The taxing problem of property

If you think the row over business rates is bad, imagine for a moment what would happen if council tax went through a revaluation.

As I’m writing this, some sort of government climbdown seems inevitable after weeks of press coverage of the rates increases faced by shops and other small businesses.

Some of the furore seems justified. The business rates system seems stuck in the past, unable to cope with out-of-town supermarkets let alone internet retailers and almost seems designed to destroy High Street businesses. There are cliff edges built into the system, especially at the bottom end. It’s not clear why farms are exempt but hospitals are not. Exemptions for empty and unused property create incentives to keep it empty.

Much of it is not. The journalists reporting from the mean streets of Maidenhead and Weybridge seem much less inclined to travel to Merthyr or Wakefield to talk to people whose business rates will be cut. The government maintains that this is a revaluation with no net increase in the tax (though some Tory MPs dispute this). That means the benefits will be felt where they should be: in less affluent areas.

The effects of the revaluation have also been exaggerated by the government’s decision to delay it by two years. If it had happened on schedule in 2015 the increases would not have been as steep but the bills would have gone out just in time for the general election.

And there is actually good reason to think that for all its faults business rates is not a bad system overall. The Adam Smith Institute is not noted for its defence of taxes but Sam Bowman went so far as to call it a ‘good tax’ in a piece for the Telegraph. There is fairly strong evidence that most rents adjust to rates over time, meaning that it’s landowners who end up paying the bill.

That’s one reason why business rates have been described as the closest we have to a land value tax (LVT). Upmarket estate agents may be lobbying to get their clients out of paying the extra business rates levy for Crossrail in London but this is the mechanism for ensuring that building owners pay for the increases in property prices triggered by public investment.

But contrast what’s happening with the taxation of business property with what’s not happening with the taxation of residential property.

Until 1988 they were part of the same system related to nominal rental values. Then the Conservative government introduced a reform to tax people rather than property aimed at spreading the burden more fairly between property owners and everyone who uses local services. Margaret Thatcher insisted on pressing ahead despite warnings from many in her own party that her community charge was deeply unfair. What became better known as the poll tax was eventually scrapped but not before there had literally been riots in the streets and Thatcher had been voted out by her own MPs.

The council tax was introduced in 1993 as a compromise, a mixture between a property tax and a personal tax. Assessments were based on the market value of properties in 1991 but single occupiers of homes get a 25 per cent discount. It was fairer than the poll tax (not hard) but still highly regressive: bills are set in relation to Band D properties (market value £68,000 to £88,000) but one in Band A (less than £40,000) still pays two-thirds of a Band D bill whereas Band H (£320,000 or more) pays double a Band D bill.

The result is that low earners pay a far higher proportion of their incomes than higher earners and that imbalance has got worse since cuts to council tax benefit in England since 2010. Even as the coalition government was introducing the bedroom tax, or removing the ‘spare room subsidy’, it was protecting the single occupancy discount against cuts and maintaining a 50 per cent discount for second homes.

Worse still, except in Wales there has been no revaluation since the tax was introduced. Average house prices have almost quadrupled since 1991 but the council tax is still based on property values 26 years ago. Labour and Conservative governments have both put off revaluations fearing the political consequences of creating so many losers in areas where property prices have risen the most (London and the South East).

The flipside of that is that people in areas where house prices have risen by less than the national average (the North and Midlands) are paying more than they should be. Ten years ago the Lyons Review of local government finance estimated that 3.7 million households were paying more council tax than they should be as a result of the cancellation of revaluation. That figure will be even higher now.

The longer the system remains unchanged the more anomalies are created. The band weightings mean that a property in Band H that could be worth millions can never pay more than three times the council tax bill for the cheapest home in the same area.

New-build properties are assessed according to what their value would have been in 1991. Combine this with business rates under the latest revaluation and you arrive at a situation whereby the tax bill for a unit at One Hyde Park in London can be £1,400 a year if it is an apartment and £244,000 if it’s a shop. The system means the council tax on an apartment worth £136 million is set at Band D (up to £88,000 in 1991) and is less than the national average. And the owner may not even be paying that: an Observer investigation in 2011 found that only nine of the 62 apartments in the building were even registered for council tax.

There have been various tweaks over the years. Wales did have a revaluation in 2005 and has also introduced an extra Band I for higher-value properties. Scotland raised expectations of radical reform and then opted to tweak the weighting of the bands and provide more means-tested support to people at the bottom. Councils have also been allowed to charge more for second homes and empty homes.

Fundamentally though, a system that was not that fair to begin with has become more unfair with each passing year. A revaluation to make it more fairly reflect what’s happened to property prices in the last 26 years is now seen as politically impossible.

Council tax is of course just one small component of a byzantine system of local government finance that is set to see bills rise everywhere this year, though not by enough to fund social care, at the same time as services are cut.

That’s beyond the scope of this blog but in terms of housing alone a more rational system would tax the value of houses or better still the value of the land they occupy. It might even act as a brake on rampant house price inflation. Instead most of the property tax burden falls on new buyers via escalating rates of stamp duty. The net result is fewer transactions and a silted-up housing market. And we exempt primary residences from the capital gains tax we charge on other forms of investment, with predictable results.

Needless to say the recent Housing White Paper had next to nothing to say about tax, despite its title of ‘fixing our broken housing market’. The furore over business rates kicks the prospects for reform even further into the long grass.