The mansion tax: opening the door to corruption and distortion

An article in the FT yesterday pointed to some of the problems that the increasingly inevitable looking mansion tax will throw up.

At the moment, assuming the starting point for the tax is to be £2m, it seems that around 95,000 homeowners are likely to end up paying the tax (Knight Frank estimates) with the vast majority of those living in houses worth under £4m.

The main focus of the objections to the mansion tax idea so far has been the idea that a good many of the people living in these houses aren’t exactly rich: one third of Londoners living in £2m houses have, for example, been living in them for more than ten years (so may not have the kind of income that would allow them to buy them today).

But this isn’t as much of a practical problem as you might think – all the parties pushing the new tax have come up with a deferral scheme of some kind to help the cash-poor – or at least to limit the bad press on the imposition of the tax on the cash-poor. The real practical problem is how on earth you figure out how much a house is worth.

Do you take some previous valuation and compound it by average house price inflation? Do you just adopt current council tax bands and somehow take it from there? Do you waste many years of public servants’ time looking at each house individually?

After all, in London two houses on the same street with the same floor space can differ in value by hundreds of thousands of pounds if one is refurbished to oligarch spec and one is not. It’s tricky and endlessly open to dispute – who wouldn’t spend a few thousand pounds in a one-off fee to a property consultant in the hope of avoiding an annual bill of many thousands forever?

However you decide to do this, you have only just begun; the very existence of the mansion tax will distort the market and change the values of all the houses around the bands.

A nice reader (thanks, James) has done a few numbers for me. Let’s say you have a house worth just over £2m and your mansion tax comes in at £5,000 a year. To see how much your house is now worth, you have to assume the tax is to be paid annually in perpetuity and so find the net present value of the stream of annual payments of £5,000, discounted back to today’s money.

The best guide we have for the appropriate interest rate to use to get there is the yield on UK ‘consols’ (these are perpetual bonds – they have no maturity date) – currently 4.12%. That gives you around £120,000. So, a house worth just over £2m pre-mansion tax is now worth only just over £1.88m post the mansion tax. But a house worth £1.99m pre-mansion tax is still worth £1.99m.

You might think that it now makes sense for the owner of the £2m house to sell up immediately and buy a £1.8m house. Sadly, it isn’t that easy. If they do, they will end up paying not far off £100,000 in stamp duty on their new house. Add that to the legal costs, estate agency fees and moving bill and it will all cost them about the same as they are soon to lose anyway.

I don’t suppose either Labour or the Lib Dems are actively planning for the mansion tax to create new distortions and corruption in the housing market, but it seems pretty clear they are going to get them anyway.

If someone can claim, quite rightly, that their house is not worth £2m for the simple reason that the existence of the mansion tax has made it worth less than £2m, what happens next?

• Stay up to date with MoneyWeek: Follow us on TwitterFacebook and Google+

30 Responses

  1. 01/07/2014, Mombers wrote

    I wonder how on earth the highly successful, low collection cost, low economic deadweight cost Business Rates system manages with this problem? Or in the US or Canada, how on earth do they keep track of all those pesky values for property tax? The valuation part of a mansion tax is a doddle. The Daily Mail can figure out the value of the house that whoever is in their stories is. It’s a very easy thing to estimate and there’s not much reward in bargaining it down as the rate is only 1%, meaning you need to knock a huge chunk off your valuation to get your bill reduced by much. Compared to the shenanigans that go on with VAT, NI, income tax, corp tax, etc, the damage is minimal.
    That said, the more simple solution is to just scrap council tax and reintroduce domestic rates, with no bands.

  2. 01/07/2014, mr clyde wrote

    I’ll keep saying this until I get banned for being boring! The exact value of a property is know at the point of sale i.e. the selling price. And the seller then has funds to pay any tax due. So, the obvious solution is to pay a property tax as a capital gains tax on the seller at the point of sale. The revenue streams could then replace Stamp duty and probably IHT as well. Oh yes, and this would also sort out the London bubble without having to resort to interest rate rises and damaging SMEs etc and other areas of the economy/country that still need low rates. It couldn’t be simpler – J**z!

    • 01/07/2014, Mombers wrote

      “The exact value of a property is know at the point of sale i.e. the selling price”
      Except if the property doesn’t sell very often (or at all). Which will happen more and more as people are discouraged from selling or encouraged to structure transactions in a way that avoids CGT. Taxing transactions is BAD – it reduces their number and creates black and grey markets. It is also unfair on those who cannot avoid having to move, and in effect a tax on labour mobility in exactly the same way that stamp duty is. Who would move to a job paying £10k more it entailed CGT of many times that?

