HM Treasury makes surprise move over to The Dark Side

From that report explaining why the 50% income tax rate should be reduced, page 8:

The impact on economic growth

2.16 In addition to their impact on the level of GDP, changes in tax rates can have an impact on economic growth. Other things equal, high tax rates in the UK make its tax system less competitive and make it a less attractive place to start, finance and grow a business...

2.17 The relationship between tax and growth has been extensively studied in research undertaken by the OECD*. Their analysis suggests that corporate taxes are the most harmful type of tax for economic growth, followed by personal income taxes and then consumption taxes, with taxes on immovable property being the least harmful tax.**

* OECD (2010) Tax policy reform and economic growth

** HM Treasury were a bit sneaky there: what the OECD actually said was "with recurrent taxes on immovable property being the least harmful." There is a huge difference between taxes on purchases/sales of land and buildings such as Stamp Duty Land Tax (bad taxes) and annual taxes on ownership of land and buildings like Business Rates (good taxes), but hey.

OECD, IMF on top form

From International Business Journal:

The Organization for Economic Co-operation and Development released a report on Tuesday calling on Germany to raise its property taxes dramatically and reduce taxes on labor. The group, whose membership is made up of 34 of the world's leading market economies, also made similar recommendations for Denmark, Norway and the UK over the past month.

For Germany, the organization recommended tripling its property taxes, while reducing its wage taxes and social security contributions, which currently make up 64 percent of total tax revenue, compared with the OECD average of 52 percent, according to the German language Immobilien Zeitung. Property taxes, meanwhile, amount to only 1 percent of total revenue collected, against an OECD average of 3 percent*. The group also called on Germany to reform its assessment mechanisms, as many properties are valued far below their true market worth...

The International Monetary Fund also made a similar recommendation to Norway this month...

The OECD has been a strong proponent recently of land value taxes, which date back to Adam Smith but were most vigorously promoted by 19th century economist Henry George. He promoted a land value tax—which is assessed on the unimproved value of underlying land, not penalizing intensive development like many property taxes today—as a replacement for all tariffs and levies, however the OECD has settled on a more moderate position, instead advocating a shift in emphasis away from other taxes and towards the land value tax.

Land value taxes can be tricky because of practical difficulties in estimating a plot's value, especially if it is a unique piece of land, or if land parcels like it do not change hands very often. Newer computer-assisted methods of land appraisal have made this job easier, though, and many countries around the world have adopted the tax.

The responses..?

The two groups' advice, however, was rebuffed by Norway's minister of finance, Sigbjorn Johnsen, who said at the press conference on Wednesday: "I have no plans to increase housing taxes."**

Denmark was subject to the same advice last month, with the Nordic Labour Journal reporting that the OECD advised the country to cut income taxes and increase property taxes. The Danish government plans to incorporate some of the OECD's recommendations into its 2012 tax reform, but a property tax hike will not be on the table. As the NLJ writes, "[t]his is because property taxes were ring-fenced in the coalition agreement covering this parliamentary term."

* In the UK, we have a quasi-Land Value Tax on commercial land and buildings (called 'Business Rates') which alone raises over 4% of total government revenues; we also have Council Tax on residential land and buildings, which is a mixture or Poll Tax and a modest property value tax, which raises another 3.5%.

** That'll be no surprise to Kj, I guess.

Killer Arguments Against LVT, Not (151)

The Daily Telegraph propaganda piece then opens with this:

Cash-strapped governments (1) have long wanted to grab a bigger share of the wealth we hold in housing (2), now the Organisation for Economic Co-operation and Development (OECD) says Britain should adopt a Continental European-style property tax.

Today let's move on to laughable contention number 2.

There seems to be some confusion over what 'housing wealth' is. A sane person would say that a country which has large, modern, attractive houses has more housing wealth than a country with old, small, ugly ones, but Home-Owner-Ism in England and the UK is so ingrained that we don't seem to care about physical housing, all we care about it keep house prices as high as possible, regardless of the cost to the economy.

