The bittersweet fat of the land

‘In 2010, we will seek up to an additional €1.75 billion from taxation. In 2011, the target will be to raise up to an additional €1.5 billion,” said Minister for Finance Brian Lenihan last Tuesday.

“Options to raise this may include the taxation of child benefit, the introduction of a carbon tax, a form of property tax and significant further base broadening.”

The notion behind a property tax is simple – levy an amount on a taxpayer by reference to the value of the property he owns. There, unfortunately, is where the simplicity starts and stops. Lenihan is obviously alert to this: I suspect that's why he's talking about a property tax only as an option, and even at that, as an option not for this year – nor even perhaps next year, but the year after.

Lenihan is a keen student of history, and he will know from the experiences of the recent past just how unpopular a property tax could be. We like our real estate. Somehow, a tax on property is more than just a money matter – it is a levy on our aspiration to own the roof over our heads.

We have made a few attempts already to establish a property tax without any notable success. Residential property tax (RPT) was introduced in the early 1980s. It was based on a fixed percentage of the value of the property owned, and was to be paid annually. Abatements were given by reference to your income – you had to earn a certain amount before the tax became payable – and by reference to the size of the household.

This experience taught us several lessons. The first of these is, of course, that a property valuation is based on location, location, location. A residential property tax based on valuations rapidly becomes an urban tax.

Figures provided to the Dáil in 1994, shortly before the abolition of RPT, showed that 75 per cent of the tax was paid in Co Dublin, about 6 per cent in Co Cork, and 2 per cent or so in Co Galway and Co Limerick. The other counties paid less than 1 per cent. Leitrim, which came last in this particular league table, accounted for only 0.03 per cent of the total. These are enormous variations, and must call into question whether a tax of this type can be in any way described as fair.

The second lesson is that the ability to pay is not just determined by the amount of income in a household, but also the amount by which the property is in debt. Few people are fortunate enough to own their homes outright, unless either they have inherited them or are coming towards the end of their careers and have paid off their mortgages.

If a property tax is to be in any way reflective of the wealth, and not just the earnings, of its owner, borrowings on the property must surely be taken into account. RPT failed to do this – the value for tax purposes of a IR»100,000 house was IR»100,000, irrespective of whether there was a mortgage on the property or not.

These lessons are particularly relevant now. In the 1980s, the property market was considerably less volatile than it is now. Arriving at fair valuations at the moment is really difficult.What would make matters worse is that there will be inevitably be a difference in property value between the time the tax is established and when it becomes due for payment.

We are already seeing problems for taxpayers who have inherited property at a particular valuation at the date of inheritance. When they go about paying the tax some months later, they find that cannot raise adequate funds, either because the valuation has dropped, or because the property is simply not marketable.

The valuation of a property for property tax purposes, therefore, can be little more than a yardstick – one component in an overall property tax package. As recently as last October, a new form of property tax was announced: a levy on second properties. This levy is valuation-independent. The mere fact of owning a second property is sufficient for the levy of €200 per property to apply. But six months on, and despite the evident pressure the government is under to collect more revenue, it has yet to be introduced.

This highlights a further difficulty with property taxes, which is the creation of the administration mechanism to collect the tax on a fair and timely basis. Another attempt at a property tax in the 1980s,the farm tax, must surely deserve a special place in history.

This was one of the few taxes ever, anywhere, to have cost more money to administer (before it was repealed) than it actually raised.

No doubt all these considerations are in play as the Commission on Taxation, the minister and his department try to formulate a workable approach to a new property tax. They will also surely be mindful that, for the tax to be fair, it must be complex.

Typically, the more complex the tax, the less it is likely to yield. Even in its heyday in the early 1990s, after years of tweaking and refinements, RPT took in around IR»14 million (nearly €18million), or just over 1 per cent of all tax collected at the time.

So there must be a temptation to take a simpler approach. As Adam Smith pointed out two centuries ago when discussing the same subject, neither a house nor the ground which it stands on produces anything. The person who pays must draw the payment from some other source. Our classic property tax, stamp duty, drew payment from savings or borrowings. Drawing payments through any new property tax must surely come through the income tax system.

The simplest property tax of all would be one which reduces an existing income tax allowance in a proportion determined by criteria such as personal circumstances, property ownership and the property's valuation and indebtedness. If a more complex route is taken, the minister's estimate for a property tax to be introduced could take a lot longer than two years. And in the space of two years, as we have just seen, the tax environment can change utterly.