PROPERTY TAX AVOIDANCE, INTER VIVOS GIFTS, AND THE JOY OF HAVING

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1 PROPERTY TAX AVOIDANCE, INTER VIVOS GIFTS, AND THE JOY OF HAVING Edoardo Di Porto Henry Ohlsson 16 June 2015 Abstract We document an episode of considerable tax avoidance that occurred in Italy after 2008 when Italian government reformed property taxation by abolishing taxation on principal residences and increasing taxation on second properties. In presence of a very low inter vivos gift tax, Italian households found it profitable to redistribute owned dwellings between their members. In a difference-in-difference analysis we estimate the causal effect of the property tax reform on inter vivos house transfers by distinguishing between taxpayers affected by the reform (the treatment group that includes high-occupation donors) and unaffected taxpayers (the control group that includes donors with low-occupation). Differences-in-differences estimates indicate that property tax reform increased the probability that high-wealth donors make an inter vivos gift by 2 percentage points (extensive margin estimate) and size transferred by 4 square meters per household member (intensive margin estimate) relative to less wealthy donors. Individuals can be reluctant to transfer property for two reasons, first losing wealth (the resource effect) and second losing the power to decide on and control their properties (the direct utility effect). A new reform on property tax in 2011 increased the taxation of second properties even more. An important difference compared to the previous reform is that the government has forbidden donors to maintain the usufruct on the property given. A final differencein-difference estimation shows that the probability to make an inter vivos gift (and the square meters transferred) did not increase after the second reform even though taxation increased. This leads us to conclude that there exists a joy of having motive not to transfer within the family although this would reduce taxes. This motive can be exploited to reduce tax avoidance. Keywords: tax avoidance, inter vivos gifts, joy of having JEL Classification Codes: H27, D31, D11 We would like to thank NOBODY NOW. The authors declare that they have no relevant or material financial interests that relate to the research described in this paper. The usual disclaimers apply. Dipartimento di Scienze Statistiche ed Economiche, Federico II University of Napoli; edoardo.diporto@unina.it. UCFS, Department of Economics, Uppsala University and Sveriges Riksbank; henry.ohlsson@nek.uu.se. 1

2 1 Introduction This paper documents an episode with considerable tax avoidance that occurred in Italy after At the end of 2008 Italian government reformed property taxation by abolishing taxation on principal residences and increasing taxation on secondary properties. The first reform was followed by another two reforms in 2011 and 2012 both increasing secondary house taxation. In presence of a very low inter vivos gift tax which exempts transfers below 1 million euros, Italian households found profitable to redistribute owned dwellings within their members. In a difference-in-difference analysis we estimate the causal effect of the property tax reform on inter vivos house transfers by distinguishing between taxpayers affected by the reform (the treatment group that includes high-occupation donors) and unaffected taxpayers (the control group that includes donors with low-occupation). We assume that potential donors in the treatment group face an exogenous and unexpected increase in property taxation, and we study how their propensity to transfer changes relatively to the donors in the control group. We use the Bank of Italy Survey of Household Income and Wealth (SHIW), which is representative of the Italian population. The survey includes information on the number and size (in square meters) of real estates received at any time as gifts, for respondents and spouses, data on parents education and occupation. Thus, we can merge information on donors and recipients to study if the changes in property taxation have affected intra household transfers. The availability of data on donors and recipients is crucial in this context, as the decision to transfer and how much to transfer is affected by both donors and recipients characteristics. Differences-in-differences estimates indicate that the 2008 property tax reform increased the probability of high-wealth donors to make an inter vivos gift by 2 percentage points (extensive margin estimate) and to increase the size transferred by 4 square meters per household member (intensive margins) relatively to poorer donors. Our estimates allow to compute (back of the envelope) the amount of tax avoidance due to inter vivos transfer because of the 2008 reform. The reform allows us to understand and describe avoidance behaviour in detail. Studying real estate intergenerational transfers in Italy is interesting for several reasons: 2