In any other country, if a new house is built, people say "Great, we are now wealthier by one house." In England, if a new house is built, people say "Boo! We existing home owners are now slightly poorer because the scarcity value of our houses has been diluted". If an earthquake or other natural disaster hits any other country, they put an effort into rebuilding houses and are pleased when people can move out of camps and back into proper houses; in England, existing home owners would be delighted if e.g. Birmingham were flattened by a tornado or earthquake, because it would be good for house prices elsewhere.

Home-Owner-Ism in it nascent form became the dominant political ideology in about 1970 when the % of households who were owner-occupiers passed the 50% mark; ever since then, the NIMBYs and latterly the Greenies have always elected governments who will do their bidding and minimise the amount of physical housing wealth we have; in return, the government has rewarded these protectionists by gradually reducing recurring taxes on housing and increasing stealth taxes on work and enterprise, this increases the £-s-d value of our housing stock, but is that real wealth?

I would volunteer a "no" in reply to that.

And as I explained last Friday, the reason that the UK government is so cash-strapped is precisely because it taxes the productive economy to within an inch of its life and uses the proceeds to push up house prices; the notion that the UK government now wants to stop focusing on paper wealth and enable/encourage real wealth creation is fanciful in the extreme.

Killer Arguments Against LVT, Not (149)

Let's chop that Daily Telegraph propaganda down into manageable chunks, starting with the headline:

House prices would be hit by 'revolutionary' property tax proposed by OECD

The use of the word "hit" panders to the notion that "High house prices are good for us", which is patently not true:

1) Best case, the older generation's loss is the younger generation's gain, so it's zero-sum.

2) Most people have children, and nearly all children have parents. Unless parents actually hate their own children, don't they want their children to be able to afford a house?

3) Apparently, a lot of parents try to "help their children onto the housing ladder" by dipping into their savings or even re-mortgaging to be able to give or lend to their adult children a deposit for an over-priced house. No doubt there are some couples somewhere who say "Luckily, our house had gone up in value, so we could remortgage to raise the money for our children to buy a house" but there's no helping people as stupid as that.

4) While the parents might be sitting on a paper capital gain, that's not real money. But the additional money which their children have to borrow to pay the higher prices is real money; it has to be repaid with interest, month in, month out.

5) Excel tells me that the total amount of repayments on a 25-year mortgage at 6.2% APR is double the amount of the initial loan [=PMT(0.062,25,100)*25]. So for every £1 of the parent's paper capital gain, there's a real £2 cost on the children.

6) One man's expense is another man's income, of course, so who are the real beneficiaries of this - the people getting the big bonuses at banks? The taxpayer who then has to bail out the banks when it all goes wrong? Who?

Killer Arguments Against LVT, Not (148)

Just to show that the idiocy goes right to the top, here are two paragraphs from HM Treasury's "Tax policy making: a new approach" as reported in Hansard:

11. In this inquiry, we received many submissions advocating radical change to the tax system, such as the imposition of a land value tax. (1) The supporters of such a tax consider that it would tax economic rent rather than economic activity and would meet the OECD criterion that recurrent taxes on immovable property were the least harmful tax. However, as the CBI notes, "the OECD acknowledges that it is politically difficult (2) for governments to shift the tax base onto property." (3) The ICAEW warned "Our initial conclusion is that, even if such a move was desirable economically (4) and let alone whether it would be politically acceptable,(5) it would involve a major rebalancing of the UK tax system which would take time to achieve (6) and risks introducing considerable distortions and behavioural changes." (7)

12. Not only are there political difficulties: practical matters, such as the way in which such values would be assessed and the extent to which such a tax should take account of the current or the potential use of land, would also need careful consideration. (8) We also note concerns that "While such a tax system would avoid distortions in economic behaviour, (9) it would be highly unlikely to yield sufficient revenues to fund socially useful expenditure (10) without producing substantial inequity." (11)

1) Oops. I think I missed that one.

