Wednesday, 10 December 2014

Reform of stamp duty should raise revenue

Stamp duty is a tax on house purchases. And it will surely go down in history as one of the most badly designed taxes ever. Why? Because, until last week, the tax operated in bands that applied to the full purchase price. For example, if a house sold for £249,999.99 then it was taxed at a rate of 1% meaning a tax of £2,500. If the price increased by two pence to £250,000.01 then it was taxed at a rate of 3% meaning a tax of £7,500. So, a two pence rise in purchase price meant a £5,000 increase in tax!
         Clearly such a tax is highly distortionary. No one was going to buy a house for £251,000. House prices, therefore, inevitably clustered at the bands of £125,000, £250,000 and £500,000. There was also the clear incentive to circumvent the tax. For instance, to buy a house for £249,999 but then agree to pay £10,000 for the living room curtains.
         In the Chancellor's Autumn Statement stamp duty was finally reformed. The current slab system was replaced with a system of incremental taxation. Paying two pounds more will now cost at most two pence in extra tax. Common sense can breathe a sigh of relief. I found it particularly interesting, though, the way that the Chancellor spun this good news.
         The headline claim was that 98% of home buyers would pay less under the new system than the old. And if you look at some raw numbers like those in the table below it is easy to see why this claim seems justified. Across the board there are seemingly significant gains for home buyers.

       Why may these gains be illusory? House prices are unlikely to stay the same. Houses that were selling for just under £125,000, £250,000 and £500,000 will clearly go up in price. This, in itself, is enough to mean that some will pay more. For instance, someone who would have bought a house for £125,000 but now has to pay £130,000 sees a £100 rise in tax. Similarly, someone who would have a bought a house for £250,000 but now has to pay £260,000 sees a £200 rise in tax.
        These are modest rises but given that a large proportion of transactions take place around the £125,000 and £250,000 mark they are not innocuous. And things may be worse. Because pushing up some prices is inevitably going to push up others. The gains, particularly in the £125,000 to £250,000 bracket, may not, therefore, be as large as the table suggests. The Chancellor may well have pulled off the political magic trick of a popular tax rise.  

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