Taming the geese

One of the most widely accepted tenents of tax theory is that it is most efficient to tax immobile factors of production such as land. Such taxes cannot be avoided, and so they do not distort behaviour. Consequently, most economists would argue that an annual land tax is preferable to a tax on land transactions such as stamp duty. The latter, it is argued, discourages people from moving to more suitable dwellings and consequently has many undesired consequences. And yet stamp duties remain a major source of tax revenue for state governments and there seems little likelihood of them being replaced by land taxes any time soon. Why is this?

Ross Gittins has a piece arguing that this conventional view is wrong because economic orthodoxy ignores important facets of human behaviour.

Actually, he makes two separate arguments and I think it is important to distinguish them. First, he invokes the Colbert principle “the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing”. In other words, people make less fuss if you tax a transaction (stamp duty) rather than a stock (land tax). Now just because there is a good political reason for something doesnt mean that economists have to like it. But Gittins also advances a normative argument economists are being ignorant of non-economic motives when they assume that the behaviour induced by stamp duties is undesirable.

Joshua Gans takes issue with this second point. He argues that these incentives do distort behaviour on average, even if they often dont matter in some individual cases. I agree. But Im more interested in Gittins first point. Why is it that stamp duties are politically favoured over land taxes?

Historically, transaction taxes arose because the existence of two parties to the transaction made reliable information easier to obtain. Gittins also argues that transaction taxes such as stamp duty are more likely to be tolerated by the angry geese because there is an immediate positive reward associated with stamp duty. You pay your stamp duty and you get a house. On the other hand, an annual land tax would have to be paid every year without the payer getting anything new for it.

I suspect though, that the issue is something more basic liquidity. If land tax were to be extended to owner-occupied housing, politicians would immediately be bombarded with examples of low-income people who will be forced to either sell their long-standing family home or eat pet food.

The challenge for those of us who would prefer to tax land is to develop institutional features that address this liquidity problem. The HECS scheme might provide useful guidance. This manages to collect funding from a population group (students), many of whom are very credit constrained. Some form of delayed payment arrangement for land tax that also covers the perceived risks of such an arrangement (eg negative equity) could conceivably address some of the key political problems associated with land tax.

At the same time however, we might like to follow Gittins advice and try to tie the payment of tax to some perception of benefit. A mandated link to some particular program (like aged care) might help, though something more immediately tied to the payment of tax might be better. The key challenges for such a tax reform are political. But just because there are political reasons for the existence of non-optimal tax policies doesnt mean that we should accept them.

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derrida derider
derrida derider
14 years ago

Among old tax hands there is a saying – “the only good tax is an old tax”. That’s all you need to know to explain why tax reform is politically hard.

Of course we already have a land tax on residential land – council rates. If I were a pollie trying to sell abolition of stamp duty funded by an ongoing land tax, I’d label the new tax a “rate surcharge” and tack it onto this system. Even so it’d be a tough sell. You’d certainly have to continue the practice of many councils of deferring collection of the rates until elderly occupants die and you can take it out of the estate – which is a good backdoor death duty.

And I agree with Gans that Gittins has mised the point about non-financial incentives. It is the *margin* that matters for policy, and at the margin financial incentives have a demonstrable effect on mobility – which is quite consistent with non-financial considerations being more important to most such decisions.

14 years ago

I recall reading more than once that any abolition/reduction of stamp duty would flow through to higher prices for land, which I think is probably correct. So transfer duty is effectively paid by vendors. Beyond that I can only speak for myself and acquaintances in saying that the “price” for a house is the contract price plus duty and that is how a bid price is assessed.

14 years ago

I think DD is pretty much right. Bruce’s bit about liquidity is certainly a practically important point.

However, part of that sounds like history-by-making-it-up about stamp duty. Historically stamp duty is surely favoured because, leaving aside specific issues of avoidance and interpretation, it is dead easy. They come to you and give you the money, you don’t have to do anything. If they don’t they don’t have a contract (or not an enforceable contract, which may as well not be a contract).

Pedro, yes the incidence of the tax is on buyers. But that argument is an argument for making sellers richer. Also, absent the special favoritism of residential property in the federal tax system, (and ignoring the rapidly growing non-taxable sector), you would be increasing income tax receipts by between 15% and 47.5% of the stamp duty receipts foregone.

Nicholas Gruen
14 years ago

Thx for the post Bruce. And good practical advice. The other political issue that’s important is that stamp duty is very occasional. I often think the health system can be as bad as it is because we only run into it occasionally. Things that are pervasive in all our lives tend to be done more effectively if not efficiently – like garbage disposal.