How to fix the UK’s housing mess

By Hugo Dixon
May 19, 2014

By Hugo Dixon

Hugo Dixon is Editor-at-Large, Reuters News. The opinions expressed are his own.

The Achilles’ heel in Britain’s strong economic recovery is the mess in the housing market.

House prices are rising yet again – by 10.9 percent in the year to April, according to Nationwide. This raises the risk of yet another cycle of boom and bust, so much so that the Bank of England recently described rising house prices as the “brightest light” on its risk dashboard.

What’s more, there aren’t nearly enough new homes being built to cope with the soaring number of new households created by rising divorce rates, people living alone in old age and immigration.

True, house building is on the rise. In the year to the end of March, work began on 134,000 new houses – a 31 percent increase on the previous year, according to official figures. But the number of new houses needed each year to meet demand is about twice that.

The high cost and low availability of housing is already causing political trouble. It is one of the arguments used by the UK Independence Party, which is expected to do well in this week’s European Parliament elections, for pulling out of the European Union and controlling immigration.

The housing mess is also prompting Britain’s mainstream political parties to come up with foolish policies. The Conservative-led government’s flagship scheme – Help to Buy – helps people who wouldn’t otherwise have a big enough deposit to buy a home. Its main effect will be to increase demand further, so pushing up prices, rather than increase the supply of homes.

Meanwhile, the opposition Labour Party has promised to institute a type of rent control if it comes to power. That sounds nice for tenants. But it too would rig the market, deterring landlords from building new homes to rent.

A better solution is not to distort the housing market but to remove existing distortions so that it operates more freely.

Top of the list is to free up the planning system, so that it is easier to build homes on both greenfield sites and so-called brownfield ones – former factories and the like. The current system artificially restricts the pace at which housing can be built, inflating prices and giving homebuilders an incentive to sit on their undeveloped land banks, knowing that prices will just keep rising.

London and the southeast of England are crowded. So it is understandable that people there don’t want lots of new homes to be built on the patches of greenery that remain. But a better balance between the need for green space and the need for new homes needs to be struck.

The tax system also needs reforming. At present, housing is massively under-taxed compared to other assets. No capital gains tax is paid on first homes. Nor is tax levied on the “imputed income” people get from living in their own homes – essentially the fact they don’t have to pay rent. What’s more, the two housing taxes Britain does have, stamp duty and council tax, both have defects.

Stamp duty is a transactions tax, which rises to 7 percent for properties over £2 million. It therefore gums up the top end of the market, giving people a reason to pause before selling.

Meanwhile, the council tax is a highly regressive charge imposed by local authorities. Take Kensington and Chelsea, in central London. Residents living in the borough’s most expensive properties worth over £100 million pay £2,134 a year – only three times what residents in the cheapest property pay.

Labour has promised to impose an extra charge, a “mansion tax”, on properties worth more than £2 million. While that would be a step in the right direction, a better solution would be simply to change the council tax to make it proportionate to the value of people’s homes – with no cap at the top.

The main effect of such a change would be in London and south-east England, where there is the biggest shortage of homes. People would think twice about whether they needed such big houses. In particular, old people, who no longer had big families, would have a strong incentive to move to smaller homes, releasing more big homes onto the market.

Another change that would help the overheated London housing market would be to change the way “non-doms” are taxed. Non-doms are people who are not domiciled in the UK but who are still living there. If they make an annual payment of £50,000, they can avoid paying tax on their foreign income. While this is a large sum for most non-doms, it is a pinprick for London’s multi-millionaires and billionaires.

An alternative, fairer, scheme would be to charge non-doms who don’t want to pay tax on foreign income a flat percentage, say 2 percent a year, of the value of their UK homes. That wouldn’t just raise money; it might take some of the heat out of the top end of the housing market.

If freeing up planning and rejigging the tax system are the main ways of boosting housing supply, two things still need to be done to restrain the demand. The government should scrap its Help to Buy scheme; and the BoE should ask for the right to cap the size of mortgages relative to the value of a property.

None of these measures would be popular. But failure to act will cause much more damage in the long term.

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The reason why these ideas won’t be implemented is an illustration of the difference between being an economics journalist and being an elected politician.

The latter has to worry both about how things look politically and about how the voters will react. Both considerations come ahead of any economic fundamentals.

That’s why no Tory government is going to impose a range of new and/or increased taxes on home-ownership: whatever the rational case for taxing “imputed income” from living in one’s own home and in particular for removing the CGT exemption for owner-occupied properties, which allows most British property owners to trouser untaxed windfall gains they can then use to pole-vault up the ladder with a massively-leveraged deposit, Conservative voters in particular, who are much more likely to be home-owners, would revolt in droves at what they’d see as a “tax-grab” on what they think of as their personal wealth.

The problems are no easier for left-wing politicians to address, not least because there are over-riding temptations to show-boat and play to the gallery with measures targeted exclusively at small and unpopular groups of wealthy people whom left-wing politicians and voters dislike rather than at the mass of home-owners whose behavior is really driving the market. So Labour and the Lib Dems are all for “mansion tax” (even though it’ll only apply in a minority of instances and the super-rich, as usual, will find a way around it). And they might also be tempted to target buy-to-let owners, even though every serious piece of economic research done by housing specialists has shown that this sector is not what is pushing house-price inflation in the UK. But while buy-to-let is unpopular as so a politically-attractive target, Labour and the Lib Dems are highly unlikely to want to apply CGT or a tax on “imputed income” to owner-occupied properties because there are simply too many of them, owned by far too many voters, for it to be electorally palatable.

So, no real change then. And here we go again….

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