Thursday, January 20, 2011

The OECD says imputed rent should be taxed

When homeowners own their property with equity, they get a tax benefit as important as the mortgage interest deduction: the imputed rent they pay to themselves goes untaxed.  To think about how this works, consider two nieghbors who own their houses free and clear.  Suppose the houses are identical, and that the nieghbors swap houses, paying rent to each other.  They now have a tax liability that they would not have had they remained in their houses.  Avoiding this liability is tantamount to a tax expenditure--a benefit to those who own their houses without debt.  The OECD is correct that countries rarely tax imputed rent, and argues that this lack of taxation has tilted investment toward housing to the detriment of more productive uses.  It also argues that the benefits to homeownership are overstated.  I am not sure that this is true (see here and here), but I will leave that for another time.

The question is how does one go about taxing imputed rent?  It is not easy.  One could start by imposing an ad valorem tax on property values (such as a local property tax), but that doesn't tax imputed rent per se, because it does not take into account expected inflation (if one person expects her house to go up in value, and another does not, the rent the first person pays is lower than the second).  Alternatively, one could find comparables in the rental market and attribute rents found there to the owner market.  But owner and rental markets are so segmented that this would be difficult to do.

This has implications for fairness; if we don't know what we are taxing, it is hard to know how much to tax it.