Local Property Tax: Change for better or worse?
Introduction.
Local Property Tax (LPT) was introduced in 2013 using valuations for May of that year as a base. The tax is due for re-basing on 2019 property values, and this is likely to produce a mixture of political opportunism and panic which may well lead to “reforms” which fundamentally undermine the tax.
Residential property taxation is part of the local or municipal tax base in most countries[1]. The traditional Irish property tax (domestic rates) was so archaic and badly-designed that it easily fell prey to political opportunism and was abolished in 1977. Rates on Commercial and Industrial property remain, and are probably in need of reform, but that is an issue for another day.
The malaise of property taxation is closely linked to the decay of local government in Ireland. Local Authorities have very little truly independent taxing power; the residential LPT operates under national rules and collection is done by a central government agency – the Revenue Commissioners. Local Authorities have lost many of their responsibilities: for water services, many road services, garbage collection, and so forth. Such powers that they have are often tightly circumscribed by central government directives and rules. No wonder local politicians, who have so little real power over local policy issues get involved in the politics of Palestine, Catalonia or Myanmar. Worthy causes maybe, but not local ones.
If we are to have local government which actually works and which is worthwhile and has some real policy discretion, then it will have to have some degree effective control over its tax revenues. This is essential: local government which is almost totally dependent on central government for its revenue, will forever be rattling the begging bowl and will never have to ask how to pay for the local public goods which citizens want. Just pass the buck to central government.
Local Government is often quite rightly regarded as inefficient and ineffective. The LPT provides a good example: the local authorities’ collection of the LPT’s predecessor (the Household Charge) resulted in much lower compliance than that subsequently achieved by Revenue. Local Authorities have also been ineffective in collecting water charges for commercial users, and have had chronic problems with rent and mortgage arrears. The latter problems are undoubtedly explained in part by social factors, but overall the operational efficiency of local authorities has not been impressive, which may explain why they have been stripped of so many functions.
Putting this right will not be easy. The culture of local politics has been degraded by its unhealthy relationship with the centre. Local councillors become adept at rattling the begging bowl. Given that getting elected to a local council is the main route to an eventual career in national politics, this is the worst possible apprenticeship for national politicians, who often tend to have the same attitude to financing national public expenditure: a total disconnect between spending money on something and having to solve the problem of how to pay for it.
A report[2] by Dr Don Thornhill prepared as part of the 2016 Budget documentation contains many proposals aimed at preventing the tax from being degraded in various respects and also at improving its structure. Dr Thornhill estimated that substituting 2016 for 2013 property valuations would produce a revenue increase of about 29%, so we could say that making a “big bang” change and using 2019 valuations would probably produce an increase in LPT charges of at least 50%. I do not intend to look at details of yield estimates or how this might vary from area to area. For the purposes of a very general discussion I will take a 50% increase as a reasonable first approximation if there were to be a “big bang” in 2019. Clearly this sort of increase is what scares politicians to death, and scared politicians are liable to propose measures which are both unfair and inefficient.
Looking at Don Thornhill’s proposals for changes to LPT, I quickly became aware of the similarities between his ideas and mine. Maybe this is not surprising: familiarity with the same fundamental concepts in public finance and the political economy of taxation might be expected to lead to a convergence of views. Don Thornhill’s proposals are worked out in much greater detail than anything I attempt to outline here, but getting the big picture right seems to me to be an essential first step.
Some proposals:
(i) Have a full property revaluation in 2019. The impact of this can be drastically reduced, but allowing valuations to become hopelessly out of date runs the danger of LPT valuations becoming like the old rateable valuations: works of fiction bearing no relation to reality. Ultimately doing nothing would undermine the LPT completely (something that some politicians[3] want, of course).
(ii) Avoid a “revaluation shock”by adjusting the tax rates (at present 0.18% up to €1m and 0.25% for that part of values in excess of €1m) so that the yield increase is relatively modest (say 10%). On a simple back-of-the envelope calculation, rates of 0.12% and 0.20% with a threshold of €1.5m might come close to achieving this.
(iii) At present, some of the LPT revenues arising in a local authority area are redistributed from high to low income areas via a centrally-administered fund. This has the effect of weakening the net local revenue effect of any decision the local authority makes (such as the discount or premium to apply in any year), Effectively any increase in revenue may be diluted by having to pay some into a central fund. The solution (also recommended by Don Thornhill) is to leave local authorities with 100% of the LPT revenues from their area and thus 100% of the revenue consequences of any decisions they take. This implies a separate central government grant mechanism to give local authorities an acceptable degree of resource equalisation, It is essential however that this is based on relevant structural factors such as demography, population density, estimates of local income levels etc.
