consumption is generally not deductible, home equity loans have provided (within limits) just such a tax-favoured way to borrow and spend.
The distributional impact of mortgage interest relief can be complex, but deductibility probably favours the better off. On the one hand, higher-income individuals may be more likely to face constraints on their access to tax-favoured assets (since this is often subject to caps), so that their opportunity cost of investing in housing is the after-tax return. This creates an argument for some tax relief to ensure that the less well off also pay an after-tax rate.
Against this, however, deductions are typically worth more to the better off, as they take them against a higher marginal rate of tax. The latter effect would be avoided if relief were provided—as many countries do—not as a deduction but as a credit (reducing tax paid, rather than the income taxed).
Ownership/occupation and transaction taxes are also important elements in the tax treatment of housing. Recurrent taxes based on ownership or occupation have potential appeal both as serving as user charges reflecting the value of local public services—and as such they are often allocated to lower-level governments—and, to the extent that these and other features are location specific, as being less vulnerable to interjurisdictional tax compe-tition than the CIT and other taxes on more mobile bases. There is indeed evidence that such taxes (along with consumption taxes) have significantly less adverse effects on growth than income taxation (Johansson et al. 2008).
Housing transactions themselves are often subject to tax, sometimes in signif-icant amounts (up to 9 per cent in Ireland).
2.3.2 Impact on prices and leverage
Tax policy can affect two key aspects of housing markets: house prices and households’ leverage. These are interrelated, as high house prices encourage removing equity through increased borrowing, the availability of cheap loans drives up house prices, and the expectation of price increases raises the ex-pected return on borrowing to acquire housing.33
in the rate of CGT on housing, for instance, would be expected to increase house prices (with some offset as sellers enter the market to realize deferred gains). It might also lead to a slower—not, as one might expect, a faster—rate of house price appreciation (because a lower pre-tax gain is needed to yield the required post-CGT return).34 In the longer term, supply responses will ease price effects, but marked effects can remain. Importantly too, distortions affecting most directly prices in one segment of the market (the greater value of mortgage interest deductions for high-income taxpayers, for exam-ple) will generate substitution effects that then feed price effects through to others. There is also evidence that more favourable tax treatment of housing is associated with greater volatility of its price (van den Noord 2005).
Tax effects can substantially reduce the user cost of—and hence increase the demand for—housing. Poterba and Sinai (2008) find, for the USA, that mort-gage interest deductibility and other tax features on average provided a tax subsidy equivalent to around 19 per cent of the user cost.35This means that, for households facing a user cost of capital of, say, 10 per cent, the favourable tax treatment of housing was equivalent to a reduction of 235 basis points, a substantial amount by the usual standards of monetary policy discussions.
The reduction is greatest for high-income households (since they take the mortgage interest deduction at a higher marginal rate), but it is nevertheless around 8 per cent for those with low incomes.
Effective tax rates on housing vary enormously across countries, and with the circumstances of the investor and investment. An effective (average) tax rate (EATR) on housing can be calculated as the ratio of the PV of total taxes over an expected holding period to the sum of the PV of imputed rent and capital gains. EATRs can be very high—sometimes more than 100 per cent—
when investors keep a house for a short period and are subject to high transaction taxes. They can also be negative—for example, in countries that allow mortgage interest deductions but do not tax imputed rents and alterna-tive assets.
Figure 2.1 shows calculated EATRs for ten countries, a mix of small and large, industrialized and emerging economies, and booming andflat housing markets. These assume a property purchased for $250,000, held for ten years, 80 per cent mortgage financed, and appreciating in value by 5 per cent per year—and then track how EATRs vary across countries as each of these as-sumptions is changed. Such changes affect the ranking of countries, but:
Spain, France, and to a lesser extent Denmark have relatively high tax rates across a range of assumptions; Ireland and the USA have low EATRs. Italy
34See Box 2.2.
35The comparison is with an idealized personal income tax of the type described above.
stands out as a country with an almost consistently negative tax rate, reflect-ing very low taxation combined with interest deductibility.
These EATRs show a number of interesting patterns. Virtually all countries show a falling tax rate as the investment period increases: this is the result of transaction taxes, which are relatively more important for short investments. In countries offering tax relief for mortgage interest, the EATR falls as leverage
Brazil Canada
Denmark France
Germany
Ireland Italy
Spain
UK
–20 0 20 40 60 80 100 120
1 2 3 4 5 6 7 8 9 10
Length of investment (years)
Brazil Canada
Denmark France
Germany
Ireland Italy
Spain
UK USA
–10 –5 0 5 10 15 20 25 30 35
0 20 40 60 80 100
Leverage (%)
Brazil Canada Denmark
France
Germany
Ireland
Italy Spain
UK
USA
–15 –10 –5 0 5 10 15 20 25 30
200,000 400,000 600,000 800,000 1,00,0000 House price
(US$) BrazilCanada
Denmark
France Germany
Ireland Italy
Spain
UK
USA
–40 –30 –20 –10 0 10 20 30 40 50
–1 0 5 10 15
House price inflation (%) USA
Figure 2.1. Effective average tax rates on owner-occupation (%) Source: Authors’ calculation.
increases. This effect is strongest for the USA, reflecting the very high upper limit for mortgage interest deduction (on debt of up to $1,000,000). Other countries have much lower limits (Ireland, Italy, and Spain) or allow deduction only against capital income, which is taxed at a lower rate (Denmark). Higher house prices increase taxation in some countries, reflecting progressive elements of ownership or transaction tax rates, or capital gains tax imposition if a threshold is exceeded. House price inflation has different effects across countries.
Special vehicles—not captured in these calculations—may have created further tax biases towards housing. Real estate investment trusts (REITs) pro-vide CIT exemption for corporations whose main business is property invest-ment (subject to fulfilling certain criteria, notably distributing a large share of profits to shareholders); dividends are taxed at shareholder level, potentially at low rates. This makes investing in property through REITs tax favoured rela-tive to doing so directly (which would attract tax, and deductions, at ordinary income-tax rates). Further, in the USA a substantial proportion of the required cash distributions from REITs is typically in the form of non-taxable return of capital, as the earnings and profits of the REIT are frequently reduced by high leverage and depreciation.
Taxation does not appear, however, to have been the main driver of house price developments since 1990. Strong price increases occurred in all countries examined above, including in the high-tax group (see Table 2.3). The same conclusionflows from the diverse experience of local markets: in the USA, for example, booming property markets in coastal cities went with more stagnant developments inland, despite relatively small inter-state variation in tax rates.
Nor are there changes in tax rules that clearly account for housing price movements over the period. Some commentators attach importance, for instance, to a substantial increase in the CGT exemption for housing in the USA in 1997, something of an inflection point for house prices. The impact of this change is not clear-cut, however, since it also eliminated rollover relief,36 which for some taxpayers was a marked reduction in generosity.
Table 2.3. Real cumulative house price inflation between 1998 and end 2007 (%) High-tax countries Medium-tax countries Low-tax countries
Spain France Denmark Brazil Canada Germany UK USA Ireland Italy
110.9 105.9 75.7 n.a. 65.2 –18.0 124.1 45.3 108.5 56.4
Note: n.a. = not available.
Source: Authors’ calculation based on data from OECD (2008a).
36This provided that any gain on disposal of a house would not be taxed if the proceeds were reinvested in another property: so no tax liability arose as long as taxpayers traded up with each move.