Spain Debates Whether Left Hand or Right Hand Should Pay Tax

Spain is currently embroiled in tremendous debate over who should pay the AJD tax, a tax on the creation of a mortgage. Should the buyers (consumers) or the sellers of the mortgage (the banks) pay the tax? The Supreme Court, the President, and the legislature have all stepped in.

At the beginning of this year,  the civil division of Supreme Court clearly ruled that the tax on mortgages should be paid by consumers and not banks. However, on the 18th of October the Contentious-Administrative division pronounced the other way, that banks should pay. So two divisions of different jurisdictions of the Supreme Court (civil and administrative) have issued conflicting sentences producing a legal mess…

that was the situation as of October 24. But then on Tuesday:

The Spanish Supreme Court has done a U-turn again: it is the clients who must pay for a controversial mortgage tax, and not the banks

…The decision was reached on Tuesday evening in the Administrative Division of the Supreme Court after two days of intense debate, and with just two votes of difference: 15 justices were in favor of making the client pay the levy, and 13 voted to confirm a groundbreaking decision reached by this same court in mid-October that it should be the banks who pick up the tab.

Leaders are up in arms and street protests are threatened:

Leaders of the anti-austerity Podemos party have already announced protests over a decision that “calls into question” the court’s independence and undermines democracy, in the words of party leader Pablo Iglesias. …Alberto Garzón, head of the United Left coalition, went even further: “Private banks are thieves, they are the main enemy of democracy and they are responsible for gutting our economies. A majority of the Supreme Court sides with them, ratifying that justice has a price and that the system is rotten and spent,” he tweeted.

Under pressure, the socialist Prime Minister announced “a Royal Decree would be approved ‘so that Spaniards will never pay this tax again’,” and the Prime Minister pledged that the new law would be in place by Friday!

What’s amazing is that the Spanish uproar is over a decision that Econ 101 says does not make a whit’s worth of difference to anything of importance. Whether the buyers send the check to the government or the sellers does not change the true incidence of the tax. As Tyler and I say in Modern Principles, “Who pays the tax does not depend on the laws of Congress but on the laws of supply and demand.” The tax simply drives a wedge between what the buyers pay and what the seller receives. Since sellers typically post prices, when the sellers must send the check the posted price will include the tax but the price the sellers receive will be the posted price minus the tax. If buyers must send the check to the government the posted price will not include the tax but the buyers will have to pay the posted price plus the tax. Either way, the seller, buyer, and government all end up net the same amount. It’s little different than debating whether the right or left hand must pay the tax. See Tyler in the video below for the diagram and further details.

Thus, the whole Spanish imbroglio has been caused by a failure to understand Econ 101.

Addendum: Bank shares fluctuated as the tax jumped back and forth which might suggest non-neutrality but that is because an earlier proposal would have had the banks pay consumers “back” for taxes the consumers paid years ago. A retroactive tax would indeed be bad for banks because while the tax would be retroactive the price would not. Going forward, however, the price adjusts with the placement of the tax so there is little beyond convenience and transaction cost to prefer one system to the other. In fact, once it was established that the tax would not be retroactive, bank share prices recovered.

Hat tip: Mauricio Drelichman.


Is it possible that the tax would be deductible for bank's corporate taxes but not from consumer's taxes, since European taxes tend to not have itemization (I don't know anything about Spain in particular)? If so, the magnitude of the tax (regardless of the incidence) might vary based on who makes the statutory payment.

Why would banks be fighting paying the tax if they could deduct it only if they are the ones who pay it from an accounting perspective? Surely the banks understand the economics of the situation?

The fact that they are fighting it at all might suggest they don't understand the economics, but I think it's more likely they are considering the behavioral economics of the situation: higher sticker prices might lead to less demand than if the sticker price was lower and the tax had to be considered by the consumers.

But surely the difference in the deductibility of the tax would swamp the behavioral effects?

If not it is ironically the banks who can be shown to not understand the economics here, while the public is actually on the economically correct side of the debate, if only accidentally.

Actually, the banks didn't really fight against it at all, despite what Pablo Iglesias could say. They do understand Econ 101, and minutes after President Sánchez said that he would issue the Royal Decree (an instrument that has its own problems, maybe even legally) they announced that they would just raise their prices.

The biggest risk for them was that the Supreme Court decision two weeks ago stated that a clause in the tax office regulation from 1995 interpreting the relevant law was void since the law had to be interpreted otherwise. And voiding a clause means that "it was never there", so they would had to pay retroactively the taxes of previous years. There it was where all the people who had already signed a mortgage saw an opportunity to get some money back from the banks (which explains why it was a popular decision and why was disappointing that it was retracted by the Supreme Court).

