Tom McDonnell: Nat O’Connor’ post on this blog on May 18th provided an excellent overview of the debate on property tax. Another important aspect of the debate relates to the effect of a property tax on economic growth.
It is important to stress at this point that I’m restricting my comments here to ‘bricks and mortar’ property. Bricks and mortar property is no more or no less a form of property than a financial asset or a car, but as it is likely that any property tax introduced later this year will effectively be a bricks and mortar tax, I won’t include those other categories of property in this post. Of course, from an equity perspective an all-encompassing property tax is preferable to just a bricks and mortar tax, because most low and middle income earners do not have substantial assets besides the family home.
The parlous state of the public finances seems to be making the prospect of some form of bricks and mortar property tax ever more likely. But fixing the hole in the public finances is not the only reason to introduce such a property tax. From an economic growth perspective, recurrent (e.g., once a year) taxes on immovable property are generally considered to be desirable because they do not penalise productive activity. One rationale is that, in the long term, recurrent taxes on immovable property will shift some investment out of housing into higher return investments and so increase the rate of growth. Taxes on property transactions are considered less desirable than recurrent taxes for a number of reasons, for example because they reduce labour mobility. Recurrent property taxes are also preferable to taxes on property transactions because they are stable over the economic cycle
Recent evidence indicates that the tax structure does appear to impact growth performance. The OECD looked at various taxes from an economic efficiency perspective and found that property taxes may be the least damaging to growth prospects. Heady et al (2009)also find that recurrent taxes on immovable property are the least harmful (or most beneficial) tax instrument in terms of its effect on long-run GDP per capita.
The full tax-and-growth rankings are (from best to worst):
1. recurrent taxes on immovable property
2. consumption taxes (and other property taxes)
3. personal income taxes
4. corporate income taxes
Finally, it should be noted that the better-off are disproportionately likely to hold property, and that it should therefore be possible to construct a progressive property tax. An inequality-proofed and poverty-proofed property tax is long overdue in Ireland.
12 comments:
Tom -
"Of course, from an equity perspective an all-encompassing property tax is preferable to just a bricks and mortar tax, because most low and middle income earners do not have substantial assets besides the family home."
All other assets are taxed already. There is no free ride here (or at least there shouldn't be).
E.g. -
1. Interest earnt on deposits is taxed
2. Dividends on shares are taxed at the marginal rate
3. Capital gains tax is paid when the assets are sold
4. 8 year deemed disposal rule of life-assurance funds (tax is paid on the fund every 8 years regardless of whether or not you sell up)
5. Stamp duty is paid on the purchase of shares
In fairness, property is as well (Stamp Duty) - it's just a matter of switching from unstable transaction revenues to a more stable annual tax.
Of the taxes on other forms of property only capital gains tax (and stamp duty for shares) are irregular taxes.
I am delighted to see growing interest in recurrent residential property taxes. Introducing such a tax makes sense.
Four things ( at least) should be considered in discussing this.
First such a tax would have to be properly designed if it is to be equitable and acceptable to the public. Second, given established property ownership patterns established after years of not having such a tax many people live in houses with values way in excess of anything they could afford based on annual incomes. Third it is unlikely that a tax directly related to the size or value of homes will in fact be progressive. Certainly at very high levels of incomes the value to income can come down. A surgeon on €1m pa may not live in a house worth €4m but someone on average incomes may live in a house worth 5 times their income. Fourth, a system for mortgage interest relief would have to be devised.
Tom Dunne DIT Bolton St.
I am delighted to see growing interest in recurrent residential property taxes. Introducing such a tax makes sense.
Four things ( at least) should be considered in discussing this.
First such a tax would have to be properly designed if it is to be equitable and acceptable to the public. Second, given established property ownership patterns established after years of not having such a tax many people live in houses with values way in excess of anything they could afford based on annual incomes. Third it is unlikely that a tax directly related to the size or value of homes will in fact be progressive. Certainly at very high levels of incomes the value to income can come down. A surgeon on €1m pa may not live in a house worth €4m but someone on average incomes may live in a house worth 5 times their income. Fourth, a system for mortgage interest relief would have to be devised.
Tom Dunne DIT Bolton St.
Thanks for commenting Mack.
I don’t at all claim there is a free ride. I’m merely flagging that my focus here is restricted to just a bricks and mortar property tax rather than to all types of property.
I certainly agree with you that a stable annual tax is preferable to the current transaction tax
The Wealth Tax Act 1975 gives three definitions of property: (a) real property, (b) personal property (i.e. other than real), and (c) 'property': interests and rights of any description. The debate is hampered by a lack of clarity in this regard - the common use of property tax is confined to only one of the three definitions. Interesting to note that Goodbody projects that ‘housing assets’ will fall by 33 percent between 2006 and 2010. Financial assets, however, will rise marginally. A property tax that doesn’t capture all ‘interests and rights’ will miss out on a lot of property – especially as financial assets make up nearly half of all assets.
