Time for a Proper Debate on Property Tax

Given that for most households their home is both their biggest asset and their largest liability it is inevitable that proposals concerning its taxation attract passionate views and are often at the forefront of political debate. The Conservatives spent years attempting to recover from the Poll Tax, whilst Labour have now bravely stepped into the fray with their proposed mansion tax, itself a variation of the idea originally proposed by the Liberal Democrats back in 2009. Labour’s idea is based on the imposition of a tax on properties worth over £2m.

One of the key issues at the heart of the proposal is Labour’s claim that it will raise £1.2bn which will be used to provide extra funding for the NHS (National Health Service). Indeed, media appearances by Labour politicians concerning the proposed tax have extensively focused upon this aspect. However, where tax revenue is spent should not have any bearing on the viability of any new tax. Spending more money on the NHS is a valid and indeed popular policy. The majority of the UK population would not particularly argue against the NHS receiving additional funding. Indeed, factors such as demographic change and the rising cost of health care means that it is an issue that all political parties will have to address in some shape or form in the future. However, the manner in which proposed tax revenue is spent should not determine whether it is a good tax or not. They are, or at least should be, separate issues. Taxing every family’s first born child to provide the NHS additional revenue would not make that a good tax.

Likewise, many people take the perspective that the Mansion Tax is a good thing because it taxes wealth. This is also a valid policy objective and fiscal aim. It does not however address the issue of whether this tax is the best way to do it. So let us take both the NHS and the principle of taxing wealth out of the equation and consider whether the Mansion Tax is itself a good tax. Specifically, is it equitable, is it workable and is it the best way to tax housing? Some may argue that given that it only applies to very expensive properties such details are not of relevance. But surely any proposed new tax needs to have a workable rationale and be an effective means of raising revenue. Who is being taxed is as much of an irrelevance as what the revenue will be spent on.

Labour claim that the tax will raise £1.2bn, although details on tax rates are not to be revealed prior to the election. Not only is there significant difference of opinion as to the amount such a tax could raise but we don’t even have consensus as to the number of properties over the £2m threshold. Whilst Labour argue that the tax would apply to less than 0.5% of homes in the country there isn’t agreement as to the exact number. Therefore, it is extremely hard to validate the claims surrounding the raising of £1.2bn. Labour have committed to a maximum charge of £250 per month for those in the £2-3m band. This will mean that in order to achieve the proposed revenue of £1.2bn a substantially higher rate would be needed for properties worth £3m plus. This in itself is not necessarily a bad thing, but the lack of detail and clarity regarding the proposals raises the perception that the policy is being driven by political, rather than fiscal and economic considerations at the fore. Whilst this may not come as a surprise it would have been hoped that given the importance of the housing market to both household wealth and the overall economy more thought would have gone into the practicalities of the tax.

On too many issues Labour’s policy reverts to generalisations and broad brushstrokes. Indeed, the £250 per month maximum charge for the £2-£3m band has itself raised questions. Does this mean that all households with properties in this range will pay £250 per month? If that is the case then the tax charge as a percentage of house value would actually fall the more the house is worth. Comments elsewhere from Labour would indicate this is the case as they say that valuations would not be needed just the placing of properties into the relevant bands. This would imply that set monetary amounts be changed for each band rather than a percentage figure. If it is a percentage then it is yet to be stated what it is a proportion of. For example, based on the current ATED (Annual Tax on Enveloped Dwelling) bands, what would the percentage for say the £5-£10m band be based on? Would it be based on the bottom of the band or the top or maybe the middle? If valuations are not to be required then some clarity needs to be provided.

Labour has suggested that valuations generally would not be needed as it would be clear what band most properties would fall into. Whilst that may be true for a suburban semi outside of the South-East, it is not as simple as is being made out. Currently Labour is claiming that the valuations will be provided through a self-valuation submitted to HMRC. Really? After all the trouble of implementing the tax would a Labour government simply rely on people’s honesty in putting a figure of £2m instead of £1.95m? It is inevitable that some form of valuation process will have to be put into place that will determine valuations and also allow for appeals regarding values around the various thresholds. This obviously does not just involve the base £2m but the higher threshold bands as well. The cost of such a procedural system is currently lacking in the proposals, simply because Labour have ignored the problem.

