Housing crisis? What housing crisis?

Mark Wadsworth works as a tax advisor and is interested in tax, welfare and land reform, as well as being the treasurer of the Young People’s Party UK. Here, he gives his take on how a land value tax could help solve Britain’s housing crisisMark Wadsworth Headshot

It would be foolish to describe the current situation in the UK housing market as a “crisis,” as this suggests some unforeseen events which suddenly come to a head and which the government has to deal with urgently.

Far from it, the state of the housing market is the inevitable result of quite deliberate changes in UK government policy over the last thirty years or so, which we are feeling the full impact of now.

Government policies

If we go back to the period between 1945 and the 1980s, what is remarkable is the rate at which owner-occupation levels increased. The share of owner-occupier households rose from 30% to 60%; the proportion of social tenants increased from 20% to 30% and – in a development which has received much less attention – the share of households renting privately fell from 50% to 10%.

The spread of owner-occupation is often perceived to have created a more equitable distribution of wealth, but as we will see, this trend did not happen by accident: it was the direct result of policies which were intended to reduce the concentration of wealth – it was the effect and not the cause.

And although the 18-year boom bust cycle was not completely suppressed, the house price bubbles in the early 1950s and early 1970s and even the late 1980s were relatively short lived affairs and bank lending/mortgage borrowing was never allowed to reach dangerous levels, so none of these earlier bubbles resulted in the massive banking ”crisis” which has persisted since 2008.

So what was the government doing during that earlier period? Why did this lead to a more equitable distribution of wealth? How was the house price and banking boom-bust cycle dampened? Why did the level of owner-occupation grow so rapidly (even before the last short term boost of the 1980s council house sell-offs)?

There was an overall package of policies as follows:

1. Since 1918, the government had been controlling rents through a variety of rent acts. Landlords could not collect all of the location value, so by definition it went to those people actually living and working in an area who could enjoy ‘for free’ the location value they helped create because of the discount from what the unregulated rent would be.

2. If the regulated rent is only half the unregulated rent, then clearly, the amount which landlords are prepared to offer to buy a home is only half what it otherwise would be, making it much easier for first time buyers to compete. Buy-to-let lending was virtually unheard of, and until 2000 or thereabouts, banks required larger deposits from landlords and charged them higher interest rates compared to owner-occupiers.

3. Rent controls are a blunt tool, so the government also increased the stock of social housing, which made it available relatively easily and at very affordable rents. Historically, social housing has always made a slight profit in cash terms for the government; even though the rents were less than private sector rents, the rents collected were more than enough to pay interest and running costs. And until the council house sell-offs, there was no need for Housing Benefit, another huge saving to the taxpayer.

4. To prevent credit bubbles arising and to prevent first-time buyers entering into a borrowing arms race (and bidding land prices back up to their unregulated value), there were mortgage restrictions. Buyers were expected to pay larger deposits and mortgages were effectively capped at twice the main borrower’s income – until the 1980s, the average loan-to-income multiple was only two.

5. Clearly, neither rent controls nor mortgage restrictions would prevent homes in the more expensive areas being sold to the cash rich for their unregulated value, so we had Schedule A taxation of notional rental income (until 1964) and Domestic Rates (until 1989) which were highly progressive – the tax on the most valuable homes was a hundred times as much as on the cheapest.

6. Until the 1970s, we were building 250,000 – 300,000 homes per year. For the reasons explained, these were not snapped up by landlords, they were sold to owner-occupiers who paid much less for them than in today’s unregulated market.

7. Also worth a mention is that rental income was taxed at higher rates than earned income.

There was some watering down of this package even in the 1970s, but Thatcher and then Blair-Brown completely dismantled every bit of it in the 1980s and 1990s.

