The black comedy of property taxation

Why is it that so few chancellors ever consider the effect of their decisions on taxation on housing?

The obvious answers are political ones: housing is near the bottom of the list of priorities; no chancellor can afford to alienate the homeowning majority; and any changes to the tax system inevitably create losers as well as winners.

As George Osborne puts the finishing touches to the Budget, speculation continues about several measures that could have a huge impact: a long-overdue clampdown on stamp duty avoidance (Osborne has already committed to this – see my blog for Inside Housing here); extra council tax bands (a distinct possibility); and a mansion tax (advocated by the Lib Dems but supposedly ruled out for now by David Cameron). Yet all of the ideas are about raising revenue for tax cuts elsewhere. There is no suggestion of the more general reform of property taxation that is so badly needed.

Given the long and undistinguished history of the relationship between 11 Downing Street and housing that is not a big surprise. The most absurd example of this was mortgage interest tax relief, a house price-boosting subsidy that lived on for almost 30 years after the tax it was relieving (Schedule A tax on the imputed rental value of homes) was abolished. Championed by Margaret Thatcher and seen as a political sacred cow, it played a major role in the housing boom and bust of the late 1980s (a proposal by Nigel Lawson to stop unmarried couples getting double tax relief triggered a rush to beat the deadline and a spike in prices) before it was finally phased out in the 1990s.

Then there is the ridiculous situation with the council tax, which was itself the product of a chequered history of local taxation. In the late 1980s, Margaret Thatcher (her again) replaced domestic rates (based on the notional rental value of a home) with the community charge. Dubbed the poll tax because it was a fixed tax per resident (with some reductions at the bottom end), it provoked furious opposition because of the way it shifted the tax burden from the rich to the poor by taxing people rather than property values. Within a few years the poll tax and Mrs Thatcher were both gone, replaced by John Major and the council tax.

The council tax restored the link with property values but, as its creator Michael Portillo admitted recently, it was deliberately designed in narrow and regressive bands to avoid big differences in the tax bill between the top and the bottom. The most that anyone can pay on the highest Band H, even if they live in a 100-roomed mansion worth £100 million, is three times the amount someone pays on the cheapest Band A.

However, the tax is still based on valuations made 20 years ago. Even though it is possible for a council to reassess the banding of a house where, for example, someone has built into the attic, extended the basement and built an extension, the valuation still has to be what it would have been in 1991. That absurd situation is the result of successive governments deciding to delay revaluations for fear of what happened in Wales in 2005, where the surge in house prices over the previous 14 years led to a third of people facing higher bills and only 8 per cent making a saving. All of which leaves us in a situation where someone in a modest semi in Nottingham can end up paying more in council tax than a billionaire in a multi-million mansion in Kensington.

Even though the council tax is levied on property it pays for local services in the same way that local income and sales taxes do in other countries. That’s one reason why pre-Budget claims by upmarket estate agents that property is more heavily taxed in Britain than elsewhere should not cut much ice.

Aside from inheritance tax (avoidable through tax planning) and capital gains tax (from which first homes are exempt), that leaves stamp duty as the main pure property tax. Thanks to higher rate bands introduced in the 1990s (up to 5 per cent on the entire value of homes worth over £1million) the Treasury’s take from stamp duty increased massively to almost £7 billion in 2007/08. There were even hopes that stamp duty would help dampen down the market but they proved short-lived as house prices soon boomed and then the tax take plummeted (£2.9 billion in 2008/09) as they bombed. There is also widespread criticism of the slab structure of the tax, the way that each the £250,000, £500,000 and £1 million thresholds each trigger a higher rate of duty on the whole amount. George Osborne is promising a clampdown on avoidance by the super-rich and there is also speculation about a possible new 6 per cent rate on homes of over £5 million.

However, the suspicion remains that if you set out to design a system with one main tax on property, stamp duty would be the very last one you would choose. As the Mirrless review of property taxation for the Institute for Fiscal Studies put it last year:

‘Transactions taxes are particularly inefficient: by discouraging mutually beneficial transactions, stamp duty ensures that properties are not held by the people who value them most. It creates a disincentive for people to move house, thereby leading to potential inflexibilities in the labour market and encouraging people to live (and businesses to operate) in properties of a size and in a location that they may well not otherwise have chosen. The “slab” structure…is equally perverse, meaning that transactions of a similar value are discouraged to completely different degrees and creating enormous incentives to keep prices just below the relevant thresholds.’

Instead of reforming existing property taxes, successive chancellors have tinkered around the edges with incentives and holidays and guarantees designed to appeal to first-time buyers and portray themselves as on the side of aspiration with little obvious impact other than to inflate house prices. They have also failed to take account of the impact of their other Budget decisions on housing. The classic example was Gordon Brown’s tax raid on private pensions in 1997, which created an incentive for people to look elsewhere for investments just as the buy-to-let boom was getting going. The same could happen if, for example, Osborne decides to fund a cut in the top rate of tax by reducing higher rate tax relief on pensions: investors will simply seek out the form of investment (housing) that is the least taxed.

All of which may explain why the Liberal Democrat proposal for a mansion tax on homes worth over £2 million attracted support from some seemingly unlikely quarters, including free-market Conservative MPs like Guy Operman who can see the case for taxing wealth rather than income and ConseravtiveHome editor Tim Montgomerie, who argues in the Guardian today that Cameron and Osborne ‘should relish a fight with Tory MPs who are more worried about people with £2 million homes than people on incomes of £20,000’. The idea is variously reported to have been ruled out by David Cameron, to be still on the table for future Budget and to be too difficult because Eric Pickles has scrapped the database of current house valuations that would be needed to run it. Here’s a piece from Paul Lewis suggesting how it could be done.

The big problem, I would suggest, is that successive chancellors have looked at ways to raise revenue or ways to make political capital without stopping for a moment to think through the long-term effects: higher and more volatile house prices; a higher proportion of incomes taken up by housing costs; reduced labour mobility; increased rents; a higher housing benefit bill; perverse tax treatment of private renting; no attempt to address under-occupation (apart from for tenants on housing benefit); what amount to investment incentives for overseas buyers. The list goes on. John Muellbauer of Oxford University has consistently made a wider point about the way that the housing market has been an engine for a massive redistribution of wealth to housing ‘have-nots’ to ‘haves’ and their children and from the younger to the older generation. Any new system has to take those considerations into account and ask the fundamental question: why do we tax the initial cost of home ownership and not the consumption of housing and the profits? For more on the case for reform, see these blogs by Alex Marsh and Kathleen Kelly.

The Mirrless Review for the IFS advocates the replacement of the council tax and stamp duty with a new housing services tax based on up-to-date valuations, with no cap and with no discount for empty and single-occupancy properties. Essentially, it is a form of VAT on housing consumption. That would be supported by reform of taxation of rented housing to level the playing field with owner-occupation. Muellbauer has argued for the council tax to be replaced with a Danish-style national property tax linked to current market values with an option for pensioners to defer payment to the sale of their estates.

Mirrlees was clearly sympathetic to the idea of a land value tax but concluded that difficulties with implementation meant it should introduced on non-domestic land first. Influential backers of the plan like Samuel Brittan of the FT argue that this caution was overdone. ‘If politicians really want to think about the unthinkable, as they sometimes claim, here is a place to start,’ he said. The big advantage of a land tax over a housing consumption tax is that it would encourage new housing development and the reuse of brownfield land.

Alternatives to the ridiculous current system and its inherent absurdities are perfectly possible even if they are not simple. It would be nice if George Osborne started to bring this black comedy of property taxation to a close on Wednesday. But I’m not holding my breath.