Over the weekend, the Irish Times led with eye-catching headline “Piketty says [Ireland's] property tax unfair and should be altered“. The juxtaposition of Piketty, arguably the world’s most talked about economist in 2014, and Ireland’s property tax, possibly the smallest property tax of any developed country, is due to Piketty’s presence in Dublin this Friday to talk at TASC’s annual conference.
Piketty’s point is that property tax – a tax on the most prevalent form of wealth – takes no account of debt, mortgages being the most prevalent form of debt. In his own words:
“I think if you have a house that’s worth €400,000 but you have a mortgage of €390,000, you know you’re not really rich. Your net wealth is €10,000 and you are paying back in interest payments as much as a tenant will pay in rent. So there’s no reason why you should pay as much property tax as someone who inherited his €400,000 house or who has finished reimbursing his mortgage 20 years ago.”
I have to admit that I cannot agree. My problem with this line of argument is that it is effectively a subsidy of leverage. This is something Ireland is consciously moving away from (for obvious reasons), in particular with the end of Mortgage Interest Relief.
Not that there is no debate to be had. Net wealth and gross wealth are separate concepts and it is certainly possible to consider which we might want to tax and why. However, taxes change behaviour and if you say to an economy “we will give you a tax rebate for every euro of debt you take on”, then if Ireland has €350bn in residential real estate, we should not be surprised if as a society that becomes our target for mortgage debt. While Thomas is correct to point out that net wealth is different to gross wealth, we should not forget that ignoring gross amounts and balance sheets is a large part of what got us (for us, read Ireland or world economy, as you choose) into this mess in the first place.
Perhaps more importantly, we tax property for a reason. That reason is that society is trying to recapture some of the wealth that it has created for private individuals, which is reflected in land values. (I am side-stepping one important issue for the moment, the property tax vs. land tax argument – as William Vickrey, 1996 Nobel Prize laureate in economics, noted: “The property tax is, economically speaking, a combination of one of the worst taxes, the part that is assessed on real estate improvements and one of the best taxes, the tax on land or site value.”)
So, the taxation of built capital aside, the taxation of land values is not just an arbitrary additional means of generating revenue. It is unique, in not affecting our behaviour, and in capturing pure economic rent. In the words of another Nobel Laureate, James Mirrlees:
Taxing land ownership is equivalent to taxing an economic rent – to do so does not discourage any desirable activity. Land is not a produced input; its supply is fixed and cannot be affected by the introduction of a tax. With the same amount of land available, people would not be willing to pay any more for it than before, so (the present value of) a land value tax would be reflected one-for-one in a lower price of land: the classic example of tax capitalisation.
If you alter that, by saying “you can borrow to buy land and not have to pay tax”, unsurprisingly you no longer have a uniquely beneficial tax. Clearly, we are far from land value tax in Ireland but the principle remains.
Even if one does not accept the argument that property tax is a charge on services provided by the state, there is a fundamental difference between a renter and a mortgage-holder: only the latter is buying a ticket to future wealth (in net terms, you already have it gross terms). At least two effects occur when you give debt-rebates for property tax. The first is increased leverage, as mentioned above.
The second is distributional and thus perhaps of even greater interest for Friday’s TASC conference. For example, in the case of Ireland, there are (very roughly) a third of households owning without a mortgage (the richest third), another third with mortgages and the final third living in rented accommodation (by and large the poorest third).
If you give a tax rebate to the middle group – who, remember, have wealth that the poorest third do not have – then by definition the other two groups have to pay more in tax to compensate (assuming that there is some fixed target for government revenues).
This doesn’t mean that I am unsympathetic to Ireland’s negative equity generation. Indeed, in the report I prepared on introducing Land Value Tax in Ireland in early 2012, I outlined precisely how one might take account of legacy negative equity in the new property tax system. But good policy should be future-proof – and can then be tweaked to take account of current circumstances. And given that it should be a major goal of policy to prevent huge negative equity from ever happening again, it seems odd that we would institutionalise this feature.
They say the best tax is an old tax. Failing that, the best tax is probably a simple one. Taxing the value of property (or ideally the value of land) is simple. Introducing tax rebates for debt – however well-intentioned – turns it into a game where everyone wants to minimise their tax liability (in this case by increasing their debt liabilities). For me, that’s not the way to go.
P.S. As is now customary for blogging economists (and perhaps soon mandatory), I feel I should reveal whether or not I’ve read Piketty’s book! It’s my book-of-the-month for June and I’m about 1/3 of the way through.