Sunday, 31 October 2010

A thought on the Housing Benefit caps

Sometimes I read a "news" report and wonder whether I'm missing something. It's not uncommon for those who drink vast amounts to suffer forgetfulness and, over time, to lose their analytical powers. Perhaps I have reached that stage, but I don't think I have. I'm talking about the proposal to cap housing benefit and, in particular, about an article peddled by the BBC (here).

For the benefit of anyone who has missed the story or who is reading from beyond these shores I'd better lay the background. One welfare benefit payable in the UK is called Housing Benefit, it provides funds specifically to cover the cost of mortgage interest payments or rent. The proposal under discussion is that the amount payable towards rent should be capped. The cap will have four stages. Those renting a one-bedroomed property will be allowed no more than £250 a week, with up to £290 a week payable for a two-bed house or flat, £340 for three and £400 for four bedrooms (or more, or so I presume). These figures equate to annual rent of £13,000, £15,080, £17,680 and £20,800 respectively.

I am not the first to observe that these are large sums of money. To have £13,000 in your pocket after tax you have to earn something in the region of £18,000. On the assumption that someone renting for £13,000 also wishes to eat, water and clothe themselves at an additional cost of £100 a week, their annual pre-tax earnings would have to be in the region of £24,000. That is not far from annual average earnings. The payment of £20,800 in rent requires pre-tax earnings of around £27,000 before a single morsel of muesli has crossed the tenant's lips.

Housing benefit is paid out of taxes received by the Treasury. It is necessarily and inevitably the case that many employed taxpayers earn less than these sums and could not possibly pay that much in rent. Their taxes will be used to pay for other people to occupy homes they could not afford. It's an easy and, I think, lazy argument to say that the proposed caps are justified merely because many of those paying taxes could not afford even those sums in rent. That rather misses the point.

Someone who has been earning more than enough to pay rent of £13,000 or £20,800 a year might lose their job and be reliant on benefits until he or she finds another position. There is nothing essentially objectionable about them receiving benefits to help them keep their home until they find new work. If that work does not allow the payment of such a high rent they will have to move anyway but if it does they will resume paying the rent. In such a situation Housing Benefit provides a stop-gap relief pending the establishment of a new situation which, I would have thought, is what benefits are intended to do. That others have never been in the position to rent a property at such values is really neither here nor there. In this context Housing Benefit is akin to an insurance payment and those who rented at these figures necessarily earned more and paid more tax than those on lower incomes. Although Housing Benefit could be seen to come partly from those on lower incomes the reality is that those who previously paid their rent out of taxed income and claim the benefit while they are between jobs have already paid for it.

There is, of course, another group - those who have not had, do not have and have no reasonable prospect of ever having enough earned income to pay their rent and are habitually dependent on Housing Benefit. For this group the question "why should people with modest taxed incomes who cannot afford such rents pay so much towards their rent?" is more pertinent. Indeed it is hard to see any justification for such people to be subsidised out of tax to live in expensive areas. Harsh though it might sound in the modern world of holistic touchy-feely wibble, beggars can't be choosers. Or to put it less harshly, if you live on hand-outs you can have no complaint about the payer saying "sorry, we can only hand-out so much".

The BBC article I linked to above (this one) asserts that the majority of two-bedroomed properties in London will be too expensive for Housing Benefit claimants if a cap of £290 a week is introduced. This is where I wonder whether I'm losing my faculties. Landlords want the best return they can get but they know they have to pitch the rents they demand according to the ability of likely tenants to pay. Pitch it too high and there are no takers. More importantly, landlords know that the worst thing possible is what is known as a "void period" - a time when the property is empty and no one is paying rent. Say the desired rent is £300 a week, that is £15,600 a year. Four weeks without a tenant reduces the annual rent received to £14,400. If you have a tenant paying £300 a week through Housing Benefit and are told the benefit payable will be reduced to £290 a week, what would you do? Throw out the existing tenants - possibly incurring legal costs and risking a void period - or reduce the rent to £290 a week? No doubt some would choose the first course but reducing the rent would still bring in £15,080 a year, a tiny reduction accompanied by the certainty of payment.

Say your two-bedroomed property commands a rent of £500 a week rather than £300. It would have to be in a very smart part of town for that to be a true market rent. On being told your existing tenant will only pay £290 because he is on Housing Benefit and that is the limit, the question you have to ask is whether you will find a replacement tenant who will pay substantially more. In areas where £500 a week is a true market rent the answer is almost certainly that you will find a new tenant. It's tough luck on the existing tenant but you cannot avoid the fact that such a property is at the high end of the market and it cannot be justifiable for taxpayers to keep someone else there when they cannot pay the going rate and others could.

