Housing – the persistent problem
HOUSING — THE PERSISTENT PROBLEM
A DISCUSSION PAPER
This paper, which was originally written in March 2000, has been revised in the light of subsequent events. It describes how land value taxation would affect and ameliorate some aspects of the housing market and the problems associated with its present mode of operation and is here reissued because the essential issues remain unchanged; indeed, recent upheavals serve only to confirm the need for the reforms proposed.
It will be evident that the introduction of land value taxation would have a fundamental effect on the working of the housing market and its associated problems, which include:-
1.The interaction between the housing market and the general economy.
2.Continuing demand for additional housing land and consequent loss of countryside.
3.The cost of housing.
4.The poor state of repair of a substantial proportion of the housing stock.
The interaction between the housing market and the economy as a whole can be seen by its behaviour since 1945. House prices rose slowly but steadily from 1945 until the mid-1960s. At that time, the main means of housing finance were through building societies, whose lending was restricted to a small multiple of savers’ deposits, the amount lent being a fixed multiple, around 2.5 times, of a single salary, and no more that 80% of the value of the house could be borrowed. Around 1965, in an attempt to make house purchase easier, it became customary to lend on the basis of two salaries. The effect was to channel more money into the housing market, and this must have been one of the factors that led to a greater rate of the price increase. House prices nearly doubled between 1960 and 1970 culminating in a round of panic buying in 1971-1972, followed by a slump. There followed a period of high inflation; by 1980, the purchasing power of money had fallen to 41% of its 1974 value. This allowed a period of “catch-up” in which money prices of houses held steady until the late 1970s, grew slightly and levelled off around 1983.
From then on, house prices tracked the 1980s boom, and there was a further round of panic buying in 1988, fuelled in part by the Chancellor’s decision to restrict mortgage interest tax relief to a single earner in a household. There followed the 1989-1993 collapse, which caused well-publicised and serious problems. This time, stricter fiscal policies were in force. House owners could not be saved by inflation and they found themselves with “negative equity”; the Bank of England Review for August 1992 reported that there were about 876,000 households with mortgage debts which exceeded the value of their property. Where house purchasers lost their jobs and were forced to sell, they were left with no homes and an outstanding debt to the building society.
The result of this fall in house prices was a general fall in activity in the housing market as a whole, because no-one willingly sells at a loss. This had a widespread and adverse effect on industries such as furniture, domestic appliances and building products, because most people embark on home improvements and furniture purchases shortly after they have moved house. And the stability of the whole financial system was threatened by the amount of money loaned by the financial institutions on the security of property values that no longer existed.
After 1996, house prices rose steadily once more, especially in South-East England on an accelerating trend, peaking in August 2007. This was encouraged by several factors. People were encouraged to buy-to-let. Houses were promoted as a way of securing a pension. Interest rates were low and there was an extremely free approach to lending. One building society, Northern Rock, was lending up to 125% of a property’s valuation and people could borrow five times their annual salary. Lenders were not too particular about borrowers’ ability to repay. House prices were rising which, it was thought, provided good collateral for the loans. It was not appreciated that the rise in prices was itself driven by the free lending policy. People saw prices soaring and were anxious to get onto the housing ladder while they could They anticipated the future profits with glee. House purchase turned into a national craze. Anxious commentators watching the spiralling prices talked about a soft landing, but the come-down was to be anything but.
Funds had been made more readily available by new financial techniques developed in the US. Good and bad loans were packaged up into bonds in a process known as “securitisation”, and these bonds were sold on to banks, which considered them as assets. This was not a process that could continue indefinitely, and in the summer of 2007, it duly came to an end in what was termed the “sub-prime” mortgage crisis. This led to the Northern Rock bank crisis, which was resolved by nationalisation. But it was no resolution and signalled the beginning of a crash. The banks realised that the “securities” they had purchased were of dubious worth. In short, the effect has been to severely restrict the supply of funds available to lend for house purchase; this was the so-called “credit crunch”. But at their peak, house prices were about 25% higher than the amount that would need to be invested in a bank account to produce in interest the same as could be earned from renting the property. This is a good measure of the extent to which house prices had bubbled up.
