By Roger Jarman*
Taxes and human behaviour
Remember the Window Tax? It was introduced in 1696 under William III in part as an alternative to levying a tax on income. Inevitably the new tax prompted the bricking up of tens of thousands of windows as property owners acted to avoid it. Taxes produce revenue to fund public services but they also influence human behaviour – look at the consequences of introducing the Window Tax.
In fact for many years governments have used tax not just to fund public services but to change our behaviour too. The tax on tobacco products is a classic example. There are recent examples too. Witness the charge levied on the use of plastic shopping bags. Only this year the sugar tax was brought in to deter consumers from buying food with excessive amounts of the sweet stuff. And the Scottish government is looking to introduce taxes on drinks based on their alcoholic content in a bid to tackle the consequences of the consumption of strong beers, wines and spirits.
So how do taxes on residential property affect behaviour?
Our residential property taxes affect human behaviour in a range of (largely) negative ways and this has detrimental effects on the mechanics of the housing market.
In essence the ‘consumption’ of residential land and related products in this country is under taxed – and this influences how people engage with housing as an economic good.
For instance, there are no capital gains levied on the sale of a householder’s principal residence. And council tax (a property-based tax) has become increasingly regressive and does not attempt to allocate housing resources more equitably. Bizarrely householders in £30m properties in Westminster can now pay less in council tax than owners of modest bungalows in the North of England. In any case council tax is levied to pay for local services. The tax does not generate revenue for a broader range of public services.
Changes to inheritance tax have also incentivised excessive consumption of owner occupied property. When Chancellor in 2015, George Osborne introduced provisions that mean a couple’s primary residence worth up to £1m will be free of any inheritance tax liability from 2020. This increases inheritance tax allowances for couples by £350,000 compared with the position in April 2016. Inevitably some older owner occupiers will ‘upsize’ to more expensive housing to exploit this new tax break.
Stamp duty land tax (SDLT) provides significant revenue for the Exchequer. However once again this is a tax which encourages perverse behaviour.
SDLT is a transactional tax that penalises mobility. The levy does nothing to encourage baby boomers to downsize to more suitable accommodation. Indeed when coupled with the changes in inheritance tax there are precious few financial incentives to encourage older owner occupiers – probably under occupying large three and four bedroomed accommodation – to move to smaller, more appropriate housing.
Intriguingly the government has used changes in the tax regime to discourage investment in one part of the residential housing market – the private rented sector (PRS). Partly in pursuit of its goal to increase owner occupation, the Conservative government elected in 2015 introduced measures that take away a number of tax reliefs from private landlords (especially those funding their business through mortgages and other debt finance). SDLT has also been increased for private landlords (over and above what other purchasers pay).
And of course these new taxes have influenced the behaviour of some private landlords. The latest official figures show that the size of the PRS in England declined by 46,000 units in the year up to March 2017. This reverses the relentless growth in the PRS from the mid 1990s when Buy to Let mortgages were first introduced. By 2020, when mortgage tax relief for private landlords is completely withdrawn a significant number of private landlords will have sold off at least a proportion of their property portfolio.
The favourable tax treatment of private landlords has ended. But the tax framework for owner occupied housing encourages over consumption of private property in the UK and reinforces the role of housing as an investment good in the economy.
This is bad news. Money has poured into the housing sector as other investment opportunities have shrunk (think private pensions). But this has not necessarily boosted the production of new homes – rather funds have been invested in existing stock by both owner occupiers and, in the past 20 years, Buy to Let landlords. And with supply restricted we have inevitably witnessed significant increases in house prices and rents.
With wages suppressed after the financial crisis, affordability ratios have rocketed. Even in London in 1997 the average house price was only four times average salaries. Now that ratio is 1:15. In some parts of the country private tenants can pay over 50% of their income on rent.
In part through the operation of the tax system, we have created a ‘dysfunctional housing market’ (as acknowledged by the government). The current orthodoxy is that the housing crisis would be overcome by a massive increase in house building. This is a fallacy. To have any effect on the affordability of housing, experts have estimated that this country would need to build 750,000 homes a year (against a current build rate of around 200,000 homes a year). Neither the market nor the public sector could produce that number of properties in the current context – and the cost would be enormous both financially and environmentally.