And that really is the point I want to make today. The Housing Benefit rent caps will only result in existing tenants having to move if others are willing to occupy the same properties and pay a higher rent out of post-tax income. That situation will prevail in some instances. There is no denying that existing tenants who are required to move will find it upsetting. Regrettable though that is, the caps are at high figures and there is only so much taxpayers should be required to pay towards the housing costs of others.

Lurking behind all of this is a state of affairs that arises whenever government subsidises anything. If the subsidy does not have a limit people will milk it for all they can. How many two-bedroomed flats for which Housing Benefit currently pays £350 a week would actually command that figure in the open market? Landlords of benefit claimants pitch the rent at the highest figure they think will be paid in Housing Benefit. The same rent might not be achieved from renters paying from earned post-tax income. If they thought they could get more from non-benefit claimants they would do so, indeed they would be mad not to do so. In real life they know there is nothing to be gained from pitching benefit claimers' rent below open market rent so it can only be the same or higher. I'll give you one guess which is the more likely.

But there's more. The Chief Executive of the political lobbying group Shelter is reported to have claimed that "tens of thousands of households could be forced from the centre" of London. Shelter started as a genuine charity finding practical solutions for the homeless. The mere fact that it has a Chief Executive means it has outgrown its charitable functon and has become a business. It is in the business of justifying its own existence in order to keep its Chief Executive and such other salaried staff as it might have in their comfortable positions, which means its first function is now lobbying. So let's look at his proposition.

Tens of thousands of households could be forced from central London, he opines. OK, let's assume that happens. How, in the real world, can it happen? The properties they occupied will still exist and the landlords of those properties will still want to have tenants. Chucking out a tenant is only a good idea if you get a replacement. A tenant who pays minimal rent and trashes the furniture but still provides a small overall profit is better than no tenant at all. It is a necessary part of the Chief Executive's argument that tens of thousands of potential tenants are currently prevented from renting because benefit claimants are hogging the properties. On what possible basis can it be right that those tens of thousands should be excluded when they are able and willing to pay but cannot do so because taxpayers (including the prospective tenants) are keeping others in those properties? It is not a one sided coin. Existing tenants will only be ousted if currently frustrated potential tenants are waiting to take their place and pay, from their own post-tax resources, for the privilege. Why is he not lobbying for these excluded unfortunates to realise their dream?

Will "tens of thousands of households" be displaced? Of course not. But even if they were, tens of thousands of other households will take their place and pay for something they desire and can afford but presently cannot attain.

The Labour Party - what is it?

I just went to the BBC's iPlayer thingy to watch Friday's episode of New Tricks. It wasn't listed separately so I clicked on "Drama and Soaps". One of the programmes listed was the Scottish Labour Party Conference.

Drama or soap?

Thursday, 14 October 2010

LVT - a cart and horse inverse juxtaposition?

Perhaps the greatest mystery about Land Value Tax is the absolute certainty with which those who support it voice the benefits that will accrue. Land prices will fall and then be kept stable, the cost to business of employing staff will be reduced thereby leading to greater employment, there will be no speculative expectation pressure on land prices, malaria will be no more and England will win the World Cup until the end of time, and so the list goes on.

In my last missive I asked how LVT will cause or contribute to a fall and then stabilisation of land prices and received some jolly interesting comments, none of which made a case I find in the least bit persuasive. A number of points made deserve a more detailed answer than comments allow, so I'll do my best to explain my continued puzzlement.

The first puzzle is: how does LVT cause prices to fall? One way this question can be addressed is by asking whether LVT would have prevented the house-price bubble engineered by Gordon Brown from about 2000 onwards. My first line of enquiry must be to ask what actually caused the bubble and then to ask whether LVT would have negated that cause. My view, which I have stated before at tedious length, is that the bubble is exclusively (or almost exclusively) the result of lenders advancing unaffordable loans, a state of affairs encouraged by the government despite the knock-on effect it had on the value of the lenders' assets. The entire state of tits-uppedness in which many banks and other lending institutions found themselves a couple of years ago (and still but they don't mention it now) was the result of making bad investments - specifically, making bad loans to prospective house purchasers. Although it is to state the bleeding obvious, if Mr & Mrs Ordinary suddenly find they can borrow £200,000 rather than £150,000 there is more money chasing the same goods and prices rise. Value doesn't rise, but prices do. We saw exactly the same thing happen in the mid and late 1980s (although it didn't cause a banking crisis because securitisation and credit default swaps did not get out of hand). How was the crisis solved in 1989? Simple, by letting the market adjust naturally. Borrowing became more expensive sbecause interest rates were set to a level that was appropriate to risk so that good loans paid for bad loans and, in consequence, prices fell dramatically. LVT didn't cause prices to fall because there was no LVT. What deflated the bubble was to withdraw the very hot air that inflated it in the first place. Would LVT have prevented "liar loans"? Will LVT remove that hot air from the current bubble? I don't see how it could or can unless it is set at such a high level that people can no longer afford to pay both their mortgage and their LVT.

