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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is an emeritus professor at the London School of Economics’ financial markets group
Imagine that we found ourselves in a world in which there was no prior structure of taxation but where the government suddenly had to raise £22bn to keep the budget balanced. From such a tabula rasa, what structure would we choose?
The answer is blindingly obvious. We would raise the bulk, if not all, of the required revenue from a tax on the returns from land ownership. Why? Because the quantity and quality of land do not react negatively to a tax on its return, while work effort and capital investment do. Also, land cannot avoid or evade tax by moving abroad, as can capital and (rich) people.
The value of land is largely not a result of the owners’ own efforts, but is instead attributable to favourable location, adjacent public services and attractive nearby private development. In other words, it is due to the efforts of the community as a whole.
The overwhelming case for a land tax has been known for centuries and made by many of the most prominent economists. Yet such a tax or its less satisfactory cousin, a property tax on the combined value of land and buildings, has played little role in the UK tax system or most others. One reason is the claimed difficulty and cost of valuing land separately from buildings. But techniques and technologies have advanced so far that this is no longer a major hurdle.
Instead, the main reason is that the rich and powerful in any country almost always dominate land ownership and oppose any land tax. But chancellor Rachel Reeves now has a much stronger political position than when a land tax was last seriously proposed by Lloyd George in 1909.
The main problem with a land tax is the initial transition from the status quo. Plans, contracts and financing have all been based on the absence of a land tax. If such a tax was to be introduced now, at a level immediately sufficient to meet the entire £22bn fiscal deficit, the research that I and my colleagues have been doing suggests this would require a tax rate equal to 0.6 per cent per year of the value of the land, but with no tax on the building, which typically accounts for about 50 per cent of the value of residential property.
In other words, the tax burden would be £3,000 a year for a £1mn property. While this would balance the budget, it could lead to an initial fall of about 7 per cent in average residential property prices — and more on high-value housing if the tax was progressive. Because this would cause some valuations to fall below the existing mortgage valuation, there would be a danger of resulting financial difficulties.
The key to the successful introduction of a land tax is therefore to solve the transitional problem. What is needed is to introduce such a tax initially at a low rate, say 0.06 per cent (or £300 a year for a £1mn property) so as not to cause a significant initial fall in house prices. This would presage a rising land tax rate that eventually, rather than immediately, closes the budget gap. It could be done either by a planned schedule of tax increases, say at yearly intervals over two decades, or through a larger tax rate on increases in land values and a lower tax rate on the level of land values.
The second option may be politically easier and result in a lower decline in house prices; but it would make the future path of revenue much more uncertain. There are, of course, myriad other transitional issues to be faced, such as how to handle low-income landowners, how to treat agriculture, how to treat royal lands and so on. But these issues are much easier to solve.
If we were to assume that we wanted not only to balance the budget but also to replace income tax completely, by 2045, say, our best estimate is that land tax would have to rise to about 20 per cent of the value of land. This would reduce average land prices significantly but would also massively stimulate the economy, increasing the profitability of investment and the incentive to work. GDP would rise by 50 per cent and residential property values by 30 per cent due to better incentives to construct and modernise buildings. There is now an opportunity to start introducing a land tax. I hope the chancellor seizes it.
