I am currently going through the rigmarole of buying a house.  The searching process has made me reflect on the distortions in the UK property market and how this is actually symptomatic of a deeper issue with the tax system.  We have been looking for houses in east London and have been struggling to find anywhere that we can afford and is also large enough for us and the early stages of a future family.  The issue is not the ongoing cost of the mortgage payments but the costs of the deposit and stamp duty which the Help to Buy scheme are supposed to help with.

This problem is caused by high and ever-rising house prices.  Why are houses so expensive in the UK? The main issue in London is constrained supply.  While there are an increasing number of new houses and flats being built, from my personal experience they are generally aimed at the top of the market.  They are also very small: in 2011 RIBA reported that new homes in the UK are the smallest in Europe.  Planning limitations also mean that it is difficult to build new tall buildings.  When they are allowed they are usually “luxury”.  There is also a strange cultural attachment to low-rise living.  The British seem to want to live in a village even if they are in the middle of a city.

There are also significant transaction costs to buying and selling a house.  For the seller there are the costs of estate agents and for the buyer there is the cost of stamp duty and their mortgage deposit if it is their first property.

All these factors pile in together to result in a system where not enough houses are being built, not enough houses are sold and land is not being used in the way that is best for society.

For the UK, and mainly in the south east and London, people can’t afford to live near where they work and add value.  The distortionary effect of taxing income above all other things is that it disincentivises desirable activity (work).  The lack of tax on property incentivises under-use of it: hence large mansions in central London which are un-occupied for most of the year.  People outside of the south east are penalised: someone earning £30,000 and living in Newcastle is contributing just as much to the economy as someone living in London earning the same.  However the person living in London, living in a more expensive house is occupying more of the country’s land resources.  They receive an unearned benefit from the rise in the value of their house just because of its location, not because they are adding more value to the country.

One could argue this could be resolved by levying capital gains tax on the sale of all property, rather than exempting the main residence.  However this would make the problem worse because it would increase the transaction costs of moving.  The solution is something which is a levy on the thing which is the source of the unearned income – the occupation of land.

The basic structure of a land value tax is that the owner of a parcel of land pays a regular fee based on the market value of the land.  There are clearly some issues with how the land would be valued – how would it be kept up to date if the land hadn’t been sold? – but there are many reasonable options, such as creating ward-level indices so that even if land has not been sold recently, its value is scaled up from its last sale according to more recent sales of land and buildings.

There are some issues with a land tax – it would strongly incentivise the high wealth/low income population to move to smaller/less valuable property.  While this effect is economically desirable because it frees up prime locations for those who are working to live near their work, it also has some deleterious social effects.  In most cases the freehold-owning retired would have to move out of inner city properties because their incomes would not be high enough to pay the land tax.  This could clearly have very negative effects both personally on those forced to move as they are removed from their social and support networks, but potentially also on the communities they leave behind. It could also result in the countryside being largely populated by the retired.

These negative impacts could be mitigated with a staggered introduction of the levy, or scaling it differently for those over state pension age.  While it is clearly in the public interest to have the most efficient use of land, there is a certain amount of injustice in forcing those who are currently retired to immediately compensate the younger generations for the distorted economy we have been blessed with.

The Land Tax has been discussed elsewhere (Financial Times, LandValueTax.org, LabourList). However, in the current pro-oldie climate no politician will touch it with a barge pole.  The only way to out more high-profile supporters (such as the semi-closeted Vince Cable) is to get more young people talking about it. It is being presented in some quarters as another “tax the 1%” proposals.  However this would probably have very little impact on anything other than political parties’ poll ratings.  The only way for a land value tax to have any impact would be for it to replace a less desirable tax, such as income tax.

In the near future I will post the results of some analysis to look at how you could structure a land tax so that it could replace income tax.