Thursday 14 October 2010

Property Taxes in Ireland

Or how to alienate all your friends with one blog post.

The prospect of property taxes is getting a lot of coverage here in Ireland of late and I’ve been very disappointed with the tone of the debate. Too much of the “over my dead body”, “I paid my taxes already”, “what about the old folks” and not enough debate about whether it’s a good type of tax or a bad type of tax. Given that we’re all going to be paying a lot more taxes I’d like to see those being good taxes and that we have a decent discussion on what that means.

Good taxes are efficient, equitable, progressive, broad based, sustainable, hard to avoid, easy to collect and immune to external shocks. They take proportionately from everyone at a level that they can afford and provide the government with a predictable and stable income.We’re going to have more taxes – there’s no avoiding that and I would prefer that we got taxes that improved things in the long term. We’ve got a chance now to fix one of the most broken parts of the Irish tax system and we should be making an informed choice about it.

First off let me say that I’m all in favour of property taxes in general and even more of a fan if they are well thought out. As far as I can see they can have most of the characteristics of a good tax if they are properly implemented. The current “Stamp Duty” style of tax on property transactions is poorly structured and has major negative effects in terms of market effects the volatility of the government revenue stream it provides. A regular annual tax on property ownership that was used to eliminate stamp duty would be a much better approach from an economic perspective. I’ll look at the reasons why I think so at the end but first off lets figure out what it might look like and deal with the common counter arguments.

Let’s assume that the property tax will gravitate to a number that is equivalent to the average stamp duty/average time a house is owned so that over a fairly long time period we’re looking at something that is mostly revenue neutral. Let’s assume for the sake of roundness that this equates to an average current homeowner having paid €30k in stamp duty (which is near enough to 9% of the average house price at it’s peak) and people hanging onto houses for an average of 15 years so the tax will be around €2k per annum for an average house. I actually don’t think the tax should be that high, possibly half that smells about right to me but we’ll work with these numbers for now.

An inability to pay is going to be a valid and real concern for many people. The best suggestion I’ve seen for this is to use a system of deferrals – basically if you can’t pay according to some assessment criteria (e.g. it would result in > 50% of your net income being spent on housing) then some or all of the tax due could be deferred against the final disposal of the property (either by sale or inheritance).

Anyway onto the screams of why it wont work.

I’ve already paid my property taxes via stamp duty. True in a limited sense, not true enough though. Yes you have paid a tax already but if property taxes were properly levied based on the economic value of the property on a periodic basis and stamp duty was abolished (because it is a bad tax) then you would be no worse off in the long term. For people selling to trade up (or down) there is now no tax to pay so it will be easier to sell (good) and the cost of your new house will be lower (even better). Provided you hold on to your houses for less than 15 years you will actually be better off under this model. If you are a first time buyer now trading up the same fundamentals apply but you will also benefit from getting a free pass on the Stamp Duty that you didn;t have to pay but was priced into the cost of your first purchase by the market. In effect a first time buyer will be better off provided they sell within 30 years (or thereabouts). The only people who will be less well off in this case are those cashing out totally, or those who exceed those periods. Given how long they are (and the reality will be even longer) I don’t think this is a fair criticism of this sort of tax. Yes you will be paying more money now – but for the vast majority of people you wont be paying more in the long run.

What about the Old folks? And  you can amend this to include the young folks who’s backs are to the wall because they’ve lost their jobs. There are many people out there who are on limited incomes, who scrimped and saved all their lives, braved out the 70’s and 80’s when it was really tough to buy and hold on to a house and are now left with nothing much apart from a house. Many of those will be pushed to, or even over the limit by a property tax. The best approach here is the deferral concept where either all, or a proportion of the tax due can be deferred against the value of the property and comes due when it’s sold or inherited. That’s not ideal from a taxation perspective as the revenue stream benefits of a regular property tax are lost but it means that the tax becomes fundamentally identical to the current stamp duty scenario so the transition can be made relatively painless for those who would genuinely suffer. Over time this will progressively hit older people more though – especially if they live in their homes for longer than 15 years which is currently pretty much what we expect. Then again if this encouraged sequential downsizing and a social transition towards structured private elderly\frail care housing developments then this would be a damn fine thing too for the longer term. I would really like to have that sort of option become practical here and this would encourage it.