2) It is only "politically difficult" because the government and the powers that be generally have spent decades brainwashing people into thinking a) that taxing economic activity and wealth creation is a reasonable way of doing things and b) that house price rises are good for us.

3) I wish they'd say "land and buildings" to make it clear what they are talking about. In any event, the CBI ought to be speaking from the point of "British Industry" who are perfectly accustomed to paying Business Rates, which are so close to Land Value Tax as makes no difference.

4) It's "were" not "was" and actually it "is" and they must know that.

5) See (2).

6) Everything takes time, it all depends which taxes you replace first. So let's start by rolling all existing taxes which relate to residential land and buildings or 'wealth' generally into a flat tax on residential land values. The only real constraint on how quickly we did this is how quickly people can be de-brainwashed.

7) No! It's the current system which creates "considerable distortions", the fact that people would behave differently if there were no taxes on economic activity and only taxes on economic rent is an argument in favour of the latter.

8) They already have two models - Business Rates for commercial land and buildings and Domestic Rates in Northern Ireland. All the info we need is already held by HM Land Registry or on the Council Tax register after that it's just a question of bunging in the [current tax rate + a percentage of current selling prices] in each defined area to get a fair approximation of the rental value of land in each area, you tot these up to give you the rental value of all residential land in the UK (the tax base, Y); you then decide a figure for how much tax you want to raise (X), divide X by Y to give you the tax rate, apply X/Y to [the local rate x size of each plot in each area] and we're away.

It'll never be scientifically perfect, but any over- or under-estimates will iron themselves out, but so what anyway? Does the rate of VAT automatically adjust itself down so that marginal businesses are kept afloat, does it automatically adjust itself up on businesses which appear to be making super-profits (banks, from 2000 to 2007 or thereabouts)? I think not. Would it not be better to have a tax which allows 'the markets' to decide the rates in the same way as we currently decide rents and prices?

9) That's not what they said at (4), is it?

10) Wot? Do they not realise the circularity involved?

a) Even under current rules, the residual rental value of UK land is about £150 billion per annum. If we taxed that at 100% instead of just collecting £50 billion in Council Tax and Business Rates we could get rid of VAT and merge income tax and National Insurance into a flat income tax of about 30% with a generous personal allowance. Would that not be "socially useful"?

b) Shifting from taxes on activity to taxes on rents gets rid of the dead weight costs caused by the former, and this extra growth goes £ for £ back into higher rental values, so it's a virtuous circle.

c) Forecast total tax revenues for 2011-12 are £531 billion (excluding booze, fags and fuel duty), that works out at an average £20,000 per household (including taxes borne by 'businesses' which are indirectly borne by households). If the average household no longer has to pay £20,000 in income tax, VAT, NIC etc, there is no reason to assume that they wouldn't be able to pay that much in LVT.

d) Then there is the invisible half of the Laffer Curve which few people talk about. Although income tax revenues would be zero if the income tax rate were zero per cent, by how much would the economy grow? A tenth? A fifth? A quarter? There's only one way to find out! Most of that growth would go into higher land rental values, so in effect, the land value tax would pay for itself, and a household's average net income would increase by something approaching £20,000 per annum.

11) Even if it's only half that, well it's not to be sniffed at, is it? Deliberately depriving every household of £10,000 or £20,000 income every year out of political cowardice seems like "substantial inequity" to me.

Killer Arguments Against LVT, Not (146)

From The Daily Telegraph:

Mr Padoan argues he should scrap many VAT exemptions – including food, passenger transport and domestic fuel – and abolish council tax and stamp duty in favour of “a property tax based on market values.”

... Instead of HM Revenue & Customs taxing property via stamp duty land tax (SDLT); inheritance tax (IHT); and – in the case of second homes – capital gains tax (CGT); annual liabilities would be calculated, based on estimations of house prices. But Mr Padoan argues that his reforms would “dampen fluctuations in house prices” and are essential to put the British economy on a more stable long-term footing.

