A Theoretical Analysis of Tobin Taxes and Real Estate Price Bubbles

In containing asset price bubbles, it is argued that raising transaction taxes to a point to where the number of transactions in those markets is reduced will dampen prices. Real Estate markets are fundamentally different from other asset markets in that relatively high transaction taxes are already present. Empirical research on real estate transaction taxes suggests that regardless of the level of taxation, the price response to an tax increase is temporary and that real estate demand is based more upon the demand for property and the functional utility of the asset rather than the investment returns present at a given point in time. Further, the functional utility of residential property and the relatively long holding period of property holdings suggest that taxes would have to be raised to a prohibitive level in order to reduce demand. Unlike other asset markets, the reduction in transactions resulting from prohibitively high levels of taxation would lead to a reduction of supply in certain markets leading to increased prices rather than a dampening in prices, especially where high demand is present. The delay in the supply response in real estate markets could exacerbate this price increase problem, especially in the face of high demand. The theoretical model developed suggests that there should be an optimal level of transaction taxes in real estate markets and that the usefulness of holding taxes in creating market efficiency should be examined in relation to flattening out real estate asset price bubbles.