The base threshold of £2m is to be increased over time in order to guarantee that properties currently outside of the remit of the tax will be subsequently liable. It is this aspect of the policy that probably has the most holes in it. Labour is currently saying that this adjustment will be based on the average rise in prices of high-value properties currently worth over £2m. Any housing economist immediately would ask a number of questions on this issue. Do you really mean a simple average? If it is an increase based on a house price index then which index is to be used and how is it to be constructed? Is there going to be any account taken of regional differences or differences across price brackets? Labour’s policy gurus appear to have failed to grasp that house prices don’t change in a uniform manner. You could, for example, quite easily see house prices over £10m change quite differently from house prices in the £2-£3m range. If for example, £10m+ properties rise dramatically it could lead to an increase in the measure and therefore the £2m threshold in excess of what houses in that price region are actually changing by. If Labour were to use an overall national figure as the basis for any adjustment then it will inevitably lead to people appealing any change in their liability based on these figures.

More importantly, the failure to understand the basic dynamics of housing markets leads us to one of the major flaws of the policy as proposed. Labour’s policy, by saying that no house below the £2m figure today will ever pay in the future, is effectively assuming that the relative value of properties does not change. Who is to say what relative house prices will be in 10, 20 or 30 years’ time? One of the best examples of this is to consider properties in areas of London such as Notting Hill. Whilst many houses in Notting Hill would be in excess of the £2m threshold today they would not have been above an equivalent figure 40 years ago. Therefore, if a mansion tax had been introduced in the 1970s you would today have the absurdity of some extremely expensive houses not being liable. You would also have many properties, probably concentrated outside of London and the South East, that whilst worth less than £2m today would still be paying a tax based on a forty year old threshold. Labour are being disingenuous in implying there will be not adjustments in the future. It is inevitable that there will be at some point political pressure to re-adjust the thresholds based on then current house prices. This is especially so as it is likely that regional differences in relative house price movements, and therefore tax liability, will take on a political element. Politicians should remember that a desire in the eighties to re-visit rateable values contributed to the Conservatives introducing the poll tax.

At present new properties are not explicitly addressed in the policy. It is therefore hard to consider details about the policy in this specific respect. However, it is easy to see this also resulting in oddities. For example, if the liability of new properties is based upon the various thresholds, as adjusted by Labour’s new index, this could lead to a potential situation that a new property over the adjusted benchmark is liable but that an existing property that is currently worth less than £2m is exempt. The tax therefore effectively takes on an element of being a tax on new properties.

One of the areas of the policy that has received the most attention is that concerning the ability to pay and that the tax does not equate it with the liability. It is not, as Labour claim, a progressive tax. In many respects the policy is potentially highly regressive. Many commentators don’t seem to appreciate that living in an expensive house does not necessarily mean that you can afford to pay a high ongoing charge relating to it. Numerous cases have been publicised whereby someone who bought a house forty or fifty years ago for a fraction of the price, in relative terms, is potentially liable for a tax that they could not afford. Labour has provided some safeguards in that people who do not pay the 40% tax rate or who earn less than £42,000 per year can defer payment. Note they are not exempt rather they can defer payment until the sale of the property. Whilst the safeguards do appear fair at first glance, they do not really address the issue. The thresholds are not that high to begin and the fact that the liability is only deferred may lead to some unforeseen and adverse consequences

The likelihood is that someone marginally over the thresholds, and thus unable to defer their liability, will be forced to move. Even if deferral is possible it will mean that on the subsequent sale the outstanding liability will have to be paid. In the case of an existing owner selling that would mean a reduced amount of equity could be taken from the sale. In the case of inheritance there is the potential for double taxation. The properties in question will be liable for inheritance tax if transferred to someone other than a spouse purely due to their high value. However, how will the deferred tax liability be accounted for? Will the inheritance tax liability be reduced accordingly or not? If not there those who inherit could be taxed twice over.

Overall the result is that there is effectively an incentive to sell immediately before any liability becomes due and builds up. No consideration has been taken of this from a number of perspectives. In all likelihood the households that will be incentivised to sell will be long standing residents who may be asset rich but are cash poor. Especially in parts of London where this effect may be felt the most the lack of a linkage between any tax charge and the ability to pay may result in households and families who have lived in an area for decades being forced to move because they cannot afford to pay an annual charge that may bears no relation to their current income. More importantly, it may bear no relation to their income or the value of the property when it was purchased.

