For someone who lived outside of the UK from 1996 – late 2007, (and indeed for anyone with any ounce of objectivity) it was clear that the property market in the UK (and in many other countries) was a bubble waiting to burst. Prices were inflating way beyond economic reality, and it should not come as any surprise to anyone that sooner or later this bubble (like all others) would burst. Unfortunately, having grown for so long, the resulting ‘pop’ is going to be that much bigger. However, now that the day of reckoning has finally arrived, there are a couple of questions we should be asking ourselves:
- What should be done about the fallout from this collapse? And
- How do we avoid similar situations occurring again?
There is I believe, an important role for governments to play in both these areas, but perhaps not in the expected ways.
The worst thing that the government could now do is to throw taxpayer money into this volatile market, where huge fortunes can disappear as quickly as the English summer sun. Any such actions merely prolong the agony as the market adjusts itself back to reality. And until it does so, the whole economy will continue to suffer, (as I hope will become obvious below).
If the government is to help, then their (our) limited resources would be better focussed on helping those who are in dire economic trouble. This may include efforts to help people remain in their over-priced houses, if the alternative is eviction, destitution and the social and psychological angst that comes with these dire circumstances. But the onus must be on those whom require assistance to demonstrate their predicament, and could for example, be provided in return for part ownership of their properties. This would be a more focused use of limited public resources compared to blanket measures such as a suspension of stamp duty which is poorly targeted, helping the well off even more than those who really need help.
The same must be said for tax breaks for mortgage holders, and indeed to cries that the Bank of England should keep interest rates low because of the impact higher rates would have on the property market. Of course no one wants to see undue suffering, but the underlying problem has been the way that the housing market bubble has so severely distorted the whole UK economy. Such high property prices filter through into higher costs throughout the economy, making the country more uncompetitive and forcing everyone to pour more and more effort, time and money into a place in which to live. Property prices may not appear in official inflation statistics, but their steep rises still contribute to higher costs throughout the economy, as anyone living with these higher prices in the UK (and other countries) will confirm.
Such a focus on property is not healthy for any economy. Aside from increasing prices, it also diverts a great deal of the country’s wealth into assets that do not in themselves create any wealth; unlike a business, which could create significant wealth in its future. And yet, absurdly, the tax system gives tax-free gains for any increase in non-wealth producing property, but taxes other wealth creating investments. Consequently, the current tax system encourages anyone with spare funds to ‘invest’ in their property (for tax-free gains), rather than in other investments that are more desirable and advantageous to the country’s economic future. And this is particularly so when the property market is growing so strongly, thereby exacerbating the inflationary bubble. The policy of governments (from both parties) of not taxing profits made on people’s primary place of residence has therefore had unfortunate and undesirable consequences. It distorts the entire economy in an undesirable way and particularly benefits those who are already better off, (the poorest in society can not afford to get on the property ladder, and do not receive any tax benefit from renting their accommodation).
This brings up the issue of how to avoid similar problems in the future. Tax policies should be neutral, raising necessary revenue for government without distorting the economy in undesirable ways; (although taxing environmentally damaging activities to modify people’s behaviour is probably ok, as this arguably distorts the economy in desirable ways).
I am the last person to advocate higher taxes, but I do want to see an equitable and neutral taxation system. Contrary to popular opinion, governments really are non-profit making organisations! If they raise taxes in one area, then they can reduce taxes in others. It is the amount of total tax that matters, as well as how it impacts on the productive parts of the economy, (and it is only through the success of the productive parts of the economy that we can pay for anything).
Despite this aversion to higher taxes overall, I strongly advocate imposing capital gains tax (CGT) on any capital gain (profit) made on people’s primary place of residence, thereby treating it on an equal basis to all other ‘investments’ we make. When I suggested this at the forum above, it was interesting to observe the knee-jerk reaction from those present, all of whom rejected this idea outright. But if you think about this, it has a number of distinct advantages over the present approach:
- It does not distort the economy, as there is no tax advantage to ‘investing’ funds into one’s home, rather than in a wealth creating business opportunity.
- In a rising property market this CGT will discourage the sort of silly speculation we have seen recently in the UK. In a falling market, the losses can be written off against other income, mitigating personal losses. This is likely to dampen swings in the market.
- In a rising property market, the government can benefit from the sometimes substantial gains that the well off are making (currently without paying any tax), allowing it to redistribute these gains to the worse off who can not make such tax-free gains.
People may claim that imposing CGT on homes will make property even more expensive than is currently the case. This is not so! Firstly, it would only be the gain in price that would be taxed, not on the whole price paid. If there is no price inflation, then no tax would be paid (allowing for personal allowances, as is currently the case elsewhere). Secondly, unlike the present system, there would be no advantage for such price increases to occur. With such high property prices, the differences in the cost of a small house compared to a larger one increases in absolute terms. (Ten years ago, moving from an apartment into a 3 bedroom house might have cost an extra £40,000: now that difference might be more like £200,000.) Buyers still have to pay this extra amount: hence the huge mortgages people need now. The only winners in such times are those down-sizing: everyone else loses out. What we should all wish to avoid is rapidly increasing prices of anything in our economy (it’s still inflationary!), especially on something as important as property and people’s homes.
As non-profit institutions, it is important to recognise that where governments tax with one hand, they give back with the other, and any revenues raised from this proposed CGT would result in tax reductions elsewhere. For one, I would advocate the removal of all transaction taxes (Stamp Duty) on property. This would better lubricate the market: moving house is expensive and stressful enough without this added tax, that hammers the poor buyer, rather than the wealthy seller (as a CGT would). In a mobile and ever changing society, we want to make it as easy as possible for people to move if necessary, rather than discouraging them as the current tax system does. (This is exacerbated by the current tax advantage of owning rather than renting one’s home.)
In the current political environment, such a proposal would probably be seen as yet another of this government’s “stealth taxes” and would therefore be very politically unpopular. This is understandable, but as I hope is evident from the points above, unfounded. The benefits from such a move need to be more widely understood (and I am here attempting to play my part in that!), but it also requires some political guts and leadership, which alas, is too often lacking! However, to mitigate the political impact of such a measure, it could be introduced progressively, through for example, slowing increasing the CGT on primary property over a number of years (with corresponding tax reductions elsewhere), until the rate equates with that imposed in other areas of the economy.
Furthermore, now is the ideal time to introduce such a tax: with property prices stable or falling, few people would pay it anyway, making it’s introduction considerably easier.
Look at it objectively (as we always should for such mattes) and you know it makes sense! Advocate it to your piers, press and politicians!
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