Risking Ayn Rand’s Ire

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Spare a thought for Mary and Sean. Both work full-time – not great paying jobs but together they pull in 60K with overtime. They need it. They bought a house three years ago, paying over the odds, but with a one-year old child they had to leave their one-bed flat. Their second child came along last year. Difficult, yes; but they were making a fist of it.

That is, until Fianna Fail got worked up. Since October, the Destiny Soldiers have really got stuck in to Mary and Sean. They took nearly €2,000 off the couple in levies. Then they smashed and grabbed another €2,000 by abolishing the Early Childcare Supplement. Mary and Sean didn’t like this but, sure don’t we all have to share the pain (that’s what RTE and the papers tell them everyday).

Now their bank has jacked up their mortgage interest. The Destiny Soldiers won’t interfere even though they practically own the bank.  Then, they read that Colm McCarthy’s committee wants to take another €720 off their Child Benefit. And they’re bracing themselves for the promised tax hikes in the December budget. Mary’s job is more insecure by the day and Sean’s employer has just unilaterally slashed the occupational pension scheme. They’re hanging on by their finger tips.

But now – they read that a property tax will be knocking on the front door.

In their collective nightmare they glimpse their future: Mary, unkempt, sits at the window all day muttering, the kids run around in unchanged soiled clothes, while Sean takes up drink, beating the cat whenever he’s not too drunk to catch it.

This is a family on the edge.

It You’re Gonna Tax Property, Then Tax Property

Are the leaks suggesting that the Commission on Taxation going to recommend a ‘Property tax’? No, it is more precisely, a ‘residential-property tax’ (RPT). If it was a ‘property tax’ then it would include all property – cars, yachts, shares, equity, financial assets.

For most people, a house makes up most of their total asset holdings. They may own a car, a pension fund (which they can’t access until retirement), a plasma TV, etc. But in all likelihood, their home is the dominant asset. Not so with the wealthy. Their principal residences are likely to make up a less proportion of their total asset holdings. Therefore, a RPT attaches itself to the dominant asset of most people but a proportionally smaller asset of the wealthy.

Not Related To Ability to Pay

Yes, those who own houses are likely to have more income than those who don’t. And the bigger the house is, usually, an indicator of higher income. But what about those with approximately the same asset worth – for instance, Mary and Sean’s neighbours. Living in similar houses they pay the same tax. However, some will have more income, some less. Double income families will face a less burden, on average, than a single income family. Families with children will face a higher burden than households without children. Nor does it take into account changed income circumstances. If either Mary or Sean lose their job or are short-timed, their income will, their RPT liability won’t.

A Tax on Younger Households

Older households are (a) more likely to have a higher income, (b) have little or no mortgage payments, and (c) have less outgoings (i.e. children have left). Younger households are, conversely, more likely to have less income, mortgage payments and child-costs.

Taxiing You for What the Bank Owns

If it is truly a ‘property’ tax, then it should tax only that which Mary and Sean owns. But they don’t ‘own’ the entire house they live in. Their equity is quite small. The bank owns the rest. Yet Mary and Sean will be taxed on both parts of the house – that which they own and that which the banks own.

Location, Location, Location

There is, of course, the urban/rural issue – housing being cheaper outside main urban areas. But Mary and Sean live in what has been a relatively low-cost area. However, if a North Metro station is built, an amenity, an urban regeneration project (even another IKEA store) – the value of their house will go up and, so, potentially their RPT liability. They haven’t done anything to increase their value – that’s been done by state and corporate planners. But Sean and Mary will have to pay the extra tax on the same income.

Broadening the Tax Base or Layering the Current One?

Mary and Sean are perplexed. They read that a RPT would not be an extra tax on labour but, rather, a ‘broadening of the tax base’. Yet, for them, it’s just one more layer of tax. Is that what broadening means? It may not technically be a ‘tax on labour’ but it is a tax ‘because Mary and Sean labour’. The only escape is to quit their jobs, so they ‘de-broaden’ their own tax liability base.

* * *

None of the above is necessarily fatal to a RPT. It is not beyond the wits of legislators to construct a fair, equitable tax that takes account of all these potentially problems and inequities. However, to do so would be to reduce the tax base. The more equity in the system, the less revenue.

[There is the suggestion that income tax would be lowered to compensate for the truly hard-pressed. If this were done through increased tax credits, the numbers look wonky. An increase of €100/€200 in single/married personal credit would cost over €200 million. Any effective off-setting would substantially reduce the net revenue of introducing a RPT never mind creating new anomalies in the tax system.]

