Bring on the mansion tax

Walk around almost any town in Britain and you will find bricked-up windows on Georgian houses. These are the legacy of the infamous window tax, introduced in England and Wales in the late 17th century. Property owners had to pay double the regular tax if they had more than 10 windows, and quadruple if they had more than 20.

Blank windows serve as very visible reminders of two home truths about taxes. First, they lead to dodges and distortions that can make them ineffective and inefficient. Second - with apologies to Benjamin Franklin - taxes may be one of life's only certainties, like death, but there's nothing certain about the form they take. The window tax was replaced in 1851 by a tax on inhabited houses, and would now be unthinkable.

So it's a shame there are no blank windows on Downing Street. George Osborne had a sterling opportunity to reform Britain's illogical system of property taxes in last week's Budget, but completely failed to seize it.

Yes, he introduced a new 7 per cent band of stamp-duty land tax (SDLT) on homes worth over £2m, in a sop to his Liberal Democrat coalition partners. And why not – a £2m-plus home is a discretionary purchase, so anyone who buys one can also clearly afford to pay the Treasury an extra £40,000.

The problem is that the new tax band builds on an absurd system. SDLT is levied on the whole value of a property. That means a £2m house comes with a £100,000 tax charge (at the 5 per cent level), but add an extra pound to the value and the tax bill becomes £140,000 (at the 7 per cent level). So a black hole in house prices, gross of tax, opens up between £2.1m and £2.14m, a range within which nobody is prepared to pay.

The current SDLT system leads to these discontinuities all along the price scale. It also encourages people to exaggerate the value of internal furnishings in order to bring the official property value below the nearest tax band. Worst of all, the whole concept of a transaction tax on property is discredited by economists for making the property market less efficient and the labour market less mobile. The experts who wrote the Mirrlees Review for the Institute for Fiscal Studies concluded it "defied the most basic of economic principles" and should be abolished.

As for Mr Osborne's clampdown on tax avoidance, it was always a myth that rich homebuyers could avoid SDLT simply by setting up an offshore company to 'envelope' the property. Mike Dalton, a tax specialist at Grant Thornton, says more "aggressive" measures were necessary to dodge the tax. Foreign buyers typically did use offshore vehicles, but mainly to avoid inheritance and capital gains taxes (CGT); they still paid SDLT unless they were buying a house already held within a company. Whether these existing corporate envelopes will now be dissolved depends on what annual charges and CGT are levied on them, subject to the consultation announced last week.

The clampdown is a good story, but will raise small change in Budgetary terms – an estimated £65m next year, or 0.01 per cent of expected tax revenues. Meanwhile, a related loophole that costs the Treasury billions remains wide open. I refer, of course, to the CGT exemption on primary homes.

Home-ownership being a middle-class holy cow, it's not surprising that none of the three main parties has pointed to this tax break, preferring to focus on "mansions" and "tycoons". The implicit assumption behind it is that owner-occupation enhances social stability. But it also favours the rich and perhaps encourages speculation, which is destabilising. The OECD's 2011 road map to growth points out the links between incentives for home ownership and the financial crisis.

The think-tank's solution is not just to remove tax breaks but also to tax "net imputed rental income" – the theoretical rental benefit of a home, less mortgage payments and upkeep costs. Chief economist Pier Carlo Padoan also suggests replacing both SDLT and council tax with a single property tax based on market values.

This may sound radical, but the authors of the Mirrlees Review prescribe almost precisely the same remedy. In fact, taxing land values is a very well-grounded economic principle, with even Adam Smith's stamp of approval. The theory is that land is in fixed supply, so commands a monopoly premium that justly belongs to society. Taxing property – which discourages investment in buildings – is less economically appealing, but it's the best proxy we have.

So why hasn't it happened? Numerous attempts to introduce a pure land tax – most famously in Lloyd George's 1909 'People’s Budget' – have failed on grounds of impracticality. But the scope for making such excuses shrinks if we focus on the more modest ambitions of a property tax based on current market values and of a level playing field between owner-occupiers and renters.

Now all we need is a politician ready to champion the issue. Any reform creates winners and losers; the winners won't thank you, the losers will defame you. But politics was ever thus, and here is a cause with a clear and obvious logic, both economic and social. Any takers?


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