At the time of writing (September 2008), house prices have fallen by about 14% in the 12 months since they reached their peak. The situation is changing almost daily with events and the government’s responses.
NEVER ENOUGH HOUSES
Will we ever be able to build enough houses? During the housing boom of the mid-1980s, it was widely claimed that the housing problem was caused by planning restriction. Would more relaxed planning policies ease matters? A repeated claim during the period of the Labour administration has been the need for so-called “affordable housing”. The government set up a commission under economist Kate Barker to examine the whole issue. The result was a proposal for a “planning gain supplement” (PGS), similar to the three failed attempts at levying development charges since 1945. Despite opposition, the government went ahead with the PGS, only to withdraw it at the last moment, to be replaced by a so-called “roof tax”, a flat-rate charge on development to contribute towards the cost of infrastructure. Now there are proposals for new towns composed of “sustainable development”. But given the shortage of finance, all proposals are shelved.
It is important to recognise that there is no such thing as the “right amount of housing”. The demand for housing is always fluid; people will spread themselves out if they can afford to. It is driven by social factors such as household size; some young people stay at home, others move out and share, and others again want a place of their own. Demographic trends, notably, the increasing proportion of older people and the growing incidence of divorce, are creating a demand for more, smaller homes. The growth in home working is also affecting the housing market as people set aside space for use as an office, whilst another change is the tendency for some immigrant groups to produce large families – a contrary trend leading to a demand for multi‑bedroomed accommodation.
The housing also needs to be in the right place, which is where employment exists. Britain has a particular problem of undue concentration of population. 80% of the population of the United Kingdom live to the south and east of a line drawn to include Liverpool, Manchester and Leeds, Birmingham, Bristol and Poole, little more than one-third of the land area. To some extent, this is a natural consequence of geographical advantage and disadvantage, but the effect is aggravated by the tax system which takes no account of geographical factors and tends to push businesses at poor locations below the margin and into non-viability.
The implication is that a policy of just building more houses is of little use. Any development needs to be take place within an overall framework in which land is made available for other uses such as business and industry, schools, recreational amenities, together with the necessary supporting infrastructure of transport and social facilities.
Vacant housing
In the period up to 2005, there were about 700,000 vacant dwellings in England alone. But there may be good reasons for such vacancies: the occupant may have died recently or gone into a care home, the owner may have moved to take up a new job, and in the case of the public sector, the property may be unattractive to a tenant reliable enough to be acceptable to the local authority. Some vacancies are due to inertia, for example, when repairs are needed before the dwelling is re-occupied. But increasingly, properties have been bought in the expectation that their value will go up and the owners have no intention of finding someone to occupy them.
Brown-field development
This is the generic term for development on sites where housing and industry has stood previously, as opposed to “green field” sites.
Brown-field sites are nearly always problematic. If they have been previously occupied by industry, they may be contaminated with toxic wastes. The ground itself may be unstable, requiring costly foundations. Access may be difficult and the shape and size of the site may add significantly to the cost of the development, especially if this precludes economies of scale. Often, such sites are located in areas of social deprivation or in unattractive environments. For these reasons, housing developments in such locations may be unpopular both with developers and prospective purchasers. Of course, not all brown-field sites are undesirable, but the considerations mentioned must be regarded as a major obstacle to this kind of residential development.
Green field development
Developers favour green field sites. The construction process is simplified and there are advantages in economies of scale. Such developments are normally in urban-edge or rural locations and purchasers generally appreciate the advantages of space, a open prospect and a perceived freedom from the problems of inner-city life. On the other hand, existing residents resent the intrusion and consequent loss of their rural prospect, as may those from the towns who use the countryside for recreation. And the growth of green-field development imposes other costs on the community at large; as the population becomes more spread-out, there is increasing dependency on cars, leading to a growth in traffic and pressure for the construction of new roads and for improvements to increase the capacity of existing roads.
The re-location of populations also imposes costs through the need to provide a range of ancillary services ranging from schools and libraries to sewage treatment works, though small developments in villages tend to sustain threatened village schools, post offices, local stores, local police stations, and the like.