      • 01/07/2014, mr clyde wrote

        This is a flawed argument.
        1. If CGT were made universal it would be no easier to avoid than income tax or NI is now.
        2. Sellers would only pay tax on their net gains. It is entirely possible that no CGT would be payable, particularly if a cummulative annual tax free allowance were applied (to mirror the income tax annual allowance).
        3. When labour is sold in return for a salary it is considered entirely acceptable to pay 20-45+% of that in tax. Why is it not acceptable to pay 20-45% (for instance) tax on gains that require no effort at all?

        • 01/07/2014, mr clyde wrote

          Further to my last:
          4. Properties that don’t sell, don’t sell because they are, by definition, not offered at their market value, so I say again, the exact value of a property is known at the point of sale! It is, by definition, what the best purchaser is prepared to pay.

          • 02/07/2014, Mombers wrote

            mr clyde, my point is that if you introduce CGT, people will be discouraged from selling. Only those who have to sell, i.e. to move to a bigger house for their family or for work, will end up paying anything. I am certainly not going to buy another house until my kids have left for uni in 20 years time and I can downsize. That’s just to avoid paying another set of stamp duty. CGT would be much, much more and will take even more houses off the market. Any argument that the money is available to pay the CGT is nonsense unless you’re downsizing, as if you’ve made a capital gain on a smaller house, the bigger house will be even more expensive so you need more, not less equity.

            • 02/07/2014, Greg wrote

              I totally agree Mombers – I’ve tried to explain that to Mr Clyde on previous posts – if anything it will make houses more expensive as the supply of second hand homes will dry up, HMRC will get less money too, plus it means that people will effectively not have to pay anything towards local services whilst owning their home, no incentive to downsize, no incentive to make improvements/develop nor use the house or land efficiently. Totally wrong approach – would arguably make the housing crisis even worse.

              • 03/07/2014, mr clyde wrote

                Mombers & Greg – you are right in that people will consider their tax position before trading their house – that’s the point! And, they will think twice before upsizing just for the tax free benefit of further gains. This will depress the demand for high-end houses freeing up what land there is for more of the smaller houses the market needs, squeeze price increases across the board and improve the efficient use of land – Greg! Eventually the market will stabilise and the CGT payable will become just another progressive tax no more or less onerous than income tax is now. Alternatively you can leave the system as is, and/or bring in LVT, MT, whatever with all the exemptions it will need to work aka Ed Balls-up, and leave me and my kind to continue making tax free loadsamoney at your expense. Which is the point Merryn is making.

                • 03/07/2014, Greg wrote

                  CGT won’t necessarily depress the demand but would certainly reduce the supply, but if this was to replace Council Tax & Stamp Duty, and you acknowledge there would be fewer transactions and tax collected, how would the Government make up the shortfall?

                  I don’t see how it would make land use more efficient as it would deter development and improvements and by selling off parts of your land for new smaller houses you would have to pay CGT so again no incentive to do so.

                  LVT is a levy which should in theory be supported across all political parties – from free market capitalists, as it allows people to improve, extend and develop without being taxed, through to socialists seeking to create green and sustainable land use and redistribute wealth.

                  I’m not sure that your ideas are exactly the point which Merryn is making, but perhaps she could clarify?

                  • 04/07/2014, mr clyde wrote

                    Ok, so I am joe-smallholder who owns a modest house with a plot where I grow veg and keep chickens. Along comes the local soviet who inform me that my land has been zoned for housing and therefore is worth a lot more and levy a comensurate LVT. It is my land, I don’t want the houses but can’t afford the tax so I am pushed off (unless of course I pay the required bribe). How is this a free market and not distortion and corruption? Ans. to J Stalin & R Mugabe.

                    • 04/07/2014, Greg wrote

                      The chances are you would pay less LVT than you would council tax – unless you live in central London or near the centre of some other large city – at the moment you probably pay the same council tax as someone in a much more expensive house or someone with a much larger house with larger gardens somewhere else – is that fair?

                    • 04/07/2014, Mombers wrote

                      @mr clyde
                      As unlikely as your hypothetical situation sounds, I struggle to sympathise with you. As someone who has repeatedly had to move house due to income and other taxes preventing my income rising fast enough to keep up with rents, I think a greater REAL crime has been committed against my private property (my earned income). I’m a homeowner now but it is my intention and hope to make more money from working and contributing to the economy than growing fat off my land.

  3. 01/07/2014, benji wrote

    This article isn’t so much about whether the MT is a bad proposal, but the consequences of not having a wholesale overall of the way we tax property.

    So, lets be done with it a flat tax, spread between 26 bands A-Z.

    At 3.5% or below, it only recoups to the State the value it creates. So, not a “tax” on capital, but a user fee. Flat, fair, simple.

    Job done.