(iv) Consider adjusting the amount of discretion available to a local authority to something in excess of the present ” 15%. This might slowly educate local authorities and councillors in exercising greater fiscal responsibilities[4].
(v) As Don Thornhill recommends, re-title the tax as a Local Council Tax. A minor point maybe, but in an era of spin getting the title right and emphasising the responsibilities of the local council would be worthwhile.
Mistakes to avoid.
In any discussion of reform it is important to avoid making things worse, especially as some really bad ideas have been aired.
- Earlier this month (Jan 15th, 2018) the Sunday Times in an editorial seemed to favour the idea of basing the LPT on house size[5]. Why should someone in 4-bedroom semi in Dublin 4 pay several times what a person in a similar house in Leitrim or Roscommon pays? Consider a household with a total income of, say, €60.000. A four-bedroom house in Dublin 4 will probably cost over €800,000 and will be way beyond the what is affordable to buy for most €60,000 income households. The house of similar size in Leitrim or Roscommon might be bought for €200,000 to €300,000, and be within the budget and borrowing power of a €60,000 income household. So for this reason alone (there are others), it is a fair bet that the incomes of people living in similar-sized houses will be higher in areas with higher property values. Sure, high property values may imply high mortgage debt, but in the long term when retirement beckons the Dublin 4 household will have much better options for downsizing and equity-release than the someone with an asset worth less than €300,000. High value areas have in general residents with higher income and wealth.
- Landlords would no doubt argue that it is inequitable that their tenants do not have to pay LPT whereas owner-occupiers do. (They really mean that it is unfair that they have to pay, but leave that aside). This raises interesting questions about the incidence of LPT. One might argue that in the long-term rentals have to cover the full economic cost to landlords, and that otherwise they will exit the market. In that case (barring distortions such as rent controls) the long-run incidence of LPT would be on tenants. However in the current state of the housing market, landlords as owners of a relatively fixed-supply of properties are likely to be making economic rents[6] and the incidence of the tax would be on them. Also in the long run we would expect LPT to capitalised into (slightly lower) house valuations so its incidence would be on property owners in general, whether owner-occupiers or landlords[7]. Overall I see little merit in changing the current arrangement for landlords – and fortunately unlike other not-so-good ideas there is little political momentum behind such a proposal.
Some more general conclusions.
- There is a real need to reform local government and to gradually give it more real powers. This is now a well-worn cliche, but one seldom hears any substantive discussion of the issues involved.
- I say gradually give local authorities more powers because the present culture of local politics does not lend itself to fiscally responsible behaviour, so local councillors face a steep learning curve. Fiscal responsibility is an essential part of political and policy responsibility. Giving local authorities power without (fiscal) responsibility reminds me of Stanley Baldwin’s remark on the subject. A properly adjusted LPT is an obvious route to greater local fiscal responsibility.
- We should not get too hung up on questions of progressivity or fairness. Overall the LPT may not be quite as progressive[8] as Don Thornhill suggests, but it only accounts for about 1% of all tax revenues and there are other larger taxes in the system which are decidedly more regressive. In any event it is the overall progressivity of the combined tax and benefit system which really matters and in this respect Ireland scores very highly.
- It has been argued that higher LPT could be traded off against lower income tax rates. While this is in principle a valid proposition, especially as property taxes are held to be less distortionary, in practice it is a difficult argument to sustain. A doubling of LPT revenues would fund a very small cut in Income Tax or USC rates. LPT reform should be done on its own merits as a mainly a local authority issue. While a relatively minor tax in relation to the total national tax take, LPT could and should be central to the operation of effective and responsible local government.
[1] The obvious reason being that taxation specific to a local area which is part of a single national economy is best based on relatively immobile assets.
[2] Review of the Local Property Tax (LPT): http://www.budget.gov.ie/Budgets/2016/Documents/Review_of_Local_Property_Tax_pub.pdf
[3] Somewhat bizarrely, politicians on the extreme left.
[4] Don Thornhill advocates authorities being able to vary the rate of tax and perhaps the size of the bands. This seems to me an un-necessary complication. One can achieve much the same effect on tax bills by using the ” 15% instrument. Keep it simple should be the watchword.
[5] Quite predictably, that reservoir of bad economic ideas (the Irish Times letters page) recently published a plea for a floor area-based tax. Also quite predictably, it was from that well-known deprived area, Dublin 6.
[6] i.e. rents in the classic economic definition considered as a surplus over and above the supply price.
[7] The question of incidence can get quite complicated. If I own a house I have to pay LPT whether I occupy it or rent it out. In that case how does it enter into my decision? If I sell it, and if LPT is capitalised into the price, how does that effect my decision?
[8] While LPT may take absolutely more money from those with higher incomes, it does not follow that it takes a greater proportion of income from those with higher incomes, which is the classical definition of the concept of progressivity.