And that is the core difficulty I have with the argument that LVT will cause prices to fall. Because LVT is recycled through the Citizen's Dividend it can only ever increase the cost of housing by less than the additional tax charged, because part is repaid to the taxpayers themselves through the Dividend. What level of LVT is sufficiently high to cause prices to fall below current levels? No one seems able to tell me. To my mind it is a false argument. To reduce a bubble you have to look at how the hot air got into the balloon and address that, seeking to deflate it by reference to something else entirely might work but it can only do so circuitously and will, inevitably, have other consequences that might or might not be beneficial.

It is then said that LVT will keep prices stable. How it will achieve this is the second puzzle. One argument is that it will remove the prospect of speculative profit and that this will mean people won't pay over-the-odds now in order to secure a windfall gain later, but this assumes the very stability it seeks to cause. In other words it is a consequence of stability and a factor that maintains stability but it cannot be a cause of stability, so how does LVT cause that stability in the first place?

There can only be one answer because only one factor can prevent price bubbles, namely the dampening of demand. That can happen in a number of ways. You can increase supply of housing to reduce the price pressure on each individual property, you can limit the amount potential purchasers can borrow or you can reduce the income of purchasers so that they can only afford to service a smaller loan. What is unavoidable is that LVT can affect only the third of these factors and it can only do so by being set at a rate which is more expensive to the landowner than the aggregate of the amount he saves through the abolition of taxes on his income and the amount he receives by way of Citizen's Dividend.

A marginal increase won't have any more effect than increases in other bills, a few quid or even a few hundred quid a year won't necessarily do it, people adjust because they save on matters they consider less important. For existing homeowners it will be an inconvenience like recent rises in prices for food, electricity and gas. They are not suggested by anyone to have had any significant effect on house prices, so why should a tax unless it really bites into their income? And it is not enough that it makes life more expensive for existing homeowners, it must be sufficiently expensive to deter potential purchasers from paying what they otherwise might be prepared to pay. So, how high would it have to be? I have no idea but it is, I think, reasonable to suggest that it would be so much that the whole thing would be politically impossible to implement.

Warning to those of a delicate disposition - the following paragraph appears to be nonsense from beginning to end and has been retained to remind me to read what I write before hitting the "publish post" button.
My puzzlement doesn't end there. The whole exercise assumes a transfer of money from landowners to non-landowners because of the Citizen's Dividend that stands alongside LVT to prevent the government making a windfall gain. The non-landowners receive a double benefit. They no longer pay Income Tax, National Insurance or VAT and they receive the Citizen's Dividend that increases as the take from LVT increases. One would think the natural result of them having so much more in their pockets and of their landlords being hit by LVT is that their rent would go up. Assuming that to be the case the acquisition of houses and flats to rent would appear to be an even more attractive business than it is now. There's no income tax to pay and your customers suddenly have many thousands of pounds a year more in their pockets, it sounds like a wonderful arrangement for landlords; all the more so because Capital Gains Tax is to be abolished too. They only need to raise rents by the difference between existing taxes and LVT and they are quids in, after all their tenants will be in profit by a lot more than that. And the effect on property prices? It hardly sounds like a downward pressure to me.

Much more puzzles me, but that's enough for today.

Tuesday, 12 October 2010

Some observations on LVT

As a dedicated reader of the meanderings of my friend Gerard I have become familiar with some of his views on tax. In particular, I am aware that he believes it desireable to abolish Income Tax, Value Added Tax, National Insurance, Capital Gains Tax, Inheritance Tax and others and replace them with a Land Value Tax. His position is perhaps explained most clearly here.