  • Rents have been rising faster than wages since the 1988 Housing Act ended rent controls and reduced security for tenants.
  • Rental income is now taxed at half the rate applying to earned income (no National Insurance).
  • There has also been a cultural shift by banks, which now view buy-to-let landlords as a better credit risk than first-time buyers. So landlords have flooded back into the market, because they can borrow more, pay more and leverage up the equity in the homes they already own. As a result, the number of households renting privately has doubled since the early 1990s – from an all time low of 9% back up to 18%.
  • Broadly speaking, people will take out a mortgage if the monthly cost is not significantly higher than the equivalent rent, but if rents are allowed to double, and then the amount which people are prepared to pay for a home will double. Add to that the interest subsidies which the government offer banks (Funding for lending, Help to buy) and inevitably house prices will double.
  • Banks will lend people as much as they are willing to borrow – the average loan-to-income ratio for new mortgages today is nearly three-and-a-half time, and 15% of borrowers owe four-and-a-half times their income.
  • So not only does the vendor make a big windfall gain compared to what he paid for his home under the old system, the banks are collecting a much larger share of location values (disguised as mortgage interest) than they did until the early 1990s.
  • Domestic Rates was replaced by the short-lived Poll Tax and then the Council Tax, which is basically a Poll Tax but dressed up a bit, so more valuable homes can be sold for much higher prices, because the new Council Tax bill was only a small fraction of the old Domestic Rates bill.
  • For crude political reasons, Thatcher and Blair sold off the nicest third of social housing, much of which is now being rented out again, often to Housing Benefit claimants.
  • NIMBYism is the order of the day, so we now have a larger population, but new construction dropped by half in the 1970s and has stayed low ever since (an average of 150,000 new homes per year).

So it is any surprise that those born in 1970 or later are more or less shut out of owner-occupation; they are doomed to either pay ever rising rents or take out a crippling mortgage which will take them decades to pay off, as against the ten years which was normal thirty or forty years ago?

Most sickening of all is that the Baby Boomers have conveniently forgotten all this;, they genuinely believe that they are somehow morally superior because they ‘rolled up their sleeves and paid off the mortgage’. They are blind to the fact that they could buy their first home for a price that was only half the regulated price, and they did not even pay off their mortgages out of taxed income – their interest payments were subsidized via a scheme called Mortgage Interest Relief at Source (MIRAS), so a large chunk was paid out of untaxed income.

The unearned capital gains they think they have earned are merely the direct result of the abolition of all the old regulations designed to redistribute the location value in an equitable fashion. The wealth that they have accumulated was handed to them on a plate; they bought at a time when the government kept rents and house prices low and are selling at a time when the government has allowed rents and house prices to skyrocket.

Speaking on behalf of the Young People’s Party, reintroducing the old system of rent and mortgage caps, building more social housing etc would be a good step forwards, but in terms of ensuring an even fairer distribution of location values and hence wealth, there is an even better policy – which is to reduce taxes on earnings and output and to increase taxes on location values instead.

Calculations suggest that if we moved half the tax burden off earnings and output and onto land values, young working households would be £10,000 a year better off. Such a tax system could easily be run in conjunction with rent and mortgage caps, so this is not an either-or choice.

Posted on: 1 July, 2014

9 thoughts on “Housing crisis? What housing crisis?

  1. VJA

    This a pretty simplistic approach to a very serious problem and frankly you can start the conversation wherever you happen to be standing within the argument.
    I don’t wish to take sides but explore a more engaging set of actions.
    These can include a number of headings such as:
    Population growth
    Immigration
    Continued building
    Use of existing building stock
    Use of brown field sites
    Planning the future
    Enabling people to make sound decisions for the long term
    Pay
    What and how to build our future towns and cities
    I could go on but one solution fits all is just a bunch of words and to engage you have to expand your thinking. I like your sub heading fairness for suture generations its a great header but now build your logic

    1. benj

      2011 census confirmed that we have more dwellings per capita than ever. London and the SE included.

      http://www.conservativehome.com/thecolumnists/2012/12/andrew-lilico-the-2011-census-data-confirm-once-and-for-all-that-the-notion-of-a-housing-shortage-in.html

      New house building has broadly kept pace with increased population and household formation.

