The central aim of Irish housing policy is outlined as 'enabling households to obtain housing of an acceptable standard at a reasonable cost'. A secondary aim is the stimulation of owner-occupation. It is with this secondary aim that I am concerned in this paper. The state supports this sector of the housing market with policies relating to mortgage interest tax relief (MITR), imputed income and capital gains. It has been argued that the existence of MITR combined with an absence of taxation of imputed income and capital gains confers an unfair advantage on those in the owner-occupied sector in Ireland. It can also be shown that government policy in relation to the three policies contributes towards inefficiencies in the operation of the Irish housing market. In Ireland, 80% of all households are owner-occupiers, in contrast with 55% in France and only 30% in Switzerland. The purpose of this paper is to examine the equity and efficiency issues associated with MITR and the extent to which the existence of MITR contributes towards the high owner occupancy rates in this country. Brief reference will be made to imputed income and capital gains in the final section, discussing possible directions for reform.
Equity or fairness consists of two concepts, horizontal equity and vertical equity. Horizontal equity is the equal treatment of comparable individuals. In relation to housing, those individuals on similar incomes with similar characteristics, such as similar family composition, should derive the same net benefits from the system. The principle of horizontal equity advocates the equal treatment of comparable people, regardless of their housing tenure. Vertical equity is the differential treatment of those in different circumstances: those on a higher income should pay a greater proportion of their income in tax and derive less benefit from, for example, subsidies, etc. than those on a lower income. Efficiency refers to the allocation and production of resources that maximise the welfare of society. Does the existence of MITR result in the inefficient production and allocation of housing resources?
Tax reliefs reduce the tax liability of an individual by a given amount. MITR is a discretionary tax relief in that it is only available to those who borrow money to purchase or make improvements to their own home. Tax reliefs are designed to induce certain behavioural responses on the part of the individual in question. Tax laws reflect in part the values of the society in which they operate, and the availability of MITR reflects a general belief in the desirability of an owner-occupied housing sector. The subsidisation of private housing is justified on two grounds. The first is that the consumption of housing services produces a positive externality for society at large. However, it is hard to envisage that in the absence of MITR, the consumption of housing services would decline dramatically. Secondly, the purchase of a house is an investment, as it is not only a source of income but also a store of wealth. If individuals are willing to save for their own future, that is by reconverting their assets (although the numbers that actually trade down upon retirement are small), then the argument suggests that the government should actively encourage this behaviour.
MITR is available to all owner-occupiers 'in respect of interest on money borrowed for the purchase, repair, development or improvement of your main residence here in Ireland or in the UK'. It is an indirect subsidy to the private housing sector. Up to a certain maximum allowable level of mortgage interest (£5,000 for a married couple, £3,800 for a widow(er) and £2,500 for a single person), tax relief at the standard rate of income tax (26%) is available (see table 1, column A). If the mortgage holder first claimed MITR more than five years ago, the maximum interest levels are further reduced to 80% of the relevant interest level plus an additional reduction of £200 for a married person (see column B) and £100 for a single or widowed person.
Table 1
|
A |
B |
|
|
Mortgage Interest Paid |
£6,500 |
£6,500 |
|
Maximum Allowable Interest |
£5,000 |
£5,000 |
|
Maximum Allowed Under 80% Rule |
N/A |
£4,000 |
|
Less Further Deduction |
N/A |
£200 |
|
Interest Allowed For Tax Relief |
£5,000 |
£3,800 |
|
MITR @ 26% |
£1,300 |
£988 |
Up to 1994, MITR was available at the individual's marginal tax rate. The 1994 Budget introduced the gradual introduction of standard rating of MITR. This had the effect of reducing the effective marginal tax rate at which MITR could be claimed, from 48% in 1993/1994 to 26% in 1997/1998. The development was as follows:
Table 2
|
Tax Year |
Interest @ 48% |
Interest @ 26% |
EMTR |
|
1993/1994 |
100% |
0% |
48% |
|
1994/1995 |
75% |
25% |
42.75% |
|
1995/1996 |
50% |
50% |
37.5% |
|
1996/1997 |
25% |
75% |
32.25% |
|
1997/1998 |
0% |
100% |
26% |
The result of the above two changes has implications for equity and efficiency (discussed below), but the most direct effect has been a reduction in the cost to the Exchequer of MITR. In 1980, MITR cost £24m, rising to a high of £216m in 1993, and is projected to fall to £109m in 1998. However, the number of claimants has steadily increased with 365,000 claiming MITR in 1997, compared to 285,000 in 1985.
Before discussing the equity and efficiency issues associated with MITR, it is important to outline the MITR system in operation in the UK. It is believed that 'it is only a matter of time before the system in operation in Britain is introduced here'. The mortgage interest tax relief at source (MIRAS) system in the UK is an agreement between the Treasury and the various lending institutions. Instead of deducting the tax relief from taxable income as is done in Ireland, the tax relief is an explicit public expenditure to the lender who then uses this extra revenue to charge the borrower a lower interest rate. It is less beneficial to taxpayers than the Irish system since taxpayers pay tax on a greater proportion of their income. However, mortgage holders who do not pay tax benefit from the lower interest rates (accepting that this group is probably quite small).