Also noteworthy is the ESRI study prior to the last budget that showed with an exemption of incomes below €15,000, a real property tax will not be progressive from the 4th decile on (they assume a tax of 0.4 percent of market value). This, however, under-states the situation since disposable income is only a partial picture of people’ actual disposable income. Using the Household Budget Survey 2005 (somewhat old but, for purpose of illustration, suitable), the ESRI impact would change if we examine the after-necessary-expenditure disposable income (excluding food, housing and utility costs):
* The middle 6th decile would face a ‘property tax’ of 1.8 percent
* The highest decile would face a tax of 1.3 percent
This is only illustrative but it shows that a property tax can be particularly penal in the middle deciles since, as Tom points out, most of these households’ assets are the family home.
It would seem that a more equitable (and less deflationary) approach would be to (a) apply a tax to all ‘property’; (b) initially apply it to incomes over €100,000 so as not to penalise the ‘spenders’; and (c) gradually reduce the threshold to eventually include all income tax payers while varying the tax rate to ensure authentic progressivity.
There are a number of questions that need addressing.
@ Michael
The ESRI findings are an important contribution and flag the need for extreme care and widespread debate about how these types of measure should be designed. Progressivity should be a prerequisite of design.
Regarding your point (b) - are you advocating that only those with incomes over €100,000 be taxed regardless of the value of their assets?
@ Tom
Your second point is key. How should we deal with situations (e.g., pensioners) where the value of the asset is far in excess of annual income? Should the property tax be capped at a proportion of current income regardless of the value of the asset?
The definitional issue is very important. Can we justifiably differentiate between bricks and mortar property and financial or personal property?
If so, is a recurrent tax preferable to a transaction tax for all forms of property? In the case of certain types of personal property (e.g., clothes)a transaction tax like VAT seems preferable to a recurrent tax.
I'd question whether a holistic property tax makes sense. In what way would taxing the total value of savings be superior to DIRT? (And would you envisage it replacing DIRT)?
It might well force savers to seek out the best rates for their savings (a positive).
On the other hand it's not difficult to imagine scenarios under which the real and or nominal values of savings decreases under the strain of low interest rates and a wealth tax. Under those circumstances Irish people won't save. They might spend their money, or speculate excess earnings on more risky undertakings that might give a return. Either way or pool of savings for future investment could be diminished.
If we need to raise more tax from savings - wouldn't it just make sense to raise the rates on the taxes we currently have?
Annual wealth taxes, based solely on wealth, are often opposed because they run into the asset rich/income poor circumstances of some, especially pensioners.
But they are not insurmountable as an exemption for the poorest is possible.
For this reason the poll tax in Britain was deeply unpopular, and helped to bring down Thacher, whereas the council tax, though hardly loved, is regarded as fair.
This should complement high taxes on inheritances, gifts (to prevent avoidance) and on all unearned income; capital gains, interest, rental income, etc. With virtually no exemptions.
It has two key effects, redistributon and pushing passive savings into productive uses.
This is very different from the current situation.
@Michael Burke
Are you arguing for a holistic wealth tax in addition to high taxes on interest?
If a citizen has €10,000 in the bank, earning 3% interest, paying 50% DIRT (high dirt tax), and inflation is at say 1.5% - then any additional tax is going reduce the real value of the savings (should interest rates fall it might also reduce the nominal value of the savings).
pushing passive savings into productive uses.
It would also reduce banks ability to lend into the economy without resorting to the wholesale markets (hardly what they need right now).
It would encourage citizens to invest in riskier assets (e.g. shares or property) - but given the tiny size of the Irish market - why would they invest in Irish businesses rather than opportunities abroad?
Tom - there could be a wealth-free allowance; that is, the first €770,000 would be exempt (that is the entry point under the French wealth tax, with a progresive sliding scale upwards). In the first instance, only those who earn over €100,000 would be subject to the tax (this would give time to create a proper administration and focus for the first couple of years on those with the highest income/wealth). Over time, the income threshold could be brought down.
It is difficult to know how much could be raised from such a tax; much would depend on exemptions and relief. One could so water it down that it could become a pointless exercise. The key would be to broaden the base as much as possible.
Mack
Holisitc is always better than piecemeal, but I think you have set the bar a little low, no? Maybe liquid assets of €0.5mn, total assets of €1mn, say, could be the theshhold(s).
The banks aren't lending to the real economy, that's really the nub of the issue. So government must find resources to fill an investment gap left by a private investors' strike, otherwise there'll never be a recovery worthy of the name.
GNP has fallen by €30bn in the recession. GFCF accounts for €24bn, and de-stocking another €2.5bn. And- before anyone trots out the canard that 'it was all unsustainble housing'- constructon accounts for less than a quarter of that, at €6.3bn.
The private sector will not invest because it cannot (cash-strapped, lack of bank credit) or will not (lack of profits).
Only govt. can fill the breach, and needs to. Soon.
What you are proposing sounds very like a tax on investment. In a country where, as has been correctly stated, there is currently a severe shortage of capital, that is a very bad idea.
On a point of fact, you are incorrect to say or imply that a property tax as is often talked about is necessarily a bricks and mortar tax. A land value tax is an example of a real property tax that has nothing to do with bricks and mortar, only the value of the land.
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