One weird old tax could slash wealth inequality (NIMBYs, don’t click!)

yesnoimputedrent

What dominates the millennial economic experience? Impossibly high house prices in areas where jobs are available. I agree with the Yes In My Back Yard (YIMBY) movement that locally popular, long-term harmful restrictions on new buildings are the key cause of this crisis. So I enjoyed learning some nuances of the issue from a new Governance Podcast with Samuel DeCanio interviewing John Myers of London YIMBY and YIMBY Alliance.

Myers highlights the close link between housing shortages and income and wealth inequality. He describes the way that constraints on building in places like London and the South East of England have an immediate effect of driving rents and house prices up beyond what people relying on ordinary wages can afford. In addition, this has various knock-on effects in the labour market. Scarcity of housing in London drives up wages in areas of high worker demand in order to tempt people to travel in despite long commutes, while causing an excess of workers to bid wages down in deprived areas.

One of the aims of planning restrictions in the UK is to ‘rebalance’ the economy in favour of cities outside of London but the perverse result is to make the economic paths of different regions and generations diverge much more than they would do otherwise. Myers cites a compelling study by Matt Rognlie that argues that most increased wealth famously identified by Thomas Piketty is likely due to planning restrictions and not a more abstract law of capitalism.

Rognlie also inspires my friendly critique of Thomas Piketty and some philosophers agitating in his wake just published online in Critical Review of International Social and Political Philosophy: ‘The mirage of mark-to-market: distributive justice and alternatives to capital taxation’.

My co-author Charles Delmotte and I argue that for both practical and conceptual reasons, radical attempts to uproot capitalism by having governments take an annual bite out of everyone’s capital holdings are apt to fail because, among other reasons, the rich tend to be much better than everyone else at contesting tax assessments. Importantly, such an approach is not effectively targeting underlying causes of wealth inequality, as well as the lived inequalities of capability that housing restrictions generate. The more common metric of realized income is a fairer and more feasible measure of tax liabilities.

Instead, we propose that authorities should focus on taxing income based on generally applicable rules. Borrowing an idea from Philip Booth, we propose authorities start including imputed rent in their calculations of income tax liabilities. We explain as follows:

A better understanding of the realization approach can also facilitate the broadening of the tax base. One frequently overlooked form of realization is the imputed rent that homeowners derive from living in their own house. While no exchange takes place here, the homeowner realizes a stream of benefits that renters would have to pay for. Such rent differs from mark-to-market conceptions by conceptualizing only the service that a durable good yields to an individual who is both the owner of the asset and its consumer or user in a given year. It is backward-looking: it measures the value that someone derives from the choice to use a property for themselves rather than rent or lease it over a specific time-horizon. It applies only to the final consumer of the asset who happens also to be the owner.

Although calculating imputed rent is not without some difficulties, it has the advantage of not pretending to estimate the whole value of the asset indefinitely into the future. While not identical and fungible, as with bonds and shares, there are often enough real comparable contracts to rent or lease similar property in a given area so as to credibly estimate what the cost would have been to the homeowner if required to rent it on the open market. The key advantage of treating imputed rent as part of annual income is that, unlike other property taxes, it can be more easily included as income tax liabilities. This means that the usual progressivity of income taxes can be applied to the realized benefit that people generally draw from their single largest capital asset. For example, owners of a single-family home but on an otherwise low income will pay a small sum at a small marginal rate (or in some cases may be exempted entirely under ordinary tax allowances). By contrast, high earners, living in large or luxury properties that they also own, will pay a proportionately higher sum at a higher marginal rate on their imputed rent as it is added to their labor income. Compared to other taxes on real estate, imputed rent is more systematically progressive and has significant support among economists especially in the United Kingdom (where imputed rent used to be part of the income tax framework).

This approach to tax reform is particularly apt because a range of international evidence suggests that the majority of contemporary observed increases in wealth inequality in developed economies, at least between the upper middle class and the new precariat, can be explained by changes in real estate asset values. Under this proposal, homeowners will feel the cost of rent rises in a way that to some extent parallels actual renters.

For social democrats, what I hope will be immediately attractive about this proposal is that it directly takes aim at a major source of the new wealth inequality in a way that is more feasible than chasing mirages of capital around the world’s financial system. For me, however, the broader hope is the dynamic effects. It will align homeowners’ natural desire to reduce their tax liability with YIMBY policies that lower local rents (as that it is what part of their income tax will be assessed against). If a tax on imputed rent were combined with more effective fiscal federalism, then homeowners could become keener to bring newcomers into their communities because they will share in financing public services.

8 thoughts on “One weird old tax could slash wealth inequality (NIMBYs, don’t click!)

  1. You can’t override fundamental economic forces; capital goes where it is treated well.

    Wouldn’t a homeowner simply move/convert his home into a time shared arrangement or rent-to-own scheme i.e. I rent my home from my neighbor and he rents his home from me? Tax avoided plus I get now get tax deductions

  2. Too complicated. It would be necessary to deduct all the expenses that a landlord pays out of rents received. Anyway, this is just the wet dream of people who can’t afford to buy in the more desirable areas. If you want a real tax that cannot be avoided and would splve a lot of real problems go back to Henry George and institute a tax of 100% on the rental value of land. .

    • I don’t think its too complicated. Taxes on imputed rent were in place till 1963, and it was abolished with the specific aim of encouraging home-ownership. Unlike a Georgist tax, this has actually been implemented in the past.

  3. Your reasoning sounds speculative and the intended results of more low cost housing in desirable areas seems unlikely. That homeowners who have invested in any class of housing would welcome lower cost housing in their neighborhood and jeopardize their investment ignores the virulence of historical local opposition to such proposals and the real economic effects of low cost housing on neighbors. There is a reason they say never buy the most expensive home on the block – the others will diminish your investment potential. This type of tax would fly in the face of long-time policies encouraging and subsidizing home ownership. As a state or federal tax, it seems very unlikely that increasing property taxes in Beverly Hills or Manhattan would increase the supply of lower cost housing in those communities. Those who oppose NIMBY low cost housing are among the most motivated and able to defeat any politician proposing it. In my city of Houston, the most crime ridden neighborhoods are those with an abundance of low cost housing. Efforts to locate them in high rent neighborhoods have had no success due to extremely strong opposition.

    • It is unnecessary for high-income neighbourhoods to welcome low-income housing for the process to work as I intend. In fact, it might even be better if exclusive neighbourhoods aimed to build luxury housing.

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