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The switch from stamp duty (housing transaction tax) to land tax is often framed as a no-brainer. But there’s an underdiscussed trade-off that goes to the heart of a key issue in optimal taxation, which itself has been understudied. A wonkish thread. 1/10 https://www.smh.com.au/politics/nsw/a-duty-to-reform-nsw-takes-path-of-least-resistance-with-tax-switch-20201120-p56gj7.html
Almost all tax remittances (or liabilities, depending on how you want to think about things) are triggered by a transaction. Wage earnings, consumer sales, dividends, capital gain realizations—the list goes on. This isn’t by accident. But it’s a trade-off between two goals. 2/10
The first is the desire to define the tax base so as to achieve some ideally worthy social goal: wage earnings to target inequality; consumer sales to exempt savings from taxation; dividends and capital gains to target capital income. That’s all reasonable. 3/10
But in a perfect, frictionless, complete-market world, all of the above goals could in theory be best achieved by having the remittance of taxes be completely independent of the transaction. Taxing at the transaction level actually moves us away from the theoretical optimum. 4/10
So why do we do it that way? Well, the second goal is that, in practice, liquidity matters! A lot. Insurance and credit markets aren’t perfect. People have all sorts of behavioral biases. Markets are incomplete. And where they aren’t, there may be large transactions costs. 5/10
In that world, we must trade off targeting the optimal base against targeting liquidity. Nowhere is that more salient than property taxes. The move from a housing transaction tax to a land tax is a move from an inferior to a superior tax base, but a move away from liquidity. 6/10
Housing transaction taxes don’t happen by accident. They recognize that realization brings liquidity. And without realization, a large tax bill can face liquidity constraints. Further, these liquidity constraints can then themselves run up against political constraints. 7/10
It’s one of the reasons we see all sorts of crazy property tax imperfections, like grandfathering property tax values or payment deferral options. When you move to a tax on an unrealized asset value, politicians are induced to protect taxpayers from shortfalls in liquidity. 8/10
This is one reason why we tax capital gains on realization rather than accrual. And one reason why some of us have big issues with proposals for a wealth tax, which would put a tax on many non-marketed assets (the sale of an asset automatically triggers a valuation!). 9/10
There hasn’t been nearly enough research on the role of the tax authority in ameliorating or exacerbating liquidity constraints. In the real world, it’s an important consideration explaining much of the tax code, and that our optimal tax prescriptions should accommodate. 10/10
