Friday, May 6, 2011

Property Taxation - Taxing Your Wealth

As we are all aware, governments around the world are awash in their own sovereign debt.  Fortunately for all of us, the Organization of Economic Co-operation and Development has released their Tax and Economic Growth Economics Department Working Paper Number 620 by Asa Johansson, Christopher Heady, Jens Arnold, Bert Brys and Laura Vartia.  This paper examines the design of tax structures across the 21 OECD nations over the past 34 years and suggests how taxes can be "tweaked" (raised) without interfering with economic growth.  The authors note that high corporate taxes are found to be the most harmful for economic growth, followed by personal income taxes and lastly by consumption taxes.  They also note that recurrent taxes on immovable property (what we in North America call real estate property taxes) have the least impact on economic growth and suggest that if nations wished to remain tax revenue neutral and still grow their economies, they should shift their tax base from income taxes to recurrent taxes on immovable property.  Just in case you missed what the authors are getting at, they are suggesting that governments could raise extra revenue to reduce their debts without hurting economic growth by increasing property taxes.  That's what I'm going to focus on for this posting.

Here is the opening paragraph of the paper:

"Tax systems are primarily aimed at financing public expenditures. Tax systems are also used to promote other objectives, such as equity, and to address social and economic concerns. They need to be set up to minimise taxpayers’ compliance costs and government’s administrative cost, while also discouraging tax avoidance and evasion. But taxes also affect the decisions of households to save, supply labour and invest in human capital, the decisions of firms to produce, create jobs, invest and innovate, as well as the choice of savings channels and assets by investors. What matters for these decisions is not only the level of taxes but also the way in which different tax instruments are designed and combined to generate revenues (what this paper will henceforth refer to as tax structures). The effects of tax levels and tax structures on agents’ economic behaviour are likely to be reflected in overall living standards. Recognising this, over the past decades many OECD countries have undertaken structural reforms in their tax systems. Most of the personal income tax reforms have tried to create a fiscal environment that encourages saving, investment, entrepreneurship and provides increased work incentives. Likewise, most corporate tax reforms have been driven by the desire to promote competition and avoid tax-induced distortions. Almost all of these tax reforms can be characterised as involving rate cuts and base broadening in order to improve efficiency, while at the same time maintain tax revenues."

The paper focuses on how changes to various taxes affect GDP and not specifically on the actual level of those taxes.  The authors attempt to determine how countries can best ensure continued maximum economic growth by fine-tuning their blend of various taxes and state that it is important to "…disentangle the revenue raising function of the tax system from its other objective, e.g. equity, environmental or public health matters.".  I'd say that most governments strictly look at taxes as means of maximizing their ability to grab cash in a desperate attempt to balance their ledgers, particularly in this time of massive deficits and mounting sovereign debt, but that’s just my opinion.

The authors note that in many OECD nations, governments have adopted a flatter personal income tax structure.  This has resulted in a reduction in the top statutory tax rates with average workers seeing a far smaller cut in their level of taxation.  As well, cuts in corporate tax rates have taken place in many countries with these cuts being  accompanied by a drop in taxation on dividends.  Once again, increased deficit spending means that these decreases in revenue need to be filled in some way.  The authors suggest that the best way to grow tax revenue is to increase the taxes on residential or immovable property and other properties such as net wealth, inheritances and legal transactions.

Property taxes are normally not collected by national governments.  Instead, it is often left up to state, provincial or municipal levels of government to collect these highly unpopular taxes.  Among OECD nations, the revenue share of property taxes has remained relatively constant except in France, Ireland, Korea, Luxembourg and Spain where the share of total revenue has risen by 2.5 percentage points since 1980.  For some OECD nations including the United Kingdom, Canada, the United States and Korea, at least 10 percent of their tax revenue (in 2005) was collected from property taxation.  These include taxes on immovable property (again, what we think of as real estate property taxes - paid by both individuals and corporations), taxes on net wealth (again, paid by both individuals and corporations), taxes on gifts and inheritance and taxes on financial and capital transactions.  Annual taxes on immovable property that are collected at the subnational level account for half of all property taxes with taxes on financial transactions accounting for about one-quarter.  Here's a graph showing how property tax revenues as a percentage of GDP have changed over the past 35 years noting the gentle rise in taxes on immovable property:

The authors observed that owner-occupied housing is taxed at a particularly favourable rate.  In some nations, imputed rental income (see below for definition) is taxed under income tax (Belgium, Netherlands, Norway and Sweden), in other nations, mortgage interest payments are deductible from personal income taxes (United States) and in Belgium and Spain, even principal repayments are deductible.  As well, capital gains on the sale of owner-occupied homes are not subject to capital gains taxes although in all countries but Canada and Sweden, if the home is sold as part of an inheritance, the capital gains are taxable.

