7 December 2017

Why a land value tax would get Britain building

By Julian Jessop

There are few things that most economists can agree on. But the appeal of land value tax (LVT) has long been one of them. So far, it has not gained much traction in UK policy circles – particularly when it is described by critics as a ‘garden tax’.

Three developments, however, suggest that its time might well be coming.

First, there is growing dissatisfaction with existing taxes based, at least in part, on the value of property. These include stamp duty land tax (which the OBR expects to raise £13.2 billion this year), business rates (£29.3bn), and council tax (£32.2 billion).

Stamp duty, in particular, has been widely criticised as an inefficient tax that dampens economic activity, restricts labour mobility, and prevents optimal use of the housing stock. The Government’s decision to exempt first-time buyers has only added further complications to an already flawed system.

Second, not enough homes are being built. This partly reflects a relatively restrictive planning system, including arbitrary height restrictions and an overly-protected greenbelt. Liberalising these rules might create the economic incentives to develop under-used land. But an additional tax on the value of land would sharpen that incentive further. This may be especially helpful when, as now, interest rates are relatively low, which is minimising the opportunity cost of holding land purely for speculative purposes.

Third, the latest official data on the wealth of the UK (the “national balance sheet”) has drawn fresh attention to the potential to raise a large amount of money. The ONS has estimated the value of land in 2016 at £5 trillion, or just over half the total net worth of the UK. As it happens, the average annual increase in the value of land since 2009 (6.6 per cent) has been slower than during the pre-crisis period 1995 to 2007 (12.4 per cent). Nonetheless, land prices have continued to outpace those of other assets.

The economic principles of a land value tax have been advocated for centuries, from the writings of Adam Smith and Milton Friedman to the Mirrlees Review. In its purest form, an LVT is a tax on the value of the underlying land, independently of any specific improvements such as the value of any property built on it. Crucially, the owner must pay even if the land is currently unused. Unlike most taxes, then, an LVT actually encourages economic activity.

There are other advantages too. LVT is a progressive tax, at least where the land owner is relatively well-off, and hard to evade. It can also be an effective way to ensure that those benefiting from improvements in local infrastructure – such as roads and other public works – make a fuller contribution. Indeed, this may be preferable to financing this expenditure through general taxation or borrowing.

Of course, there are some caveats and concerns. For a start, someone would have to work out what each individual holding of land is worth. It is one thing for national statisticians to come up with an estimate for total UK wealth, quite another for a local assessor to come up with a specific figure that may well be challenged.

Taxes on income or transactions are based on values determined in the market, which may not always be possible in the case of an LVT. However, many countries do operate some form of LVT, so the problems here are not insurmountable.

There may also be issues of fairness, which mean that an LVT can only be phased in over a lengthy period, if it is to apply generally. Otherwise, people who happen to own land could be hit with a large and unanticipated bill. It is certainly unrealistic to expect an LVT to replace all or many other taxes any time soon, which is what some of its keenest supporters are suggesting. Even the three property-related taxes noted earlier only account for around £75 billion out of the total UK tax take of £693 billion.

Finally, there is a danger that the introduction of any new tax is either used as an excuse to raise the overall burden of taxation, or to indulge in wasteful public-sector infrastructure projects that have limited value, or both. This suggests that any LVT should be revenue-neutral, at worst – with offsetting reductions in other taxes, including capital gains tax on property, as well as stamp duty, business rates and council tax.

The hurdle for assuming that a project can or should be financed by an LVT should also be set very high. The could partly be done by making it a purely local tax. All the revenue would then stay in the local area, ensuring that councils benefit from the planning gain resulting from improved infrastructure, housing, retail development and office space. If the local councils were also on the hook for the cost of the project, the increased devolution of both risk and reward should strengthen fiscal responsibility and deliver better outcomes.

So while LVT could be the answer to our housing woes, as ever, the devil would be in the detail.

Julian Jessop is chief economist at the IEA