The £7 Trillion game of property Craps
Benjamin Franklin once famously penned, “in this world nothing can be said to be certain, except death and taxes” and probably no more fitting at the present time during a pandemic where everyone faces one or the other by the time this is all over. Death or higher taxes that is.
The Chancellor would have spent much of the last nine months laying awake at night considering how he was going to fill the current £300bn hole that has appeared in the public finances, and significant tax rises will play the greatest contribution, spending cuts less so.
Unfortunately for stakeholders, property wealth is an obvious starting point for Mr Sunak when you consider the enormous sums involved. The ONS puts the UKs net wealth at £9.8 trillion, with land accounting for £5 trillion (51%) and housing £1.8 trillion (18%). Let’s call it £7 trillion, as these numbers are over a year old. Very large low hanging fruit. It would seem an obvious place to start to generate some much-needed tax receipts, but the Treasury should, tread very carefully. Ultimately though it will be a roll of the dice to start with, and then perhaps a swift second or third roll until the right combination is found.
I remember once in my informative Directorial years, I was discussing salary models with a past mentor and he rightly told me that “salary breeds behaviour” and followed up with several what if scenarios to illustrate his point. The housing market is no different but its activity according to Oxford economics accounts for 8.6% of GDP. As I write, the GDP of the UK is currently 8.2% lower than before the lockdown in March, so that provides some context to how big 8% is when you consider the economic shockwave that fall produced.
So, 8% is a big deal, hence the Chancellors’ gamble with his throw of the dice is to raise property taxes but without reducing that vital economic activity that the housing market produces, and the jobs in the supply chains that it protects. He is well aware of this though, hence in early July he introduced the current stamp duty window. Not to save buyers money as presented, it will have done the complete opposite in fact, but the frenzied activity they created rushing out to claim this perceived saving protected millions of jobs and produced hundreds of millions in tax receipts, or in other words increased our GDP.
Like my salary model though, this is where the jeopardy lies. Property tax is the dimmer switch of the housing market, it is that controllable and that instant. Raise taxes, behaviour changes instantly. Decrease taxes behaviour changes instantly. Leave taxes unchanged, behaviour remains unchanged. Look at the stamp duty increase in 2016. Look at the current stamp duty holiday; records of activity being broken everywhere you look in spite of a dire economic backdrop that you would think would have people hiding under their beds.
So, this is a risk reward venture of generating higher tax receipts without the prospect of reducing the volume of tax receipts at the same time and it is important to understand that a higher rate of tax does not automatically mean higher tax receipts as socialists, who are forever demanding higher taxes on the middle classes, simply fail to understand.
Higher taxes lead to the changes in behaviour not only in terms of economic activity but also in terms of societal responsibility. Take the higher income tax threshold for example. When it was announced in 2009 that it would be raised from 40% to 50% in 2010, the people it affected simply felt targeted and that it was disproportionately high even for their broad shoulders. A point of principle. To put it in children’s parlance, it simply wasn’t fair.
Dividend payments that year dropped dramatically, money was moved offshore as people restructured their businesses to legitimately reduce their tax liability. Tax receipts fell. When in 2013 it was reduced to 45% by the Tories, who were lambasted for giving the rich a tax break, net tax receipts started rising again. Ever get those annual letters from Sky or O2 saying they are putting up your monthly payments by £1.06? Letter goes straight in the bin, not worth the phone call or effort to argue about. If it was £5, I might take a different view. Less is definitely more.
So, this is the challenge for the current government, to essentially take a punt not only on which taxes to increase but by how much. Let’s look at Capital Gains Tax as an example, one of the largest potential windfalls to be had, currently set at 18% & 28% for lower and higher rate taxpayers. The usual left-wing ranting and raving calls for these rates to be lifted to the prevailing rates of income tax, so to 20% & 40% to supposedly increase tax receipts. As you might expect though from this article, property tax rises are never as simple as that.
Firstly, these are a once in a generation set of circumstances, some say a once in a century, and the pandemic has created a one-off “property” set likewise that make increasing property taxes more complicated. With Capital Gains that is made all the more difficult with the fact that it is currently the reserve of investment properties as main residences currently have complete relief from taxation, something that no Tory Chancellor would conceivably think of changing unless the brief was to make them unelectable for the next General Election which is not as far away as people think in 2024.
So, with it essentially being a tax on buy to let properties in the main, the task of introducing any change is complicated by the handcuffs the government have placed on landlords to be able to evict their tenants with a Section 8 or Section 21 notices, both currently set at 6 months under the 2020 Coronavirus Act. This would make any changes to CGT before April 2022 impossible as there would no doubt be some legal challenges to any changes in April 2021 by landlords who have been denied the opportunity to gain vacant possession before the tax increase or take advantage of the stamp duty holiday, which is essence has prevented them from selling bar to other investment landlords at a discount.
