Scrap council tax – wealthy homeowners must pay more| Larry Elliott | Opinion
The government is short of money. The Treasury is scrabbling around looking for ways to fund Theresa May’s pledge to spend an extra £20bn a year on the NHS. Pressures on the public finances are bound to continue increasing because the population is ageing and older people need more health and social care. The way to square the circle is obvious. Philip Hammond should use his autumn budget to announce the abolition of council tax and its replacement with a fairer system of property taxation. That means a land value tax, an idea whose time has come.
Council tax is 25 years old this year, even though it was a quick-fix solution to the mess the Conservative party found itself in as a result of Margaret Thatcher’s determination to replace domestic rates with the poll tax.
The story goes likes this. Thirty years ago this month, Britain’s housing boom reached its peak. Tax changes in the March budget that restricted tax relief on mortgages were post-dated until August, resulting in a summer of orgiastic property speculation. It was during this period that Thatcher decided that the poll tax – first tried out in Scotland – should be extended to England and Wales. By the time the change happened in the spring of 1990 the housing bubble had burst, Britain was heading for recession and people were taking to the streets.
It is often said that Thatcher’s departure as prime minister later that year was due to Tory divisions over Europe. In truth, it was the poll tax riots that did for her. When John Major replaced her in December 1990, he knew that without a crash rethink, Thatcher’s legacy would ensure Conservative defeat in the next election. The Treasury saved Major’s bacon by coming up with the council tax, but the long-term consequence has been a system of property taxation that is not fit for purpose.
As the Resolution Foundation thinktank has noted , council tax is only weakly linked to the value of property and has failed to capture changes in house prices. The original council tax bands – using 1991 valuations – have never been changed.
There are two consequences of this. The first is that council tax is deeply regressive. Someone living in a home worth £100,000 in 2015-16 faces an effective tax rate five times as high as someone living in a million-pound property. Average income tax paid by the top 10% of earners is 45 times that of the bottom 10%, but average net council tax is only 2.7 times higher for the top 10% of properties than the bottom 10%. The Resolution Foundation says that only the TV licence can match the regressiveness of the council tax. “It appears that, despite replacing the unpopular ‘poll tax’ (community charge), council tax has come to look increasingly like it,” the thinktank says.
The second big problem with the council tax is that it is supposed to be one of the UK’s main methods for taxing wealth, but has proved spectacularly bad at doing so. Rising house prices are a prime reason why wealth has grown 2.5 times faster than the economy since 1980, but wealth-related taxes have remained flat. Those lucky enough to have been owner-occupiers during Britain’s regular surges in house prices have kept their windfall gains but home ownership, especially for young people, has been falling fast.
John Muellbauer, professor of economics at Oxford University, says the aim of government policy should be to make the UK housing market look more like that of Germany, which builds more homes and where house prices, adjusted for inflation, are lower than they were in 1980. In a paper published this week by the National Institute of Economic and Social Research, Muellbauer says a crucial part of the reform package would be the scrapping of council tax and its replacement by a green land value tax designed both to be more progressive and to raise more revenue.
The new tax would consist of a standard per square metre charge on land, with regular revaluations. On top of that there would be a surcharge on any buildings sitting on the land that would vary according to energy usage. An energy-neutral home would pay no surcharge.
Muellbauer’s idea is an elegant one. It takes account of the fact that taxes on something that is immovable are hard to avoid. It would provide incentives to use land and energy more efficiently, and would lead to better home insulation and higher environmental standards, helping the UK to meet its climate change targets. What’s more, a green land value tax would fall more heavily on older people, who own more of Britain’s wealth. If taxes have to rise to pay for the health and social care needs of an ageing population, it is right that the main beneficiaries of the extra spending should make a higher contribution. To protect cash-poor but land-rich households who would struggle to meet higher payments, there would be a right to defer the tax until the property was sold or transferred.
Labour’s interest in a land value tax is welcome and long overdue. Every government since Major’s has known full well about the inadequacies of council tax, and one of the great missed opportunities of the 1997-2005 period was Labour’s failure to use its two thumping parliamentary majorities to bring about change.
Various excuses have been trotted out over the past 25 years for leaving council tax in place, none of them especially convincing. The real reason for inertia is political cowardice: a deep fear of a backlash from those doing well out of the status quo. And that’s not a good enough. Britain’s housing market is broken and it is time to start fixing it.
• Larry Elliott is the Guardian’s economics editor