3 First, in Italy the ratio of aggregate real estate wealth to total wealth is 86 percent for those aged 60 or above. Second, the largest portion of real estate is the house of residence: for those aged 60 or above the owner occupancy rate is 75 percent. Thus, many elderly transfer real estate, and it is of course an open issue to what extent these transfers are voluntary or an attempt to elude tax payments. Moreover the second property tax reform that occurred in 2011 allows us to perform a bare bone test for what we call joy of having. Individuals may be reluctant to transfer property for two reasons, first losing wealth (the resource effect) and second losing the power to decide on and control their properties (the direct utility effect, i.e., joy of having). The second 2011 property tax reform in Italy increased the taxation of the secondary house taxation compared to the taxation of the main residence even more. There was, however, a very important difference compared to the first reform. In 2011, a decree on property taxation added an important qualitative change to the preconditions the behavioral effects of property taxation on the one hand and inheritance/inter vivos gift taxation on the other. 1 Taxpayers who chose to transfer their secondary properties had to leave the usufruct of these properties to the recipients to avoid tax liability. 2 Otherwise they would remain in charge for the payment of the property tax even if they did not own these secondary properties anymore. These rules had the aim of reducing the incentive to avoid taxes on secondary properties by redistributing the properties within the family. Such redistributions were easily done by inter vivos gifts. This qualitative change is an important identifying assumption in the paper when we test if behavior is affect by joy of having. (The first reform a resource effect only, no direct utility effect as the donor could keep the usufruct of the secondary property. If the donor is altruistic, the loss in resources is compensated by the fact the resources of the donees increase. The second reform a resource effect and a direct utility effect as the donor cannot keep the usufruct of the secondary property. Even if the donor is altruistic, the loss in resources is cannot be compensated by the fact the resources of the donees increase as the donor loses the usufruct.) 1 (SHOULD BE INVESTIGATED WHEN) 2 (Usufruct defined. 3

4 Studying the second reform using difference-in-difference estimation shows that the probability to make an inter vivos gift (and the square meters transferred) did not increase after the last reform. This leads us to conclude that the joy of having channel exists and can be exploited to reduce tax avoidance when designing tax reforms. 2 Italy: An Interesting framework In the last 15 years Italian tax system have been focus of several reforms. In this paper we are interested mainly by two core types of taxation: taxation of inheritance and inter vivos gifts on the one hand and property taxation on the other. Inheritance taxation was reformed in two steps, it was reduced in 2000 and abolished in The inheritance tax was then reintroduced in 2006 but with a very high basic exemption, transfers received below 1 million euros are tax exempt. For a donor with two children the total exemption will be 2 million euros. The municipal property tax called ICI (Imposta Communal sugli Immobile) has been the focus of many reforms especially in the last 10 years. The tax base included residential, commercial, and industrial buildings plus agricultural and residential land (Slack and Bird, 2014, Longobardi, 2013). Tax rates were set by municipal governments within the range of percent. Following the 2008 election, the newly elected government excluded primary residences from the tax base. The loss of municipal tax revenue was compensated by increased grants from the central government. The exemption of owner-occupied dwellings lasted until the end of 2011 when, as part of a major package of fiscal reforms, the municipal property tax was reformed. Taxation on the principal residence was reintroduced but only for luxury dwellings (Messina and Savenago, 2014). Nonetheless, a new municipal property tax was introduced in The new tax called IMU (Imposta Municipale Unica) fundamentally reformed and increased property taxation. Primary residences were brought back into the tax base and cadastral values were scaled up considerably. A deduction was, however, introduced for the principal residence. The annual 4