If such households were to move who would come in their place? The policy could actually lead to a reduction in diversity given who the likely buyers of multi-million pound properties in London are. Indeed, the frequently cited concerns over foreign ownership of properties in London could be exacerbated under this policy. In addition, what would impact would any large scale selling have on the market? It may lead to an increase in the supply of properties, thus contributing to a weakening of market conditions. In all likelihood this impact would be seen more clearly at the lower range of properties. This segment of the market may already be somewhat depressed as it is inevitable that a reduced number of people will be prepared to pay over the £2m threshold. More generally, any reduction in house prices in this segment of the market will obviously also adversely affect tax revenue from stamp duty. It is not inconceivable that people with say a property valued £2.4m are not only forced into selling it but also end up selling for less than £2m. Many may not have that much sympathy with someone who had bought a house for say £60,000 forty years ago and are thus making a substantial profit anyway. However, it is inevitable that the media will find and highlight individual heart wrenching cases. Those individuals highlighted by the media are unlikely to be high earning investment bankers, rather characters far more sympathetic to the general public. In some respects Labour are being quite brave in going against the aspirational orthodoxy that has developed over the course of the last thirty years with respects to the housing market.

From the opposing perspective there has been extensive comment that the Mansion Tax would unduly impact London and the South East. It has been often argued that the mansion tax would see actual mansions of say 8 bedrooms in the North of England not being liable but some two-bed apartments in London coming under its remit. This is a red herring of an argument though. Firstly, as anybody in real estate knows the size of a property does not necessarily equate with value, rather location is the key. Secondly, given its economic wealth it is inevitable that any tax on income or wealth will raise a disproportionate amount from London and the South East. A household that buys a 2-bed apartment in Central London obviously has the means to do so and if bought recently possibly paid far more than a large detached property in the North of England. Complaining about the concentration of properties over the £2m threshold in a single region and saying it is unfair is exactly the same as saying that people who live in London shouldn’t pay a disproportionate amount of income tax. The biggest potential impact on London is actually the adverse social implications that may come to pass.

If the Mansion Tax is not the best option available then what is? One alternative that is rarely mentioned in the UK is the approach adopted firstly by California and subsequently by a number of U.S. states. In the late seventies California passed what was known as Proposition 13. Under the system households pay a percentage, in California set at 1%, of the assessed value of the property. This assessed value is initially based on the purchase price of the property. That value can only be increased by a maximum percentage every year. When the property changes ownership the assessed value is changed to the then market value. Whilst one may disagree with either the exact figures used in California and/or that it applies to all housing, the broad principals have many advantages. The key issue, and in marked contrast to the Mansion Tax, is that there is a link with the owner’s ability to pay. This is because the assessed value is based on the price the household paid for the property. Therefore, someone who bought a house for say £80,000 thirty five years is taxed differently from someone who bought a similar property for £2.5m today. Because it is based on income, at least that at the time of purchase, Proposition 13 is actually a more progressive tax than that proposed by Labour.

One obvious disparity in such an approach is that people in similar, if not identical properties, may have different tax liabilities. However, that is arguably fairer than people paying the same irrespective of their income. The Conservatives tried that in the late eighties and it was hardly a rip-roaring success. In addition, people living in identical houses already have differing tax liabilities in other areas, the prime example being income tax. Many were concerned that the introduction of an ongoing tax at least partly based on a historical purchase price would inhibit mobility. Someone, especially after an extended period of residency, could quite easily see an increase in tax liability if they moved house. That is true. However, their new liability would be known to them when moving. They could therefore factor it into their considerations when looking at alternatives, just as someone today would naturally take into account any stamp duty and other costs involved with a house move. In addition, academic research has shown that household mobility is not substantially different in California than in states without such a tax. Even if housing turnover was affected may it not provide the benefit of removing some of the froth we’ve so commonly seen in the U.K. during housing booms? Its transparency is arguably the biggest advantage to a Proposition 13 type structure. By being based on the purchase price households can factor it into their decision making process. Furthermore, it would mean that there was no need for valuations, or even in Labour’s case the assignment into bands. It would also eliminate any potential for legal challenges regarding the status of the property and its assessed value. This would be clearly evident and transparent and would not be able to be challenged. Even retrospective assessments would be relatively easy to implement.

Despite the importance of housing to the households of the UK we have continually failed to have a full and frank open conversation across the political spectrum to find the best means of taxing property. There are many ways of taxing residential property, none are perfect. However, we need to move away from politically motivated arguments to consider what is the most efficient means of taxing property. Labour is running the risk of repeating the mistakes made by the Conservatives with the Poll Tax in rushing in the implementation of a policy where insufficient thought has been given to the details and the practicalities. By limiting a new tax on housing to expensive properties Labour will be hoping that the public don’t view the policy as impacting themselves. The proposal may be good politics, indeed it may be a vote winner, but that does not make it good economics or good fiscal policy.