So should we disregard ‘property’ as a source of revenue? No. Opposing property taxes sui generis is not an option, either economically or tactically. We just have to examine alternative starting points.

Alternative 1: A Real Property Tax

One such is a ‘property’ in the real sense of the word: a 1% tax on all asset holdings over €1 million (inclusive of principal residence but excluding ‘productive’ assets). It could earn as much as the leaked proposals in the Irish Times (less than €1 billion). It would be less deflationary. It would truly be a ‘broadening’ of the tax base. It would impact on those who could most afford it.

But, of course, that is so statist retro – taxing the rich. We’d risk being labeled what Paul Simon sung about:

‘I’ve been Ayn Rand-ed / Nearly branded a communist / ‘Cause I’m left-handed’

Alternative Two: Tax Gain, Not Consumption

So let’s get a little creative, nuanced, forensic. Mary and Sean’s house is a peculiar thing. Yes, it’s a capital asset. But it’s also an item of consumption. The couple don’t make money of their house, don’t realise a ‘gain’; they just live in it. As a capital asset it’s different from a rented apartment. As an item of consumption, it’s pretty much the same thing.

So, let Mary and Sean ‘consume’ their house tax-free. And only tax it when they treat it like an asset. When does that happen? When they sell it (or transfer it as a gift/inheritance to someone who doesn’t live in it). If you want to tax a house as a capital asset, tax it when it realises a capital gain for the owner/vendor. If one accepts the principle that all income, regardless of source, should be taxed – then it’s hard to argue for the exemption of principal residences from capital gains tax. Let’s take an example.

  • I bought a house for €50,000 in 1992. Owning it outright, I sell the house for €325,000. I receive a net gain of €275,000. My tax liability would be just under €69,000 (less, if it was inflation-indexed).

That after-tax gain is still not bad money for what is essentially ‘unearned income’. This is truly a new tax base. As it wouldn’t come out of current income, it would be far less deflationary. It would be far simpler to administer and monitor for compliance.

We could tweak it to make it more equitable, in addition to only applying the tax after the primary mortgage was paid. Any repairs or improvements (a new roof, central heating, etc.) could be deductible. This could help ensure tax-compliance by builders. And we could exempt a small amount (say, the first €50,000 gain). This would make the system more progressive.

How much could this tax hope to earn? There is little data on the cost of exemptions from capital gains tax. The NESC states that in 2002 the cost was nearly €800 million. If the current capital gains tax rate had applied, the exemption would have been worth over €980 million.

Of course, such revenue would rely on the level of transactions. The fewer houses sold, the less revenue comes in. Interesting to note that the loan approval for second hand houses (for every second house bought, there is the same number sold) was at the same level in 2008 as it was in 2002. But now we’re on the downward slope. This merely reflects the fact that all taxes related to economic activity are falling – even a RPT which would be reduced as unemployment rises and prices fall.

A tax on capital gains of house sales would be part of a longer-term structural reform – earning higher revenue as the economy and housing market returns to optimum; helping close the structural deficit as part of a medium-term strategy. In addition, a capital gains tax would help stabilise the housing market – the lack of taxation, combined with the tax reliefs, having been a contributor to the property bubble.

This is not a ‘last-stand’ argument against a RPT. It merely shows up problems and charts alternative solutions. But mostly this is a hope – that we can have a debate somewhere above the superficial level where concepts and numbers are bandied about with little if any analysis. That we can have proposals that find a new well instead doesn’t keep returning to the old ones (and giving it a new trend name).

And a hope that we can bring Mary and Sean back from the edge.

Even if we risk Ayn Rand’s ire.

 

One Response

  1. Fliujniligui

    July 30, 2009 1:37 am

    Eh,

    Residential purchase is often the Greatest Scam. It is marketed and promoted as the Greatest investment of a lifetime. I, myself have a rented appartment when I do not live at my parents’ home and prefer to buy securities. Yes, From all my dividend securities, no one has the hassle of a House. Holding a security costs nothing, trading it costs 10$ and is instantly done as they are very liquid. I am only taxed a little on the gains I do on DISPOSAL of the security and not on the amount invested in it every year. Also, the security doesn’t need repairs and dust management by me since it has employees and management team to do so and they come in the deal. Yes, housing is a hurdle, a necessary evil which should be treated as something which is essential but to which the minimum of resources to obtain satisfaction should be directed.

    Also, making 2 kids getting the big mortgage and car after having just 2 years of work behind that, no net asset, debts, credit cards is just like buying stocks on margin at the end of a bull market. Face it, it was an error, now you manage your way out of it with what you have or declare bankruptcy, and I hope that there is the following positives : You lose your naïveté and learn risk management.