Possible reforms of real estate taxation: Criteria for successful policies

A tax on residential property can be advocated on efficiency grounds, acknowledging that taxes on immovable property are found to be among the least detrimental taxes to growth. There are different approaches to taxing residential properties, i.e. as a tax on investment returns or consumption services. Alternatively, it can be regarded as a charge for local public services.

Immovable property is most often regarded as an investment good, which should be taxed as other investments to achieve tax neutrality. A first-best policy implies taxation of imputed rents and allowing for deduction of mortgage interest payments. Experience shows, however, that it is politically difficult to sustain an appropriate tax level on the return of the property, particularly in a situation with rising house prices. In this situation, a second-best policy could be to remove mortgage interest deductibility and introduce a recurrent tax on property. Such a tax would serve a proxy for taxing the return on or the consumption service of the house.

Moreover, in order for the tax to function properly, it is essential to regularly update the tax base according to price developments on the housing market. In case of negative distributional impacts for certain vulnerable households due to the increased property tax burden, targeted mitigating policy measures can be considered. Finally, the paper provides an overview of the state of play regarding these issues in the EU.

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