<Question marks over social housing>

News about changes in VAT for housing have dominated newspaper headlines in recent weeks, and the problem was seemingly resolved by a proposal for "social housing". However, it is still too early to talk about any solution. There are several significant obstacles that stand in the way of the actual implementation of "social housing" into our legislation, and many questions linger over the proposal itself.

What is this about in short? The Czech Republic is expected to lose its exemption for the reduced VAT rate on housing in the near future, and despite some attempts, the government has not been able to extend this exemption. Therefore, the Ministry of Finance, together with the Ministry for Regional Development, submitted a proposal to the government defining "social housing," which would remain at a reduced five percent rate. According to Minister Sobotka, about 70% of new apartments would fall under this regime. Both ministries suggested that the term "social housing" for the purposes of the reduced VAT rate should cover three categories of housing:
1. Buildings serving for the accommodation of people at risk of social exclusion - such as children's homes, retirement homes, sheltered housing, shelters, weekly care facilities, etc.;
2. Rental apartments funded from public sources or with their direct support - which includes, for example, apartments subsidized by the Ministry for Regional Development or the State Housing Development Fund, or apartments built by municipalities without state funding;
3. Other apartments and family houses, if the total floor area of the apartments does not exceed a specified limit - such as family houses up to 150 m2 and apartments up to 90 m2.
Newspapers soon carried definitive reports that "social housing" would look just like this, even though it might be otherwise. Moreover, perhaps due to the general belief that keeping housing prices down is correct, there haven't been many critical voices regarding the essence of the proposal.

First, let's address the necessary conditions for the implementation of "social housing." First and foremost, the concept must be agreed upon by the European Commission. Furthermore, we have parliamentary elections coming up in the near future, the outcome of which is currently unpredictable. Thus, a completely different government may be behind any potential amendment. Thirdly, this proposal must be approved by the new chamber, which, as is customary, may not spare the government proposal from criticism. While there may not be much dispute about the first two parts of the definition (facilities for people at risk of social exclusion and municipal housing), the determination of "social housing" based on floor area could look completely different. The ministries themselves speak of 90 and 150 m2 in conditional terms! Given that these figures are not backed by strong arguments, their change could be easy. So those deciding today on the form of their future projects cannot make any rational decisions. On the other hand, the fact that the market has been aware of the change in VAT well in advance has caused developers to already include this in their projects. They may not know exactly how the change will occur, but "social housing" is essentially a bolt from the blue that has likely surprised many and thus may further reassess the form of projects after January 2008. Nonetheless, developers might be partially satisfied because the government would limit the increase in VAT only to a smaller part of the construction. Which seller would wish for a higher tax to be imposed on their goods?

The second part of the issue is whether our economy needs something like this. Is this proposal rational and economically effective? Will it cause more harm than good? The main goal of the definition of "social housing" is supposed to be that housing construction does not become more expensive. However, this is not dependent solely on VAT. If the price of a new apartment were to rise exactly by the change in the rate, the price increase would be 13.3%. We must remember that in recent years, the prices of apartments have risen significantly, often by more than 15% per year. For instance, the year-on-year increase in January 2002 was 26% for the entire Czech Republic. Some Prague districts, due to speculation before EU entry, saw increases of almost 40% in just one year. Therefore, even if VAT were increased on all housing without exception, the price shock, which could be dangerous for the economy, should not occur. Housing prices are steadily rising and are far from a point where speculation bubble can be discussed; in the long run, increasing VAT on all types of housing would not mean much. Moreover, it is naive to expect that prices would increase precisely by the rise in VAT. Developers will sell only as many apartments as customers are willing to buy.
Sellers would likely have to respond to the VAT increase, at least in the short term, by reducing their own margin, so that the "discount" from the increased VAT would be paid for by their lower profits. Moreover, there would be more pressure on prices before the increase itself; most interested buyers would try to avoid the higher rate by completing transactions before the end of 2007, which would itself push prices up. And given that the change in VAT would be absolutely predictable, we cannot expect a repetition of the pre-EU panic arising from uncertain expectations. The second question is how "social housing" might affect prices. It cannot be claimed that new constructions falling under the definition would maintain their price trend and that only the price of "non-social" housing would jump. The effect is difficult to estimate, as large apartments sell differently than small ones. For small apartments, for example, prices may increase higher than the trend, because they will suddenly become relatively cheaper, allowing more room for their price increase.

Much worse than any potential price deviations, however, is the intervention in the structure of supply. Who will build apartments with an area of 91 m2 or houses of 151 m2 after the introduction of "social housing"? And from what size area will it again be worthwhile to build apartments at the basic rate? A part of the natural supply will suddenly disappear from the market, and there will be a gap in apartment sizes. And how big will this "gap" be? To some extent, various tricks and loopholes can be expected, which will solve the problem of the basic rate by combining smaller apartments or apartments with non-residential spaces. Taxpayers are creative, and such cases may arise. The tax regulation will motivate them to bypass it through some semi-legal means. Furthermore, it is necessary to ask why the boundaries for usable area are precisely set at 90 and 150 m2. Why not 80 and 160 m2? As Daniela Grabmüllerová, director of the housing section at the Ministry for Regional Development, admitted to the newspapers, the proposal was based on the average usable area of a family house, which was 151 m2 two years ago. For apartments, the approximately ninety-meter boundary was set similarly arbitrarily, although not based on the average area of completed apartments, which is lower (around 67 m2). The question is why the average, or some other abstract number, should be a criterion for sociality? The average indicates nothing about the relationship between area and the real needs of users or their social situation. An 80 m2 studio can be a luxurious apartment in a prestigious location inhabited by a single person, while an apartment of 110 m2 can be occupied by a six-member family that struggles to make ends meet. Therefore, determining sociality based on area is completely nonsensical.

What is sad about the proposal is how it devalues the word "social." There is actually nothing social about it, as it is generally understood. Most people who are currently able to afford housing in a new build are not among those who need state social assistance. "Social housing" would be similar to state subsidies for apartment construction; support would once again be provided to those who are somewhat wealthier. Viewed from the opposite angle, it would essentially be the introduction of a luxury tax. The five percent rate imposed on most housing can be seen as a basic rate, and a higher rate is essentially imposed on larger apartments and houses, thus constituting a luxury tax.

The government's proposal to define "social housing" for the purposes of lower VAT is primarily a political gesture, charmingly masked by the word social. When it comes to supporting genuine social housing, the government's efforts should be directed entirely in a different direction.

Lukáš Posolda
The author studies economics at IES FSV UK in Prague