Spain Argues Whether Right Hand or Left Hand Should Pay Tax

The supreme court, the president, and the legislature have all stepped in.

Spain is currently embroiled in a 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. As Spanish Property Insight noted:

At the beginning of this year,  the civil division of [the] 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, as El País reported:

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: Fifteen 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 have been 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 that “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.

This article was reprinted with permission from Marginal Revolution.

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