Labor Tax Reductions in Europe: The Role of Property Taxation

Abstract

We use a New Keynesian DSGE model with search frictions on the housing market to evaluate how financing a labor tax reduction by higher property taxation affects the real economy and welfare. Search on the housing market enables us to explicitly model stocks and flows, which is necessary to differentiate between recurrent property taxes (levied on stocks) and property transaction taxes (levied to flows). We find that using recurrent property taxation as financing instrument outperforms other instruments although all policy measures increase aggregate economy-wide welfare. Our simulations suggest that using property transaction taxation as financing instrument is the least favorable measure.

Implications of US Tax Policy for House Prices, Rents, and Homeownership

“…Tax deductions are not refundable, so y ̃ = 0 if y − ψ( j ) < 0 . 9 Renters are permitted to deduct the following amount from their total income,…”

“…The US tax code allows landlords to use a maximum of $25, 000 in rental property losses to offset their taxable income from other sources, but phases out this deduction between $100, 000 and $150, 000 of income. Our model of the tax code abstracts away from both the maximum and the phasing out of this deduction 9. We abstract away from phasing out of deductions with income, as was the case in the United States prior to 2010.…”

Who benefits from using property taxes to finance a labor tax wedge reduction?

“…Hence, our simulations suggest that the use of property taxation may outperform the use of consumption taxation to finance budget-neutral labor tax wedge reductions. This is also found by Bielecki and Stähler (2018). However, they find that the use of property transaction taxation fares worse than the use of consumption taxation.…”

“…To our knowledge, the first paper that addresses the use of property taxation to finance a reduction in the labor tax wedge is provided by Bielecki and Stähler (2018). They 2 The papers just mentioned use a Walrasian labor market framework (households decide on the amount of hours they want to supply).…”

“…The arguments in favor of such a shift are based on findings in the literature on optimal tax policy, which show that it is most efficient to tax objects with a rather immobile base and where tax-induced distortions are kept at minimum -conditions that are apparently fulfilled for property goods (see, among others, Mankiw et al, 2009, Feldstein, 2006, Slemrod, 1990, or Diamond and Mirrlees, 1971. Bielecki and Stähler (2018) show in a recent paper that property taxation can indeed marginally outperform consumption taxation as the financing instrument to finance a labor tax wedge reduction.…”