[By Ted Pinchbeck and Hans Koster]
Are you paying attention? In many situations research suggests not. For example, when we buy things online, on average we respond more to the purchase price than to the shipping cost. As the total comprises the sum of both costs, this doesn’t make sense. A series of recent tests look at whether we take full account of the future when we buy things that are durable, like cars or fridges. Much of this evidence suggests that for these types of purchases we tend to undervalue the future, in some cases by quite large margins. That is when we buy a new car we focus too much on the up front price, and not enough on future savings that come from better fuel economy. This matters from a policy perspective because it means we end up with too many gas guzzlers.
In a recent paper, we apply these insights to the valuation of future Council taxes in home purchases. The basic idea behind our paper is to work out how much we pay upfront to reduce our Council Tax by one Pound every year (by looking at similar homes either side of Local Authority boundaries with different tax rates).
As with the work on cars, we test to see if people pay attention to the discounted costs resulting from future property taxes. The bottom line is that on average it looks like they do: our figures suggest that £30 or so will buy you an annual reduction in Council tax of £1 per year. If we can assume this saving is indefinite, your £30 investment yields a return of between 3 and 4%. This seems a reasonable return as it sits roughly comparable to average mortgage rates over the period.
Why do we care about this? Well for one it tells us that where we find some evidence that people are inattentive to the future in some places they appear to be pretty rational when it comes to home purchases (or at least in valuing the tax elements). Clearly one size does not fit all.
However, we also find that beyond 2008 that discount rates implied by taxes remain flat, and as such become detached from prevailing real terms market rates. Although we are not yet in a position to fully explain why this is (that’s research, folks!), it is clearly interesting because we’d expect changes in borrowing and lending rates to feed through to how people value the future. Our paper suggests that this is not always the case.