BOO! Real estate tax!

08. marts, 2010


Vjačeslavs Dombrovskis

Here we go again. News were leaked that the IMF recommended raising real estate taxes to 1.5% (and bringing cadastral prices more in line with market prices) and all hell broke loose. The newspapers are full of indignant reactions, and even the Prime Minister Dombrovskis was forced into guilty excuses that "these are only recommendations", and "taking into account [low] purchasing power, 1.5% is too high". Well, as we all know, the budget deficit needs to be reduced by some 800 million LVL over the next two years, whatever the "purchasing power". It can only be done by increasing taxes, reducing expenditures, or (most likely) both. And yet, the real estate tax seems to have become some sort of a 'third rail' of Latvian politics. Touch it - and you're dead.

Is real estate tax really such a monstrous tax, compared to other methods of taxation? What does the economic theory say? Roughly speaking, there are three criteria with which economists analyze taxes: (i) distortions to incentives; (ii) tax collections costs; (iii) distributional fairness. Distortions arise whenever individuals (or firms) modify their behavior to avoid taxes. Usually these result in efficiency costs. For example, high levels of (combined) personal and social taxes produce huge distortions for the economy through encouraging envelope wages. Tax collection costs (ease of administration) depend on how easy it is to evade taxes. Personal and social taxes are pretty easy to evade, especially in small firms, not least because both employers and employees benefit from envelope wages. Evading VAT is more complicated because it leaves substantial paper trail that enables detection via cross-referencing, and especially in retail trade where detecting evasion via ‘control purchases’ is relatively easy. Distributional fairness is whether individuals pay the same share of their total income in taxes. One may argue that personal income taxes largely fall on the poor and the middle class. The rich (business owners) can avoid personal taxes with relative ease.

So what about the real estate tax? On all counts, it’s a pretty good tax. The distortions it introduces are pretty small. It’s very easy to collect (although there is an issue with determining the value of real estate) since tax evasion is near impossible. It’s fair because someone who has a villa in Jurmala will, in all likelihood, pay much more, than someone with a ‘serial apartment’ in Purvciems. Even more so, why is there such a determined opposition to a tax that seems so optimal relative to other taxes?

We’re talking about political economy of taxation now. It doesn’t matter whether some tax is good or bad for a ‘representative’ tax payer. What matters is the distribution of gains and losses from such a tax, as compared to other taxes. Small but politically powerful groups of population would prefer the tax burden to fall disproportionately on those who are large in numbers, ignorant, and politically disorganized. In other words, a somewhat cynical explanation for such a great opposition to the real estate tax lies precisely in the fact that it’s such a fair tax. Someone with a villa in Jurmala WILL pay quite a lot with a higher real estate tax and little, if anything, with a higher personal income tax. Naturally, those someones would favor higher personal income taxes rather than higher real estate taxes. And this is precisely what happened during the last round of fiscal consolidation.

Ok, there is nothing surprising about the parties of the rich protectingthe interests of the rich. That’s called delivering good value for their patrons’ money. What IS surprising, however, is the silence of all those parties that classify themselves as “social democrats”. In other words, where is the LEFT, and where has it been?! Where are the guardians of the poor and deprived? Why aren’t all the parties like the Saskanas Centrs, Sabiedriba Citai Politikai, PCTVL, social-democrats (who else is out there?) galvanized when some parties offer to raise personal income taxes instead of real estate taxes?!

Paraphrazing Eminem, would real social democrats please stand up?

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