A recently proposed draft law on the real estate tax provides for the introduction of a 1 percent real estate tax for individuals. The following presents LFMI’s arguments against the tax.
1. The real estate tax must be paid without having real sources for paying it. The tax thus reduces people’s real income.
Property does not produce income by itself. The critical defect of the real estate tax is that its object is a thing, which has been chosen for taxation only because it is material, tangible and impossible to conceal. No doubt, taxation would enwrap other things, too, if they were as neatly accounted as immovable property is. Things like this did happen in history: taxes were charged on windows, beards and other physical objects. However, with the development of society and the evolution of more effective taxes, this kind of taxation was scrapped. Countries where real estate taxes still exist have never desisted from contemplating their removal.
A situation when an individual has some property but not always income is very typical of Lithuania, where acquisition of real estate has traditionally been regarded as a safe investment in the context of inflation and instability of the banking sector. If signed into law, the real estate tax would increase people’s sense of social insecurity and reduce real income. It should be noted that people pay taxes on all personal income, including income derived from real estate.
2. Calculation of a taxable value is costly, inaccurate and unrealistic. The effective rate of the real estate tax will always differ from the nominal one.
The application of the real estate tax involves a number of administrative difficulties which bear most heavily on the taxpayer. For the most part, these perplexities are related to calculation of taxable value, or asset valuation. The market value of an asset is determined only when this asset is sold on the market. To appraise a taxable value, administrative methods of asset valuation are used. There are several of them and each has serious flaws. Even the estimation of the so-called “market value” by independent valuers is incorrect due to inevitable subjectivity involved.
The restoration value method may be used in some cases for insurance purposes, but taxation of an asset according to “today’s” costs of building an identical item is inexpedient as “today” no one would build anything like this. So, the effect of all administrative methods of asset valuation is that the real tax rate for each individual item differs from the one established by law and the tax burden becomes highly differentiated. Finally, the absence of an objective measure of value provides an open invitation to artificial asset valuation and abuse.
To avoid subjectivity in valuation, the purchase value method should be used, whereby a tax is charged on the value of an asset for which it was obtained and indexation is applied if inflation exceeds the established level. This eliminates the need for asset valuation, as the value of an object should only be recorded. Yet, this method affects the real estate market by reducing people’s mobility: in Lithuania a rise in real estate prices would make the tax burden fall more heavily on new-settlers.
In conclusion, no method of asset valuation exists that would serve the purpose of asset valuation for tax reasons. There is no justification for a value which is set not by the seller and buyer but by a third party outside the market.
3. The real estate tax infringes on the fundamentals of private ownership. It will lead to a decline of large, fine buildings.
Taxation of real property encroaches on the fundamentals of private ownership, cripples people’s motivations and provokes squandering and vagrancy. Fearing new taxes, people, instead of providing themselves with dwelling, will tend to spend their savings for other purposes. It is a fallacy to think that the tax will help to do away with abandoned buildings. Quite the opposite. Those which are being looked after today will be abandoned, while many new ones will not be built at all. Every new construction will be designed with the thought of lightening the tax burden as much as possible. The architectural scenery of Lithuania will be affected not by people’s needs but by the real estate tax.
4. The real estate tax will widen, rather than even out, the differences in taxation regimes for corporations and individuals.
One frequently cited argument for the real estate tax is that it will help even out tax conditions for corporations and individuals. But these conditions cannot be uniform given that corporations use assets for business activity, whereas individuals for residence. Enterprises pay the real estate tax before corporate tax, while individuals pay taxes on all income. This means that they pay the real estate tax from income that has already been taxed once. Therefore, the tax regimes should be evened out by abolishing the real estate tax for corporations rather than imposing the tax on individuals.
5. The introduction of the real estate tax will result in double income taxation.
Given that all personal income is taxed without any deductions, the real estate tax will be paid from income already taxed once. Double taxation is one of the biggest defects of the tax system, making it irrational and non-transparent.
6. One of the forms of property taxation is already used in Lithuania.
Income tax levied on rent is an indirect form of property taxation.
7. The true incidence of the real estate tax will be shifted to other categories of taxpayers than those envisaged by law.
The incidence of the real estate tax can be shifted so that the tax will not be paid by the owners. In this case, the best illustration of the tax incidence is rent. The owner shifts the real estate tax onto a tenant by increasing the rent. Thus, the tax burden falls not on large property owners but on those who do not possess any property at all and are forced to rent it. Similarly, it will injure middle-income individuals who use taxable property for their own needs.
8. The real estate tax is at odds with the principles of tax fairness, neutrality, proportional taxation and effective administration, the principles which are endorsed in a governmental programme for revising the tax code.
The real estate tax is unfair as it results in progressive or regressive income taxation, depending on who the real taxpayer is. The tax is not neutral either, as one type of property is picked from among a range of assets and is made subject to specific tax rules. The real estate tax, in its essence, cannot ensure tax equality because corporations and individuals use assets on a different basis and for different purposes. The effectiveness of administering the real estate tax, compared to other taxes, will be much lower.
9. The real estate tax will be targeted not only at luxury.
The widely quoted argument that the tax affects the rich and their wealth is entirely spurious. Possession of property is not necessarily an indication of luxury or affluence. People may acquire property through inheritance or restitution, or they may purchase it with borrowed money. For big families, a large dwelling is not a luxury but a necessity. Large houses may be occupied by several generations, so the real estate tax will force people to parcel their property, thus causing personal and formal difficulties.
10. The real estate tax runs counter to the government’s programme of supporting the acquisition of dwelling.
The state now supports acquisition of residential facilities. In the context of the real estate tax for individuals, this initiative is viewed as a means of swelling the ranks of new taxpayers.
11. The real estate tax has a negative effect on the real estate and mortgage markets.
The real estate tax will lead to a drop in prices of immovable property. The real estate market will be faced with diminishing liquidity. Under such conditions, one will have to mortgage more assets to get a loan from a bank. Consequently, credits will become more expensive, even if interest rates do not change. This will bear most heavily on novice entrepreneurs and family businesses.
Conclusions
The enactment of the real estate tax has a whole range of negative implications. The tax has damaging effects on society and the institution of private ownership. It cripples people’s motivations and market processes. The real estate tax for individuals should not be introduced. Furthermore, it is necessary to abolish the land tax and the real estate tax on enterprises and organisations.
