Land and wealth – some differences

The IPPR report in its proposals for land and property taxes makes a number of fundamental errors which have serious implications with regard to equality. It treats land differently from other sources of wealth. Although there are some reasons for treating land differently due to its unique characteristics, the approach adopted by the IPPR has serious implications.

A lot of wealth consists of investments in shares, pension assets etc. If we were to compare two households with identical levels of wealth we would find that the tax take would vary considerably at all income levels.

This seems an odd way of dealing with inequalities in wealth, in fact if taken with the interaction between income and wealth, inequalities could deteriorate.

There are problems with disparities in wealth. We need policies to reduce such disparities, these could include maximum limits on wealth holdings including land and at the same time reducing the differences in earnings.

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What is the ‘optimum’ use of a piece of land?

The IPPR report on land and taxes makes great play of the issue of the ‘efficient’ or ‘optimum’ use of land. But what does this mean?

The other crucial flaw of business rates is the way unused and undeveloped land is treated. The fact that the charge is either reduced or levied at zero on this type of land creates significant distortions in the incentives to hold and develop land, and encourages its inefficient use. Business rates also discriminate against certain kinds of business – agricultural land is exempt, for example – and this creates additional perverse incentives to use land inefficiently (ibid).

The implication here is that land which is not developed is being used inefficiently – is that an appropriate approach?

We think not. Agricultural land is being used for a good reason producing food! And what exactly is ‘unused’ land or ‘undeveloped’ land? Again the implication seems to be that land should be developed.

Moreover, SDLT actively discourages mutually beneficial transactions, it restricts ownership of residential property by those who value it most (first-time buyers), reduces incentives for people to move home, and it means some people are encouraged to live in an area or size of home they otherwise wouldn’t have chosen (ibid).

We think the problems facing first-time buyers are somewhat more complicated than the use of Stamp Duty Land Tax – poor earnings for example, competition from buy to let purchasers, holiday home/second home buyers! What does the statement ‘some people are encouraged to live in an area or size of home they otherwise woudlt have chosen? mean? We think it means that people on low incomes who live in nicer areas where house prices are higher or in larger homes would have to move. But people on high incomes would not have to move! How bizarre!

Introduce a land value tax to replace business rates The government should replace business rates with a land value tax (LVT), as others have argued, including the Institute for Fiscal Studies (Mirllees et al 2011), the Centre for Progressive Capitalism (Aubrey 2016) and the Tony Blair Institute (Adler 2017). A land value tax is based on two principles. It taxes the value of land, not the property standing on it. And the value of the land is calculated on the basis of its ‘optimum use’16 under existing planning permission, not its current use (Ryan-Collins et al 2017). These principles confer several advantages over our current business rates system. By taxing undeveloped land on the basis of its use value, it penalises those who hold land without developing it, and incentivises development. Since the value of a property is excluded from the valuation of the land, it does not penalise those businesses that improve their properties, as business rates do today.

Again, what is the ‘optimum’ use?
A plot of land may have permission for retail but if retail is under pressure to the owners simply have to pay up or is the optimum use changed?

Development land may not be developed due to lack of demand, what would be the point of taxing it?

The ‘optimum’ in terms of the potential return might be that land is rented out as holiday accommodation but that would not be a particularly equitable approach.

The IPPR report adopts a simplistic approach to a number of complex issues while failing to produce appropriate policies.

Creating perverse incentives for over-development!

Continuing our critique of the IPPR report ‘The Invisible land’ we look at their proposals for land reform which consist of extending the use of compulsory purchase and zoning land for developement and freezing the price.

In essence the aim is that most of the increased value of land arising from development is captured by the state and used to provide infrastructure and affordable housing.

What are the problems?

Well as we have said previously it is incorrect to attribute all the increase in land value to the community in terms of public investment. Land prices reflect the location of the land and demand for it. Land in central London is worth far more than in a town in the north of England simply because of the demand for land in the former arising from economic forces (financial sector in London for example), and because lots of people want to live there.

Lets think of the extra value as the cost obtaining a commodity in short supply. Taking away most of the extra value and giving it to the state does not mean the value disappears, it is transferred from one owner to another. Which means that land and therefore housing is not necessarily cheaper.

Giving the state such powers would provide a powerful incentive for local government to encourage development (shades of Cornwall Council), on the grounds they would make money out of development. This raises a whole range of concerns over sustainability for a start.

As we have said the value of the land would not disappear, there would still be demand for development whether housing or other forms of development. As soon as the land was sold on someone would capture any difference in value that arose. If luxury housing was built then the owners would gain the extra value.

And there is the question of what happens to other land? Owners of existing land could still operate in a private market. Would the land value for a Tesco store be frozen? Probably not.

The IPPR assumes that development land is required by the (local) community, but in Cornwall for example that is often not the case. Most housing, and by implication, development to support that housing is needed for people moving to Cornwall – perhaps they should pay for the cost of providing infrastructure?

