Policies that pass on inequality through the generations

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Policies that pass on inequality through the generations

By John Muellbauer

Published: March 26 2007
Ref: www.ft.com/cms/s/a52a81c8-db2d-11db-ba4d-000b5df10621.html

Almost all advanced countries have annual property taxes. Britain's
council tax is shockingly unique in one respect and very unusual in
another. It is unique because Britain is the only country where those
living in £20m houses pay the same every year as those living in £1m
houses. It is also unusual because of the system of council tax bands.
Everywhere else in the world, the tax bill rises with the value of the
house and, in some countries, taxes are progressive so that the tax rate
rises with value. The British system privileges multi-millionaires at the
expense of the middle classes. The top rate of stamp duty on property
purchases at 4% kicks in for houses valued at £500,000. The overall
property tax burden on the middle classes living in houses valued between
£500,000 and £2m is therefore far greater than on property
multi-millionaires.

The Lyons Review of local government finance offers a fig-leaf of reform
by suggesting one new higher band of council tax which only slightly
touches the £20m-house owners, especially in inner London, but would take
proportionately more from the affluent middle classes. Rather wistfully,
Sir Michael Lyons recommends that the government should, in the longer
term, reconsider a return to a "point value tax" under which bills are
based on a set percentage of property value every year, instead of the
current bands.

There was an obvious alternative, however. Bands make no sense for the
highest values. There, the potential tax revenues greatly outweigh the
modest costs of valuing a small number of houses. Sir Michael could have
argued for valuing the £2m plus houses and taxing in proportion to value,
even if the bands were retained for the rest.

The Lyons Review rejected a land value tax as an additional or alternative
source of business rate, despite its merits. However, it points in welcome
directions. Sir Michael proposes reform to tax exemptions for empty
properties and agricultural land and a closing of the loophole whereby
owners choose dereliction to avoid business rates.

The government has a concern for poverty and social exclusion, backed by a
proliferation of means-tested subsidies. Yet, the past 10 years have seen
one of the greatest rises in social exclusion in postwar history. This is
the pricing out of the housing market of people without pre-existing
housing equity or family connections with such equity. This perpetuates
disadvantage through the generations. As the Barker reviews of land-use
planning argued and our research confirmed*, the rise in house prices is
explained by demand increasing in the face of stagnant housing supply.
Demand was driven by economic growth and population growth, fuelled by
immigration and to a lesser extent by lower interest rates. The government
contributed to stagnation of new building by tightening planning
restrictions and continuing the cuts in building of social housing which
began under former prime minister Margaret Thatcher. It is plain from the
Lyons Review that tax reform will not play a significant role in improving
the demand-supply balance. Much rests, therefore, on the reforms of
planning proposed in the latest Barker review.

These would be made more effective by the following policy change. A
land-buying agency could gradually buy up tracts of less distinguished
farm land without planning permission. As the portfolio grew, so would the
opportunities to assemble pieces of land for development of new towns and
villages. A diversified portfolio would also be useful in offering barter
trades to farmers willing to relocate after selling up. If the entry of a
large buyer on the market for farm land raised prices excessively, the
Lyons recommendation of bringing higher priced farm land under the
business rate (or under inheritance tax) could damp prices.

Since the granting of planning permission raises farmland prices a hundred
times or more, the profits from the sale of some of the building land to
private developers could fund social housing and infrastructure
development. Both social and private housing supply could expand
substantially. This would release one of the most serious constraints on
the growth of the British economy and reduce social exclusion. The basic
point is that the land price differentials between farm and housing land,
and the huge capital gains of landowners who receive planning permission,
are policy constructs. So is the housing affordability problem, at least
in the long run. All that is needed is a government with vision.

* CEPR Discussion Paper 5619, April 2006

The writer is professor of economics at Oxford University