THE COST OF HOUSING
Housing costs will always tend to rise to the maximum that people are willing to pay, where “willingness to pay” is a matter of social attitudes and subject to change. But it is not the cost of houses that is so variable. Building costs are quite stable, as can be ascertained from, the RICS Building Cost Index. What varies sharply is the price of land. This important point is usually lost sight of.
From the 1960s, an increasing number of married women went out to work, providing households with two incomes, and the building societies acknowledged this trend in their lending policy. This meant that people could afford to pay more for their housing, and house prices rose accordingly; this was undoubtedly an important factor in the rise in house prices (in reality the price of housing land) that took place around 1968-1972. The lending policy of banks and building societies towards house-purchasers has been an important factor in determining house prices; in the 1960s, lenders restricted borrowers to loans of no more than 80% of the value of the property and 2.5 times the borrowers income; for the past ten years up to 2007, restrictions were been relaxed and this too shunted funds into housing, driving up prices. After the so-called “credit crunch” in late 2007, finance for house purchase became scarce. Prices fell at the rate of about 1% a month, a process that continues at the time of writing.
In the low-cost rented sector, the situation has been somewhat different. Subsidised public sector rents have been replaced by a system of means-tested housing benefits available to tenants in both public-sector and privately owned accommodation. The availability of additional funds has revived the market in private renting but by directing funds into housing, it stoked-up rents which in consequence rose inexorably, a trend which was somewhat checked by restrictions in the amount of benefit that may be paid, especially to young, single people.
One of the problems caused by this system is that means-tested housing benefit constitutes an important component of the “poverty trap”, the effect of which is that many people are better-off when unemployed and receiving benefit than when working for low pay. This has affected the wider economy; people will not accept low-paid jobs in the “white economy” and, indeed, could not afford to take them, resulting in unemployment levels that are higher than would otherwise be the case.
DISREPAIR OF HOUSING
A substantial proportion of the British housing stock is in a poor state of repair. Quantitatively, this is a matter of how “poor state of repair” is defined, and there is nothing new about this state of affairs. An important element here is that public sector housing constructed in the period from 1945 to 1980 embodied novel design features, novel materials and novel methods of construction. Worse still, construction was subject to stringent capital cost limits with no attention being paid to whole-life costs. A further issue is that the design of many of public sector developments proved troublesome and ultimately unacceptable to occupants; some were demolished and redeveloped – sometimes, ironically, to the original Victorian street layout that was obliterated when the estates was built.
Disrepair in the private sector comes in two forms. There are poorer owner-occupiers who find it difficult to keep their homes in good order, and a body of absentee landlords with few resources and little incentive to do anything other than a bare minimum of repairs.
The problem is exacerbated by the structure of the building industry, where skilled and responsible craftsmen are scarce. To some extent, this is a product of the tax system, which is one of the factors that has helped to end the practice of training by apprenticeship, because labour-related taxes, including PAYE income tax and National Insurance Contributions, all nominally paid by the employee, are in practice a burden on employers and make it uneconomic to employ marginal labour such as school leavers with no experience. A further problem caused by VAT, Income Tax, and the NIC, is the almost universal use in the building industry of sub-contract labour as a means of tax avoidance and evasion, again leading to declining standards of responsibility and competence as the so-called “black economy” has burgeoned.
For those wishing to employ builders working in the official economy, tax is an obstacle in another way. Value Added Tax is a direct tax on building repairs and materials, and, as suggested above, matters are even worse than this, because the home owner employing a builder is also effectively paying the income tax and national insurance contributions of the builders employees; for every pound paid to the builder, over 30p goes directly in tax.
DISCUSSION
Taxation and housing
In addition to the relation between taxation and repairs described above, tax policy has been one of the most important issues in housing for the past 45 years, effectively turning home ownership into a form of tax haven.
Before 1963, owner-occupiers were subject to what was known as “Schedule A” tax. The theory behind this tax was that living in ones own home was equivalent to receiving income in kind, this being the rent that would otherwise have to be paid. This notional rent was regarded as “imputed income” and considered taxable. The rental values used were the same assessments as had applied for local authority and water rates, but since no valuation had been carried out since before the Second World War, the assessments were a fraction of the true rental values. Mortgage interest relief was treated as an expense to be set against this imputed income.