      If you do manage to supply more homes where demand is highest, due to the effects of agglomeration, GDP and therefore land rents rise. Which is why rental values(and therefore HP’s) are highest in the biggest cities in the World.

      If you supply homes where demand is low, this causes even more deadweight losses (allocational inefficiency) than we have now. Yes aggregate HP’s may fall, but this is a pretty banal approach. It will do nothing much in terms of real affordability.

      For housing to become more affordable, it has to do so as a ratio of discretionary income. So, if people are £10,000 better of in their pocket, that achieves far more in terms of affordability than any amount of building ever could.

      And, on top of that, you can factor in a reduction in HP’s, and better use of what property resources we’ve already got. Like the 25 million empty spare rooms for example.

      If we did have a LVT, it’s unlikely we’d need to build a single new home on green field sites for the foreseeable future.

  2. GNNMartin

    A good article, but I would like to add a few points.

    One important mechanism that drives the increase of house prices in selected areas is the desire for a store of value. This has become a major force in the last few years as the ability to earn a yield on wealth has decreased and the amount of wealth owned by people who merely want to preserve that wealth has increased. It does not matter if people buy gold as a store of wealth; it does not matter much matter if people buy works of art or jewellery; but it does matter if people buy commodities or land or housing simply as a store of value.

    The problem of expensive housing is particularly hard to address because the pain caused by falling house prices is disproportionate. The result is that many of the proposed ways to address the high cost of housing promote ways of helping people to afford the house, rather than finding ways to drive down the cost. Helping people afford the high cost of housing removes one of the few brakes on the rate of increase.

    Those proposals that do seek to decrease the cost of housing do not acknowledge the social or economic cost involved. Attempts at shared ownership and such like are simply a one off assistance for the first buyer. Builders do not want to build houses for the poor, or even for the not particularly well off, because those people cannot afford the result: they build for the wealthy. Releasing more land for building will not significantly drive down the cost of housing, and if it did, the effect on building societies, banks, and individuals who had bought at the peak would be so great that the policy would be quickly reversed or throttled by some balancing legislation. We need to recognise that prices must fall, that the fall will damage society in the short term, and that we need to plan to mitigate that damage where possible.

    Part of the problem is that the relationship between lenders and borrowers puts all the power into the hands of the lenders. I would like to see the lenders shoulder more of the risk: this would be a better way of making them cautious than legislating for how they should diminish their risk. I would like to see a return of the perpetual fixed interest mortgage, or the introduction of the USA style non-recourse mortgage, but that it probably too much to hope for. At least the lenders should be required to guarantee that repayments need not rise by more than some fixed small percent above inflation. At the moment, if interest rates rose to 10% people who bought in the last 10 years on a mortgage they could just afford would be unable to keep their house. I suggest the lender should be able to increase the interest rate, but the householder should have the right to roll up the extra interest payment as capital, perhaps paying a slightly higher rate of interest rate on rolled up interest. I also suggest that any repossession should be offered to the local council for council housing, so that a defaulting borrower can remain housed as a council tenant. Both those proposals would need careful wording to prevent unintended behaviour.

    I strongly agree that property should be taxed. I’m sorry that it has been promoted as a mansion tax, because the tax needs to be applied right the way down the value chain. I also strongly advocate capital gains tax on all property gains. Both these will cause difficulties over valuing existing houses, but the householder’s interest will be in arguing for a high current value for capital gains tax purposes and a low current value for property tax purposes, so if the two schemes are introduced together then it may be possible to greatly reduce disputes of value in domestic property. The particular difficulty faced by people who bought their property in an area where prices have since risen enormously could be addressed by allowing them to roll up most of the tax as a government mortgage on the property.

    I disagree that MIRAS was a distortion or a tax subsidy. In business, interest payments are allowed against profit, so it is a distortion to say that interest on domestic mortgages can not be allowed against profit. The distortion comes because the ‘profit’ of owning your own house is not recognised. There is no schedule A or equivalent, and no capital gains tax. I do not actively advocate the return of MIRAS, but if taxation of property is adjusted appropriately, MIRAS or some equivalent might be appropriate.

