Saturday, 20 October 2012

Gettting the housing market going? Using simple economics for policy analysis

Ed Balls says let's use prospective 4G licence fees to fund a stamp duty holiday.  On this idea, we know what will happen since we have some evidence from when it was tried before: Chris Giles points us to the paper. from HMRC that evaluates the effect of a temporary relief on stamp duty for first time buyers March 2010-March 2012.

As my Imperial MBA students will know, the effect of a tax reduction in a Supply and Demand model depends on the elasticities of demand and supply.  Suppose as seems very likely due to planning, the supply curve is very inelastic.   Then tax falls have minimal impact on quantity.  If demand curves are quite elastic then any falls in taxes translate into minimal falls in prices for buyers, but rises in prices for sellers. Finally, falls in taxes are expensive for the state, since with little extra quantity the gain in revenue from the additional marginal quantity is small, but the loss from the inframarginal is large. 

So we can use some very simple economics to make some sharp predictions.  

And the findings in the real world from the study?  They show Economics right on the money.  Here's an extract from the summary.

The effect on quantity is tiny: 
The number of additional transactions is therefore estimated to be closer to 0‐1  per cent (1,000 additional transactions) 
The effect on buyer prices is tiny:

Considering the impact on prices, ... This implies that the majority of the 1 per cent tax  relief was capitalised in higher prices. It is equivalent to stating that the post‐tax
outlay for buying property is estimated to have decreased by 0.3‐0.5 percentage  points. The relief therefore appears to have had a small impact on reducing the
overall outlay of buying a first home. 
The costs to the state are huge:

The cost of the tax relief was around £150 million in 2010/11..[with].. 1,000 additional transactions across the 13‐month period April 2010‐April 2011, this represents an estimated cost to the Exchequer  of approximately £160,000 per additional transaction in tax relief.