House prices have begun to rise again. Figures from the Nationwide building society next week are expected to show a second successive monthly increase in prices. You might find this puzzling. Official figures last week showed that employment has slumped by 740,000 since February. Surely this must depress house prices. So why are they going up?
Part of the answer lies in an important idea in economics – that of tax incidence. This says that the impact of a tax change does not necessarily fall upon the people you might expect it to hit. Some economists, for example, think the effect of higher corporate taxes is to cut investment and jobs. To this extent, their incidence falls not upon companies but workers.
A key determinant of tax incidence is how responsive people are to changes in prices. If companies respond to higher taxes on profits by relocating overseas employment will fall and so workers will bear the incidence of what is labelled “corporation” tax. But if people are unresponsive to changes, it is they bear the incidence. Traditionally, governments have taxed tobacco because smokers are addicts who pay the higher price of cigarettes; the incidence falls on them.
Which brings us to Rishi Sunak’s announcement of a stamp duty holiday on housing transactions of less than £500,000. The idea of tax incidence tells us that the benefit of this does not necessarily accrue wholly to buyers. Depending on elasticity, it can instead push up prices to the benefit instead of homeowners. In fact, if the supply of houses were perfectly inelastic, all the benefit would accrue to them.
Luckily for buyers, this is not the case: the prospect of increased demand causes some home owners to put their house on the market.
Nevertheless, we have strong evidence that stamp duty holidays do push up prices to some extent. In a study of the 2010 holiday, Anne Bolster, an economist at HMRC, estimated that a one percentage point lower duty raised prices for first-time buyers by just over 0.5 per cent. “The majority of the 1 per cent tax relief was capitalised in higher prices” she concluded. And the LSE’s Tim Besley and colleagues have estimated by 40 per cent of the benefit of the 2008-09 duty holiday went to sellers.
Other evidence fits this view. Australian economists have estimated that stump duty changes there also fuel changes in house prices. And it’s likely that the replacement of rates with the poll tax in 1989 helped fuel house price inflation, whilst the introduction of the council tax a year later contributed to the slump in prices.
All this implies that Mr Sunak’s stamp duty holiday is also raising prices. With a £400,000 house seeing a cut in stamp duty of £10,000 these estimates suggest its price will rise by one per cent or more.
There is, though, a problem with holidays. They end. The restoration of duty might be as grim a sight for homeowners as Heathrow airport is for returning holiday-makers, as it could reverse our current rises. Indeed, with unemployment likely to rise in coming months – and uncertainty about our economic prospects likely to remain high – we have another reason to suspect that prices will fall.
Property-owners, then, should not be fooled by rising house prices now. They might well be unsustainable.