But even in this case clients would have had to get a refund from the Spanish tax office (more specifically their regional delegations) and then the tax office should have sues the banks, based on them not paying a tax that the normative from the tax office itself said at the moment that they didn't have to pay. Therefore it was a risk for the banks, but not an imminent nor inescapable hit to their bottom line.

The ones that apparently didn't know econ 101 were (some of) the Supreme Court justices, the media, and several politicians that now think that a rule that had been in place for 23 years without them changing it is an outrage that should be amended in an emergency basis.

I tried getting a refund from the Spanish tax office once. Took about 2.5 years, albeit from abroad.

I suspect that in the absence of clear proof of who bears the economic incidence, people will fight the statutory incidence.

Administrative costs add to this effect.

It isnt immediately apparent that current property owners bear 100% of the incidence of an increase in property taxes even though that is what theory tells us.

Reality might also depart from simple models.

The independence of statutory incidence and economic incidence is a well known theory. Is there any empirical research on the actual incidence of taxes, or any theory specifically related to this situation?

A shoe fly horses around albeit not from Cambridge with suki

Yes, this is the economy undertanding level we have in Spain. Sad.

And worst, Prime Minister Pedro Sanchez, is an economist!

Alexandria Ocasio-Cortez has an economics degree from Boston University and, among many other things, she doesn't know the difference between the total yearly budget for the US Department of Defense plus the military-related budgets of other departments and agencies ($700 billion) and a single year on year increase in that budget ($61 billion) and the amount of increase which was not requested by the Trump Administration ($42 billion) and the amount by which the increase exceeded the amount requested by the military itself ($0).

She graduated cum laude and is an idiot.

This is even better: "Unemployment is low because everyone has two jobs. Unemployment is low because people are working 60, 70, 80 hours a week and can barely feed their family."

Again, she graduated cum laude from B.U. with a degree in economics and was just elected to the House of Representatives of the United States.

In Florida, supposedly a low tax state, we have a tax on deeds (at the rate of $.70 per $100) that is paid by the seller and a tax on mortgages (at the rate of $.35 per $100; loans not secured by Florida real estate are subject to the tax but it is capped at $$2,450, the point of the cap an acknowledgment that if no Florida real estate secures the loan the lender and borrower can simply move the situs of the loan out of state and avoid the tax entirely) that is paid by the borrower. Both of the taxes often come as a big surprise to out of state buyers/borrowers. And then there is title insurance for the buyer and lender. The convention in most of the state is for the seller to pay the title insurance premium (it can be very high for a large transaction), but in south Florida the convention is for the buyer to pay; the convention everywhere is for the buyer/borrower to pay the title insurance premium for the lender's policy (it's a fraction of the premium for the owner's policy if issued simultaneously with the owner's policy). As Tabarrok points out, sophisticated buyers and sellers take these costs into account in pricing real estate. As with all taxes, there's the role (and fees) of the tax adviser. There's little controversy in Florida about these taxes. Unlike the sales tax. Florida has a sales tax (at the rate of 6% but up to 8% in counties that adopt a local option). Some items are excluded from the tax (such as some groceries), and services are excluded. Many years ago the legislature passed and the governor approved an extension of the sales tax to services. The net result was the end of the political careers of many politicians. The tax was repealed and the tax and many former politicians have never again seen the light of day.

Perceptive readers will appreciate the negative reaction to a sales tax on services. We don't do income taxes in Florida (we have a small corporate income tax but most corporations are exempt). A sales tax on services looks a lot like an income tax. The tax, like sale tax generally, is supposed to be paid by the buyer. But I can say that the brief time the tax was in effect, buyers of services (legal services in my case) weren't buying it, and the tax ended up being borne by the service provider (by lowering his fees to offset the tax)..

I was a child and she was a child,
In this kingdom by the sea

Are the Spaniards being irrational, or do they know something you don't know? If the former, how can we assume they know anything about their own business, including how to set prices, incentivize their workers, etc? If the latter, what does it say about the usefulness of econ 101?

The debate may also involve whether the tax is visible or invisible. If the tax is paid directly by consumers, they will know about it. If it is rolled into the price of the mortgage, maybe not.

Given the stock price results, it looks like the banks understand neutrality. Individuals have little skin the game here and so little incentive to be correctly informed about tax incidence. Together, I do not question anyone's abilty to participate rationally in the market.

Bottom line: This is good news in the sense that politicians and voters can rail against the policy and legislate something else to feel like "winners" while the banks realize that have nothing to lose!

At the bottom of one the links provided by Alex might be answer to the riddle:

"What is the AJD?......the tax is not calculated on the amount of the loan itself, but on the mortgage guarantee, which is the sum of the loan amount, interest, late fees and legal expenses in the event of default."

