Homeownership Investment and Tax Neutrality: a Joint Assessment of Income and Property Taxes in Europe

The Great Recession started in 2008 has revived interest towards housing taxation. Owner-occupied housing taxation in particular has been one of the subjects holding the spotlight in the past few years’ public discourse over government intervention. On the one hand, existing tax provisions have been causally linked to households’ indebtedness (Fjærli, 2010; Saarimaa, 1979a; Goode, 2010) and the housing bubble that triggered the crisis in the US (Manestra et al., 2011). On the other hand, governments on both sides of the Atlantic have been facing the need to consolidate their public finances, and to do so are tempted to adopt forms of taxation least detrimental to growth (Arnold et al., 2011; Bielecki and Stähler, 2000). Housing taxation has thus entered the scene, with several publications released on the matter, and reform recommendations issued, by international bodies such as the European Commission, the IMF and the OECD (e.g. IMF, 2009; Andrews et al., 2011; Norregaard, 2013; Slack and Bird, 2014; European Commission, 2012).

The subject has a long tradition in the economic literature. Homeownership represents an investment yielding a return in the form of non-cash income, i.e. the avoided cost of paying for the residential services enjoyed, which is referred to as figurative or imputed rent (IR) (Frick et al., 2010). Neutrality, benchmark criterion for efficiency in taxation (Johnson and Myles, 2011), requires IR to be taxed as other returns from investment in order to avoid distortions in households’ portfolio choices leading to inefficient investment decisions. However, tax policies applying in most western countries, including the US and many in Europe, do not follow such recommendation. On the contrary, tax rules provide for a favourable tax treatment of owner-occupied housing, most notably in the context of personal income taxation: IR (or an equivalent tax base) and capital gains are tax exempt, and often also tax reliefs on mortgages incurred to purchase housing apply.

The normative rationale behind this choice broadly relates to the idea that homeownership generates positive externalities, in terms of social capital, citizenship (DiPasquale and Glaeser, 2007a; DiPasquale and Kahn, 2007b) and lower crime (Glaeser et al., 2010), house (Galster, 1983) and neighbourhood maintenance (Dietz and Haurin, 2007), children’s educational outcome (Bramley and Kofi Karley, 1998; Haurin et al., 2012) and assets accumulation in long run (Di et al., 2007). However, the scientific debate has not reached consensus on the point, as several authors trace the link to a selection mechanism, pointing rather at homeownership hampering mobility and therefore employment (Bover et al., 2000; Cameron and Muellbauer, 1998; Boeri and Terrell, 2000). In practice, owner-occupied housing taxation is highly unpopular, for a variety of reasons (European Commission, 2012). These include the salience of particular forms of housing taxation (e.g. recurrent property taxation), but also the non-cash nature of imputed rents, and a popular notion that housing constitutes a primary need. The last argument, however, would equally recommend the income tax exemption of rent paid by renters, a practice which does not apply, or does to a very limited extent, in the same countries that exempt imputed rent.

Past prominent contributions (Goode, 2010; Aaron, 1970; Rosen, 1979; Poterba, 1992), followed by a considerable body of later research, have illustrated the multiple drawbacks of this favourable treatment of homeownership (e.g. Skinner, 1979; Kneller et al., 1999; Arnold et al., 2011; Fatica and Prammer, 2017). On efficiency grounds, lack of tax neutrality in household portfolio choices leads to overinvestment in housing along the extensive and intensive margins (Hanson, 2012; Saarimaa, 1979a) and to the crowding-out of more productive alternative investments that are more heavily taxed (Turnovsky and Okuyama, 1994; Leung, 1999). Also, the favourable income tax treatment of owner-occupied housing might increase house prices (Berger et al., 2000; Damen et al., 1998; Martin and Hanson, 1999; Sommer and Sullivan, 2018) without necessarily expanding housing opportunities, but rather fostering inflation and volatility (Catte et al., 2004; Splinter, 2018).

On distributional grounds, a related stream of research has discussed horizontal and vertical equity of existing tax provisions in relation to Comprehensive Income Taxation, requiring the tax base to reflect both monetary and non-monetary potential consumption opportunities (Haig, 1921; Simons, 1938). These works generally found existing housing-related income tax provisions to bear horizontal inequity, and mortgage interest reliefs in particular to bear regressive distributional effects (e.g. Anderson and Roy, 2011; Matsaganis and Flevotomou, 2007; Poterba and Sinai, 2008; Figari et al., 2017).

