OSH GORDON

Special to The Globe and Mail

Published Friday, Mar. 10, 2017 12:11PM EST

Josh Gordon is assistant professor at the Simon Fraser University School of Public Policy.

The Ontario government is reconsidering its opposition to a foreign-buyer tax for the Toronto market, according to Finance Minister Charles Sousa. Introducing a stiff foreign-buyer tax is a smart policy move and they should do so without delay. Here’s why.

First, the primary forces driving Toronto’s high housing prices lie on the demand side, not on the supply side. I document this claim carefully in a report being released Monday by the Ryerson City Building Institute.

Many have alleged that weak supply is the main problem, yet the evidence does not support that. Housing construction in Toronto has remained strong in recent years relative to population growth. Construction of detached houses is somewhat lower than in past years, but modestly so, and meanwhile condo building in 2015 and 2016 was near record rates.

Some analysts have pointed to the region’s greenbelt as a major cause of rising prices, because it limits land supply and thereby increases the price of land. Scholarly research suggests, however, that such geographic constraints cannot account for much of the price increases Toronto has experienced. Toronto’s urban footprint has not “bumped up” against the greenbelt yet, and only 20 per cent of the land set aside for greenfield expansion in the 2006 Growth Plan has been built on.

Second, foreign capital has played an important role in pushing up prices. The provincial and federal governments have not gathered good data on foreign ownership, but we can infer its role in reliable ways.

For one, capital flight from China of around $1-trillion (U.S.) in 2015 and nearly that much in 2016 has flooded specific property markets in the developed world. Countries that keep better track of these things, such as the U.S. and Australia, saw a trebling of residential buying from China in the past few years – and intense price pressures in the affected cities. And in surveys of elite Chinese citizens, Toronto has been among the top destinations for external real estate investment: sixth globally in a 2014 survey, while Vancouver was third.

The Vancouver experience is also illustrative. Here we do have some data, however limited. Foreign nationals comprised almost 15 per cent of the market in a five-week period leading up to the introduction of a foreign buyer tax in July, 2016, after which point the share dropped precipitously. This underestimates the amount of foreign buying, because what matters is where the income and wealth is generated, not nationality. Nevertheless, since imposing the tax, the market has gone cold in important segments, with sales of detached homes down 54 per cent year over year – and prices have started to fall overall.

This sharp slowdown suggests that foreign money was having potent “knock-on effects.” Foreign money was driving up prices, and thereby stimulating local speculation and panicked first-time buying. Once foreign money was curtailed, the knock-on effects of speculation and panic-buying subsided.

The contrast of the Vancouver market with the red-hot Toronto and Seattlemarkets – major alternative destinations for Chinese capital – couldn’t be any clearer or more revealing.

Third, federal policies targeted at other major demand forces would be too blunt. Raising interest rates would have a big impact on the Toronto market, but it would also harm economic activity in the rest of the country.

Further reforms to mortgage rules, while perhaps prudent, would depress property markets in other parts of the country, which do not see worrisome price trends. The ineffectiveness of the mortgage “stress test” introduced last fall also suggests that it is not first-time buyers that are driving the Toronto real estate “gravy train,” but rather wealthy investors, both local and foreign.

That leaves provincial policies that can be targeted directly at Toronto, and which can have an immediate impact – especially on price expectations, which are a crucial element to housing bubble dynamics. A stiff foreign-buyer tax meets those criteria.

Such a tax would not achieve housing affordability on its own. None of its proponents, myself included, have ever claimed it would. What it would do is help calm a dangerously frenzied market.

After introducing a foreign-buyer tax, the Ontario government should consider an annual property surtax that could be offset by income tax paid. It would be aimed at higher ends of the property market, and seniors who had paid into CPP at a high rate for 10 or so years would be exempt. This would effectively target the surtax on those who owned expensive property based on foreign income or wealth, or illicit domestic income. And it would be retroactive in effect. Local income earners would have little to fear, if the legislation was properly designed.