The consequence in the real world is that the tax amount may vary depending on the bank you ask the loan. For the same loan amount, asking a a loan to a bank with higher late payment and legal fees yields a higher absolute tax amount. The numbers people see are a 1000€ tax for a 100K loan at bank A, and 1500€ tax for the same loan at bank B. The definition of the tax base may explain the popular perception of banks as vultures.

Of course, how the tax is perceived doesn't change the underlying facts presented by Tyler. But humans, we're not that rational. Banks look so suspicious with the current arrangement. A nice solution would be to change the definition of tax base to make it equal to the amount of the loan.

Ps. I just read the law on the ADJ tax.

This part: "as hipotecas, prendas y anticresis se valorarán en el importe de la obligación o capital garantizado, comprendiendo las sumas que se aseguren por intereses, indemnizaciones, penas por incumplimiento u otro concepto análogo...."

The tax base and therefore total tax amount depend on the loan interest rate.

Let that sink for a min, the people that pays more tax is: (i) the people with low provable income, and (ii) people that have a higher loan to home value ratio.

Poorer people pay proportionally more tax for the same loan amount. People complain, Alex says it's ignorance.......Econ 101is no substitute for empathy =(

It sounds like a nuisance which should be eliminated anyway, replaced with adjusting the base dimensions of the income or value-added tax. Not sure about Spain, but o'er here you get this sort of thing from politicians when they want more revenue but don't want to contradict something they put on a campaign brochure.

"a failure to understand Econ 101": it's a peculiarly American trope to suggest that some common sense that you should have learnt at your father's knee should instead have been learnt in formal education; indeed, as late in your formal education as first year at university.

Some people are viscerally aware that taxes will be "passed along" to consumers but not have any idea what percentage of it will be passed along. Elasticity is not a rudimentary topic. Casual observation cant usually discern marginal effects from total effects when violating ceteris paribus.

Deadweight losses from taxes and price controls arent immediately apparent or widely known. I refer to these as invisible victims. Practically all leftist policies rely on this invisibility.

"Spain Debates Whether Left Hand or Right Hand Should Pay Tax."
"But when thou doest thy taxes, let not thy left hand know what thy right hand doeth."

Spaniards are not being irrational.

Those that ask for a loan have, by definition a preference for spending now and paying interests later. Buying a home often involve further inmediate costs (the "fixing-upping" and furniture). It is a bad time for having to pay the AjD tax upfront. Much better to have the monthly payments of the mortgage slightly higher. Indeed, there is an upper limit for mortgage loans, 80% of home value, which most would like to see higher.

And also, the judicial decision would have impacted loans already signed in the last 4 years, with the banks unable to react raising the payments.

"It is a bad time for having to pay the AjD tax upfront. "

So you're saying that only if the banks pay the tax can the cost be rolled into the mortgage? In that case, as long as the tax is retroactive, both the banks and public should prefer that the banks cut the check.

"Indeed, there is an upper limit for mortgage loans, 80% of home value, which most would like to see higher."

Which would mean that the tax would tend to reduce housing prices. In fact, we should expect that regardless of who pays or what upper limit exists. So perhaps it's neither the banks nor buyers who would be paying the tax but rather existing owners of homes whose property values would be reduced.

Banks prefer to cut the check. But not if a tax is applied retroactively to an already signed contract. For a while it looked like that would be the case.

The tax has not been proven to have lowered the forever-wildly-soaring house prices in Spain. Probably because that situation makes por inelastic suppliers/sellers of housing.

I would say the interesting thing is that while it anyone who has taken Economics 101 "knows the answer" the 'salience' of the tax might actually sneak up on them anyway.

A behaviorally informed legislature we try to sneak their taxes by with the least salience.

RE left hand-right hand.

Of course, this is the same argument regarding Medicare-for-all versus private health insurance. On net, you either pay through your taxes or pay through your premiums.

No, it's not. The amount you pay in your premium and the amount you would otherwise pay in taxes are unrelated. Some people pay very little in taxes and and would continue to pay very little in taxes regardless of whether the government funds health care or not. Some people would have a very low private insurance premium but would see their taxes rise substantially.

In this case, the tax is depends on the value of the particular mortgage involved - it is determined on an individual basis.

Given the prevalence of group-rated insurance, very few people's premium cost bears a relationship to their individual circumstances. Some pay more, some pay less than what they get out of it.

In a switch to Medicare, that relationship might shift for individuals, but on net it will balance out. Some people would pay less in taxes than they paid in premium.

