Five Key Council Tax Reforms and Twelve Reasons to Enact Them

An efficient property tax could bring great benefits to the UK economy in terms of economic efficiency; the environment; a better balance of regional and local economic performance; a better sectoral balance between the booming service sector and depressed manufacturing and farming; a more stable economy and one which could have a realistic prospect of joining the Eurozone without disastrous consequences.

It is rare indeed that social justice, efficiency in resource allocation and macroeconomic stability are all served by a single reform measure. A government that prides itself on 'joined up thinking', for which avoiding boom and bust has become a mantra and which wishes to keep open the option of joining the Euro might have been expected to be interested in bringing about such reform. But this appears not to be so - reform of Council Tax is not on the agenda.

Twelve arguments against the current system of Council Tax:

First, the Council Tax is highly regressive within each local authority. Those living in a house worth £1m pay only twice the amount paid by those living in a house worth £70,000 and only three times the tax paid by those in the poorest accommodation. The disproportionate burden it imposes on the poor makes it little better than the Poll Tax it replaced, as pointed out by the New Policy Institute. Indeed, in many of the poorer metropolitan local authorities outside the South East, most residents live in band A properties so that locally Council Tax is almost the same as Poll Tax. This feature of the current British form of property taxation appears to be unique: the great majority of developed countries have property taxes and we know of no other with a deliberately regressive structure.

A second form of regressiveness lies in the fact that second or third homes attract only half the tax rate of first homes. One effect of this is to push up prices in commuter and holiday villages, pricing young families out of their traditional communities.

Its third form of regressiveness is regional: there is strong tendency for Council Tax rates as a proportion of house values to be lowest in the localities and regions with the most expensive housing such as Westminster and Kensington and Chelsea and highest in those with the cheapest, such as Liverpool and Salford.

Fourth, while these forms of regressiveness are reprehensible in themselves, this lack of a level playing field also violates basic efficiency principles in taxation. There are three main arguments in favour of a property tax. The first is to create a level playing field between owner-occupiers, tenants and landlords and between rent income and other forms of income. It is unreasonable for rent income to be tax exempt when other forms of income are taxed. An owner-occupier does not pay rent by virtue of ownership. This is a form of income and should therefore be taxed. A property tax achieves this effect. The second reason is the general one in favour of a broad tax base, especially including taxes which are hard to avoid and cheap to collect. The third is that property values in part reflect communal investments, for example in schools, roads, and amenities. They also reflect environmental concerns embodied in the land use planning system. It is reasonable that some of the returns from these investments are returned to the community in the form of tax. The weak and uneven relationship of Council Tax to property values violates these basic principles.

Fifth, one of the specific economic distortions resulting from the points made so far is the unemployment and poverty traps caused by Council Tax. As research at the Institute for Fiscal Studies points out, Council Tax is unique in having its own 'Council Tax Benefit' which ameliorates its regressiveness. Nationally, almost half of households in the lowest tax band are on Council Tax Benefit. For low income families who work or potentially could work, withdrawal of benefit results in effectively high marginal tax rates which discourage work. Many pensioners appear not to claim the Council Tax Benefit for which they are eligible, perhaps because of loss of self respect.

Sixth, another specific economic distortion is the inefficiency in the use of the housing stock, for example, by increasing demand for large and second or third homes with low tax rates and promoting the conversion of houses containing flats 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.

Seventh, the lack of a level property tax playing field discriminates against the market rented sector in several ways. One is the tax bias in favour of owner-occupation noted above. The other is that, since rental housing units tend to be smaller than owner-occupied units, the Council Tax which is paid by tenants or their landlords hits the rented sector more heavily than the owner-occupied sector. Yet, as is well known, a flourishing market rented sector helps make possible a flexible labour market with mobile workers.

Eighth, unlike the Uniform Business Rate which applies the same tax rates across the country on business property values, the locationally regressive Council Tax discourages location in the cheaper and often economically less successful areas. This helps to explain the cumulative decline and population loss from metropolitan authorities such as Liverpool and Salford and some of the migration within and between regions to typically more affluent areas with lower tax rates per £ of property value. Some of this is seen in the high migration flows of recent years to the South East putting pressure on already congested areas where Green Belts and urban lungs of green space are under pressure. Empty houses in the North and overbuilding in the South are not necessarily signs of a dynamic, efficient economy. A reformed Council Tax would work with the grain of the market, making redundant some of the bureaucratic, piece-meal, costly and often not very effective interventions in the form of urban renewal schemes and regional task forces.

