Tax Evasion, Capital Gains Taxes, and the Housing Market

Abstract

In this study, we exploit a policy shock that differentially increased capital gains taxes for housing units with holding period less than 5 years, and document tax avoidance and tax evasion in the residential resale market in China. We show suggestive evidence that after the capital gains tax increase, resale transactions exhibit more bunching above 5 years of holding period, but the responses are small and imprecisely estimated. More importantly, using precise information of both the actual transaction price and the reported price to the tax authority, we find that tax evasion, measured by the difference between the two prices, becomes 23.3% higher. We also document that the policy has strong heterogeneous effects, whereby cash buyers are 8.4% more likely to buy a house than buyers who need financing after the policy. This is mainly because financing buyers prefer a higher reported price (and so less tax evasion) to secure higher bank loans but cash buyers do not have such concern.