Despite such long-standing endorsement for abolishing the differential income tax treatment applying to owner-occupied housing investment, a political argument brought to bear in its defence is that this investment is then subject to recurrent property taxation. Recurrent owner-occupied property taxation may then possibly be correcting the lack of neutrality embedded in income taxation.¹ Yet no evidence exists - to our knowledge – on whether this is actually the case i.e. on the size and the distribution of a possible homeownership bias (lighter taxation for homeownership investment) arising from the interplay between income and property taxes. The answer to this empirical question is highly relevant for informing the current debate on taxation reform prospects. On efficiency grounds, in order to assess how far current provisions actually stand from neutrality, and therefore the scope for potentially growth-enhancing reforms; on distributional grounds, because of the peculiar equity concern that the prospect of expanding owner-occupied housing property taxation raises, including lack of progressivity of property taxes and the need to safeguard asset-rich but income-poor households.

In what follows, we respond to such research needs offering new quantitative evidence, drawn from after the Great Recession onset, in eight European countries (Austria, Belgium, Finland, France, Germany, Italy, Spain and the United Kingdom) selected to represent heterogeneous institutional settings (Anglo-Saxon, Central European, Mediterranean, Nordic), with respect to housing markets, population distribution of homeownership, and tax systems. Section 2 describes the relevant tax provisions prevailing in each country. The analysis is based on data drawn from the Statistics of Income and Living Conditions (EU-SILC) and the UK Family Resources Survey (FRS), and builds on the multi-country tax benefit model EUROMOD, as described in Section 3. The methodological set-up and its implementation are illustrated in Section 4. The contribution that our results, presented in Section 5, provide is fourfold. First, we quantify the budgetary size of this lack of neutrality. Second, we address its efficiency side computing the population distribution of effective marginal tax rates applying to alternative portfolio choices i.e. homeownership versus financial investments.² Third, to gauge the horizontal (in)equity side of (lack of) tax neutrality, we compute differential average tax rates applying across alternative portfolio choices, for otherwise identical taxpayers that, in principle, should not be discriminated by preferred investment type – unless further economic reasons would recommend it. Finally, we turn to vertical equity and measure the extent to which the overall tax system progressivity is altered by the homeownership bias.

Results, discussed in Section 6, show that a sizeable distortion in favour of homeownership (w.r.t financial) investment, is indeed embedded in current direct tax systems, even when property taxation is accounted for. Actually, property taxation on the main residence represents only a partial compensation to the homeownership bias inherent in income tax provisions in all countries, except France. The distributional profile of the homeownership bias varies across countries, in reflection of country-specific income and property tax designs and the population distribution of incomes, homeownership and financial investments. Finally, the homeownership bias generally slightly enhances the overall tax system progressivity, due to the definition and population distribution of the underlying exempted tax base.

Table 1 describes the income tax rules applying to owner occupied housing,³ in contrast to tax provisions applying to other types of investment, namely financial investment, as of 2012.⁴ Strikingly, in no country IR is subject to income tax: rules de facto exempt returns from owner-occupied housing investment, yielding a tax discount reflecting legal marginal tax rates spanning from 10 to 50%. On the contrary, returns from financial investment are subject to income taxation, either under the marginal tax rate in PIT or, in most countries, under proportional separate taxation with rates below the top marginal rates in PIT (see column ‘Financial’). Hence, the chance of an income tax induced distortion in households’ portfolio choices, potentially leading to overinvestment in housing, seems possibly present in all the countries we consider.

Besides, mortgage interest (MI) tax reliefs might apply to owner-occupied housing investment, although there has been a tendency to reduce them in recent years.⁵ MI tax reliefs have been entirely abolished in Spain (2012) and France (2010) and reduced in Finland (since 2012, while previously the country provided one of the most generous). It has been reformed in Belgium in 2005 in a way that did not affect the generosity of the system.⁶ Italy appears the only country, among those providing for a sizeable MI tax relief (in Italy the maximum amount returned to the taxpayer per year corresponds to about one third of median monthly earnings), which has made no plan of reducing it, despite its undisputed regressive nature.

On the contrary, no tax relief exists associated to negative interests in the case of financial investment.

The following Table 2 covers instead recurrent housing property taxation rules. In all the countries we consider, except the UK,⁷ a recurrent tax applies to owner-occupied housing.⁸ The assessment of housing values appears quite out of date in all countries, with some exceptions, most notably Finland which provides for regular re-assessments, reflecting a feature of other Nordic Countries. Indeed, property taxation varies a lot with respect to the amount of revenues raised (Barrios et al., 2019).

Clearly, to assess its weight in each country, and the potential for compensating the owner-occupied return exemption from income taxation, it is imperative to consider the integration of different housing tax measures (Lunde and Whitehead, 2021). For example, Austria and Germany display very light housing property taxation, but no (or very limited, in the case of Austria) mortgage interest relief is granted to homeowners. The UK has removed homeowners’ mortgage interest reliefs, but a relevant homeownership bias still stems from the combined effect of IR exemption and the lack of a property tax. In a few countries, ‘safeguard mechanisms’ are in place, to protect individuals who might be assets-rich but income-poor (Shan, 2010). For example, France, where since 2012 the total tax burden cannot exceed the 50% of taxable income. Such mechanisms represent a promising avenue for enlarging the role of housing taxation while safeguarding the most vulnerable in societies.

