Policies that pass on inequality through the generations
By John Muellbauer
Published: March 26 2007 03:00

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 per cent 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
Copyright The Financial Times Limited 2007