The Arithmetic Behind Israel's Plan to Tax Owners of Multiple Homes

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Moshe Kahlon and Benjamin Netanyahu, August 14, 2016.
Moshe Kahlon and Benjamin Netanyahu, August 14, 2016.Credit: Emil Salman

This week the prime minister was asked what he thinks of Finance Minister Moshe Kahlon’s plan to slap a 1% tax on owners of three homes or more. Netanyahu pointed out that as the owner of three homes, he was in conflict of interest and would therefore keep his opinion to himself. But we have to assume that if he supported the tax, he’d have said he owns three homes and will suffer from the tax, but supports it.

He’s in good company. According to the Finance Ministry, some 54,000 people in Israel own three or more homes, and they are the only ones fighting against Kahlon’s plan.

Let’s talk about the economic, social and substantive policy behind this tax. The tax system fulfills a number of roles. First of all, it brings money to the state so it can function. Secondly, it gives the state some control over the division of income in this country, enabling it to increase or decrease inequality and to encourage or discourage consumption.

The plan to tax owners of three homes or more is calculated to bring the state 900 million shekels a year in revenues. But its main goal is two-pronged and otherwise – it’s to reduce inequality and make people stop hoarding homes. If they’re taxed they’ll be more likely to drop their hobby, which should increase the supply of housing. Maybe housing prices will even drop a bit. (Moves of this sort however are far from a done deal; the homeowners may simply roll the tax onto their tenants.)

But before discussing how the tax will affect rental rates or housing prices, let’s discuss its merits.

The proposed tax would be a relatively rare one, in which the state retroactively hits people who had, beforehand, bought three homes, paying whatever taxes were due while about it, and demands more money. It’s sort-of like the country’s decision to tax gains on natural resources (natural gas, potash and chemicals) at a higher rate – retroactively, after major hydrocarbon discoveries. Here, too, homeowners have made a fortune on their past purchase of dwellings and the state would like a bite.

So now the state is coming to these home collectors and saying, “We enabled you to get rich by our actions. We built roads and infrastructure, cultivated gardens and built schools and clinics and synagogues for your neighborhoods. Now we feel okay about demanding you share the reward of your asset’s betterment.”

However, the value of homes people bought years ago didn’t double and more only because of the state’s deeds. They also rose in value because of the state’s omissions. The state controls most of the land in Israel and its marketing policy, and poor planning, has created an acute shortfall in land for housing development. When that shortage is conflated with convenient financing terms because of the low level of interest rates, the result is a huge leap in housing prices.

By its sins of commission and omission, the state is directly responsibility for the quantum leap in housing prices and for many people deciding to take loans to invest in housing. Essentially, the state enabled people with capital, or access to capital, to collect homes in their investment portfolios, raise housing prices and make it harder for anybody but people like themselves to afford a home.

Since the state feels it deserves credit for creating this wealth, it feels comfortable about demanding a share.

Policies of the sort could make sense when the wealth created is extreme, or in the case of structural failures that enable extraordinary profit levels to be achieved and when these failures cause auxiliary problems, such as widening disparities and the persisting climb in home prices, making it impossible for parts of the public to buy a home.

The same logic can apply to natural resources: The state blew it when it sold licenses to produce gas and chemicals for peanuts. It made a tiny group tremendously rich and then felt a need to fix things and tax the natural resources at a higher rate.

(This, incidentally, begs the question of what happens in the reverse situation – when structural boo-boos destroy wealth. Suppose a bank fails – will the state be consistent in this mutuality and compensate the victims? It will, very often. The state is capable of compensating for lost wealth.)

In recent years we have seen all the various ministers of finance and housing trying to contend with housing prices – including through active measures like of increasing the supply of land for residential development (especially in the last two years) and by hiking tax on investors in an attempt to remove them from the market.

There were also numerous remarks hoping to influence the psychology of the market, albeit contradictory (Lapid: “I advise young couples to wait and not buy a home”; Kahlon: “I advise young couples to rush to register for the Mehir Lemishtaken affordable housing plan”). Meanwhile, housing prices have been rising for nine straight years.

Taxing homes bought for investment purposes is far from an ideal solution. It will probably lead to “tax planning” and registering assets in the names of family members or the dog. It is somewhat tantamount to admitting the failure of other “solutions” to massively increase the supply of homes, which the treasury doesn’t want to do.

All in all, the move is proportional and reasonable under the circumstances, and not really radical.

Will it really reduce inequality? That’s taking it too far. The practice of taxation based on the number of assets, not by their value, is a problem. Somebody could own three homes worth 2 million shekels and gets slammed, while another guy owns one home worth 15 million and doesn’t pay a penny. Don’t expect the GINI index, measuring inequality, to collapse because of the tax.

What, therefore, can we expect? To constrain the motive to buy a third home.

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