Taxing property

Why is there a lot of talk about a mansion tax at the moment? The short, obvious answer is because the budget is imminent.

Liberal Democrats have long held the belief that it is better to tax wealth than income. This position was reaffirmed at Spring Conference. A belief in the desirability of a mansion tax is not restricted to the Libdems. You can even find the odd Tory who is sympathetic to the idea.

In the context of the budget the Libdems were campaigning for a switch to a mansion tax to accompany a reduction in the higher rate of income tax. Not a reduction in the overall tax burden for wealthier households but a change in its composition. Moving taxation to wealth reduces the disincentives on productive effort. Taxing high value property is seen as also having the advantage that it is harder to avoid or evade than taxes on income. That has got to be true, assuming that it is possible to curb the ruse of setting up offshore companies to hold property and avoid tax. While the property itself can’t easily be hidden, a bit of creativity over legal ownership can reduce or remove tax liabilities.

Even though the mansion tax has been back on the agenda because it’s budget time, I don’t expect the budget will introduce such a tax. The burden of the 50p tax rate and the ownership of high value properties do not entirely overlap. The spectre of little old ladies being forced to leave their multi-million pound properties because they cannot afford the tax bill has been conjured up to scare politicians off. Even though it is perfectly possible to roll up the tax liability and settle it as part of an estate. And even though the strategy of pricing people out of their homes because they can no longer afford them is considered entirely acceptable in the social rented sector.

At the Liberal Democrat Spring Conference Nick Clegg pulled the “tycoon tax” rabbit out of the fiscal policy hat. I don’t have a clue where that idea came from. It resonates with developments in the US, of course, but I must not have been paying attention if it has been part of the debate closer to home. The fact that Clegg mentioned it is presumably significant. While it seems to me to be a less than convincing idea, and there is a risk that it will turn out to be legally unenforceable, my suspicion is that this is the route that the Coalition will go down in lieu of a property tax.

I don’t suppose that a tycoon tax will be introduced imminently. More likely the Chancellor will cut the higher rate of income tax with a promise to take some sort of compensating action elsewhere. But I don’t expect that compensating action to occur over quite as rapid a timescale.

So is that the end of the discussion of a mansion tax?

It might be, but I think we need to revisit why property taxation is a good idea.

The budget discussions have focused on a mansion tax as an alternative to income tax as a means of raising revenue. But we need to recover at least two other aspects of property taxation, that should play a role in our thinking.

First, a property tax can act to influence the broad allocation of resources. The tax treatment of residential property in the UK is relatively favourable, particularly for primary residences. It has long been argued in the economics literature that this leads to a misallocation of resources. It diverts investment into property and away from more productive uses. In the context of a broader debate about how to rebalance the UK economy, developing ways to encourage investors to put their money to alternative use could make a significant difference to the productive capacity of the economy.

A tax for holding property – or, even better, land – suitably structured, can also be a mechanism for trying to ensure physical resources are put to best use. The Government’s planning reforms only really attempt to deal with a part of the issue. I suspect that without reform of land taxation they are not going to be as successful in bringing forth new supply for development at the rate required to meet the population’s housing needs. Changing the holding costs could, for example, encourage developers not to sit on large landbanks for years.

Second, we could move away from thinking about property taxes primarily in terms of raising revenue for government and return to thinking about them in terms of their housing market function. There are credible arguments that an appropriately structured property tax can act as an important counter-cyclical mechanism for dampening price fluctuations.* Given that most informed commentators see house price volatility as seriously dysfunctional, not simply for the housing market but for the broader macroeconomy, taming the worst excesses would deliver great dividends.

A property tax levied as a percentage of current value could have the desired effect (but other, less fine grained approaches are possible). The anticipation of increased tax liability will act to dampen buyers’ enthusiasm for bidding high and thereby, in turn, moderate price increases. In market downturns the tax take will decline, assisting affordability.

Critics will no doubt counter at this stage with, for example, an argument about the difficulties associated with identifying current property values on which to base the tax. Arguments of this sort always puzzle me somewhat. They imply that what is being suggested is some sort of outlandish novelty. Rather than a policy operated in other countries for years. If they can manage it elsewhere surely we can manage it here? The existence of such a tax has been offered as one of the reasons why the Danish housing market has been much less volatile than the UK market.

Of course, arguments about feasibility are often simply rationalisations, rather than rationales, for objecting. They can mask positions which boil down to nothing more complex than the rich wishing to keep hold of their wealth. When the wealth is unearned, as much housing wealth is, I can’t say I’ve got a great deal of time for these arguments.

The point about the housing market function of property taxes is that because of their cyclical nature they do not generate a predictable level of tax revenue, although damping volatility should smooth the tax take. This implies that property taxes should not be assumed to be a direct substitute for the higher rate of income tax. But then, the imposition of a mansion tax is likely to suppress the values of higher value properties, at least around the margin where the tax kicks in, and as a consequence the revenue raised will be lower than otherwise expected. So again assumptions about revenue generation would need to be tempered.

Property taxes are not without problems. While the benefits noted above do not exhaust the arguments in their favour. We need to retain a broad view of the benefits that taxing property can deliver, rather than give up the cause if the Chancellor succumbs to the siren voices of the shires and the City and turns his back on a mansion tax this week.

* See, for example, Muellbauer, J. (2005) Property taxation and the economy after the Barker Review, Economic Journal, vol 115, C99-C115.

Image: Author  (Houses on Richmond Hill).

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  1. Steven Clarke says:

    I absolutely think we need more property taxes. But for me the only show in town is a Land Value Tax on all forms of land use.

    - It would raise significant revenue.
    - It is collecting rent, rather than wealth per se.
    - it does not impede improvements made upon the land.
    - It is collecting socially generated value, rather than privately generated value.
    - Land would no longer be held for speculative reasons.
    - Land would be redistributed – so would wealth.
    - Land would be cheaper – so then will houses and the cost of building new buildings, factories etc.
    - Public infrastructure would become self-financing as it would raise local land values.
    - It is non-distortionary. It impedes no productive use of labour or capital.
    - It’s revenues could be used to reduce taxes on labour and capital.

    I’m sure there are other advantages. The disadvantages can be got round – and apart from the diminshed unearned wealth of the ‘losers’ from this change – I can’t think of any serious moral or economic argument against it that holds up.

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