Download Optimal Taxation Theory and the Taxation of Housing

Optimal Taxation Theory and
the Taxation of Housing
Alan W. Evans
Centre for Spatial and Real Estate Economics
University of Reading
Optimal Taxation Theory
• Premise: a government wishes to raise a
given sum through taxation but recognises
that taxes distort choice.
• Question: How should it raise this money if
it wishes to minimise the distortion which
does occur?
Price
B
A
Supply curve with tax
E
D
Supply curve (perfectly
elastic)
C
O
G
F
The welfare loss (Atkinson & Stiglitz, 1980)
Quantity
For Efficiency or Equity
• For Efficiency: Impose taxes on goods
with low price elasticity, like housing
• For Equity: Impose taxes on goods with a
high income elasticity, unlike housing.
A Survey of Recent Research
Cremer and Gahravi (1998)
• They set out to explain housing subsidies
for the poor.
• Subsidies are OK if poorer households
can be distinguished, and
• If poorer households have a stronger
preference for lower quality housing than
do wealthier households
So subsidies are a side issue, since the
Cremer and Gahravi result is not very policy
relevant.
All other research relates to the question of
the separate tax treatment of owner
occupation and renting.
Past research, going back to Laidler (1969),
suggests a welfare loss of a half a percent
or so, but this research uses static models
Skinner (1996)
• Argues dynamic effects are substantial.
• Uses an overlapping generations with
bequests model – welfare loss of 2%
• Low tax on o.o. causes price rise
• This results in a windfall gain to existing
owner occupiers.
• The saving of younger generations is
distorted and goes into low taxed housing.
Gervais (2002)
• Models a dynamic general equilibrium life
cycle economy.
• Finds that low taxes encourage owner
occupation, and
• Encourage owner occupiers to over-invest
in housing
• Simulation (for U.S.) suggests:
• Stock of business capital is 6% too low
• Stock of housing capital is 8% too high
Englund (2003)
• Tax incentives encourage the young to buy
early
• This results in a pattern of saving where
savings are high until they can buy, then
low (Englehardt, 2003)
• The incentives also encourage taking on a
high risk which they should not.
Eerola and Maattinen (2005)
• Taxes on owner occupied housing should
be higher than on business income, not
lower
• Firstly, the tax on imputed income from
property, and then
• Secondly, an extra tax on housing as a
good or service (like VAT)
The Problem of Land
• Land is not included in these models, it is
something ‘where further research is
needed’.
Property Taxes in the USA
• These are ignored by researchers
• The justification is that they pay for
benefits
• Therefore the two cancel out
• Research shows that taxes reduce
property values and benefits increase
them
• But at the margin?
• And with other tax systems?
A Conclusion
• Property taxes are much higher in the US
than in most other countries.
• Equal to about 1% of value. Differences
like Proposition 13 in California make it
difficult to generalise.
• But US tax policy is more neutral than
previous researchers suggest.
The UK & Tax Neutrality
• Used to have a tax on the imputed income
from owner occupied housing, up to 1961.
• Used to allow mortgage interest as a tax
deduction, but this was phased out
between 1976 and 2000.
• Gervais regards interest tax deductibility
as the main problem in the US
Other Taxes & Other Investment
• Capital Gains Tax – Neutral, because of
roll over relief.
• Stamp Duty (Transfer Tax) – Neutral
because small and charged on both.
• VAT – Not charged on any residential
property, except extensions.
Income Taxes
• Contributions to pension schemes have always
been tax deductible and for most this is their
main form of saving and investment.
• Since the early nineties investment through
PEPs and then ISAs has been possible which is
not subject to income or capital gains tax. For all
but the wealthiest the amounts are substantial.
• Does this help to ensure neutrality?
Property Taxes in Britain
• The UK property tax (Council Tax) is not
proportional to capital value.
• It is regressive, a high percentage on low
value dwellings, then lower.
• It is effectively a fixed amount for dwellings
worth over about £1m
The UK System
• The older and wealthier are favoured over
the poorer and younger
• Although the younger may be paying
mortgage interest they are encouraged to
buy and wait until, after ten or twenty
years mortgage interest can be ignored
• This is exacerbated by the implicit tax on
land.
Price/
Cost
Constraint
D
T
D’
A’
A
O
S
Land
Constraint
Price/
Cost
Or Tax
D
T
D’
Tax
A’
A
O
S
Land
The UK and Land
• House prices rise by 3.3% p.a. in real terms (W.
European average 1.8%)
• An implicit tax, paid by the younger generation to the
older
• House construction is constrained
• New dwellings are smaller than in the rest of western
Europe – England 76 sq.m., France 112.8 sq.m.,
Germany 109.2 sq.m. (Eurostat, 2002)
Commercial Land
• Taxed at a higher rate than residential land
• Extensive Uses (i.e. Manufacturing)
Discouraged
• Intensive Uses (i.e. Offices) Encouraged
• Property Rented by Firms (possibly by
Sale and Lease Back), not owned
Conclusions
• More research is needed on the role of land.
• In the UK land controls mean that there does not
seem to be overinvestment in housing.
• Favourable tax treatment of savings helps in this
• But the market is distorted both by controls and
the Council Tax, and the latter is definitely not an
optimal tax.
• There seems no reason why VAT should not be
imposed on new housing.