  4. 01/07/2014, Mark Wadsworth wrote

    “a good many of the people living in these houses aren’t exactly rich”

    Poor Widows In Mansions

    http://kaalvtn.blogspot.co.uk/2013/01/a-poor-widow-bogey.html

    Valuations is easy peasy, they are going to extend the ATED to two new lower bands £0.5m – £1m and £1m to £2m. So what we end up with is five or six new council tax bands. The tax will never be more than the site only rental value and roughly the same % of total value as Council Tax for normal houses.

    http://kaalvtn.blogspot.co.uk/p/valuations-and-potential-lvt-receipts.html

    “two houses on the same street with the same floor space can differ in value by hundreds of thousands of pounds if one is refurbished to oligarch spec and one is not.”

    The underlying land value is the same for both, so actually the tax works better if both pay the same or similar – that doesn’t discourage improvements (and probably encourages them).

    ” find the net present value of the stream of annual payments of £5,000, discounted back to today’s money.”

    A tax on the rental value does not affect the rental value. It might or might not affect the selling price, but that is irrelevant. It is like interest rates, if they change the rental value stays the same and the price changes.

    ” the existence of the mansion tax has made it worth less than £2m, what happens next?”

    Absolutely nothing, why should it? We’re still paying council tax based on 1991 values, so why not base the “Mansion Tax” or whatever they call it (which will be exactly the same as the ATED which has been a great success) on 2014 values and have done with it?

    Admittedly, there are plenty of things they could do to make it better, i.e. complete council tax revaluations based on land values (i.e. average values on a street minus rebuild costs) and have twenty or thirty bands instead of 8 or 9 plus 5 or 6, they could also take the opportunity to get rid of Inheritance and Stamp Duty Land Tax (and the non-com £50,000 annual charge etc) because that’s only fair and also shuts up the moaners, but there you go.

    • 02/07/2014, Greg wrote

      I agree with Mark.

      It’s wrong that people living in “mansions” should be paying the same council tax as someone in a more modest home – that effectively distorts the market too.

      I think it’s wrong that buildings are taxed rather than land and Stamp Duty, Council Tax, Capital Gains Tax and arguably Inheritance Tax effectively encourage inefficient use of land, discourage creativity and improvements to the buildings sat upon it.

      A Land Value Tax replacing Stamp Duty, Council Tax and possibly Inheritance Tax would simplify and improve the property market, encourage more housebuilding and instantly make housing more affordable for all.

  5. 01/07/2014, WhyNot wrote

    Perhaps use a revised rating system to control the situation

    http://voxspeak.co.uk/post/2014/07/01/BOE-Approach-To-London-Housing-Bubble.aspx

  6. 02/07/2014, Angela wrote

    The valuation part is easy. The local VO already has all the necessary information on record.
    I still don’t see why we need a Mansion Tax, and not just a couple of extra bands on the Council Tax.
    Domestic Property is taxed at a local level, why change that principle? It’s cheap, effective and universal.

  7. 02/07/2014, Angela wrote

    Anyway, if you don’t like the valuation, that’s what Lands Tribunals are for.
    The systems is there, it doesn’t cost anything to use it.

  8. 02/07/2014, WhyNot wrote

    Referring to the previous link

    What is the problem with basing rates on the last purchase value at Land Registry and applying a country-wide percent to that value?

    Not rocket science – everyone pays the same percent according to the value of their house

    After all no-one forces anyone to buy a property and quite frankly you would not buy a car if you could not afford to run it – so why are houses different?

  9. 02/07/2014, r wrote

    I would like to see the emphasis on reducing government spending to an amount that is within the means of the country and not new ways of raising taxes to implement more spending.

    Why do so few people consider this principle and the majority of people on ways of taxing us more and more?

    r.

  10. 02/07/2014, MaldonWonder wrote

    The problem with CGT is how to derive the inflation or tapering adjustment. An example: my parents bought their house in 1959 for £3,000. It is now worth, say £280,000. Should they pay a percentage (say 40%) of the £277,000 gain, leaving them £169,200 to buy a replacement. If we use the RPI as an inflation adjustment, 1959-2013 is 19x (I believe) which inflates £3,000 to £57,000, which still leaves £223,000 on which to pay, say 40% CGT. To be fair, we should use the house price inflation index. Then, on average, there would be no CGT to pay.

    Most people buy a house to have somewhere to live. If someone sells their house, they should be able to buy an equivalent with the proceeds. Just because some people use property as an investment, which drives up the price, does not mean we should all pay CGT.

  11. 02/07/2014, Clive wrote

    This isn’t a mansion tax, it’s a tax on the South East.

    Say you’re living in a £2m house in the South East. It’s deemed to be a “mansion” because it’s amongst the most expensive (say) 2% of properties in the region. OK, I get that.

    But, you can be living elsewhere in the country, in a £1m property that’s again amongst the 2% most expensive properties locally. You’re also living in a “mansion” by local standards (and chances are, you have a MUCH bigger house/grounds than the £2m house in the South East). As you’re living in a mansion, you should also pay the tax.