In 1963, the Schedule A tax was abolished but the interest relief remained, putting housing in an exceptionally favourable position in relation to other investments. The privileged status of owner-occupied housing was further enhanced because it was not made subject to Capital Gains Tax when that tax was introduced. These two measures increased the effective demand for housing, while doing nothing for the supply. The result was to divert personal savings into houses rather than other investments such as equities, whilst, at the same time, helping to bid up house prices generally. Inflation was an additional factor attracting funds into home ownership, because the family home came to be regarded as the average mans safest hedge against inflation.
Development and improvement discouraged
Perversely, whilst sucking funds into house purchase, the tax system discourages the construction, improvement and maintenance of housing. We have already seen how VAT and labour-related taxes drive up the cost of repair when builders are employed legally and “on the books”. Under the former Schedule A tax and the local authority rating system, as well as the present Council Tax, nothing was payable on a derelict site or building, whilst a well-appointed modern property in good condition was assessed at its full value. Planning Gain, together with the requirement for providing a proportion of “affordable housing” in new developments, also discourage development. The same would have applied to the “Planning Gain Supplement”, now abandoned, and to the so-called “roof tax”, which seems likely to go ahead.
The tax system is equally defective in promoting the smooth operation of the housing market. The absence of any tax on vacant land encourages land hoarding and speculation; the extent of this problem indicates a fundamental defect in the property market. Land prices do not fall to market clearing levels and if market conditions are unfavourable, sites with planning permission are often withheld in the hope of an “improvement” ie. higher prices. The Council Tax, if anything, aggravates the housing shortage; with a rebate of 25% for single person households, which can only encourage under-occupation. Any government that was serious about alleviating the housing problem, would take the view that since no-one is forced to leave their property empty, except perhaps for short periods, for example, after the death of a former occupant, there is no reason why the rest of the community should subsidise this essentially voluntary waste of resources.
A further obstacle to the smooth working of the housing market is Stamp Duty Land Tax and other transaction costs, which encourage people to hold on to property long after it has ceased to satisfy their requirement. Older people might be more willing to move into more appropriate accommodation if the costs of a move were lower, which would release under-occupied houses for families.
Regional imbalance
Regional imbalance is also aggravated by the tax system, as mentioned earlier. Some parts of the country enjoy geographical advantages over others. This is mostly a matter of local resources, communications and accessibility to markets. In general, this favours London and the South East of England, as opposed to the North East, the North West, and Scotland (except on the east coast around Aberdeen opposite the oil fields); these latter regions can be considered as marginal locations. The tax system, however, takes no account of geographical advantage and thus the same rates of tax are payable throughout the United Kingdom. In Scotland, Wales, and Northern Ireland, tax and productivity/geographical disadvantage is, to some extent, offset by higher levels of public expenditure, which is 23% higher per head in Scotland than in England. In spite of this, the overall result is that people migrate, for economic reasons, into the most densely populated part of the country, driving up house prices and adding to the pressure for new development.
HOW LAND VALUE TAXATION WOULD ALLEVIATE THE HOUSING PROBLEM
Houses are, in one respect, unlike all other forms of property. Although a house is a man-made construction, its value derives partly from its location; identical houses may differ widely in value according to where they are situated, and this difference is the difference in the value of the plot of land each stands upon. It is possible, conceptually, to imagine the bricks and mortar separated from the site they stand on; the property would have a value even if the building burnt down. Since the value of the bricks and mortar are much the same anywhere, and related to current building costs, the residue of the total value of the property is the value of the location – the land itself. Now the value of land is sustained by the community at large; land values are established by the infrastructure, the utilities, the proximity of employment, schools, parks and the general attractiveness of the area. All of these things are provided either on private initiatives or by the public bodies who provide services paid for out of taxation, such as the highways, schools, police and fire services.
Thus, house ownership has a dual quality. Bricks and mortar are in the nature of a personal possession, and akin to, for example, articles of clothing a lawnmower, or the car in the garage or on the driveway. But as land owner, a house owner effectively appropriates a “public good”, the value of which can either be enjoyed personally, or sold on or leased. Moreover, what we think of as a boom or slump in property prices is, strictly speaking, a boom or slump in land prices. This is no fine distinction, and a recognition of the dynamics of the land market are vital to understanding the housing problem. Land value taxation would alleviate this, especially since it can and must be accompanied by substantial reduction on other taxes.