Data are drawn from the European Statistics of Income and Living Conditions (EU-SILC) for all countries except United Kingdom, for which we use Family Resources Survey (FRS). These correspond to the surveys acting as input databases for the multi-country microsimulation model EUROMOD, which we exploit for empirical analysis. The EU-SILC provides cross-sectional and cross-country comparable yearly data drawn from nationally representative samples, covering different topic domains, including housing tenure, house characteristics and quality indicators, besides information on households financial circumstances. The FRS, the UK household budget survey, offers a considerably larger sample size than the British component of EU-SILC, as well as much more detailed information on household incomes, valuable for tax modelling. The data used here refer to 2010. Information on country-specific homeownership rates are shown in Table 3. Homeownership is most prevalent in Belgium, Italy, Finland and Spain, where rates score above 70%, and lower in Austria and Germany (below 60%).

Assessing the tax saving enjoyed by homeowners because of the IR income tax exemption requires measuring the exempted tax base. Although the EU-SILC provides estimates of IR, i.e. the return from homeownership investment, for all the countries involved since 2007, these are known to suffer from comparability issues (Juntto and Reijo, 2010; Törmälehto and Sauli, 2013) because derived under country-specific methodological choices. For this reason, we employ IR measures estimated adopting a cross-country comparable approach (Figari et al., 2015b) as described in Appendix 1.

The empirical analysis is developed adopting a fiscal microsimulation approach, which allows estimating household incomes under different taxation scenarios, holding everything else constant (Figari and Paulus, 2015a). Tax scenarios are implemented using EUROMOD, the multi-country European wide static tax-benefit microsimulation model that generates comparable measures of direct taxes, social insurance contributions and cash benefits. Simulations reflect given tax-benefit rules, applied to populations as characterised in the underlying input datasets; further tax benefit policies which are not simulated, as well as market incomes, are taken directly from the data. As such, EUROMOD allows to gauge the first order effects of specific tax-benefit policies in terms of government budgets, income distribution and a variety of effective tax rate indicators (Sutherland and Figari, 2013). Specifically for our purpose it is important to note that mortgage interest tax reliefs are simulated in the countries where they exist (notably Belgium, Finland, Italy and Spain). The property tax is simulated in Belgium and Italy, while for Finland, France, Germany and Spain the amounts are taken from the data.

The baseline tax-benefit systems simulated refer to tax policy rules applying in 2012. Appropriate price and income indices are used to update monetary variables from the income reference period (i.e. 2009) to policy system year (i.e. 2012). The simulations of these policy systems have been cross-checked with administrative statistics and tested through a number of other applications.⁹

We quantify the homeownership bias based on the comparison between the baseline tax scenario (reflecting actual income and property tax rules) and a tax-neutral micro-simulated counterfactual tax scenario. The counterfactual scenario is designed to achieve tax-neutrality in portfolio investment decisions, considering low-risk financial investment as an alternative to homeownership investment.¹⁰ In this counterfactual scenario, neutrality is achieved by applying the same income tax rules provided for financial investment (typically proportional taxation at source) to the return from homeownership investment, i.e. net IR; and also removing any further differential tax treatment between the two types of investment, i.e. removing housing property taxation and mortgage interest tax reliefs that would only apply to homeownership and, as such, contribute to shaping an homeownership bias.¹¹ In sum, the counterfactual scenario implies an increase of the tax rate on IR in order to equal the tax rate on financial investment.

This counterfactual scenario is purposely not designed to achieve revenue-neutrality. The underlying idea is that the level of taxation is left as a political choice to policy makers, or citizens’ representatives in democratic societies (Johnson and Myles, 2011). Besides, availability of additional tax revenues might be valuable in times of fiscal consolidation needs, and anyway enlarge the scope for growth enhancing tax-shifting measures.

The comparison (i.e. differencing) of the population pre- and post-tax income distribution arising under the baseline and the neutral tax scenario allows to quantify the budgetary dimension of the homeownership bias; also, to quantify the specific and offsetting contributions of various homeownership tax provisions: namely IR exemption and Mortgage Interest Tax Reliefs (MITR) contributing to the bias, and entailing a fiscal cost on the one side; property taxation partially offsetting the bias, and collecting revenues, on the other.