I can't find the actual OECD report, but there's a brief summary of it here.

Jolly good, that list of taxes to be replaced will look familiar to regular readers. And then the Home-Owner-Ist shit storm is unleashed; in quick succession we get "would hit house prices", "unpopular", "tenants would face higher costs", "the need to value every property", the "Poor Widow Bogey" ("Any plans to increase the bands for council tax or introduce wealth tax are always accompanied by an outcry about elderly ladies living in large houses on limited incomes").

Yawn, been there, dealt with those.

Then the Homeys shift up a gear and start gibbering "... the more you tax something, the less you get of it. Taxing people’s homes would discourage home ownership and all the benefits that go with that", merrily ignoring the fact that the Home-Owner-Ist policies (heavy subsidies to and light taxation of owner-occupation or rental income) pursued by the UK government over the last ten years has led to a dramatic fall in the number of owner-occupiers (down from 72% to 69% if my memory serves correctly). The flipside is more buy-to-let landlords, more second homes and more vacant homes - homes which would become owner-occupied again if we had such a tax.

But the fun part is the very first comment, it appears that Homeys suffer from a terrible variant of dyslexia which prevents them from being able to take in the list of Bad Taxes which the OECD said should be replaced, and they launch straight into this:

For F**KS sake! More taxes? We're already massively over taxed. We pay tax from the second we're born to the moment till after we're dead. It's utterly disgusting. I'm sick of this endless BS form the state. It costs a f***ing fortune, provides bugger all and is next to incompetent in the dictionary.

I wonder, do these people go into a shop to buy something, do they just accept the goods and then start effing and blinding when the shopkeeper demands payment? Are their short term memories so bad that they forgot that they have just been given something which they wanted and are now being asked to provide something of equal value in return?

Trade to population, GDP ratios

As I said here, "Of course imports (or exports) as a percentage of GDP are higher in the UK than in the USA or the Eurozone, because their economies are five times as big (five times as many people), but that was on the basis of three random figures* and basic logic.

Just to see whether this stacks up in real life, I have now taken the time and trouble to harvest the relevant figures for GDP, an average of exports/imports (referred to as 'trade') and population from the fine OECD website** and prepared a chart of the trade-to-GDP ratio plotted against population (click to enlarge):
The correlation between trade-to-GDP ratio and the logarithm of the population is 0.60***.

The chart for trade-to-GDP ratio plotted against GDP looks much the same. The correlation between the debt-to-GDP ratio and the logarithm of GDP is also 0.60*** (click to enlarge):Ah well, at least we know.

* One of which is open to debate as to its accuracy. The UK's and the USA's trade-to-GDP ratios were stated correctly at 32% and 16%, but the figure given by the FT for the Euro-zone was 16% but according to the OECD it's 41%. I suspect that the OECD merely added together country figures without netting off intra-Euro-zone trade. Twats.

** I used figures from 2008 for consistency, choosing GDP and import/export figures expressed in terms of USD/purchasing power parity/current prices. Luxembourg, with a population of less than half a million has a trade-to-GDP ratio of 161%, which is completely off the scale, probably exaggerated by all the cross-border trades routed through it for tax reasons, so I excluded that otherwise tip-top country.

*** I decided to chuck out the figures for the Euro-zone and recalculate the correlation of the trade-to-GDP ratio with the logarithm of GDP or population, which is 0.60 in each case. The correlation with the actual GDP or population is only 0.37 and 0.27, i.e. much lower, which were the figures I gave originally.

OECD talkin' sense

From FT Adviser:

OECD economists speaking at the launch of the OECD's report, Housing and the Economy: Policies for the Renovation, said the abolition of stamp duty would reduce barriers to entry in the housing market. Asa Johansson, OECD economist, said stamp duty should be replaced with an increased council tax where part of the funds went to local councils and part to the Treasury.

She said: "I think stamp duty should be removed and replaced with a property tax based on the value on the house. It adds on costs for people entering the market."

