We all know the housing market in this country is a mess. Sky high prices, ever increasing rents, a whole generation locked out of owner occupation. The biggest problem is that for years we simply haven’t built enough houses.
High prices are also supported by ultra-low interest rates, helping those who already own and hurting those who want to get on the housing ladder for the first time.
Both these problems are soluble, but only in the long run. However much faster we start building houses now it’s going take a very long time before that really starts to have an effect on affordability. And we’ll have to wait for the economy to normalise before interest rates get back to normal levels. And who knows how long that will take?
So if we’re really looking to do something about our housing problems within the next decade, say, we’ll have to look elsewhere.
And the most obvious place to look is at the taxation of housing. Our entire tax system is riddled with damaging incentives, complexities, unfairnesses and downright absurdities. But you have to look a long way to find a part of the tax system that is more damaging and more unfair than the taxation of housing.
What we have designed is a set of taxes which reward people for staying put and punish them for moving. That helps to gum up the housing market. It contributes to the problems of young families not being able to purchase appropriate properties and the older generation not being able to unlock the wealth tied up in their houses.
There are several elements to this dysfunctional tax system. I would argue that one of the problems, actually, is that it continues to favour owner-occupation over renting. But the two really big problems are the structure of council tax and the structure, level, and indeed existence, of stamp duty.
What in particular is so problematic about these taxes? Well, however unpopular it might be, council tax is fine in principle. It makes sense to tax people for the benefit they derive from living in their home. The problem with council tax is that it does this in a staggeringly silly way.
First, it is based on the relative value of properties from a quarter of a century ago, so the amount each of us pays bears increasingly little relationship to the actual value of the house. And, second, the amount of council tax due rises much less than proportionally with the value of the property.
Those living in houses worth a million pounds and more pay much less tax as a fraction of their house’s value than do those living in the cheapest houses. It’s rather like charging Vat at a lower rate on Bentleys than on Fords.
But at least council tax makes a certain sense in principle. The same cannot be said for Stamp Duty.
A rationally designed tax system would still have – a much improved – version of council tax. It would not have stamp duty at all. Yet far from phasing it out successive governments have raised it, raised it, and raised it again. And you can sort of see why. You’re buying a house, you’re already spending more than you’ve ever spent before. What’s a few per cent extra in tax when you’re shelling out half a million quid?
That might explain the politics, but it doesn’t change the economics. One of the most basic tenets of the economics of taxation is that transactions taxes should be avoided.
There is no reason to impose a heavier tax charge on those properties that change hands more often. That’s because, in theory, assets should be held by the people who value them most. But transactions taxes such as stamp duty mean that doesn’t happen.
If a family in a small house want to move to a larger one (because they are having children, for example) while a neighbouring family in a large house want to move to a smaller one (perhaps because their children have grown up and left home), stamp duty will discourage them from buying each other’s houses, leaving both families worse off.
What that means is that fewer houses are bought and sold, people find it harder to move to where the jobs are, young families struggle to trade up, and older people are forced to hold tight to bigger properties they might prefer to leave, because it costs so much to move.
So we should get rid of stamp duty on residential property transactions. That’s a popular demand. But I’m not a politician, so I’m going add an unpopular bit. That will cost more than £7 billion. At least some of that should be made up by increasing council tax on more expensive properties.
This article was first published by The Telegraph and is reproduced here in full with permission.
Paul Johnson is Director of the IFS, follow him on twitter @PJTheEconomist.