The IPPR talks of the local authority haveing the power over what would be built on the land – but surely this is the case now? It is not necessary to own the land to determine it use.

Compulsory purchase laws should be reformed to allow local authorities and public bodies in England to buy land at a fair value that enables the delivery of high quality development. We propose the reform of compulsory purchase laws, by amending the 1961 Land Compensation Act, which has been recommended by a number of organisations including Shelter (Jeffreys et al 2017), the Royal Town Planning Institute (RTPI 2018) and the Centre for Progressive Capitalism (Aubrey 2017). This is the approach already taken in a number of countries, including Germany and the Netherlands and that was in operation in the UK prior to 1961. In practice, the expectation would be that compulsory purchase would be used sparingly (though it must be a credible threat), but this change would reduce price expectations and allow the cost of land to fall. The landowner could still expect to receive a return on their investment which provides them with an incentive to bring forward their land.

Planning authorities in England should be given the powers to ‘zone’ areas of land for development and freeze its price close to its current use value, as happens in Germany and argued for by Falk (2018). Landowners would still get a fair return, but any windfall would accrue to the state to pay for infrastructure and affordable housing to benefit the local community. Authorities would have the power to determine what would be built on the land, ensuring that these new developments deliver high quality and sustainable communities. Areas designated through these zones would generally be areas of strategic importance or where the land was underutilised.

IPPR tax policy proposals would harm local residents in St. Ives!

The IPPR propose replacing council tax with a property tax. [Whats the difference?]. The higher the value of the house the higher the tax. Households would have to pay regardless of income. As property taxes are regressive, the poor pay more as a share of household income.

Let us take the example of St. Ives. Average house prices there are according to Zoopla, £352,000. The average for Cornwall is £257,000 and for England £292,000. Earnings in St. Ives are amongst the lowest in the UK.

According to the flawed approach taken by the IPPR, homeowners in St. Ives would have to pay a higher level of tax than the average homeowner in England. Now the homeowners who have second homes in the town would probably be able to pay whereas local residents on low incomes would not. Which would result in local residents paying more tax as a share of household income and probably having to sell up if they sold the property which would result in more properties available for the second home market!

And if they sold a property, as they would have less funds available they would not be able to afford to purchase one in St. Ives!

Presumably the idea is that they then move to a cheaper property in say Camborne?

Well it would free up more properties in St.Ives for holiday homes and holiday lets!

Council tax to property tax- replacing one regressive tax with another one.

Many people would probably agree that Council tax is a poor way of taxing people and ought to be replaced. It is regressive with people on low incomes paying more as a share of income than those on high incomes. As a Joseph Rowntree report noted in 2006 – The position is complex, however, because there is no direct relationship between household income and council tax band. As the Lyons Inquiry Interim Report noted: people in higher bands may be ‘wealthier’ by virtue of owning a more valuable house, but will not necessarily have a higher income. So reducing the council tax bill for people in Band A, for example, will reduce the bill not only for some people on low incomes, but also for some on middle and high incomes. In contrast, an increasing tax bill for those in the highest council tax bands will impact on some people with low incomes, as well as those who are at the top end of the earnings scale. (Lyons Inquiry into Local Government, 2005, p. 12)

It would seem strange therefore to replace one property tax with another one as the IPPR proposes in their latest report.

The IPPR suggest that households who are cash poor but asset-rich would be able to defer payment. What they mean is that the poor who could not fund the tax due to low income would pay later.

Let us take the example of St. Ives. Average house prices there are according to Zoopla £352,000. The average for Cornwall is £257,000 and for England £292,000. Earnings in St. Ives are amongst the lowest in the UK.

According to the flawed approach taken by the IPPR, homeowners in St. Ives would have to pay a higher level of tax than the average homeowner in England. Now the homeowners who have second homes in the town would probably be able to pay whereas local residents on low incomes would not. Which would result in local residents having to sell up – which would result in more properties available for the second home market!

Is this fair, is it equitable? No. But that is what you get when people produce reports based on flawed assumptions about land, housing and the property market.

[Contrary to the IPPRs belief, high house values in St. Ives are not due to public investment, neither are they community derived. They are the result of high demand for second homes and holiday lets from affluent households – who have the wealth and income to support such purchases]

The government should abolish council tax and replace it with a property tax that is proportional to the present-day value of homes. Such a tax would be far more progressive than council tax, and would effectively capture increases in house prices in a way the current system does not. Unlike a land value tax it would also be a tax on the property. This is appropriate for domestic property because a home is effectively ‘consumed’ and in economic terms should be liable for a form of VAT (Mirrlees et al 2011). The new tax would therefore act as both a property tax and a tax on consumption.

