Tax reform is a crucial part of the solution to the UK’s housing problems. Some proposals—such as taxing sites with unbuilt planning permissions—come around frequently despite their lack of merit. Improvements in the taxation of housing have little attraction for politicians, as they need to be gradual—so they don’t offer quick fixes—and are controversial.
Tax proposals should come from a clear diagnosis of the housing market. The key issues can be expressed simply, although details may differ according to location. Because England is densely populated, we are reluctant to build as much new housing as rising incomes and a growing population demand. Consequently the price of housing space tends to rise relative to incomes.
The expectation that price rises will continue encourages first-time buyers to stretch their mortgage capacity and older home owners to remain in larger houses. These incentives are enhanced as principal residences are free from capital gains tax and increasingly from inheritance tax.
Housing has a particular combination of features. It is regarded as a good to which all should have access. It is both a consumption good and a long-term investment and new supply carries environmental costs. Arguably the consumption of housing is already taxed, through council tax, but this bears little relation to housing values. Investment returns to owner-occupiers are little-taxed. VAT is not charged on new housing, though it is levied on renovations and extensions. Finally, stamp duty is charged on housing transactions, though most economists regard this as a bad tax in principle.
Tax changes are needed that encourage more housing supply (including expansion of the existing stock) and discourage housing as an investment (although to some extent housing will always be part of financial planning). I’ll make five proposals.
First, it’s often argued that a land value tax would boost new housing supply, and there is a case for such a tax at a low level for reasons of equity. However, the planning system means that there is already a very large incentive to use land for housing, so unless this tax were rather high it is unclear that it would change new supply significantly (although it would lead to an immediate fall in land values). More helpful would be to tax vacant or underused brownfield land as typically these are areas the planning system wishes to see brought…