Ms Johansson proposed replacing stamp duty with a yearly tax, similar to council tax but with part of the funds going to the council and part to the Treasury. She acknowledged such a tax would have the most impact on those home owners who are asset rich and cash poor but said a revised taxation system would be fairer as it would not penalise those who engaged in property transactions.

The OECD also urged the government to tax vacant land to incentivise owners to develop the land and build property on it.

Dan Andrews, OECD economist said: "The current property tax base should be updated to better reflect market values. This would provide more incentives to use vacant land which could help alleviate some of the supply side problems in the UK housing market."

Spotted by Jack C at HPC.

VAT: Regressive or Progressive?

More to the point: who cares?

Here's a handy chart from yesterday's FT, figures taken from OECD, IFS and HM Treasury (click to enlarge):
So really, VAT is quite flat as a % of income or spending (especially if you strip out the VAT on tobacco and alcohol, which is probably flat across income deciles in £-s-d).

Seeing as net household income/household spending is only about 60% of total income and VAT averages out at 11% of either (and that's at the old rate of 17.5%, which has now risen to 20%), I think we can safely say that VAT acts, by a circuitous and destructive route, as a flat tax of approx. 7% on people's gross incomes, whether earned (salary, wages, profits, dividends) or unearned (rents, welfare, pensions).

We will never know quite how the burden is shared between 'consumer' and 'producer' (I suspect it is split one-third to two-thirds) but as all taxes are ultimately borne by individuals (who might be consumers, producers or more likely both) it doesn't really matter, so when estimating people's total tax burden, I shall henceforth assume that VAT is 7% of gross income.

i.e. it may the case that a household with median income of £40,000 pays £2,800 in VAT out of its income minus tax/plus benefits; or it may be the case that people who work for/are shareholders in a VAT-able business have their gross income depressed by 7% (so in the absence of VAT, their gross income would be £42,800), or it may be anywhere in between - but however you split it, the two parts always add up to 7%-ish.

The main reason why VAT is The Worst Tax Of All cannot be measured like this - the real cost of it is all the businesses that fail (or never get off the ground); all the jobs that are destroyed (or never created) and all the free exchanges of goods and services (i.e. wealth creation) that are no longer profitable and hence do not take place; and of course, without these effects, receipts from less damaging taxes like income tax or corporation tax would be higher, and welfare payments would be lower etc - I suspect that if we just scrapped VAT, the 'loss to the Exchequer' would be about half the amount that VAT currently raises.

Killer Arguments Against LVT, not (82)

The OECD recently repeated their ground rules for taxation:

Taxes can be a disincentive to work, invest and innovate, with adverse effects on economic growth and welfare. But these distortions can be minimised:

• Change the overall tax structure to raise more revenue from taxes on consumption and residential property tax and less from personal and corporate income taxes;
• Broaden tax bases to enable rates to be kept as low as possible;
• [Let's politely ignore the bit about 'Green taxes']
• Ensuring that all citizens pay their fair share of taxes contributes to fiscal consolidation. OECD initiatives to counter offshore non-compliance are yielding billions of euros in extra tax revenues. [This point is superfluous if you stick to point one - you can't move land or 'consumption' offshore, as a caveat, VAT is not a tax on consumption, it is a tax on production]

This prompted the inevitable Home-Owner-Ist wailing in e.g. Estate Agent Today. I won't dignify that article by quoting from it, but, notwithstanding they complete overlook the bit about "less from personal and corporate income taxes", what these Vested Interests quoted in the article seem to be claiming is variously that:

1. LVT would push house prices down
2. LVT would make houses less affordable
3. Landlords would be discourage from renting out
4. Landlords would be able to increase the rents anyway (which is only true if income tax were reduced)
5. People would be 'forced' to sell
6. Nobody would be able to buy
7. Existing owners would be disadvantaged
8. Potential buyers would be disadvantaged relative to existing owners
9. There would be no new development.