Here is a table showing how residential property taxes vary across several OECD nations:

The authors feel that recurrent taxes on immovable property are more efficient than other forms of taxation since their imposition has a less adverse impact on the economy.  Unlike corporate taxes, they do not impact the decisions of producers to invest in human or mechanical capital (i.e. create employment) and they do not impact the plans of businesses to produce more goods.  The immovable property tax base is stable and predictable since there are generally less cyclical fluctuations in real estate values.  An obvious exception to this would be for those who happen to have lived in the United States over the past 5 years; many municipalities have seen their property tax bases severely eroded as house prices have fallen and homes have been vacated although it is important to note that this had generally not been the trend until the Great Recession.  Most importantly to those who will collect these taxes, evasion is very difficult since the physical nature of the taxable asset (i.e. your house and lot) make it basically impossible to move or hide.  As well, governments love these taxes because they are easy to assess and very cheap to collect.

Property taxes on land and buildings can also be used to affect how underdeveloped land is used.  As the system stands now, low taxes on vacant property and undeveloped land can encourage the owners to keep the land undeveloped which keeps the assessed value of the land at a low level; this is seen to be an inefficient use of property since, from a government’s perspective, it generates far less tax revenue than it could.  This is already becoming an issue in some municipalities.  I can recall a friend telling me that a several acre plot of land that they owned outside of a major city was being taxed as though it were fully developed since it was their choice to retain it as an acreage surrounding their house rather than selling it off as a residential development.  That strikes me as more than a bit unfair.

I found it interesting that the authors are concerned that the preferential tax treatment of housing has distorted "capital flows".  This means that since owning a residence is taxed at a lower rate than other forms of investment that "investors" will prefer to buy real estate rather than invest in stocks or bonds because any gains on these investments are taxed at a higher level.  The authors feel that this has and will continue to result in the creation of housing market bubbles.

The authors state the following:

The distortion between housing and other investments should be removed by taxing them in the same way: taxing the imputed rent and allowing interest deductibility. "

Here is the definition of "imputed rent":

"The amount (of money) that would have changed hands had the owner and occupier been different persons is called the imputed rent.” 

Imputed rent is just a technical way of describing how much value is in your home based on what you would have to pay to rent a similar dwelling from another person.

Basically, the OECD recommends that home owners be taxed on the value of their home based on what they could rent it for rather than an assessed value most often based on potential market pricing.  While, as noted previously, some countries already assess property taxes based on the imputed rent, many governments underestimate the rental value according to the authors.

To summmarize, the authors of the OECD paper feel that property taxes, particularly those on real estate, are the best way for governments to raise revenue to assist in balancing their deficits and reducing their debts (like that's ever going to happen!).  An increase in immovable property taxes would be least likely to harm economic growth and would have the added benefit of reducing investment in less productive home ownership thereby reducing the upward pressure on prices that has created a housing bubble.  As well, by reducing investment in real estate, investors would be forced to invest in other products which would result in more meaningful increased economic growth.

To say that I'm skeptical of this idea would be a vast understatement.  This appears to be yet another scheme to encourage governments to find a way to help taxpayers part with more of their income.  As part of a “wealth tax” package, governments could ultimately have the ability to tax your real estate assets more heavily as they rise in value or as you accumulate wealth assets of other types.  That would result in a disincentive to save since as part of the “wealth tax”, inheritance taxes would also likely be imposed or raised.  Perhaps, as the authors suggest, such a tax scheme would generate additional economic growth.  My suspicion is that, with our spend and tax governments, any additional tax revenue would simply allow them to overspend even more than they already do.  Rather than tweaking the revenue side of the balance sheet, perhaps more energy needs to be put into controlling the spending side.

Call me a cynic.  An untrusting one.


  1. Interesting, thank you - I enjoy your blogs.
    One wonders whether the property investor market (as opposed to the property owner market) is the real tax target here.
    For example, in the UK, mortgage interest is tax deductible on all investment property but not for your own home. The reverse applies for capital gains tax i.e. own home is exempt but investment property is not.
    I recognise that my comment here is looking at just a small part of a huge web.
    BTW, I entirely share your cynicism about poor government cost/spending control.

  2. Property Taxes are in effect a mechanism by which the Government steals your property and rents it back to you under threat of violence.

    It goes way,way beyond just collecting to maintain streets and provide basic public safety.

    Ask the former sharecroppers around Hilton Head who had their land stolen for development because they could not pay taxes. Or elderly people in hundreds of now-affluent neighborhoods across the country that were once comfortable middle class.