5 deduction is 200 euros plus 50 euros for any resident household member resident younger than 26 years. 3 The basic tax rate was set at 0.76 percent but municipalities were permitted to alter the rate within ±0.3 percent. The tax rate for primary residences was set at 0.4 percent but municipalities were allowed to alter the rate within ±0.2 percent. Overall, the new tax design resulted in a significant increase in property tax revenue. Because the central government was entitled to half the revenue yield from the standard rate, municipalities had little incentive to reduce the tax rate, especially on non primary residences. In fact primary residences were excluded from this calculation (Longobardi, 2013). In principle these reforms have produced the following effects: overall the property tax is increased but, and more interesting for the purpose of this paper, the increment was extremely more pronounced for secondary properties. The owners of more than one dwelling faced an increasing differential between what they were paying for the principal residences and the other properties. Indeed, the taxation on the principal residence was zero the years spanning from 2008 to 2011, 4 while taxation on secondary properties increased. By the way, starting from 2012, when the first residence was reintroduced, the larger share of property tax revenue came from taxes on secondary properties. Anecdotal evidence, not surprising Italian citizens, is that during these year they were used to hear a typical refrain from the center-right parties, always supporting governments until 2012: the principal residence is a right for any household and should not be taxed. As aforementioned, the 2012 reform implied that municipalities had no interest to reduce tax rates for secondary properties. As a matter of fact, 85 percent of the Italian municipalities have set the tax rates for secondary properties at its maximum level. Some statistics can help to understand the implication derived form the anecdotal evidences. As we describe in... 3 Keen (2012) calculated an average increase of 49 percent. 4 The tax was reintroduced on luxury dwelling just for the

6 Table 1: Municipality tax revenue in the main Italian cities share from principal residence share from secondary properties Source: Table 2: Two taxpayers with principal residence in Rome ( 100m 2 ) and a secondary property nearby on the shore. Source: 6

7 3 Theoretical Framework The objective of this theoretical framework is to derive predictions to be tested empirically. We start, however, by discussing two observations from a review of the literature on wealth, bequests, inter vivos gifts, and taxation: Observation 1. People tend to keep their money as long as possible. Schmalbeck (2001) concludes that: people simply do not like to give away their property while they are alive. There are several reasons for this observation suggested in the literature. The first is that wealth gives economic power and economic control in particular within the family. This was suggested by Thurow (1976). A second suggestion is that wealth gives direct utility. This is sometimes phrased as the spirit of capitalism and the resulting transfers at death as capitalist bequest. Moore (1979), Carroll (2000), and Luo and Young (2009) are from different fields in economics but share this direct utility conjecture. Third, wealth provides insurance and can be seen as precautionary savings for, for example future medical costs (Poterba, 2001). Recently several papers include wealth in the utility function, see for example Piketty (2011). Observation 2. People tend to transfer inter vivos when the tax savings are large enough. Joulfaian (2004) and Ohlsson (2011) provide empirical evidence. Starting from the two observations we will present a simple model for a parent p with one child k. The parent has some initial wealth, w p,0, from period 0. We can think of this wealth as the total value of residential properties owned. The parent has altruistic motives and, therefore, cares about the consumption possibilities of the child. But the parent also derives direct utility from wealth, in other words there is joy of having. Laitner (1997) uses the term hybrid model for this type of models. The parent makes decisions in period 1 and passes away in period 2. 7