On net, medicare would take less money from individuals via taxes than the private system does through premiums. (If current ratios hold - and particularly if Medicare is actually allowed to bargain for drug cost.)

Even with group rated insurance, your premium is not pegged to your income. Taxes are. Under a government run system, richer people are always going to end up paying more into the system than poor people, across the board.

Charge card companies forbid merchants from charging a surcharge for using a credit card, yet do not forbid offering a cash discount. For that matter, they don't seem to prohibit merchants from charging a "convenience fee" for using the Card.

Perhaps it's all the same (one way or another, that merchant fee must be paid) but so long as user perception is different the charge card companies seem determined to contractually enforce a demand that amounts to saying a discount for using cash is somehow different from a surcharge for using credit.

Watch out, because I sense the great pendulum of un-bundled costs is starting to reverse its swing....

If the banks pay it, the tax is only clearly visible to the banks. If the (many, voting) consumers pay for it, it is more visible. This matters for the same reason tax withholding, with the celebrated refund, vs requiring workers write a check. Even if the net amount paid by both sides is the same, the probability of tax hike/cut changes depending on how visible the tax is to voters.

As part of the overhead of hiring someone, payroll taxes are borne by workers.

Only partially, depending on the elasticities of supply and demand for labor.

But clearly the apparent 50/50 split under the statute is wrong.

This assumes that the buyer and seller are both citizens.

What if the seller is local, and the buyer is foreign. While you would think the foreign buyer would know about the tax, and demand a lower purchase price, don't assume knowledge or that consumers aggregate prices--they may compartmentalize them--just as when I purchase a house and don't consider recurring annual property taxes in my valuation. Of course, I am sure that all of you consider property taxes and real estate transaction fees and registration fees and transfer fees and recording fees and cable hook up fees when you purchase a house.

Spot on! I couldn't agree more with the post; I have shared it online.
However, there is a political angle to this question that is worth mentioning and perhaps Alex T. didn't know about: the AJD tax has been fully devolved to the State level in Spain (the regional governments), so the new decree sanctioned by the central government abolishing the tax will affect the revenues of the regional governments. A non-negligiable domestic political issue among State and central governments of different political colour in many cases ... .

It´s pretty ironic that the President of the Spanish government has a "doctorate" in Economics. There was already a scandal regarding whether he qualified for it.

"At the beginning of this year, the civil division of Supreme Court clearly ruled that the tax on mortgages should be paid by consumers and not banks. However, on the 18th of October the Contentious-Administrative division pronounced the other way, that banks should pay. So two divisions of different jurisdictions of the Supreme Court (civil and administrative) have issued conflicting sentences producing a legal mess…"

It appears that an equally appropriate headline would have been "Should the left hand or the right hand of the Spanish Supreme Court have jurisdiction to hear the appeal"?

This blog entry shows me that economists are badly educated. Econ 101's "law of supply and demand" isn't a truth, its a model. It simplifies reality in many ways. Applying the "law" to a real situation, always needs caveats, worries about the extent to which the real situation fits the simplifying assumptions of the model. The people who fight passionately to restructure a real situation in ways that the model says won't make a difference, are not being foolish.


Motivations of various parties:

1. Government Bureaucracy - a) If it wants to ensure that compliance is maximum, it would prefer to tax the banks rather than the consumers.
b) If it wants to maximise the tax, it will prefer consumers to pay the tax (as consumers likely cannot use the tax payment as a deductible for income tax while banks might be able to)

2. Banks - Mostly neutral, I think. May slightly prefer consumers paying so to reduce regulatory burden

3. Consumers - would prefer banks pay the tax because a) their tax payments will not be deductible but the banks' tax payments might be deductible and b) why pay full tax amount now instead of paying in installments with the mortgage payment?

Trust Spain to not understand that who the courts say must pay a tax has no bearing whatsoever on who actually does pay it.

Fucking tax incidence, how does it work?

Why are they taxing the creation of a mortgage?

My non-professional opinion (I am an engineer, not an economist, and Spanish too) is that the problem is a bit more complex than stated by professor Tabarrok and explained in the video. Here you have three actors (plus the taxing Government): the buyer, the seller, and the bank. The bank sells a loan to the buyer based on the price of the house, which is determined by the seller (ok, by supply and demand). The tax cost depends on the house cost also, but the bank cannot influence on it directly, only through the loan interest. Maybe this changes nothing, but the analysis is not as simple as stated.

Surely the courts are debating wording of law, which must be very unclear given the disagreements. Is it really a debate over tax collection policy in any way? Is econ101 relevant?

Liability-side equivalence doesn't necessary need to hold. Example from the labor market: , based on . Of course, this doesn't mean that it cannot hold in the mortgage market, but still...

Anything left untaxed?

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