A necessary component of this tax reform would be the introduction of a mechanism to allow the deferral of payment for those households that are cash-poor but asset-rich. Such a mechanism would allow payment on sale or death of the property owner. There would need to be regular revaluation, potentially on an annual basis as is practised elsewhere (Corlett and Gardiner 2018), to ensure that the tax was reflective of its tax base. Regular revaluation would also ensure that the tax would better capture the increase in house prices that arose from public investment, such as in new transport links (for example, High Speed 2), and vice versa should house prices fall.

Source: IPPR.

Council tax and business tax – some strange assumptions. (IPPR)

1. Council tax
As a consequence of these design flaws, council tax has failed to capture the unearned windfalls that have accrued to homeowners over nearly three decades. As well as being unjust – there is no reason why capital gains on property should be taxed more lightly than other forms of capital gain – this incentivises the overconsumption of housing because it is undertaxed relative to other assets.

It is strange to argue that homeowners have accrued unearned windfalls. It is incorrect to compare the value of a house in 2018 with its value in 1998.

At one level the homeowner appears to have gained in that the property’s value has increased over time. This will probably be the case even if inflation is taken into account. But the inflation rate to use is house price inflation not the Consumer Price Index. This is because for most homeowners with one property what is important is the value or price of their house relative to other houses in the area. For most people, it is probable that house prices in the same area will also have risen at the same rate of house price inflation. Therefore if in 1998 their property was valued at 105% of houses in the area, then in 2018 it is likely that it will still be valued at 105% of the average for houses in the area. The homeowner is no better off.

If however the homeowner has more than one property and then can sell the extra house and convert the value into cash, as house price inflation may be higher than inflation in general, they will have made a gain.

They would also gain if they had one property but then purchased a similar property in a lower priced area.

And what is ‘over-consumption’ of housing? Presumably more housing than you can afford if you were taxed on its value?

Which means that those on low incomes would be priced out of high price properties and areas. Odd how a so-called left leaning think tank actually helps the really wealthy and affluent!

2. The national non-domestic rate (NNDR or business rates)
As a consequence of business rates, property-intensive businesses are at a disadvantage relative to other businesses in the UK. They are also cited as being at a disadvantage relative to international business competitors – business rates are routinely highlighted as a cause for the lack of competitiveness in the UK steel industry (Boxall 2017; Pickard and Pooler 2016). The other crucial flaw of business rates is the way unused and undeveloped land is treated. The fact that the charge is either reduced or levied at zero on this type of land creates significant distortions in the incentives to hold and develop land, and encourages its inefficient use. Business rates also discriminate against certain kinds of business – agricultural land is exempt, for example – and this creates additional perverse incentives to use land inefficiently (ibid). Finally, there are inconsistencies between council tax and business rates, the consequence of which is that there is a clear incentive for the use of land for housing at the expense of commercial use.

The argument here seems to be that ‘unused’ or ‘undeveloped’ land should be developed but is that always desirable? Do we really want to turn all ‘unused’ and ‘undeveloped’ land into development land? And how is ‘unused’ defined?

The implication is that because agricultural land is exempt from business rates it is used ‘inefficiently’!

The tenor of these points appears to be that the tax system should encourage what the IPPR consider as the ‘efficient’ use of land, but in reality is to encourage development.

Sustainable? not really.

Land Value Tax – another non-solution to housing issues!

The IPPR report comes out in support of a Land Value Tax. A tax which was put forward by Henry George in the C19th.
The rationale is: “The tax upon land values is, therefore, the most just and equal of all taxes. It is the taking by the community, for the use of the community, of that value which is the creation of the community.” Henry George, 1879.

But LVT is flawed in several respects.
Firstly not all value is created by the community. It is the case that if a piece of land can obtain a higher value than previously for development, due to public investment, then it can be argued that some of that uplift in value should be captured by the tax system, but not all value is derived in that way.

What if the value arises from demand created by someone on a high income who wishes to buy the land in question? That value is not community derived.

Land value can increase due to the attractiveness of the area – a coastal or rural location for example. Again that increase in value is not community derived.

LVT supporters fail to distinguish between increases in development value and increases in general value. Projects such as the Jubilee line are often cited as examples of where public investment led to increases not only in the value of land which was developed but existing properties. The problem with taxing the increase in value for the latter category is that existing households may see a nominal increase in the value of their property but do not see an increase in income. Existing households only gain if they move to a location where there has not been an uplift in prices. If they move within the zone where prices have increased they are no better off. [We have suggested in previous blogs that there should be a mechanism to even out house prices, such that moving from a high to a low value/price area would not result in a financial advantage accruing to the mover].

A significant objection to LVT is that it is based on nominal changes in the value of an asset not actual income derived from the asset. Neither does it take account of the total income of the household. Paradoxically, high income households gain from the introduction of LVT, as they can afford to pay! A strange way of dealing with inequality!

Oddly enough supporters of LVT operate on the assumption that land and therefore house prices continue to rise, otherwise the revenue stream is reduced. They do not seek to lower house prices.

We shall deal with other flaws later.