The central principle seems to be that tax will be levied at so-many percent a year on the value of land (the value being assessed by reference to sale prices actually achieved in the area). Numerous alleged benefits of Land Value Tax (LVT) have been identified in the many posts Mr Wadsworth has made on the subject (collected here), including that LVT will contribute to the prevention of future land price bubbles and that it will not be as damaging to enterprise as the existing tax regime. I have long had reservations about both these claims, so I thought I'd say why.

Take LVT as a contributor to preventing price bubbles. The obvious first question to ask is how it will have this effect. And the obvious answer is that it will make it undesireable for prices to rise because any rise will cost landowners more in tax. To an extent it is hard to dispute this, but I cannot see how it goes very far.

Does it put any pressure on government to adopt policies that encourage stability or even a fall in land values? No, it does exactly the opposite. If land values fall so do LVT receipts and no government has ever seemed keen on reducing its tax revenues. Whereas a rise in land values will boost the Treasury coffers. On the face of it one would expect government to encourage a rise in land values.

Of course there is another side to this. A general rise in prices leads to a rise in LVT which everyone will have to pay either because they are landowners or because they rent from landowners who have to increase rents in order to cover their extra costs. When everyone is being screwed for more tax simply for the privilege of living in the same place they lived in for a lower cost last year, we can reasonably expect more than a few to cough a polite "ahem" and question the fairness of this windfall accruing to the Treasury. Perhaps the most obvious result will be the need for regular reductions in the percentage in order to keep the overall tax-take roughly the same; yet we can be confident that any such reduction will involve an element of drag so that more tax is taken year-by-year but not quite as much as it would be without a reduction in percentage.

Whether or not that is a correct inference to draw, how could LVT cause or contribute to a fall in land prices? The only way, it seems to me, is for LVT to be so expensive that it makes a significant difference to how much people are prepared to pay for any particular property. At the moment I think it reasonable to suggest that the main factor affecting how much people are prepared to spend on housing is the cost of servicing the loan they take out to buy somewhere. If they think ahead they would be well-advised to build-in a margin for the risk of interest rates rising in the future but in any event they will look at their finances and say "we can afford £20,000 a year", or whatever figure is appropriate to their circumstances. The wise ones will also take into account likely running costs including costs of insurance, repairs and utilities, so their thinking might actually be "we can afford £25,000 for housing, comprising £5,000 for running costs and £20,000 for paying for the place". The matter that determines how much they are prepred to pay is how much they can borrow in return for repayments of £20,000 a year. For sake of example, let's assume they can borrow £300,000. They do not approach the issue by saying "this house costs £300,000, how will we pay for it" but by saying "we can pay £300,000, what can we get for that sum?"

For LVT to have any appeciable effect on prices it must affect the amount people can afford to borrow. LVT can affect how much people can afford to borrow in one way only, and that is as a running cost that forms part of the overall household budget. Using the example I have just given, those with £25,000 to pay for housing would alter their analysis to something like: "we can afford £25,000 for housing, £5,000 will be needed for running costs, something for LVT and the balance to pay towards a loan". If the amount left to repay the loan is less than £20,000 that is fair enough, LVT could reduce prices. But, by definition, those very people are no longer paying Income Tax, NI or VAT, so their disposable income has increased. Say they paid £10,000 in IT & NI and £2,000 in VAT. Instead of starting with £25,000 to pay for housing they now have £37,000. So LVT would have to exceed the cost of the taxes it replaces (£12,000 in my example) for it to be able to make any difference at all.

The exact figures do not matter for this purpose. What does matter is that LVT will have to take more from household incomes than the taxes that are to be abolished for it to be able to have any effect on purchase prices at all. That is why I said it would have to be expensive. In order to have an appreciable effect it would have to be very expensive. In my example it would have to exceed £12,000 a year on a property costing £300,000. That is only 4%, so would 5% be enough, 7%, 10%? Whatever figure is chosen above 4% would provide the Treasury with a phenomenal windfall before any influence on prices fed through.

As to it not being as bad for enterprise as existing taxes, I am, again, unconvinced. The most stifling factor on enterprise is cost. Whether that cost is tax, wages, materials or fuel, the more expensive it is to start a new business or expand an existing business the less likely it is that the start or expansion will happen. VAT, Income Tax and National Insurance Contributions are the most stifling taxes because the first forces a business to make a profit just to break even and the other two increase the cost of hiring staff. Were all three abolished, enterprise would undoubtedly be rewarded ... or would it?