None of these are correct (except maybe 1 and if that is true then 2, 6, and 8 cannot be true etc), and in any event, they all contradict each other. Even point 9 is not necessarily correct, and even if it were, our NIMBY nation sees that as A Good Thing.

IF all the things that they say were simultaneously true THEN the only logical conclusion it that we would end up with huge amounts of vacant homes (because existing owners can't afford to live there any more; potential buyers can't afford to buy; landlords don't want to let them out; and even if landlords want to let them out, potential tenants can't afford the rent etc).

Logic says that this would not be the outcome, and observed facts tell us that the reverse would happen

The UK already has Land Value Tax on commercial premises (or its close equivalent, Business Rates) and:

i. New office blocks are being built all the time,

ii The main thing stopping factories, power stations, airports, railways, roads etc being built is NIMBYism (which is totally anti-free market, so things are bound to go wrong),

iii. When Labour reduced the exemptions from Business Rates for vacant properties, occupation rates actually went up slightly. Remember The Golden Rule - if you tax something, you get less of it (unless it's in fixed supply, like land), so when they started taxing vacant buildings, we got fewer vacant buildings.

Cross posted at HPC

Gloriously misleading statistics of the day

The BBC run an article entitled UK teenage girls 'worst drunks'.

[Yadda, yadda, waffle] ... ah, here we go:

One in five 13-year-olds in the UK reports having been drunk twice - four times higher than countries such as the United States, Sweden and the Netherlands. Among 15-year-old girls in the UK, 50% reported getting drunk, almost three times higher than their counterparts in France. The rate for boys in the UK in this age group getting drunk is 44%.

Yup, that's right. Not "drunk at least twice in the past week"; they really do mean "drunk at least twice in their whole lives so far", and what counts as "drunk" is not actually specified.

And the OECD says ...

... in the summary to their research on Tax & Economic Growth

Corporate taxes are found to be most harmful for growth, followed by personal income taxes, and then consumption taxes (1). Recurrent taxes on immovable property appear to have the least impact (2).

A revenue neutral growth-oriented tax reform would, therefore, be to shift part of the revenue base from income taxes to less distortive taxes such as recurrent taxes on immovable property or consumption. The paper breaks new ground by using data on industrial sectors and individual firms to show how re-designing taxation within each of the broad tax categories could in some cases ensure sizeable efficiency gains. For example, reduced rates of corporate tax for small firms do not seem to enhance growth, and high top marginal rates of personal income tax can reduce productivity growth by reducing entrepreneurial activity.
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(1) Unfortunately they make the mistake of lumping in VAT with 'taxes on consumption'. if you go to pages 18 and 19, you'll find this, which certainly applies to VAT:

38. Because they lower the purchasing power of real after-tax wages, consumption taxes may curb labour supply in much the same way as a proportional income tax. Consumption taxes can also reduce labour demand in the short-term if they add to wages and labour cost... Most empirical studies that assess the effect of taxation on employment exclude consumption taxes from the relevant wedge. However, some recent studies that include the consumption tax in the overall labour tax wedge find that a rise in this wedge reduces market work ...

Exactly, the clue is in the name: it's called "Value Added Tax", and what is "value added" if not the same thing as "profits"? So why is it be any better than any other "corporate taxes" (i.e. on profits)?

... and this, which applies to proper consumption taxes:

40. Specific consumption taxes that penalise the production and consumption of “bads” can improve environmental outcomes while generating revenues that can be used to offset other taxes on, for example, labour. Examples are excise duties on petrol and diesel. A similar argument can be made for “bads” that affect consumers’ health, with potential social externalities (e.g. tobacco or alcohol), though the extent of such externalities is controversial...

I'd agree with that as well. The killer point being that demand for these things is price-inelastic, so taxes thereon do not affect behaviour very much, and people just pay more for the same amount of petrol, fags, booze. This makes a mockery of the argument that such taxes discourage driving, smoking or drinking, but hey. As long as the taxes at least cover the external costs, that's the main thing.
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(2) I'd also like to highlight these paragraphs, a bit lengthy, but a good summary nonetheless:

Recurrent taxes on land and buildings have [only] a small adverse effect on economic performance...