The two developments noted above, namely the restriction of the amount of interest available for relief and the standard rating of MITR were introduced mainly on equity grounds. MITR was vertically inequitable because it was a regressive subsidy. It was found that 17% of all claimants for MITR in 1993 were earning more than twice the non-agricultural wage, yet they accounted for 24% of the total expenditure associated with MITR. In general, the larger a person's income, the greater the value of his mortgage and therefore the more likely he was to be able to claim the maximum amount of relief.
MITR is only available on the interest payments on an individual's main residence. However, there is an anomaly in the system, in that if a person is rich enough to buy a second house, why should this person be allowed to retain the right to claim MITR on interest payments for his first home?. Finally, MITR is a subsidy that is only available to those who have the resources available to enter the housing market in the first place. Should subsidies and aid towards housing provision not be directed more towards those who are at a disadvantage when it comes to providing decent accommodation for themselves and their families?
Married and non-married couples are treated identically. However, the Irish MITR system is fairly equitable in terms of horizontal equity: inequity occurs when those in other housing sectors are compared to those in the owner occupied sector. Up to 1995, mortgage holders could receive tax relief on their mortgage repayments whereas in the private rented sector, only those over 55 could receive tax relief on the basis of their rent payments. In 1995 rent relief was extended to all tenants. However, the maximum limits are considerably smaller than those for MITR (£1,000 for a married couple and £500 for a single or widowed person). While we cannot compare rent with interest payments on a mortgage, it does seem that mortgage holders receive a greater benefit from tax relief than do tenants in private rented accommodation.
Efficiency in the context of housing taxation and subsidisation refers to the situation in which the production of housing resources and their subsequent allocation results in the highest possible level of societal welfare. A perfectly competitive housing market is characterised by competing landlords and a private sector free of government intervention. However, certain features of housing itself (for instance large sunk costs and investment status) necessitate government intervention. Government intervention inevitably leads to distortions in the production and allocation of housing resources.
The existence of MITR leads to a number of inefficiencies:
The above distortions in respect of allocation create difficulties in the supply side of the market. Since MITR is available to everyone who buys a house, it has been suggested that it has increased house prices. However, MITR is only one of a number of factors contributing towards high house prices, and to suggest that MITR alone causes exorbitant house price inflation is an over-simplification.
Is it necessarily in the best interests of society to encourage owner-occupation? Does the favourable treatment of owner-occupation in comparison with other capital assets distort the investment market? Tax neutrality suggests that all assets should be treated equally in terms of taxation and subsidisation, yet this is obviously not the case in Ireland.
Environmental issues concerning land usage should prompt the government to rethink its attitude towards owner occupation. Owner occupation favours the construction of individual homes, which reduces the population density, thus reducing the efficiency of public transport as well as contributing towards the expansion of towns and cities and the spread of 'bungalow blitz'.
Measures to reform the MITR system should address the equity and efficiency concerns outlined above. The lowering of the allowances and the restriction of MITR to the standard rate of income tax increases equity and efficiency in the operation of the MITR system. Most housing commentators are against the abolition of MITR, as this would disadvantage first time buyers to a greater degree than those with more established mortgages, thus violating the principles of Pareto-efficiency. Further restriction of the MITR system is generally advocated with particular attention to limiting MITR to the first five years of a mortgage, as is the case in New Zealand.
It is agreed that an integrated approach encompassing MITR, imputed income and capital gains reform is necessary. A general housing tax is seen by many(eg FFS, Kleinmann, CHAS, Commission on Taxation) as a workable solution. Such a tax would be levied on all owner occupied property, calculated on the basis of the capital value of the property tied to a real money market interest rate (to cover taxation of imputed income and capital gains). MITR would still be available, but only at the standard rate of income tax with restrictions on the amount of applicable interest. It has also been suggested that the responsibility for the collection of such a tax (and consequently for the redistribution of the revenues) should be vested in the local authorities. This could contribute towards greater efficiency in the local housing markets as well.
Owner-occupancy in Ireland is actively encouraged through a variety of government supports, the most important being MITR and the absence of taxation on imputed income and capital gains. MITR was shown to be both vertically and horizontally inequitable as well as inefficient in various aspects of its administration. However, recent changes have reduced the inequalities and inefficiencies to a certain extent. Measures for reform include the continuation of restricted MITR and the imposition of a general housing tax which would tax imputed income and capital gains, at present untaxed. However, the popularity of owner occupancy in Ireland may be as much a result of historical and cultural factors as financial incentives, and the government must bear this in mind when designing policies which impact on the owner occupied housing sector.
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