Portugal’s tax policy, particularly its approach to taxing real estate, offers a fascinating case study in the balance between revenue generation and economic growth. The country applies both recurrent taxes on immovable property (Imposto Municipal sobre Imóveis, or IMI) and a turnover tax on property transfers. While recurrent taxes on property are one of the most efficient types of taxes, Portugal’s turnover tax on real property transfers (Imposto Municipal sobre as Transmissões Onerosas de Imóveis, or IMT) has been identified as a significant drag on economic growth.
The IMT makes it harder for people to relocate for better jobs and living conditions and constrains investment into the development of housing and buildings. This is because the tax is levied on the sales price of real estate at every transfer of ownership, without any deductions for purchasing and investment costs. This design is particularly harmful to capital investment. It places a hefty price tag on the reallocation of real estate, limiting people’s ability to make changes in their living and working spaces.
High transaction tax rates reduce capital investment in buildings and structures as the transaction costs reduce the value of a building over its lifetime. This decrease in property values translates into reductions in new developments, driving up rental prices and decreasing housing affordability.
Given these outsized efficiency costs, reform efforts should concentrate on eliminating the transfer tax and replacing it with VAT on new buildings and structures. This would improve the incentives for the development of housing and structures to align with those for other goods and services, allow homeowners to make the most of their living space, and help people relocate to better jobs.
In 2021, revenues from the transfer tax stood at EUR 1.3 billion. Municipalities can compensate for the revenue loss through a mix of higher property tax rates and lower government spending on housing development. The central government could also support municipalities by apportioning a share of VAT revenue back to its source jurisdictions.
This case study serves as a reminder of the importance of tax policy design in promoting economic growth and investment. It underscores the need for careful consideration of the potential impacts of different types of taxes on economic activity and the importance of ongoing tax policy reform.
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