Optimal%20Taxation%20Theory%20and%20the%20Taxation%20of%20Housing

1
Optimal Taxation Theory and the Taxation of
Housing

• Alan W. Evans
• Centre for Spatial and Real Estate Economics
  University of Reading

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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?

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Price
B
A
Supply curve with tax
E
D
Supply curve (perfectly elastic)
C
Quantity
F
G
O
The welfare loss (Atkinson Stiglitz, 1980)
4
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.

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A Survey of Recent Research
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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

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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
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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.

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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

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• Simulation (for U.S.) suggests
• Stock of business capital is 6 too low
• Stock of housing capital is 8 too high

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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.

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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)

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The Problem of Land

• Land is not included in these models, it is
  something where further research is needed.

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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?

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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.

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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

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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.

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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?

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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

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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.

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Constraint
Price/Cost
D
T
D
A
A
O
S
Land
Constraint
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Or Tax
Price/Cost
D
T
D
Tax
A
A
O
S
Land
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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)

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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

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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.