Over my dead body/this is my house, I built it with my bare bands/Gerroutofit ye thieving Gummint carpetbaggers. Honestly John Galt appears to have set root in Ireland lately and it’s not pleasant. There are lots of issues behind this type of comment but I’m going to ignore the ones that are mostly about people just not wanting to pay their fair share of tax. That’s something we’ve got no choice about and I’m tired about the whinging - people seem to forget that we have taxes for good reasons as well as the current high profile bad ones and even now most of the money is being spent for good reasons. In any case how and why you got\built or grew your house is irrelevant but you own it and it has both an asset value and it delivers an ongoing benefit to you. Sure you are paying for it (most of you anyway) but it is also returning a regular income to you in the form of rent that you would otherwise have to pay. If you put the money in a bank, generating interest and rented a house then you’d have to pay taxes on the investment income and also pay rent after all. There’s no logical reason to treat the invisible income from an investment in a home any differently from other income, certainly not here where home ownership is somewhere north of 80%. That income may not come in the form of money but it is still income. Just as the benefit I get from having a company car has to be taxed the effective saving a house owner makes from not having to pay rent should be taxed, and property taxes do just that. For those with mortgages that probably should be offset (somewhat) by the mortgage interest payments but the economic benefit of accurately pricing home ownership and rental the same way from a tax perspective are significant.

But I bought this as my retirement fund. Well whoop-de-do. It was a good strategy at the time, by far the most tax efficient thing to do but frankly not economically healthy for the rest of us. And just because it used to be a tax free (or very tax efficient) way of stashing away money doesn’t mean it should remain that way. This is particularly true for the 250k second homes out there sitting idle. The current system encouraged capital to be invested in properties that are now a total deadweight from an economic perspective. Taxing them actively will help prevent that sort of gross misallocation of resources in the future and go some way towards pulling some of those vacant follies back into the productive part of the economy. First, second and whatnot houses should all be treated and taxed the same way – the current second home levy is a bad concept and should be ditched along with stamp duty. Remember if there’s a genuine financial stress issue with this then my earlier comments regarding deferrals is a fair way to deal with that. In the longer term I have little sympathy – my own retire-early-with-a-fat-pension prospects have been substantially scuppered by the mismanagement of the economy by those who fed the property boom so I see no reason why anyone involved, even someone who simply bought a house as an “investment” should be given any particularly special treatment. 

We’ll lose the family home when Mom\Dad dies. Grow up. Seriously. If you’re that worried then do something about that now and help Mom and Pop pay the bill today. If you can’t then you can’t afford the house when you inherit it anyway.

On the plus side:

Immediately delivers a long term stable revenue stream for the government. This is the key benefit – instead of having a massive decade long hole in the public finances the government gets to pull in a tax revenue stream that will remain immune to economic cycles. That’s a very good thing. One way or another the government is going to get that money out of us but this way they get the cash they need now in a way that will prevent them screwing things up repeatedly in future. That’s a win.

It’s progressive and equitable. By definition – if you have a bigger, better house or more of them then you will pay more and you should because you are richer. If you don’t own property (and are by definition poorer) then you don’t pay. It’s a tax that almost everyone will have to pay (or defer) since over 80% of the households in the country own houses but it’s one that will by and large be imposed on the basis of relative wealth. Those who made paper millions by having and holding onto a nice house in a good area since 1980 will be hurt but they should be allowed defer [some of] the payment if it’s punitive and, to be brutal about it, anyone in that position did absolutely nothing to earn the €1.5million that the house they paid €20k for is now worth.

It’s hard to avoid. Again it’s pretty obvious but tax avoidance and evasion are going to be huge issues over the next couple of years and a simple (or relatively simple) property tax code based on real valuations (or good proxies to them) should be relatively immune to abuse.

Its economically efficient. I’m not sure if efficient is the right word but if something is taxed as if it generates income then basic economic forces will lead to more accurate pricing (no more bubbles which is a good thing*) and will help prevent wasteful resource allocation (no more, or fewer ghost estates). To be fair the elimination of all of the dodgy tax-exemptions for building trash pits will do more on this front but having a property tax apply to property as soon as land is zoned for development will go a long way towards making sure that waste is avoided.

 

More to follow – I’ve got to look into the issues of property (and other investment asset) taxes and corporate entities. I think that the same basic principles need to apply but I’ve no idea what the current scenario is.

 

* unfortunately no more bubbles and efficient pricing of the housing market would mean that it will be about 10-15 years before there’s any chance that house prices will recover to 2006 levels assuming we get out of the current mess in a year or two. That would also mean that homes would never gain be a “good” investment. They will be safe and stable and affordable though which is what we really should be looking for, isn’t it?