Some Home Truths

It is often said that the nature of the British housing market restricts the amount of labour mobility. The small size of the private rented sector, restrictions on the mobility of local authority tenants, and the high rate of owner-occupation, all play a part in this restriction. One indicator of low labour mobility is that unemployment rates in the regions of Britain are much more persistent than in the United States (that is, if unemployment is high one year, it is much more likely to still be high ten years later).

This suggests that regional labour mismatch (put simply, this arises when workers cannot migrate or commute to regions with better prospects) is an important British phenomena. For example, while high relative earnings and good employment opportunities in the South East should encourage migration, higher house prices and demand for housing as a portfolio investment crowd out people who wish to migrate. This helps to explain why net out-migration from the South East peaked in 1987-89 when the South East labour market was so buoyant, and also why inflationary problems are reappearing ten years on.

Our research suggests that migration responds strongly to relative earnings and relative employment prospects (*). However, high relative house prices discourage migration into a region, although this may be offset a little by the expectation of fast future house price growth in that region. Recent experience of negative returns in housing also acts as a strong disincentive against migration into a region. Overall, even if high house prices and the fear of negative returns deter migrants into a region, commuting can take the place of migration to some extent. Of course, commuting comes at a cost, and a sharply increasing one with time and distance; even now, commuting into the South East from north of Birmingham is of minor importance.

The recession of the early 1990s affected the South East relatively heavily and reduced North-South unemployment differentials to their lowest levels since at least the 1920s. For a time, the unemployment rate in London was above that of Scotland. However, after four years of robust house price rises in the South East, history is repeating itself as a 'North-South' divide begins to re-emerge. Given its costs, long distance commuting is unlikely to prove a large enough saftey valve for the inflationary pressures inherent in this regional imbalance. This helps to explain why the wage pressures in one part of the economy (predominantly the South Eastern service sector) can be worrying the Bank of England while at the same time, manufacturing output can be stagnant.

These problems are particularly British and particularly troublesome in an economic upswing, but this is not to say that reforms of the housing market could not change the future. We would suggest that there are two main areas of possible reform: policy towards the market rented sector and the Council Tax.

The market rented sector in the UK, after many years of rent and tenure controls and fiscal bias against landlords and tenants, has fallen to what is surely an undesirable size, as low as 7 per cent (excluding social housing) of dwellings in 1990, though a slight recovery has since occurred. The evidence suggests that private rented tenants have the highest mobility rates, even after controlling for age and other characteristics. A larger market rented sector would therefore permit greater labour mobility simply because moving is cheaper for private rented tenants. Furthermore, during portfolio-driven upturns in housing demand, owner-occupiers tend to move into larger dwellings, and rental properties tend to be converted into owner-occupied ones which are free from capital gains tax. This crowds out living space for employees. A larger institutional market rented sector would lessen these tendencies and therefore reduce the kind of wage pressures that arose in the South East in the late 1980s.

Though controls on rent and tenure are no more, the market rented sector suffers from two remaining tax discriminations. First, as noted above, landlords are subject to capital gains tax, unlike owner-occupiers. Second, the Council Tax falls more heavily on the rented sector than on owner-occupiers, as we shall discuss below.

This leads on to the other area of possible reform, the Council Tax system. There are six main arguments against the current system. First, since Council Tax charges are not linked to current market values, they cannot help to stabilize regional and national economic activity. In the typical upswing of the business cycle, house prices rise substantially relative to incomes. If the Council Tax were linked to current house prices, the higher tax revenue would help to dampen demand in booming areas. Second, the tax revenue raised by the Council Tax, around £10 billion in 1996, is only about a third of that raised by the old Domestic Rates (as a proportion of national income). This shows the scale of the fiscal disaster that followed the introduction and abolition of the Community Charge. This fall in revenue implies a major shift from property taxation towards other forms of taxation, which is surely inefficient.

Third, the Council Tax is highly regressive. Those living in a house worth £1m pay only twice the amount paid by those living in a house worth £70,000. Moreover, Westminster, the local authority with the most valuable houses has the lowest tax rate in the country. Fourth, this regressiveness leads to ludicrous inefficiency in the use of the housing stock, for example, by promoting the conversion of houses containing flats back into single family residences. This is at a time when all the demographic trends point towards the desirability of smaller housing units, since households are getting smaller. Fifth, since the elderly often live in valuable houses that do not match their incomes, the Council Tax is particularly harsh on the elderly which increases resistance to higher tax rates. Lastly, we can highlight the interaction between the Council Tax and the market rented sector by pointing out that since rental housing units tend to be smaller than owner-occupied units, the Council Tax hits the rented sector more heavily than the owner-occupied sector.

Any reforms of the Council Tax have to address the six problems highlighted above, and should ideally include the following reforms. First, properties should be revalued every two years, or indexed to local house price indices with a full revaluation every five years. Second, tax rates should be more proportional to house value above some lower limit (say £20,000) and local authorities should be required to set a Council Tax within a certain range (say, between 0.6 per cent and 1 per cent of the property value). Third, to help the Council Tax play a role as an automatic stabilizer of the economy, rate support grants to local authorities should be reduced when higher house prices raise the local tax base, to stop authorities spending all the extra revenue. Finally, the elderly should be offered the option (following North American practice) to build up a Council Tax charge with accumulated interest, to be settled upon the sale of the dwelling or the death of the surviving resident spouse. Efficient financial markets would readily allow local authorities to convert these claims into cash.

In this short paper, we have suggested a number of ways in which the small size of the market rented sector, the high level of owner-occupation, and the volatile nature of the British housing market, can lead to problems of regional mismatch in the labour market. This mismatch is typically too large to be offset by regional commuting and leads to both higher inflation and higher unemployment than is necessary. Moreover, the presence of a 'North-South' divide makes it more difficult for the Bank of England to set monetary policy. We have proposed a number of reforms that would help the housing market to act more as a stabilizer on the economy, rather than in its familiar role as a destabilizer.

(*) 'The Housing Market and Regional Commuting and Migration Choices' by John Muellbauer and Gavin Cameron, The Scottish Journal of Political Economy, vol. 45, no. 4, pp. 420-446, September 1998 and Centre for Economic Policy Research discussion paper, no. 1945.
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