The most equitable, efficient and effective way to address our housing crisis is to radically reform the tax on residential land and property. This would immediately reduce the attractiveness of housing as an investment good and influence behaviours accordingly.
So how do we reform our property taxes?
Historically the state raised revenue by taxing land holdings or the produce derived from land. Our ancestors knew a thing or two. This form of tax has always been difficult to avoid/evade and relatively simple to collect.
Over the years this type of tax has reduced, particularly as a proportion of the total tax taken by the state. Taxes levied on income and consumption (VAT, excise duties, etc) has soared and now accounts for some 85% of all taxes levied in the UK. Taxes on inheritance, land, property, wealth and corporations make up a small proportion of all taxes collected in the UK.
As a country we need a more balanced approach to the taxes we levy. We need better methods of taxing residential property and land thus generating a wide range of benefits – in general but more specifically to help create a housing market that works for ‘the many not the few’ .
The two principal taxes on property need to be reformed: council tax and SDLT.
If a new land value tax is discounted because it is deemed too radical we have to work on reforming council tax. First there should be an immediate revaluation of properties so that more valuable properties are subject to significantly increased tax rates. And the revaluation should occur regularly – perhaps annually. After all, keeping abreast of changes in property values should be relatively straightforward given the development of web platforms such as Zoopla and Rightmove.
There is also a strong case for getting rid of the single person discount that applies to one person households under the current council tax regime.
Under this reform a proportion of the council tax so raised would go to the Central Exchequer rather than to the local authority where the property is sited. This would enable the distribution of resources from areas of high housing wealth to poorer parts of the country.
Overall imposing an increased annual charge on property would result in more efficient use of the nation’s housing stock. With some households subject to financial penalties for the overconsumption of property, a proportion would move to properties which attract less tax. The tax would put a brake on house price inflation and could actually result in price falls. Over time affordability would improve and prospectively there might be a return to the long-term 1:4 salary/house price affordability ratio.
A reformed council tax regime should be introduced over time so that households could adjust their consumption of housing to the tax levied. Also provision should be made so that a charge could be placed on the estate of the householder who chooses to remain in his/her property and where the new tax cannot be covered by current income. In such cases the tax would only be levied on the death of the householder.
Coupled with the introduction of a reformed council tax regime, SDLT should be completely overhauled. There is a strong case to retain differential stamp duty rates for the purchase of second homes and investment properties but generally SDLT should be dramatically reduced. (Intriguingly a reform of this kind might actually be welcomed by estate agents as they would see business activity increase significantly as households move to reduce their tax bills).
Properties left empty could be subject to more tax penalties – through the council tax regime – for remaining void. This would build on changes already introduced by the government.
Time for reform
Social geographer Professor Danny Dorling and others are right. There is broadly the right number of homes in this country relative to our population. It is the distribution of that property that needs to be addressed and ensure that the 20 million or so spare bedrooms are used more productively. Reforming property taxes would help achieve a better distribution of housing resources in our country – and reduce the propensity for people to treat housing as an investment good and over consume this vital asset.
Maybe the time for reform is here.
Certainly the topic is creating more interest. The Resolution Foundation is pressing for reform and the IPPR has set up a Commission looking at the best ways to reform property taxation in the UK for the benefit of the housing market and the economy more generally. Furthermore the Select Committee for Housing, Communities and Local Government is looking at a related subject – the effectiveness of current land value capture methods associated with house building activity.
Probably most significant of all, Number 10 has a new Housing Adviser – Toby Lloyd.
Lloyd was Head of Policy at Shelter and co-authored the seminal ‘Rethinking the Economics of Land and Housing’ (Zed Books). He knows how taxes distort the operation of the UK’s housing market.
Now if only Toby could have as much influence on government housing policy as his predecessor Alex Morton, the architect of the highly regressive and pernicious Housing and Planning Act 2016.
We live in hope…..
* About Roger Jarman
Roger has almost 40 years experience in the housing sector. He has worked as an academic and in local government as well as for a number of central agencies. He had spells as a senior manager at both the Housing Corporation (1991 – 1999) and the Audit Commission (1999 – 2011).
He currently works as a housing consultant and trainer with a wide range of clients including local authorities and housing associations. He also helps run several small housing organisations in London either as a paid official or as a non executive director.
Note: This is an updated version of a blog first published by Housing Quality Network in June 2018