Effect of property tax in house price volatility

Effect of property tax in house price volatility

House price volatility is important contributor to macro financial stability. Developments in the housing market have been at the heart of the global crisis, prompting a debate on alternative policy responses. On the other side, housing market has important implications for macroeconomic stability through its impact on aggregate demand and supply. On the demand side, housing wealth is an important part of the net worth of the private sector and housing-related expenses (e.g., mortgage payments, rents) represent a major part of household expenditure.

Hence, changes in house prices may affect demand through various channels, including spending on residential construction and spending on non-residential consumption (wealth effect). On the supply side, house prices have implications for labor mobility and property assets of businesses contribute to the production process.

Tax policy tools can influence housing markets through affecting demand for housing. There is a wide range of property taxes and subsidies, with the main being: mortgage rate deductibility, tax on imputed rents, capital gains tax, recurrent taxes on land and buildings, wealth tax, inheritance tax, VAT, and stamp duties (or acquisition taxes). These could be grouped into three broad categories: (i) transaction taxes, (ii) recurrent property taxes, and (iii) mortgage interest deductibility.

In a study of IMF regarding to the relationship between property tax rates and house price volatility it’s been concluded that property taxes have a negative impact on house price volatility[1].

The impact is causal, with increases in property tax rates leading to reduction in house price volatility. Specifically, a 0.5 percent increase in property tax rates leads to 0.5 – 5.5 percent decline in house price volatility depending on the empirical specification and the measure of volatility. The results are supported by the difference-in-difference regressions exploring the exogenous variation in housing supply due to the geographical location and regulatory constraints and are robust to different measures of house price volatility and estimation methodologies.

The key policy implication is that property taxation could be used as an effective tool to dampen house price volatility.

However, using transaction taxes in a countercyclical fashion may not be the best option given that they tend to thin the markets and discourage transactions that would allocate properties more efficiently. In addition, unlike macroprudential tools, transaction taxes cannot be changed very frequently and implementation lags can be too long given the need to amend legislation.

On other effect it is that, they could adversely impact labor mobility by increasing the cost of changing property.

Instead, reforms could target recurrent property taxation and mortgage interest deductibility, with the objective of ensuring tax neutrality between investment in housing and other types of capital.

The objective should be to reduce incentives for debt-financed home ownership permanently. One possibility is to tax imputed rents. The practical issue with this approach is that these rents are difficult to measure. Hence, increasing recurrent and transaction property taxes could be used as an alternative.

Another possibility is: (i) not to allow mortgage interest deductibility, and (ii) to levy a lower recurrent tax on property. In this way, housing investment would still be taxed and the tax system would not favor debt. Both options would reduce incentives for debt-favored house financing.

The extent to which house prices adjust to accommodate demand shocks driven by property tax changes is affected by the responsiveness of housing supply and regulatory arrangements.

[1] which is consistent with the theoretical prediction of Van Den Noord (2005)

Share this post

Leave a Reply