Reduce tax on residential mobility

Casper van Ewijk, Michiel van Leuvensteijn, 30 March 2010

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The first EU council president Herman Van Rompuy has recently announced plans for a follow-up of the Lisbon Agenda. The next European summit will be focused on how to increase structural economic growth in Europe. Increasing labour market flexibility should be at the top of the agenda.

A new and challenging idea proposed by Andrew Oswald (1999) suggests that a lack of mobility in the labour market may arise from rigidities in the housing market. Oswald proposes that homeownership may be a hindrance to smoothly operating labour markets and may increase unemployment. High transaction costs may limit residential mobility and reduce the willingness of homeowners to accept job offers outside their own region.

Following from this idea, we argue that an abolishment of transfer taxes on residences in combination with a reduction in the general subsidy of owned residences, would increase residential mobility, boost welfare and increase labour market flexibility.

Transfer taxes are substantial

Transfer taxes are a major part of the transaction costs of residential mobility. Figure 1 shows that transaction costs of moving residence are quite substantial for homeowners in most countries. Remarkably, governments impose additional burdens in the form of transfer taxes, on top of the already high transaction costs due to costs and commissions. These taxes range from 0.6% in Denmark to 10% in Greece and Portugal, and even 12.5% in Belgium. Rather than promoting mobility as one would expect, governments thus directly add to rigidity in the housing market and cause substantial welfare losses.

Figure 1. Transaction costs in the housing market in Europe

Source: Belot and Ederveen (2005)

Welfare gains of abolishing transfer taxes

Simply abolishing these transfer taxes would result in welfare gains. Table 1 provides a rough estimate for the welfare gains of abolishing transfer taxes by calculating the deadweight loss associated with the transfer tax (Van Ewijk et al. (2007).

The deadweight loss can be expressed as ½ ε t, where t stands for the tax rate and ε reflects the elasticity of the tax base for the tax rate. A reasonable approximation for ε is eight as reported by Van Ommeren and Van Leuvensteijn (2005). Table 1 reports for each European country a range of welfare effects that follow from the observed tax rate and the size of the tax base as percentage of GDP. The range reflects differences in interpretation as to whether the notary costs and commissions should be interpreted as a real social cost or as an indirect tax due to regulation.

Table 1. Welfare gains from the abolishment of transfer taxes on residential property in 2006

Countries
Welfare effect in billions of euros (2006)
Welfare effect as percentage of GDP
Austria
0.08-0.30
0.03-0.11%
Belgium
1.27-2.40
0.40-0.76%
Denmark
0.00-0.03
0.00-0.02%
Finland
0.02-0.11
0.01-0.06%
France
1.44-7.41
0.08-0.41%
Germany
0.40-1.88
0.02-0.08%
Greece
1.60-3.19
0.75-1.49%
Ireland
0.60-1.21
0.35-0.69%
Italy
3.75-14.04
0.25-0.95%
Luxembourg
0.03-0.11
0.09-0.33%
Netherlands
0.71-1.42
0.13-0.27%
Portugal
1.20-2.52
0.77-1.62%
Spain
3.24-9.17
0.33-0.94%
Sweden
0.02-0.16
0.01-0.05%
Switzerland
0.07-0.32
0.02-0.10%
UK
0.09-0.62
0.00-0.03%
Total
14.52-41.70
0.13-0.38%

Source: Van Ewijk and Van Leuvensteijn (2009)

We estimate that abolishment of transfer taxes on residential property would result in an overall gain of somewhere between 0.15% and 0.40% of GDP in the 16 European countries presented in Table 1 above. Welfare gains would be especially large in absolute terms in France, Italy and Spain. In these countries, transaction costs are relatively high compared to the average. In Italy, the maximum welfare loss is relatively high because the overall transaction costs on the housing market in Italy are large at 19% (see Figure 1).

Increase labour market flexibility

In addition to these welfare effects, these measures would improve labour market flexibility. From a microeconomic perspective, the housing status of an individual agent can interfere at different stages of labour market dynamics. Transaction costs associated with distant moves typically hamper job mobility. The way in which transaction costs influence unemployment is more complex though. Unemployment in the steady state depends on the inflow into, and outflow out of unemployment. Transaction costs may affect both inflow and outflow rates. At a first sight, one might expect that transaction costs increase the inflow into unemployment while reducing the outflow – in which case unemployment rises unambiguously in the steady state. This is in line with Oswald’s finding of a positive association between the fraction of homeownership and aggregate unemployment.

Fiscal prudence: Reduce subsidies to homeowners

If governments combined a reduction in transfer taxes with a reduction in subsidies for home ownership, then fiscal prudence in the long run would become a key element of this fiscal measure. The amount of transfer tax is paid instantly when the home is bought while the subsidy is a flow of monthly payments to the homeowner thereafter. This means that the fiscal stimulus of the reform will be paid back gradually over the years. In fact, homeowners do not have to pay the transfer taxes forward and demand additional finance from banks that are currently reluctant to provide mortgage loans that exceed the value of the home due to falling house prices. This measure could therefore restore confidence in the housing market. If governments abolish taxes and remove subsidies then this would be good for governments and people alike.

In many European countries, promoting homeownership is an official objective of government policy, usually supported by favourable tax regimes. A traditional argument for promoting homeownership is that homeownership creates positive externalities (i.e. homeowners take more care for their homes and neighbourhood). Although these externalities are found to exist, their size is probably too small to warrant policy interventions (Glaeser and Shapiro 2002). In the end, the arguments in favour of promoting homeownership are weak.

There is therefore a general tendency to reduce the (implicit) subsidisation of homeownership. But this subsidy is still considerable in many countries (Hendershott and White, 2000).

Conclusion

Governments have the option to kill at least two birds with one stone. Abolishing transfer taxes would stimulate the economy in the short run and improve the flexibility of the economy structurally. Reducing transfer taxes provides additional labour market flexibility, because it enables homeowners to accept jobs outside their own region reducing the inflow in unemployment and increasing the outflow. Combined with a reduction in subsidies in the housing market, this measure would also result in prudent fiscal policy in the long run.

References

Belot, Michèle and Sjef Ederveen (2005), “Indicators of cultural and institutional barriers in OECD countries”, CPB Memorandum, The Hague.

Glaeser, Edward L and Jesse M Shapiro (2002), “The benefits of the home mortgage interest deduction”, NBER working paper 9284.

Hendershott, Patric H and Michael White (2000), “The Rise and Fall of housing favored investment status", Journal of Housing Research, 11(2):257- 275.

Oswald, Andrew J (1999), “The housing market and Europe's unemployment: a non-technical paper”, Warwick University.

Van Ewijk, Casper, Bas Jacobs and Ruud De Mooij (2007), “Welfare Effects of Fiscal Subsidies on Home Ownership in the Netherlands”, De Economist, 155(3):323-362.

Van Ewijk, Casper and Michiel van Leuvensteijn (2009), “Introduction and policy implications” in Casper van Ewijk and Michiel van Leuvensteijn (eds.), Homeownership and the labour market in Europe, Oxford University Press.

Van Ommeren, Jos and Michiel van Leuvensteijn (2005), “New Evidence of the Effect of Transaction Costs on Residential Mobility”, Journal of Regional Science, 45(4):681-702.

Topics: Europe's nations and regions, Labour markets
Tags: labour market flexibility, Transfer taxes

Professor of Economics, University of Amsterdam and Director, Netspar

Senior Economist at CPB Netherlands Bureau for Economic Policy Analysis

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