk about is the old nugget that gets thrown at you every time you mention property tax, it is the opposition trump card and all pervasive example….. ‘What about an old widowed pensioner who’s only income is social welfare, and they live in a house worth a million’.

That is a natural example to consider, because when it comes to tax the concern isn’t really about those who can and will pay, it is to be mindful of those who can’t (as opposed to won’t). I struggled with this question for some time, it is poignant because it is a real life example and many of us likely know a person in this very situation. How is property tax ‘fair’ to a person like that?

And that is when I was told ’stop for a second, if we want to talk about fairness in its truest sense then we need to ask ourselves ”who created the value of that property” is it existing as an island of wealth on its own? Or is it due to the amenities in the area,? The schools, location, transport and other things? We take a complex variety of these things and they are interpreted in a market fashion by ‘price’.

The value of the actual ‘Land’ isn’t theirs, that particular element of value was created by the state and should be the source of revenue for municipalities’ (note: he didn’t mention the value of the property/house on the land, that is created by a person and the additional wealth it offers can be private because the creation was private).

The value of a property is indeed largely accounted for by public spending but the property is held privately, in my own neighbourhood I didn’t pay for the Dart, the two large city routes next to me, the school, park, playground or anything else which make the location desirable, granted, I paid tax (haven’t figured a way out of that yet!) but it was from the communal pot that the money came, in particular I don’t have to pay for any of the benefits my area offers.

Back to the widower though, if they truly can’t pay then there are options, the coldest being ‘you are thus consuming far above your requirements and that is a personal decision, live with the cost’ this is the same argument you would use from an environmental perspective if we brought in a weighty fuel consumption tax (on the price of petrol) for a person who says ‘I’m old and widowed and all I have to get around is this four litre engined Mercedes’, grin if you like, we all understand the communal value of the environment but it seems to stop there.

The option would be to use a Californian method (evident bias: I’m a Californian!) where the person in retirement has a choice, they either pay and have an unencumbered property or they can start to accrue tax plus interest and it is paid upon death (at the transfer to their estate), the obvious second line in an Irish context is ‘what about the poor kids inheritance?’ [note: everybody seems to be widowed, a granny, on welfare and orphaned when we have these conversations]. The fact is that if kids truly want to have the property as-is then they could offer to pay the tax, if they don’t want to then the truth is that they don’t see the point and wanting to keep the asset but not pay is just rent seeking, which is fine, its just not justified.

We need to make some serious changes in Ireland, perhaps in the entire western hemisphere, if we are to change the road we are presently on in which increasing amounts of wealth and power are distributed to the East. Every nation has its moment in the Sun, their time to shine, the west does have the option of creating an economic daylight-savings time and ensuring this twilight occurs further down the line, the question is ‘do we have the appetite?’. If we do then the fundamental system of taxation is one of the core issues that must change.

There are three broad benefits to regulation of a financial system.

Firstly, avoidance of negative externalities, often the societal costs of these outweighs the private cost and prevention is possible when a regulator is function well and doing their job correctly. They do this by preventing excesses, by promoting conservative risk management in the financial sector and helping to maintain confidence by ensuring (for instance) that a liquidity shortfall in one institution doesn’t spill over into others (i.e. avoiding multiple bank runs which take down well functioning solvent banks in their wake) resulting in a widespread credit crunch.

Secondly, to set solvency and reserve requirements for banks, at times there are significant asymmetries in information within the consumer/institution relationship, or worse still, information gaps (where both institution and consumer don’t have full information – as happened in the sub-prime loan market in the USA), when nobody can determine the quality and reliability of a financial product a strong regulatory environment will ensure that banks are in a position in which they can weather the storm.

Thirdly, the provision of safety nets such as investor compensation schemes or deposit insurance. The downside of these are the degree to which they can promote moral-hazard, in other words, consumers stop caring about the strength of a bank balance sheet because they feel protected at any cost and equally banks may decide to take more risk than they normally would expecting a bail out if there is ever widespread panic.

From an Irish context our regulator is a failure in each of these examples, in the first example the Department of Finance has done a far better job of balancing the internal and external shocks to the Irish financial system.