47. Recurrent taxes on land and buildings (especially residential buildings) are generally argued to be more efficient than other types of taxes in that their impact on the allocation of resources in the economy is less adverse. This is because these taxes do not affect the decisions of economic agents to supply labour, to invest in human capital, to produce, invest and innovate to the same extent as some other taxes. This conjecture is supported by the new empirical work undertaken in this project (see Section 4).

Another advantage of property taxes is that the tax base is more stable and the tax revenue generated from this tax is therefore more predictable than for revenues obtained from labour and corporate taxes, partly due to less cyclical fluctuation in property values.

Also, as real estate and land are highly visible and immobile these taxes are more difficult to evade, and the immovable nature of the tax base may be particularly appealing at a time when the bases of other taxes become increasingly internationally mobile.

Property taxes also encourage greater accountability on the part of government, particularly where they are used to finance local government. Property taxes, with regular updating of valuation (which, with modern technology, is now feasible), can also increase the progressivity of the tax system (for example, by the exemption of low value properties), provided that special arrangements are made to reduce the liquidity constraints that the tax may imply for the relatively small number of people with low incomes and illiquid assets.

…and they could contribute to the usage of underdeveloped land…

48. The design of property taxes on land and buildings can also be used as an instrument to affect land development and land use patterns. For example, low taxes on vacant property and undeveloped land can encourage the under-utilisation of land which may lead to a reduced supply of land for housing particularly in urban areas. Linking the assessment value to market value may increase incentives for developing land as market prices also reflect the development potential of land.

But, in many OECD countries the assessment values of land lag substantially behind the actual development in land prices generating gaps between taxable land values and current land prices, which are politically difficult to close (e.g. Finland, the United Kingdom).

…while preferential housing tax treatment may distort capital flows...

49. As described in Section 2, owner-occupied housing has a favourable tax treatment relative to other forms of investment in many OECD countries through reduced tax rates or exemption for imputed rental income, mortgage interest payment deductibility and exemptions from capital gains tax. While the favourable treatment of owner occupation is often justified by the specific nature of housing and the positive externalities for society associated with its consumption, they may distort the flow of capital out of other sectors and into housing. They can also reduce labour mobility and thus the efficient allocation of labour.

In these circumstances, raising taxes on immovable property could improve economic efficiency and growth. The distortion between housing and other investments should be removed by taxing them in the same way: taxing the imputed rent and allowing interest deductibility. However, most OECD countries do not tax imputed rent at all, while those that do often under-estimate the rental value. In such circumstances, the denial of mortgage interest relief and the use of property taxes can provide a ‘second best’ approach, though local government control over property taxes makes it difficult in many cases to implement this approach in a co-ordinated fashion.

By contrast, taxes on financial and capital transactions are highly distortionary...

50. It is always less distortionary to tax the income and services provided by assets than the transaction involved in acquiring or disposing of them. This follows from the Diamond and Mirrlees (1971) result that taxes on intermediate transactions are inefficient, in the sense that the same revenue and distributional effect can be obtained at a lower distortionary cost by taxing income (including capital income) or consumption (consumption of housing services).

The lower distortionary effect arises because both transaction taxes and taxes on income/consumption discourage the ownership of the assets, but the transaction taxes have the added distortionary cost of discouraging transactions that would allocate these assets more efficiently. For example, they discourage people from buying and selling houses and so discourage them from moving to areas where their labour is in greater demand.

In fact, the distributional effects of transaction costs are probably also less desirable, as the tax falls more heavily on people who trade more frequently, such as people who need to move frequently for their jobs. Nevertheless, governments have found these taxes attractive for two reasons: they are relatively easy to collect and they compensate for the difficulties of applying VAT to the financial sector.

Capital gains taxes, which are paid only upon realisation, suffer from some of the same shortcomings as taxes on intermediate transactions.