It would operate as a property tax, being an annual charge on an assessed valuation. In this respect, it would be similar to the former rating system, but with an important difference: the valuation would be that of the site alone, regardless of whether the site was developed or not, or any buildings occupied. Thus, all land allocated for housing would be subject to the tax, and the liability to the tax would result in a reduction in the selling price.
There are many ways in which the tax might be introduced. It might initially, replace the Council Tax, with subsequent increases being accompanied by cuts in other taxes, for example, by raising income tax thresholds. Provided that the tax rate was sufficiently high, the introduction of land value tax would have beneficial effects, by acting as a holding charge. Land hoarding and holding of property vacant would be discouraged, as owners would have to bring sites forward for development and into occupation in order to pay their tax liabilities. The imposition of site value taxation would, for the first time, create competition between landlords, since the option of leaving property empty would be far more costly than it is at present. This competition would bring about a reduction in rents and house prices, together with an improvement in standards. The tax would be a move towards equality of treatment between owners and tenants, reducing the relatively privileged position of the former. Landlords would no longer be negotiating from a position of strength but would be in the same position as any other tradesmen in respect of their customers. By altering the balance of market conditions to create a plentiful supply of low cost accommodation, site value taxation should make it possible to abolish rent controls where these still exist. There is no need for rent control because landlords would take care not to ask their tenants to pay more than they could afford; if the tenants went, then the landlord would pick up the land value tax bill.
Land value taxation would also reduce the intensity of boom-slump cycles and, at a sufficiently high rate, would virtually eliminate them. This is because, a rising land market acts as a bandwagon as people rush to buy, thinking either to make a profit or fearful that prices will rise so high that they will not be able to afford to purchase. In effect, it corresponds to what in a physical system would be described as “positive feedback”; prices are subject to runaway growth, the growth phase ending when purchasers are no longer forthcoming at the bloated prices. The market then stalls and falls back, leading to sluggish trading conditions. The “credit crunch” beginning in the summer of 2007, and the events that led up to it, are a classic example of such a boom-bust event. Land value taxation would provide a measure of “negative feedback”, thereby stabilising the market, because rising values would be reflected in rising assessments and rising tax liabilities for land holding. As long as the rate of land value taxation was sufficiently high, no-one would purchase or hold more land then they required for their immediate purposes, thereby eliminating the element of speculative froth from land pricing.
Further benefits would accrue from the reduction in existing taxes that the introduction of land value taxation would permit. A reduction in labour-related taxes and VAT would reduce the cost of construction and repairs, and might even make it possible to revise some form of apprenticeship training, thereby improving the quality of building workers’ skills.
The other effect would be a reduction in regional imbalance. Geographical advantage is reflected in land values, which are higher in prosperous areas than those less favoured. Land value taxation would thus be directly related to geographical advantage, and in general, the replacement of existing taxes by land value taxation would work to the benefit of those in marginal areas who would be relieved of a burden of taxation that is frequently unsupportable. The present system of regional grants and subsidies tacitly acknowledges this state of affairs already. Land value taxation would reduce the need for grants and subsidies by not removing resources from marginal parts of the country in the first place. LVT creates tax havens precisely where they are most needed. In the long term, this would help to regenerate the economies of the less prosperous regions, stemming the migration of population and reducing the pressure for housing in London and the South-East.
CONCLUSION
The substantial replacement of existing taxes by land value taxation would stabilise the housing market, encourage the use of vacant land and under-used buildings, alleviate regional imbalance and dampen the boom-slump cycles which have characterised and plagued the property market for the past twenty-five years.
One of the reasons why housing policies have consistently failed is because the housing problem is not recognised as a land market problem. The mere habit of referring to the problem as a “housing problem” perpetuates the misunderstanding. Other than temporarily, there has rarely been a shortage of building materials or of the labour needed to construct a house. The bottleneck is in the supply of land. Not only could the housing problem be greatly alleviated by the partial or entire replacement of existing taxes by land value taxation; in the absence of land value taxation, no solution is possible.
October 2008