8 The utility function of the parent is: U = u(c p,1, w p,1 ) + λv(c k,1 ) + λv(c k,2 ) (1) where U = the total utility of an altruistic parent, u = the direct utility of the parent, c i,t = the consumption of agent i, period t, w i,t = the wealth of agent i, period t, λ = the degree of altruism, and v = the direct utility of the kid. We assume that the parent maximize utility subject to several budget constraints. The first budget constraints is: c p,1 = ȳ p g 1 (1 + t w,p,1 )w p,1 + w p,0 (2) where ȳ p = the permanent income of the parent, g 1 = the inter vivos gift from the parent to the child, and t w,p,1 = the wealth tax rate of the parent period 1. The gift in period 1 is the difference between the parent s initial wealth and the wealth the parent decides to keep: g 1 = w p,0 w p,1 (3) The wealth that the parent decides to keep in period 1 is bequeathed to child in period 2 when the parent passes away: b 2 = w p,1 (4) We assume that a child receiving a gift of wealth (property) in period 1 is obliged to keep the wealth until period 2. Wealth taxes and gift taxes will reduce the consumption possibilities of the child in period 1: c k,1 = ȳ k (t w,k,1 + t g )g 1 (5) where ȳ k = the permanent income of the child, t w,k,1 = the wealth tax rate of the child in period 1, and t g = the gift tax rate, Wealth can, on the other hand, be freely disposed in period 2: c k,2 = ȳ k + (1 t w,k,2 )(b 2 + g 1 ) t b b 2 (6) 8

9 where t w,k,2 = the wealth tax rate of the child in period 2 and t b = the bequest tax rate. Using the budget constraints to substitute into the utility function the following objective function is obtained: ) U = u (ȳ p t w,p,1 (w p,0 g 1 ), w p,0 g 1 + ) + λv (ȳ k (t w,k,1 + t g )g 1 + ( ) + λv ȳ k + (1 t w,k,2 )w p,0 t b (w p,0 g 1 ) (7) Differentiating (7) with respect to gifts and some rearranging yields an inequality that needs to hold for there to be any gifts: u ct w,p,1 λv 1(t w,k,1 + t g ) + λv 2t b u w (8) where u c = the parent s marginal utility of consumption, u w = the parent s marginal utility of wealth, v 1 = the child s marginal utility of period 1 consumption, and v 2 = the child s marginal utility of period 2 consumption. The inequality (8) implies the following. Regarding the extensive margin, there will be a gift if the lhs of (8) is greater than the rhs. The probability of a gift is increasing in the wealth tax rate of the parent in period 1 and in the bequest tax rate. It is decreasing the wealth tax rate of the child in period 1 and in the gift tax rate. And if the marginal utility of wealth increases, the gift probability will decrease. Turning to the intensive margin, we know that this requires (8) to hold with equality.... The 2008 reform. Except for the very wealthy t b = t g = 0. For parents owning secondary properties and children not owning a principal residence t w,p,1, t w,k,1 0. And it was possible for parents to write contracts keeping power and control even though ownership was transferred to children, i.e, u w = 0. The inequality (8) reduces to u ct w,p,1 > 0. The predictions from this are that the parent will give and give as long as it is possible to convert own secondary properties to principal residences of children. The 2011 reform implied that the parents no longer could keep the usufruct when trans- 9

10 ferring ownership to children. The loss of economic power and economic control implies that u w > 0. In addition, for parents owning secondary properties the tax was increased further, t w,p,1. The inequality (8) becomes u ct w,p,1 > u w with respect to the extensive margin. In this situation it is not clear that there will be a gift. The gift probability is increasing in the the wealth tax rate of the parent in period 1 and decreasing in the parent s marginal utility of wealth. The 2011 reform increased both the wealth tax rate and the marginal utility of wealth. Acccording to the model, the combined impact of this is ambiguous. Conditional on there being a gift, the intensive margin effects are as follows... To sum up, the model predicts increased gifts as a result of the 2008 reform whereas it does not provide an clear answer whether gifts will increase as a result of the 2011 reform. Regarding the gift sizes, the model predicts... 4 Data and Descriptive Statistics We use the Bank of Italy Survey of Household Income and Wealth (SHIW), which is representative of the Italian population. The survey includes information on the number and size (in square meters) of properties received at any time as gifts, for respondents and spouses, data on parents education and occupation. Thus, we can merge information on donors and recipients to study if the changes in property taxation have affected intra household transfers. The availability of data on donors and recipients is crucial in this context, because the decision to transfer and how much to transfer is affected by both donors and recipients characteristics. 5 Econometric Strategy We employ difference-in-difference estimation implementing a strategy very close to et al (2010). 10