Ninth, the regressive features of the Council Tax both within and between locations have had and continue to have further regrettable consequences in unbalancing the national and regional economies.This contributes to the high level of interest rates, the overvaluation of Sterling and the resulting crisis in manufacturing, farming and mineral extraction, and causes job losses in areas where these activities are more heavily concentrated (broadly, this means the West Midlands and other regions to the north of the South East).

To explain why this is, recall the many ways Council Tax preserves features of the Poll Tax. The introduction of the Poll Tax was not only a political, and as many saw it, a moral disaster, but by removing property tax in the form of Domestic Rates it raised house prices at the peak of the Lawson Boom, exacerbating the boom and following bust. Economists at the time calculated that the permanent abolition of Domestic Rates would raise house prices by around 20 percent. Because Council Tax does have some, albeit a weak relationship, with property values, it is likely that the reintroduction of the old Domestic Rates would reduce house prices in the long run by somewhat less than 20 percent, perhaps by 15 percent, almost enough to offset the current rises, which risk turning into another boom. The interest rate and exchange rate reductions this would permit would certainly prevent a generalised fall in house prices.

A tenth feature of Council Tax, which it shares with Domestic Rates, is the lack of regular revaluations. Council Tax is based on 1991 housing valuations. The lack of much relative price change has been used by this Government as a reason for not revaluing.However, as soon as substantial changes occur they will be used another reason not to revalue on the argument that the scale of the creation of winners and losers will be politically troublesome. This is an argument which helped to persuade Mrs Thatcher to switch to the Poll Tax rather than face a revaluation of Domestic Rates.Avoiding regular revaluations makes the job of the valuers unecessarily difficult, since they are supposed to work out what the price would have been in 1991 of houses built or modified in the meantime.

But most important, preserving at least an approximate link with current market values makes the economic effectiveness in terms of resource allocation gains and the automatic stabiliser role a property tax can potentially play all the more effective: in UK business cycle upswings, it is usual for house prices and consumption to outpace income. If higher house prices lead automatically to higher taxes and homeowners expect this, the upswing will be automatically dampened.

For very similar reasons, a reformed tax would help to stabilise differentials between the most and least economically successful areas, but without stifling individual enterprise.

An eleventh reason for reforming the Council Tax is connected with the last two: differences in credit, housing and financial market institutions between the UK and the Eurozone make it permanently harder for the UK to live with a common short term interest rate set by the European Central Bank, as explained in 1998 research by Maclennan, Muellbauer and Stephens (*). Reforming property tax in the form of Council Tax could help stabilise the UK economy and reduce the need for the big swings in interest rates which domestic conditions are otherwise prone to require.

The last reason for reforming the Council Tax lies in the UK's current cyclical position. It is probable that part of the reason why Council Tax, conceived of in 1991 and introduced in 1992, was so weakly related to property values lay in the fear by policy makers that a proportional property tax might aggravate the UK's economic downturn. This was in the depth of the UK's most severe housing slump in 70 years with home repossessions running at unprecedented levels. Bringing in a proportional property tax in these circumstances would have lowered property prices further and led to even more repossessions. With a 16 percent per annum rise in UK house prices just recorded, and rises of 20-25 percent in the South East, exactly the opposite argument now holds. The timing of long-term tax reforms which promise to bring important efficiency gains can be important. It would be most regrettable to lose the timing gains now available.

Five Essential Reforms:

First, properties should be revalued every two or three years. They could also be indexed to local house price indices with a full revaluation every five years. Developments in the electronic data base, software and valuation techniques make these proposals much more feasible than in the past.

Second, tax rates should be more proportional to house values above some lower limit (say £10-20,000) and local authorities should be required to set a Council Tax within a certain range (say, between 0.4 per cent and 0.8 per cent of the property value). If the system of tax bands is retained, at least half a dozen new bands over £320,000 would be needed.

Third, to help the new Council Tax play a role as an automatic stabiliser 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. The rate support grant formula needs to be revamped in any case.

Fourth, 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. This reform is crucial because it is inevitable that among older households, some living in valuable houses will not have cash flows to match. It is necessary both to avoid distress and the political resistance which lay behind the desire to reform Domestic Rates in the first place.

Finally, any reform should avoid there being too many losers. The reform could be designed to raise taxes on the top 20 percent of the distribution of properties and to increase the total net tax yield, given that Council Tax Benefit payments would be much reduced. Some of the extra revenue could be given back in the upper half of the distribution of households by instituting an income tax band with a tax rate of 35 percent before the 40 percent rate comes into effect. There seems no reason why a reform of this type should not be politically acceptable.

(*) 'Asymmetries in Housing and Financial Market Institutions and EMU', by Duncan Maclennan, John Muellbauer, and Mark Stephens, Oxford Review of Economic Policy, vol. 14, pp. 54-80, Autumn 1998.
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