By loprespub on May 17, 2022
If housing supply and housing demand could talk, they would tell us that proposals that increase supply have the effect of reducing the price of housing and increasing quantity. As for proposals that increase demand, they raise both the price and quantity of housing.
This HillNote presents a supply-and-demand perspective on housing affordability in Canada.
Budget 2022 Proposals
In Budget 2022, the federal government acknowledged that Canada faces a housing shortage and explained that it will need to double its rate of new construction – currently 200,000 housing units per year – to 400,000 housing units per year over the next decade to fill the existing gaps and keep up with its growing population.
To address this challenge, the government has made 24 proposals through which it plans to spend a total of $10.1billion over five years to build more homes and make housing more affordable. These proposals can be divided into four main categories:
- proposals that increase housing supply elasticity, i.e., that make housing supply more responsive to price changes (e.g., using federal infrastructure and transit programs to encourage provinces, territories and municipalities to build more homes);
- proposals that increase the supply of market and non-market housing (e.g.,establishing the new Housing Accelerator Fund, speeding up housing construction and repairs for vulnerable Canadians through the National Housing Co-Investment Fund, rapidly building new affordable housing by extending the Rapid Housing Initiative, and establishing the new Co‑operative Housing Development Program);
- proposals that reduce housing demand (e.g., the two-year ban on foreign investment and taxation of capital gains on a principal residence held less than 12 months); and
- proposals that increase housing demand (e.g., establishing the new Tax-Free First Home Savings Account, doubling the First-time Home Buyers’ Tax Credit, and extending and increasing the flexibility of the First-Time Home Buyer Incentive).
Housing Supply and Demand
Housing supply represents the quantity of housing units that developers and existing homeowners (sellers) are willing to sell over a range of prices in any given period. As shown in the figure in the appendix, it is represented graphically as an upward-sloping curve, with price on the vertical axis and quantity on the horizontal axis, depicting the positive relationship between the price and the quantity supplied.
Examples of factors that can influence housing supply include land and construction costs, as well as geographical constraints (e.g., oceans and mountains) and municipal land-use planning restrictions, which fall under provincial, territorial and municipal jurisdiction, and limit the types of homes and where they can be built. Geographical constraints and municipal land-use planning restrictions are key determinants of a city’s housing supply elasticity. A supply shift (an increase or a reduction in the housing supply curve) changes the quantity that sellers are willing to sell at all price levels and occurs because of a change in at least one of the factors that influence supply, except the price itself. A change in the quantity supplied, rather than a supply shift, occurs when only the price changes due to a demand shift in the absence of a supply shift.
Similarly, housing demand represents the quantity of housing units that buyers are willing to buy over a range of prices in any given period. As shown in the figure in the appendix, it is represented graphically as a downward-sloping curve, depicting the negative relationship between the price and the quantity demanded.
Examples of factors that can influence housing demand include buyers’ borrowing capacity, buyers’ income, employment, population growth and tax measures that increase the after-tax return of homeownership compared to other investments. A demand shift changes the quantity that buyers are willing to buy at all price levels and occurs because of a change in at least one of the factors that influence demand, except the price itself. A change in the quantity demanded, rather than a demand shift, occurs when only the price changes due to a supply shift in the absence of a demand shift.
In each housing market, supply and demand curves intersect at the equilibrium price, where the quantity supplied and the quantity demanded are equal. As a result, determining whether government initiatives and funding proposals would modify housing supply elasticity, housing supply or housing demand can provide valuable insights about their impact on the new equilibrium price and quantity of housing after their implementation.
Proposals that Increase Housing Demand
As shown in the figure in the appendix, when housing supply is somewhat elastic, proposals that increase demand increase the equilibrium price and quantity of housing by shifting demand higher for all price levels. However, according to the International Growth Centre (IGC), they are “ineffective in cities where housing supply is constrained by stringent planning restrictions and limited land availability.” In such cities where housing supply is inelastic, proposals that increase demand “simply translate into a rise in house prices” without any increase in the quantity of housing.
According to the Department of Finance Canada, the Income Tax Act and the Excise Tax Act contain net incentives for owning a home versus renting estimated at $5.3 billion per year in 2021 (e.g., the non-taxation of capital gains on principal residences, the Goods and Services Tax rebate for new housing and the First-Time Home Buyers’ Tax Credit minus the Exemption from Goods and Services Tax for certain residential rent). As noted by Evan Siddall, former President and Chief Executive Officer of the Canada Mortgage and Housing Corporation in 2018, the non-taxation of capital gains on a principal residence combined with “low interest rates make investing in our homes an irresistible means of savings” because a “home’s value can increase ten-fold or more without triggering capital gains tax.” According to Mr. Siddall, the benefits of the non-taxation of capital gains on principal residences are “greatest for higher-income households” because there is no limit on the amount of tax-free capital gains that can be earned through the sale of a principal residence. On the other hand, tenants who earn capital gains in non-registered accounts – i.e., not a registered retirement savings plan or a tax-free savings account – must pay federal and provincial/territorial taxes on 50% of these capital gains.
Proposals that Increase Housing Supply
As shown in the figure in the appendix, when housing supply is somewhat elastic, proposals that increase housing supply through direct government provision, capital contributions, loan subsidies or tax measures reduce the equilibrium price and increase the equilibrium quantity of housing by shifting supply higher for all price levels. However, according to the IGC, when implemented in the context of municipal land-use planning restrictions “that create housing supply inelasticity,” these proposals “cannot increase the total housing stock, but rather serve to crowd out unsubsidised housing with housing built by subsidised developers.” Moreover, these proposals alone are generally insufficient to tackle the fundamental factors that make land and construction costs so expensive in the first place.
Proposals that Increase Housing Supply Elasticity
In 2021, the Bank of Canada estimated that the median housing supply elasticity was 2.2% among all Canadian cities, which means that a 1% increase in home prices in the median Canadian city was associated with a 2.2% increase in housing supply. However, it found significant differences across cities. For example, the estimated supply elasticity was 0.63% in Vancouver, 0.89% in Toronto and 4.3% in Winnipeg.
According to the IGC, when a city’s housing supply is inelastic, “[u]nlocking land for housing requires removing the constraints to, and thus lowering the costs of, obtaining formal land that is well-connected to the city.” Examples of these constraints include stringent land-use planning restrictions and challenges securing well-located government land for housing. In 2020, the C.D. Howe Institute estimated that these constraints added on average $230,000 to the price of a new home across the eight most restrictive Canadian cities and $644,000 in Vancouver.
As explained in Budget 2022, all levels of government will have a role to play in enabling the construction of more homes and making housing more affordable across Canada over the next decade.
Appendix
Figure – Housing Supply and Demand
Note: The numerical examples are provided for illustration purposes only.
Source: Figure prepared by the Library of Parliament.
Further readings:
Lee, Marc. Canadian Centre for Policy Alternatives, BC Office. Upzoning Metro Vancouver’s Low-density Neighbourhoods for Housing Affordability, February 2022.
Office of the Parliamentary Budget Officer. House Price Assessment: A Borrowing Capacity Perspective, 17 February 2022.
Ontario Housing Affordability Tax Force. Report of the Ontario Housing Affordability Task Force, 8 February 2022.
By Édison Roy-César, Library of Parliament.
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Categories: Economics and finance, Social affairs and population
Tags: Bank of Canada, Budget, Budget 2022, Housing, housing demand, housing shortage, housing supply, International Growth Centre
