Lindsey Wicks summarises a study and recommendations from the Organisation for Economic Co-operation and Development, including lowering transaction taxes, capping main residence exemption and mortgage interest relief, and reassessing rental income.
House price inflation making access to the housing market increasingly difficult for younger generations is not unique to the UK – it is an issue in all Organisation for Economic Co-operation and Development (OECD) countries, as highlighted by the OECD’s study Housing Taxation in OECD Countries.
While housing is the main asset for most households, high-income, high-wealth and older households hold a disproportionate share of that wealth. Although housing debt tends to be concentrated in the top income quintile, across 19 OECD countries (those with the available data), two-thirds of mortgage-bearing households in the bottom income quintile face a mortgage debt-to-income ratio of greater than three. This declines with each successive income quintile and is less than 10% for mortgage-bearing households in the top income quintile.
Property ownership cycle
On acquisition, there may be transaction taxes and VAT on the sale of new property. Thirty out of 38 OECD countries apply transaction taxes on housing purchases.
During the period of ownership, there could be recurrent taxes (such as council tax), income tax on rental income, mortgage interest relief, real estate wealth taxes and net wealth taxes (levied by Norway, Spain and Switzerland).
On disposal, capital gains tax may apply, or inheritance tax or gift taxes. Most OECD countries exempt gains on the sale of a main residence and around half of those levying inheritance tax apply preferential treatment to the main residence.
Suggestions for reform
The study considers there is significant scope to enhance the efficiency, equity and revenue potential of housing taxes.
Transaction v recurrent
The first suggestion is that recurrent taxes should play a greater role and transaction taxes should be lowered.
Recurrent taxes are often based on significantly outdated property values. For example, in England and Scotland council tax is based on 1991 values. In Wales, it is based on 2003 values. Using outdated valuations creates unfairness as households with properties of a similar value may not pay similar amounts of tax and those with more valuable housing may not pay more tax. Those in undervalued housing may remain even if the property no longer suits their needs. However, the study recognises that these taxes are also a cost-of-living issue for lower-income households, including retirees.
Greater reliance on recurrent taxes would require regular valuations to improve fairness. Any changes would fit better alongside a comprehensive overhaul of property taxes. Transitional measures may be required to mitigate sudden increases in tax liabilities.
The study acknowledges that transaction taxes are attractive as they are easy to administer, but it flags that they can discourage transactions and adversely affect residential and labour mobility. It recommends reducing or removing transaction taxes, but highlights it is essential that this be done gradually and accompanied by other tax reforms (eg, a shift towards recurrent taxes) to avoid increases in house prices and windfall gains for existing homeowners.
Capping main residence exemption
The study concludes that maintaining an exemption is justified in order to reduce lock-in effects. However, it does affect tax revenues. For example, private residence relief in the UK was estimated to cost £28.4bn in 2020/21.
To reduce some of the upward pressure on house prices, the study suggests placing a cap on the main residence exemption. This would be at a level to exempt capital gains on the main residence for most households, but tax the highest value gains to strengthen progressivity.
Remove/cap mortgage interest relief
While mortgage interest relief is intended to support home ownership, empirical evidence suggests that it fails to raise home ownership rates and contributes to higher house prices where housing supply is constrained.
The study submits that removing or capping relief for owner-occupied housing should have a positive impact on progressivity, tax revenues and house price affordability.
The UK is ahead of the curve in this respect as mortgage interest relief for owner-occupiers was removed from April 2000. Furthermore, since April 2020, the UK has limited tax relief for the finance costs of individual landlords on residential property to the basic rate of income tax following a three-year phasing-in period.
Encourage housing supply
The study cautions against considering tax incentives to encourage home ownership as they can contribute to increased house prices where the housing supply is constrained. To have a greater impact on affordability, it recommends encouraging the supply of housing and promoting a more efficient use of the existing housing stock through other measures.
The study reports that some cities have introduced recurrent taxes on vacant homes to encourage the return of these dwellings to the rental or housing market. Analyses of existing vacant home taxes suggest that some taxes have been successful in increasing housing supply, while others have had a limited impact. It advises that such taxes are only appropriate where local housing concerns are linked to excess vacant properties and that taxes must be accompanied by credible measures to monitor compliance.
Taxing rental income
Throughout the OECD, rental income is generally taxed at the same rates as other types of personal capital income. The tax base is typically realised net rental income (that is, realised rental income minus costs), but a minority of countries tax imputed rental income (ie, a deemed return based on the value of the housing). The study concludes that declaring and taxing net rental income (including mortgage interest payments) and taxing it either with total income or capital income (in countries with a dual or semi-dual tax system) strengthens efficiency and equity.
The study notes that some countries apply special tax treatment to short-term rentals (eg, the furnished holiday lettings regime in the UK). It acknowledges that while there may be a rationale for differing treatment, it can create distortions and risks affecting the supply of long-term residential housing. It therefore advises that short-term rental income is properly declared and is not taxed more favourably than long-term rental income.
Data capture and sharing
The study recommends that reporting requirements are strengthened, including third-party reporting and international exchanges of information. This is already emerging with the reporting and sharing of details and income of sellers by online marketplaces (in the UK from 1 January 2024). This will include accommodation let via a digital platform.
It also acknowledges that the use of sophisticated structures can exploit loopholes in the tax system. Individuals may also illegally evade taxes on housing, for instance by complex schemes obfuscating asset ownership or under-declaring housing values. It suggests that reducing the attractiveness of holding housing through corporate structures or trusts can help minimise tax planning. The UK has already taken some steps here with the annual tax on enveloped dwellings, the 15% rate of stamp duty land tax in England and Northern Ireland and the Register of Overseas Entities that own UK land or property.
Reducing carbon emissions
Like ICAEW, the OECD is also considering how the tax system can contribute to reducing carbon emissions. The study highlights the considerable carbon footprint of the housing sector, noting that it accounted for around 22% of global final energy consumption and 17% of total energy-related CO2 emissions in 2019. The bulk of the energy consumption of residential property originates from heating, although the construction of dwellings is another major contributor to emission levels. Much of this is attributable to the manufacture of building materials such as cement, steel and glass.
To comply with the climate goals of the Paris Agreement, average energy use per square metre in buildings would need to be reduced by 30% by 2030. It seems clear that tax will play a part as governments seek to use a range of policy reforms to achieve this goal.
The other key problem with housing is that the residential sector generates other significant environmental impacts on land use, biodiversity, transport and water consumption.
Although there is evidence that tax incentives encourage energy-efficient housing renovation, the study acknowledges that tax incentives for retrofitting energy-saving materials and equipment often subsidise or partially subsidise investments that would have occurred anyway. Furthermore, the disproportionate uptake by high-income households raises concerns over their equity and effectiveness.
Lower-income households are more likely to occupy dwellings with greater scope for reductions in energy use. Therefore, targeting low-income households could contribute to greater emissions reductions and enhance the equity of tax incentive schemes.
Could there be change?
The study acknowledges that as we emerge from the COVID-19 pandemic, governments are considering how to raise tax revenue to support economic recovery. Governments are also under increasing pressure to address inequality and affordability (perhaps it is no coincidence that in the UK we have the Department for Levelling Up, Housing and Communities).
However, it recognises that tax reform is not the only answer. The interaction between tax policies needs to be viewed holistically alongside the interaction with non-tax policies. Timing is also key. The wider macroeconomic environment (particularly interest rates) can have a significant impact on housing markets and reforms will inevitably affect household types differently. Therefore, mitigating the impact of any reform for vulnerable groups could enhance public acceptability.
About the author
Lindsey Wicks, Technical Editor, ICAEW
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