Britain’s inefficient and unfair property levies need reform

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Adam Smith, considered to be the father of economics, claimed in his 1776 magnum opus, The Wealth of Nations, that tax policy should adhere to four principles: fairness, certainty, convenience and efficiency. Britain’s system of property taxes violates all four.

Council tax, stamp duty, and business rates — which together raise over £90bn, or close to 9 per cent of all UK government revenue — are good examples of poorly designed taxes. They exacerbate inequality and reduce productivity, curbing Britain’s economic potential. They each sorely need reform.

Start with council tax, a levy on properties that in England is based on property values from 1991. Large changes in house prices since then makes the charge highly regressive. The share of median annual gross pay spent on council tax varies from 2.2 per cent to 10.9 per cent, with those in the north-east and south-west paying the most, relative to wages, while those in London — where incomes and home values are higher — pay the least.

A fairer solution is to eventually replace the tax with an annual proportional property value tax based on up-to-date house valuations. Councils should retain access to the revenues, to give them an incentive to develop their local areas. Tax rates could be chosen such that each authority raises the same amount as it did with council tax. Central funding to local authorities should then be adjusted to reflect differences in tax base. Any such shifts should be phased in to avoid large changes in bills. Caps and reliefs can also be applied for the most vulnerable, and the ability to defer payments until sale or death would support cash-poor owners.

Next consider stamp duty, a tax on transactions that is a strong contender for the title of Britain’s worst tax. Charging the levy when people move home discourages owners of large properties from trading down and more generally gums up the housing market. This restricts the mobility of workers across the country, which deepens the UK’s productivity woes and worsens local skill shortages.

The tax should be gradually reduced with a long-term view to scrapping it. For illustration, stamp duty and council tax in England could eventually be replaced by a 0.5 per cent tax on current property valuations in a way that is revenue neutral, according to Fairer Share, a charity.

Finally, take business rates, a flawed tax on the value of premises. It combines an efficient tax on land with an inefficient levy on the structures upon it, thereby discouraging companies from investing in their property. This could be addressed by removing the value of new structures from its taxable value, which would generate long-term growth benefits by encouraging development.

A land value tax — which acts as a levy on the unimproved value of land — has long been debated in the UK, but deemed too difficult to implement. This reform to business rates would be a stepping stone towards an LVT; which Smith would have considered to be the perfect tax.

Political challenges make these reforms easier said than done. Indeed, the property tax system has suffered from inertia given the potential winners and losers from change. Phasing in and cushioning the costs will help any transition. Planning reforms meanwhile would help capitalise on new development incentives.

But, as long as the status quo with council tax, stamp duty and business rates remains in place, the UK will be a more unequal, less productive, and lower revenue-raising country. That benefits nobody.

This is the fourth in a series of editorials on reforming the UK tax system. The first, on the need for reform, can be found here. The second, on corporation tax, can be found here. And the third, on motoring taxes, can be found here.