Besides, we are able to describe the income-distributional pattern of the homeownership bias arising from the combined effect of income and property taxation rules applying to homeownership. In more detail, we explore two economic concerns embedded in tax neutrality: efficiency (i.e. the homeownership bias entailing distortions to otherwise efficient portfolio investment decisions) and equity (i.e. discrimination of taxpayers based on legitimate portfolio preferences). We explore the (in)efficiency side of the homeownership bias computing effective marginal tax rates i.e. the size of taxation applying to a marginal investment in housing, as opposed to a marginal financial investment. This is achieved applying baseline tax rules to an hypothetical marginal increase in each form of investment, quantified as the 10% of country-specific median IR for current homeowners.¹² While income tax rules applying to the two types of hypothetical investments are simulated, the property tax applying to the hypothetical marginal investment in homeownership is obtained through calibration.¹³

Next, we turn to the horizontal and vertical equity side of tax neutrality. Horizontal equity requires non-discriminatory tax treatment of ‘equals’: in other words, two otherwise identical taxpayers, should not be discriminated being charged with higher tax liability by preferred investment type. We compute indicators for the burden of taxation, namely average tax rates, that households actually bear under existing tax provisions (income tax exemption of IR, MITR, property tax), and those that would arise if they had invested in financial capital instead of homeownership (their actual IR being taxed as if financial income).

Finally, we gauge the vertical equity embedded in existing housing-related tax provisions, with respect to a tax-neutral scenario of homeownership bias removal. We do so by computing progressivity indexes for tax liabilities in the two scenarios. Indeed, the peculiar distributional pattern of specific tax provisions contributing to the ‘homeownership bias’ (IR exemption, MITR on one side and recurrent property taxation as a possible compensation on the other) questions the role of the latter as a counterbalance to the first two components and may raise a vertical equity concern.

In Europe, the Great Recession has made it imperative to identify forms of taxation least detrimental to growth, and shift the tax burden towards those, thus reviving interest towards owner-occupied housing taxation. For decades, in sharp contrast with economic principles, western countries’ income tax systems have exempted IR, i.e. the return from investing in owner-occupied housing, from income taxation.

Existing tax measures often seem driven by political attempts to maximise consensus, as showcased by the succession of owner-occupied housing tax reforms passed in Italy over the past decade, with the property tax on the main residence being repeatedly announced to be, and then actually being abolished, re-introduced, reformed, at a pace replicating that of the political cycle (Figari and Fiorio, 2015).

A political argument against reforming existing tax provisions, removing the IR exemption, builds on the presence of an additional tax burden on homeowners stemming from recurrent property taxation of the main residence. Despite a long-standing endorsement of removing the homeownership bias, lack of updated comparative evidence on its size, also in relation to existing property taxes on housing, and on their joint distributional effect, is currently hampering the tax policy debate. This paper has addressed such research need, offering novel evidence on aggregate and distributional measures of the homeownership bias in eight European countries, observed after the onset of the recent crisis, accounting for the extent to which the bias might be mitigated by recurrent property taxation.

Our results confirm that a sizeable bias in favour of homeowners is indeed embedded in current income tax systems, with non-trivial country specific distributional profiles (both in terms of tax incentives to specific forms of investment, and in terms of average tax advantage granted) and implying a general slight contribution to enhancing the tax system progressivity, due to the definition and population distribution of the underlying (exempted) tax base. Importantly, against an argument brought to bear in defence of maintaining the IR exemption, results reveal that, in all countries except France, property taxation represents only a partial correction to this bias. Clearly, the adoption of income-based or property-based housing taxation would bear different implications (in terms of tax evasion, distributional profile, gross or net tax base definition, liquidity constraints and need for safeguard mechanisms etc.) and a discussion of these, and whether the two forms of housing taxation should be regarded as substitutes or rather integrated as complements, is left for future research.

We acknowledge that our analysis presents some limitations: to begin with, the reflected policy rules date back to 2012, although in most countries the structure of housing taxation has not been revised since. Also, further tax components, possibly contributing to the bias, such as capital gains, or indirect taxes on housing transactions, although minor in quantitative significance, could not be accounted for in our analysis, mostly due to data limitations. Finally, the analysis and discussion are focussed on housing investment on the main residence, rather than investment in further housing properties, which, although less prevalent among the population, are subject to less generous tax treatment, and might bear the burden of both property and income taxation.

Hopefully, despite these limitations, this cross-country comparative evidence will be valuable for informing the policy debate on the search for new sources of tax revenues, and in particular for those less detrimental to growth and equity.

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Author details

1. Francesco Figari

   For correspondence

   francesco.figari@uniupo.it

   "This ORCID iD identifies the author of this article:" 0000-0003-0735-1076

2. Gerlinde Verbist

   Herman Deleeck Centre for Social Policy, University of Antwerp, Antwerp, Belgium

   "This ORCID iD identifies the author of this article:" 0000-0001-9253-3477

3. Francesca Zantomio

   "This ORCID iD identifies the author of this article:" 0000-0002-7839-7867