Abolishing Income Tax raises a particular problem because salaries are agreed gross not net. Someone on a headline salary of £30,000 is entitled to £30,000 from his employer whether or not part of that sum is paid to the Treasury as Income Tax. Get rid of Income Tax and employees' NI Contributions (which are also deducted from gross wages) and on the face of it, the employee would still be entitled to £30,000, there would be no saving to the employer. Employers' NI Contributions would be a saving, as would VAT. In their place would come LVT on the employer's premises. Who is to say whether this would be more or less than the saving in VAT and NI? I see no reason why substituting one tax on an employer for another should necessarily reduce his overall costs of doing business.

Maybe it will, maybe it won't, but unless the total tax take is reduced all that can ever happen is that the burden of tax is shifted onto someone else. Perhaps the victims will be landowners generally, both domestic and commercial, but it seems to me to be little more than guesswork (or perhaps nothing more than guesswork) to suggest that LVT will reduce business costs to any significant extent. It cannot be ignored that any sizeable increase in the cost of living of employees accompanied by a reduction in costs of employers will lead to calls for higher wages to return the balance to what it was before. And it is hard to resist the inference that employers would accede to those calls, at least in part, either voluntarily or after facing a revolt from the shop floor.

In this regard there is a difference between employees being hit by higher taxes from the government and employees being taxed more in order to make things cheaper for their bosses. In the former case the boss has an answer: "I've got no extra money, sorry" whereas in the latter it is necessarily the case that that excuse does not arise.

Once LVT has come into effect and the running costs of a household are increased accordingly it is unavoidable that some will not be able to increase their incomes and will find their homes unaffordable out of current income. The only answer given by LVT-ists is that such people will have to trade down to something they can afford, whether it be a cheaper rented place or a cheaper owned place. In itself that raises a serious policy issue. Is it right that taxation policy should force people to move from a home they could previously afford? This is illustrated most acutely by those on modest incomes who own a "high-value" property. The existing tax arrangements allow them to retain their home whereas LVT makes it unaffordable so they are forced to sell and move to something cheaper.

The usual justification given is that these people are not putting the land they occupy to efficient use and the benefit accruing from it being freed for more efficient use outweighs, as a matter of public good, the cost and inconvenience to the displaced individuals. I find this a most unattractive argument. In many parts of London and the South East the supposed justification cannot be assumed to be correct in fact. Even small properties command prices existing occupiers / owners could not afford were they buying a home today. Forcing out existing residents of one or two bedroomed flats and houses will not lead to the properties being used more efficiently, it will result in them being used by pretty much the same number of people but the new occupants will just happen to have higher disposable incomes than their predecessors.

Even where a couple moves out of their three-bedroomed home to something smaller in an area they might or might not know in order to allow one or two additional people to occupy their old house, the more efficient use of their former home hardly justifies the eviction. The occupation of land is not just an economic exercise; sentiment, including family history, are important aspects of life. People have a reasonable expectation, entirely separate from any windfall capital gain that will accrue on sale, that public policy will not render unaffordable the home they own. Of course they could remain in those homes and pay LVT out of capital by allowing their LVT liability to be charged against their home and redeemed when they sell or die. It is arguable that their homes are actually affordable on this basis because LVT simply sucks-up the equity they have acquired (but not earned) while house prices have soared. It is still a most unattractive policy to my mind because it then places these people in debt when they have arranged their affairs specifically to avoid debt. That the debt is to be paid out of a profit they have not earned is no answer except in an accountant's ledger. If you want to divest them of unearned profits wait until they are dead and apply Capital Gains Tax, don't worry them while they are alive.

What, I wonder, will be the position once LVT is in place and all those with homes they cannot afford have been forced to move to something they can afford. It is when we look at that position that we see the essential circularity of reasoning that underlies and undermines LVT. Where will people live? Answer: in homes they can afford. What is affordable? Answer: that which you can pay for out of income or by reducing your capital. What will be the most common form of affordability? Answer: paying out of income. No doubt some would choose to stay put and diminish capital for the privilege of remaining in the home they occupied since long before LVT moved the goal posts, I would suggest it is reasonable to infer that the vast majority will pay for their housing (including LVT) out of income. The inescapable conclusion is that LVT will be linked directly to income in the vast majority of cases. So, a tax brought in to prevent taxes being based on income (because that is potentially damaging to enterprise) will itself be based on income a few years down the line. And at every stage of the adjustment from current taxes to LVT the government will trim things so as to increase the total tax-take - I mean any government of any political hue.