11 6 Results Differences-in-differences estimates indicate that the 2008 property tax reform increased the probability that high-wealth donors made an inter vivos gift by 2 percentage points (extensive margin estimate) and square meters transferred by 4 meters per household member (intensive margin estimate) relative to poorer donors. Our estimates allow us to compute (back of the envelope) the amount of tax avoidance due to inter vivos transfer in Italy and so to understand and describe avoidance behaviour in detail. Studying real estate intergenerational transfers in Italy is interesting for different reasons: First, in Italy the ratio of aggregate real estate wealth to total wealth is 86 percent for those aged 60 or above. Second, the largest portion of real estate is the house of residence: for those aged 60 or above the owner occupancy rate is 75 percent. 7 Conclusions TBA References Carroll, C. D. (2000). Why do the rich save so much? In Slemrod, J. B., editor, Does Atlas Shrug? The Economic Consequences of Taxing the Rich, pages Harvard University Press, Cambridge and London. et al, J. (2010). Joulfaian, D. (2004). Gift taxes and lifetime transfers: time series evidence. Journal of Public Economics, 88(9 10): Keen (2012). Laitner, J. (1997). Intergenerational and interhousehold economic links. In Rosenzweig, M. R. and Stark, O., editors, Handbook of Population and Family Economics, volume 1A, chapter 5, pages North-Holland, Amsterdam. Longobardi (2013). Luo, Y. and Young, E. R. (2009). The wealth distribution and the demand for status. Macroeconomic Dynamics, 13(S1):1 30. Messina and Savenago (2014). 11

12 Table 3: Baseline results and placebo, extensive margin Post ** Post 2004*HPO Any Any Any Gift Gift Gift Gift per Post 2004 Post 2006 Post 2008 Capita 2008 Post Post 2006*HPO Post Post 2008*HPO *** ** HPO *** *** *** *** Female Head *** *** *** Head Birth *** *** *** * anapcf *** *** *** ** Region FE YES YES YES YES Year FE YES YES YES YES Region*Year FE YES YES YES YES Observations Source: 12

13 Table 4: Dwelling surface per capita, intensive margin Sup Sup Sup Sup Ab per cap Ab per cap Ab per cap Ab per cap Tobit coeff Tobit Coeff Marg. Eff. Regr Coeff (<4gift per cap) Post Post 2008*HPO *** *** * *** HPO *** *** *** Female Head *** *** *** Head Birth *** *** anapcf ** *** ** Region FE YES YES YES YES Year FE YES YES YES YES Region*Year FE YES YES YES YES Observations Source: Table 5: Joy of having test Any Any Gift Sup Gift Gift per cap Ab per cap reg coeff Reg coeff reg coeff Tobit Coeff Post *** Post 2008*HPO *** ** * ** HPO *** *** *** *** Post2010*HPO Covariates YES NO YES YES Region FE YES NO YES YES Year FE YES NO YES YES Region*Year FE YES NO YES YES Observations Source: 13

14 Moore, B. J. ( ). Life-cycle saving and bequest behavior. Journal of Post Keynesian Economics, 1(2): Ohlsson, H. (2011). The legacy of the Swedish gift and inheritance tax, European Review of Economic History, 15(3): Piketty, T. (2011). On the long-run evolution of inheritance: France Quarterly Journal of Economics, 126(3): Poterba, J. (2001). Estate and gift taxes and incentives for inter vivos giving in the US. Journal of Public Economics, 79(1): Schmalbeck, R. (2001). Avoiding federal wealth transfers taxes. In Gale, W. G., Hines, J. R., and Slemrod, J., editors, Rethinking the estate and gift tax. Brookings Institution Press, Washington DC. Slack and Bird (2014). Thurow, L. C. (1976). Generating Inequality. Macmillan, London. 14