    There has always been a tension between the need for the state to provide for its poorest citizens and the desire to control the increasing power of the state. Councils attempted to sell off council housing before Margret Thatcher forced them to do so at bargain prices and prevented them from investing the proceeds in more council housing. Selling off council housing cheaply has been a decision more disastrous than Gordon Brown selling the UK’s gold reserves: at least we don’t need the gold though it would be nice to have stored and not spent the value held therein since that value has soared. But we do need the council housing, we still feel obliged to house the poor, so we not only sold the asset cheaply but we are obliged to buy (or rent) it back now the value has soared. According to Inside Housing John East, director of commissioning at Newham Council, told delegates at the Chartered Institute of Housing conference in Manchester on June 24 that more than half of the council houses sold in Newnam are not in owner occupation. I cannot offer proof, but I suspect many of the tenants of those rented out receive assistance with the rent.

    Reference to Inside Housing: http://tinyurl.com/nzuc56k

  3. benj

    It would be interesting if the IF forwarded this article to David Willetts MP(author of The Pinch) , and published his response.

  4. philip ross

    I like the article as it does address head on the issue of a location tax. When an area improves because the actions of residents or even public investment, it should the people that live there that benefit, not the landlords.

    It is a key garden city principle and needs to be included in what is defined as a garden city.

  5. AW1983

    An excellent critique Mark and I certainly know plenty of baby boomers who prefer to pat themselves on the back than acknowledge the problems faced by their children. As a generation known to include a large cohort of individualists (some may even say narcissists) I guess this is more palatable to their world view.

    I guess the question is whether they will feel quite so smug when they’re sitting amongst elderly strangers in an understaffed care home, having lost their asset to pay the nursing bills and getting no visitors because their children couldn’t afford to live in Britain anymore and decided to emigrate for a better life. My wife and I have lived abroad before and we’ll do it again; we have no intention of stretching ourselves financially to live somewhere that salaries are low and tax and house prices are not only high but discriminate against the young. There are plenty of better opportunities out there.

  6. kar

    This is very similar to US baby boomers benefitting so much from govt policies – interstate highway system that opened up cheap land in suburbs, cheap public education, high wages from unions – even a simple High School graduate could easily raise a family of 4 or 5 on his salary alone, buy a nice house, get a nice secure pension, send his kids to cheap schools. But then with Reagan these same “lunch pail” “Reagan Democrats” (white working class middle class) turned on the govt that create most of this wealth for them and criticize younger generation for debt (due to high price of housing, high price of education, high price health care) and criticize them for use of food stamps/rent subsidies/unemployment insurance because they can no longer make a living wage from ordinary working class jobs.

  7. Tim Lund

    It’s only the headline I disagree with, suggesting that there isn’t a housing crisis, just a problem with intergenerational and other inter-sectoral distribution.

    Just one sentence on supply:

    • NIMBYism is the order of the day, so we now have a larger population, but new construction dropped by half in the 1970s and has stayed low ever since (an average of 150,000 new homes per year).

    Fair point, but if a fairer tax system meant that “young working households would be £10,000 a year better off”, where would that money end up? I’d suggest most would find its way to existing property owners where such households are already looking to live – e.g. London, closer to the centre the better, but excluding the super-rich ghettos of Kensington & Chelsea – see postings here on my local Forum:

    Why is housing such a luxury and

    Under occupied housing in London

    1. benj

      That’s £10,000 better in their pocket, so not going anywhere.

      Additionally, a 3.5% charge on property would at the very least keep a lid on HP’s increases. If land rents are always collected at 100% of their value, the selling price of land should theoretically fall to zero.

      This would mean a drop of 66% on average in HP’s.

      So a first time buyer would on average be paying around £7,000 less per year in mortgage payments.

      So £10,000 + £7,000 better off.

      And on top of that, you have the reduction in deadweight costs. Reckoned by some economists to be 48% GDP.

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