Spanish home prices fall faster on tax changes

The income tax filing season for the 2010 tax year, which began on April 4 and ends June 30, will be the last in which the vast majority of Spanish homeowners will be able to write off on their tax returns 15 percent of the interest and capital they pay on their mortgages up to a cap of €9,000. As of this year, only homeowners earning less than €17,000 per year will be able to benefit from the full extent of the tax break, while those earning up to €24,000 will find that the amount they can deduct has been progressively capped at much lower levels than before. Higher income earners will be able to deduct nothing. More than a third of tax payers will no longer benefit from the tax break.

Introduced in the 1980s as a way to stimulate the economy and boost home ownership, the tax break has long been popular with voters and thus very difficult for any government to change despite repeated attempts to do so. But with the current Socialist administration desperately attempting to tame ballooning public debts and balance the budget, the tax break was an obvious target – maintaining it costs the state more than €4 billion per year. Many analysts and international institutions, among them the IMF and the OECD, had long been calling for it not just to be scaled back but to be eliminated entirely.

One side effect of sweetening the deal for home owners with mortgages as opposed to renters (who have only received a similar tax break on rental payments since 2008) was a distortion in the housing market that contributed to an unprecedented boom in property prices until the bubble burst three years ago.

Not only was the tax break an incentive to buy homes, thereby increasing demand, but it directly played a role in increasing home prices as developers realized that the tax break – by effectively reducing the cost of a mortgage – would allow buyers to pay more. As many analysts have noted, the tax break may have appeared to benefit homeowners directly, but indirectly and more significantly it padded developers’ pockets as they were able to charge higher prices for the properties they put on the market.

“The change (to the tax break) is a step in the right direction, because it only helped to keep prices high,” argues Julio Rodríguez, the former chairman of Banco Hipotecario Español. “However, maybe the best time to make the change would have been during the boom, when house prices were still rising, not now when they are falling.”

Since their peak in 2008, property prices in Spain have fallen around 15 percent, though the pace of the decline slowed last year as home buyers rushed to buy properties before the tax changes went into effect. Though the tax break has been modified as of January 1, 2011, it only applies to mortgages taken out since that date. Homeowners who bought before will continue to benefit under the old system for the duration of their mortgage. The savings for the state are therefore likely to be very limited for many years to come.

However, with the tax break gone for many potential home buyers, so too has one incentive to buy a home.

New and used home prices fell 4.7 percent in the first three months of this year compared to the same period a year earlier, compared to a 1.9 percent fall in the previous quarter.