On the second issue they didn’t encourage anti-cyclical provisioning, indeed, reserves should be set aside with a multiplier that rises as the wider economy goes up, this means that more is set aside the greater the upside volatility in order to be prepared for the downside volatility that often follows any boom. Dynamic provisioning is not a feature of the Irish regulatory framework.

On the third front, our deposit guarantee scheme had a paltry €527m in it last year, this wouldn’t be enough to save our smallest bank, and meanwhile the lenders have in effect been bailed out, the profits of capitalism have been privatised but the losses made into a public issue.

The Regulator is an entity which has not been sufficiently brought to question for their role in the financial crisis in this country, they are the police, the guardians at the gate, the very fact that bank balance sheets exploded on their watch while they stood by and did nothing about it are evidence that they were not fulfilling their mandate of protecting the economy from systemic risk, while the individual banks are to ‘blame’, it must be remembered that they have no mandate for the protection of the wider economy, they are, by their nature machines of greed and decisions are made on capturing market share and profits, any protective measures are made in favour of their balance sheet, not the national interest.

Their behaviour was akin to that of a police department sitting by while the city is looted, we paid the regulator to protect us, to be our caretakers, to keep the enemies from the gate, the costs of this failure are ultimately born by the taxpayer, and now, to a lesser degree, by the banks. Where are the calls for their public tribunal? Where are the answer? Quis custodiet ipsos custodes?

Yesterday the National Asset Management Agency (NAMA) legislation was brought out in the Dail (that’s the Irish Government buildings for our international readers) . We have put some of the developments into simple graphs to give an idea of the way NAMA will work and what the prices are as well as what they mean (for the pedants out there- they were drawn by hand to demonstrate the point).

So the total value of the loans is €68 billion, adding on €9 billion in rolled up interest - development accounts often had this factored into the end sale price, generally showing c. 15% profits (as a minimum) with the roll up included.

The €77 billion in loans will receive a 30% haircut (across the board) meaning the price paid will be €54 billion. It is important to note that different institutions will see larger haircuts than others, so it might be that BOI gets 20%, AIB 25% and Anglo 37% / INBS 42%, the 30% represents a varied pot in which individual loan sizes and haircuts will vary, having said that we know already that the biggest discounts will need to be applied to INBS and Anglo.

Brian Lenihan stated that the original value of these assets was €88 billion, of which the loans were €68 billion (before rolling interest was added on), an average LTV of 77% applied (which is over standard commercial lending levels so some more digging may be needed to see if there were cross-security/cross collateral considerations or cash flow producing securities for additional lending involved). These loans will being bought for €54 billion imply a 40% drop in the values of the assets on an economic basis (not today’s market price basis).

Each loan going to NAMA will have 185 queries/questions required on the property itself, and a further 300 on the loan, that means the diligence will be c. 500 questions that must be answered for each property. The staff of NAMA (c. 50) can’t cope and thus the banks are taking people out of credit and having them go to work for NAMA but on the bank payroll, so in essence NAMA has outsourced the work at no additional personnel cost which was a smart move (one of few).

The actual value of the assets in today’s market is (we are told) €47 billion, this means that there is an upfront shortfall of €7 billion, so no matter what happens there has been a potential tax payer cost of €7 billion at a minimum, obviously that is the market value though and not a long term value which assumes that prices will eventually rebound (the estimate is 10% in 10yrs), that point can be argued for and against, the issue will be (in my opinion) the ongoing cash flow to ensure loans are serviced. There isn’t any information put forward about expected default rates and that could easily skew the numbers.

The debt is also predicated on Euribor and while Liam Carroll’s case was tossed out of court because it relied on low interest rates, we have pegged the NAMA on the same hopes! It tells me that this plan probably wouldn’t stack up if it was provided judicial oversight, then again, fairness was never part of the plan.

Having said that, of the assets going across c. 40% of them are cash flow producing assets - in some cases this is blocks of apartments that were retained by developers and let out or other commercial rents. The banks will have a big job ahead of them in the near future: they will have to raise some capital quickly to avoid dilution of their shares/potential nationalisation (or at least majority state ownership which is effectively the same thing), if today’s share price performance is anything to go by the appetite is back so this seems likely to be a working solution. NAMA isn’t about fairness, and in that respect it is a massive failure, it is about a plan with a chance and in that respect it has a better chance of success than the alternatives put forward.