Even April 2022 may be too soon as there is currently a backlog of about 30,000 applications for possession under Section 8 notices that is growing by the week that some commentators say will take until 2023 to clear as there are too few Courts operating at too low a capacity, something that could once again be used as mitigation by landlords who may have chosen to sell their properties sooner had the government not made decisions on tenant evictions and Courts processes.
Would that mean any rise would have to be delayed until April 2023, or will they simply accept the risk they themselves may face in the Courts and make the change sooner anyway? Even April 2022 may be unpalatable to the government as it would be too fresh in landlord memory come their trip to the ballot box in 2024 which I will come back to.
Secondly, tax increases that change behaviour in one area reducing tax receipts in doing so, then also have a knock-on effect on other related tax receipts. So far example if CGT was increased to a level deemed too cost prohibitive for landlords to sell then they may choose to play the long game and keep that property for another 5 or 10 years, perhaps liquidating other assets instead like shares for example. Not only would the current rate of CGT not be collected by the Treasury had they left alone, but with a lack of BTL properties coming available to buy, there would be fewer transactions each year, less stamp duty paid by buyers, less VAT in the supply chain, less activity for surveyors and lawyers which could mean redundancies as they look for a lower cost base.
Most commentators are agreed that BTL sales would drop if CGT was increased. Would it lead to lower CGT receipts over all? Only time would tell but combined with lower SDLT receipts and less VAT there is a reasonable chance that tax receipts would fall. Any chance of landlords taking it on the chin and carrying on as normal? None I would say. CGT is not the only option though.
There has been talk of a precept or mansion tax on properties over a certain value for example but the problem here is how do you establish who has the cash? Many property rich people are cash poor and have no way of accessing the equity they have amassed through lenders, and the wealth only materialises when they sell. Slapping lots of older people with a £20k bill they can’t afford to pay won’t achieve much. An increase in stamp duty perhaps?
The elephant in the room of course is reducing property taxes, something counter intuitive to many. What do you think would happen if the rate of CGT was reduced for 2 years for example? As we have seen with this stamp duty window, we would see bustling activity from landlords, a great many of have been scarred by rent arrears during the pandemic and increased taxes as with Section 24, who would take their opportunity to sell up. The government has made no secret of the fact that they would like to reduce the number of private landlords as they continue to encourage the Build to Rent sector to take up the slack, so this would kill two birds. Less is more. The perception of a tax break leads to greater activity and more tax collected. Salary breeds behaviour.
Thirdly, the general election has already become a headache for this current government, even though the last one was only 12 months ago. Tax policy is slow to introduce and stays long in the memory so new administrations usually do it as early in their new terms as they possibly can. Not only do they have fresh mandate and immediate popularity straight from results night, but they also need the time the 5 years affords them to increase taxes, have people forget, and they introduce tax cuts in the run up to the next election, so in essence it’s a 1, 3, 1-year cycle. Year 1 is tax increases. Years 2, 3, 4 are raking in the tax and having people forget. Year 5 is tax cuts and campaigning.
The fact that this administration has effectively lost 15 months already before the Spring Budget in March 2021 is critical. It would seem likely that any changes I have detailed on CGT or any other property tax could not happen before April 2022 which is then pretty much halfway through their term, only eighteen months for people to forget and for them to slam the tax truck into reverse. Not enough time.
Many economists for different reasons are advising that we ride out 2021-3 with no tax rises, to continue to borrow, to invest in infrastructure, create jobs and economic activity that will see GDP bounce back far more quickly. Takes hikes and austerity do the opposite and whilst the deficit would start to drop, the economy would take far longer to grow. Makes sense.
So should the government focus on improving the economic health of the country first which would lead to higher tax receipts which would enable them to pay off the overdraft more quickly but not for a few years yet, or focus on paying off the overdraft now, but knowing it will take far longer and the overall mood would be bilious.
Damned if you do. Damned if you don’t. Mr Sunak has the choice going into the general election as the guy that introduced tax hikes that led to a slow economic malaise for several years, or the guy who invested but was at the helm that oversaw the largest public debt in history. Will people remember the pandemic was the route cause, or instead the way the government handled the crisis? If they had invested the £300bn so far in finding a vaccine 6 months ago, instead of having people stay at home would we already be out of this mess?
So, I am clear on what options the Chancellor has, but not on what he is likely to do or when. I am not sure either he could ever expect to be confident on the prognosis of any tax policy changes he makes, which is why it feels like he will be stood in the Casino, dice in hand, hoping whichever way they roll it is the right way. Reduce taxes to stimulate activity or increase them in the hope of a windfall.
I fear however the temptation of raiding the £7 trillion war chest is surely likely to be a gamble too tempting to resist taking before too long.