Mark Wadsworth: Time to look at Land Value Tax?

Mark Wadsworth, a Chartered Tax Advisor, sets out the case for Land Value Tax. He wrote a paper for the Bow Group on the subject in 2006, and a subsequent article on ConservativeHome addressing concerns.

1. Land and location values

Before we look at economic theory or the existing tax system, it is best to look at the facts, for example a table published in the Daily Telegraph recently:

House prices are made up of the value of the bricks and mortar and the location value, which is broadly speaking, the value of the plot of land on which it is built. The cost/value of the bricks and mortar element of an average home is around four times a household's disposable income, so while the house price-to-income ratio has fluctuated between four and seven over the last half a century, the average value of a plot of land has ranged between a negligible amount and three times a household's disposable income over the same period.

2. House prices, the economy and politics (1)

It should be clear from the chart that booms and busts in the economy coincide pretty much with the eighteen-year house-price cycle. Anthony Barber's 'dash for growth', the 'Lawson boom' and the 'Brown bubble' are all immediately recognisable – and we all know what happens next...

ConservativeHome is a political website for people who would like to see the Tories return to and stay in power for as long possible. Is it not the case that changes in government are far more likely when property prices and the economy are in a downturn? Shouldn't the Tory party be developing policies that will help put an end to these booms and busts?

 3. Economic theory and practice

Classic free-market liberals from Adam Smith and David Ricardo via Henry George and Winston Churchill all the way to Milton Friedman have said that a tax on land/location values is the least-worst tax. This is because it is more akin to a user charge than a tax.

On a practical level, land with planning permission is in more or less fixed supply (barely over 10% of the UK by surface surface area is developed; even in the South East the figure is only about 15%), and in long run, house prices are a fairly fixed multiple of net incomes. 

Although George Osborne has repeatedly said that he will stick to Labour’s existing spending plans, the government currently wastes at least £50 bn a year on quangos and pointless initiatives, so there is ample scope for spending and tax cuts without affecting frontline services. However, although in the long run tax cuts help the economy grow, in the short term there are insufficient productive assets in which to invest. Thus, as previous experience of ‘dashes for growth’ have shown, the immediate effect of tax cuts is that house prices and land/location values rise – in other words, extra net income merely goes into existing non-productive assets. 

4. Existing property taxes in the UK

The total receipts in 2006-07 from existing taxes on residential property were as follows:

Council Tax  £22.2 bn

Council Tax Benefit  £(2.0) bn

Stamp Duty Land Tax  £6.5 bn

Inheritance Tax*  £3.6 bn

Capital Gains Tax**  £1.9 bn

TV licence fee  £3.0 bn

Total  £35.2 bn

This amounts to just over 6% of total government tax receipts; Council Tax alone only makes up a quarter or so of local authority income – the bulk of it is from redistributed Business Rates or grants from central government out of general taxation.

    * * I have taken the total figure for Inheritance Tax, it nearly all relates to property values.
    * ** I have taken half the figure for Capital Gains Tax

In the interest of simplification, if nothing else, all these taxes could be replaced by a single tax, payable by the owner not the occupant, set at a small percentage per annum of the capital land/location value of each residential property.

5. What's the point?

The total value of all privately-owned residential property is currently around £4,000 billion, of which three-sevenths relates purely to land/location values, i.e. £1,700 billion. If and when house prices fall to their long run average of five times disposable household income, then land/location values will fall by two-thirds to £570 billion.

This would be exactly the right time to introduce LVT - the fiscally neutral rate required to replace all existing taxes on residential property in their entirety (see list above) would be about 6% per annum on site-only land/location values. The tax would act like an extra interest rate, so in future, price rises would be dampened and values/prices would be kept low and stable. There would be no windfall gains to land- and home-owners, but just as importantly, there would be no risk of land- and home-owners suffering ‘windfall losses’ – what doesn’t go up can’t come down.

Assuming that existing property taxes were replace pound-for-pound, the bill for an average house would be about £1,700, or a few hundred pounds more than Council Tax bill plus the TV licence fee – but there would be no Stamp Duty Land Tax to pay of up to 4% of the price of a house when you buy and sell; no more Inheritance Tax to worry about and no more Capital Gains Tax on the sales of second homes or investment properties.

6. House prices, the economy and politics (2)

The idea that LVT is the least-worst tax is not idle economic theory, Hong Kong for example has a feudal land system and the government derives the bulk of its income from leases, which is why they can keep their rate of income/corporation tax to a flat 20%. Stephen Reed, the Mayor of Harrisburg, who introduced LVT in 1982, has been continually re-elected ever since.

I am familiar with all the arguments that people use against LVT, I shall deal briefly with the most common ones here:

7. “Asset-rich, income-poor people would be forced out of their homes! What about ability to pay?”

Pensioners would be allowed to defer LVT to be repaid by their heirs. Which is why Inheritance Tax and Stamp Duty Land Tax should be scrapped as a quid pro quo.

If the Tories want to be a One-Nation party, should they not also show some concern for “asset-poor, income-poor” people? In any event, a flat-rate LVT would be cheaper for low- to average income households in smaller homes or in cheaper areas than Council Tax/the TV licence fee are at present (both of which are highly regressive).

As mentioned, if LVT replaced all existing property taxes pound-for-pound, the bill for an average household might be a few hundred pounds more than Council Tax/the TV licence fee is at present. To smoothe the transition, there have to be more winners than losers of course, but rather than introduce complications like exemptions or discounts, would it not be preferable to simultaneously increase the personal allowance for income tax by one or two thousand pounds, so that most households' net income increases by more than enough to pay any increase? Or at the upper end, to increase the threshold for higher rate tax?

8. “It would be very difficult to value twenty million homes”

It would not be necessary to value individual homes, as LVT ignores the cost/value of buildings and improvements.

In each post-code sector ('LS' = area, 'LS28' = district, 'LS 28 5' = sector and 'LS28 5PZ' = unit) there are about three thousand properties, five or ten per cent of which are sold each year, which would give a fair sample of a couple of hundred actual sales each year in each sector. HM Land Registry already records selling prices and knows plot sizes, so all that is required is to report rebuild costs (using the ABI calculator, for example) on the TR1 form when a property is sold. HM Land Registry would deduct this from the selling price, add up the residual values of all sites sold in each sector, divide the total by the total area of all the sites sold in each sector to arrive at an up-to-date value per square yard for each sector, to be updated at least annually. 

And do not forget the huge administrative cost savings that could be achieved by scrapping all the other taxes that LVT could and should replace!

9. “The cost of local services should be paid for by equally by all local residents, i.e. a Poll Tax”

Surely, it is more important to look at the value of what the home-owner gets (as reflected in land values) than the cost of local services. For example, having more policemen on the beat reduces crime, cuts a household's home and car insurance bills and makes an area more desirable, thus boosting selling prices. Having armies of five-a-day advisors and environmental-awareness-officers costs just as much but adds no value whatsoever.

This imposes a fiscal discipline on local councils. If they want to collect more money, than can only do this by concentrating spending on useful, value-added activities, which boost land values and hence tax receipts.

10. Disclaimer

I have made a small fortune in property over the last ten years precisely because the government did not have the moral courage to introduce LVT back in 1997. Unless the next government has the nerve to follow my advice, I have every intention of making a large fortune over the next cycle, so from a personal point of view, LVT would deprive me of a large pile of money.