    Regardless of how it may be implemented, it’ll cost a fortune to implement, have lots of “oh, but you’re a special case, we’ll let you off (all farms ?), or let you pay it later (asset rich, cash poor), have lots of anomalies ” and raise very little.

    All things considered, waste of time.

  12. 02/07/2014, Greg wrote

    Merryn I’m afraid I disagree with the valuation argument in your article. The house worth over £2m pre-mansion tax would not be worth less than the one below £2m, simply the market would adjust and yes it might be worth less than it currently is but not less than the house which is cheaper to start with – it would effectively be a new market distorting Council Tax band but having it would arguably be better than the present situation where someone in a modest 4 bedroomed house up North pays the same as someone with a ‘mansion’ in Kensington or Chelsea. It’s far from the best solution but clearly a political move so Labour & the Lib Dems are seen to be taxing the “wealthy” – even if the owners are property rich but cash poor. There are bound to be valuation disputes for properties close to the threshold of the tax but most of the property affected would be straight forward to identify.

  13. 02/07/2014, rftc wrote

    Following the hallowed example of Stamp Duty with its ‘slab’ structure, where tax is payable at the higher rate on the whole, rather than just on the increment above the relevant threshold, of the purchase price of a property, Labour and Lib Dem proposals for a mansion tax are all set to introduce yet another perverse distortion in the housing market.
    At present, if you try to sell a house valued at just above £2 million, you will struggle because of the way stamp duty hits properties in that bracket. Hence a house costing £1,999,999 is liable for stamp duty at 5% (ie just short of £99,000); a house costing £2,000,001 is liable for duty at 7% on the whole amount (ie just over £140,000). So £40k extra in tax is payable on a purchase price precisely £2 higher.
    Not content with this, Ed Balls and Danny Alexander are all set to make it absolutely impossible to sell any house valued just over the £2 million mark. This is because they propose to charge the tax in bands, the first of which, they suggest, will bracket together houses valued at between £2 and £5 million. So far, we have been told that they intend to levy the tax at 1% p.a. of the value above £2 million. So, for the sake of argument, 1% of the excess of the average of £2-5 million could be as much as £15,000 p.a. (£1.5 million * 1%).
    Hence the seller of a house valued at just over £2 million will have to convince the buyer not only that it is worth paying an extra £40,000 in stamp duty; but that in addition, he will face a yearly tax of £15,000 – all, of course, to be paid out of already taxed income.
    It will be interesting to see how this affects house prices around the £2 million mark as the election draws near. Logically, anything currently valued at a few hundred thousand pounds above the £2 million mark should presumably fall in value. Perhaps such properties will, in fact, fall below the £2 million threshold itself – in which case, will that be taken into account when HMRC sends its valuers round?
    Whatever happens, it promises to introduce yet another monstrous distortion at a totally arbitrary price point. Plus ça change !

  14. 02/07/2014, Mark Wadsworth wrote

    @ RFTC, it would be an absolute tragedy if the price of homes currently over £2 million were to fall to just below £2 million to avoid the cliff edge.

    That might reverse as much as six or nine months worth of unearned capital gains, wouldn’t it? We’d be setting the clock back to the dark times of late 2013. *shudder*

  15. 03/07/2014, mr clyde wrote

    Mombers & Greg – you are right in that people will consider their tax position before trading their house – that’s the point! And, they will think twice before upsizing just for the tax free benefit of further gains. This will depress the demand for high-end houses freeing up what land there is for more of the smaller houses the market needs, squeeze price increases across the board and improve the efficient use of land – Greg! Eventually the market will stabilise and the CGT payable will become just another progressive tax no more or less onerous than income tax is now. Alternatively you can leave the system as is, and/or bring in LVT, MT, whatever with all the exemptions it will need to work aka Ed Balls-up, and leave me and my kind to continue making tax free loadsamoney at your expense. Which is the point Merryn is making.

  16. 04/07/2014, mr clyde wrote

    Greg – would I pay more CT than LVT? – possibly, but that is not the point. At least CT is based on an approximate value of the property now, rather than some abstract future estimate, which is also the reason why stamp duty is also flawed in that it is a property tax levied before any gain has been realised.

    • 04/07/2014, Greg wrote

      No, actually your Council Tax will increase if you choose to extend your home or subdivide it – but if you were to pay LVT you would pay the same as before the extension/improvements/sub-dividing, and possibly less if land values were to fall. Yes, if land values were to increase due to a new railway line or road you might pay more tax but why should you benefit from a windfall created by taxpayers? I agree that Stamp Duty is flawed – you are effectively paying the CGT of the previous owner.

  17. 16/07/2014, mr clyde wrote

    But how on earth do you distinguish between what is an increase in the value of the land and what is an increase in the value of the structure built on that land? Eg. I build an extension on my house at the same time as the OFSTED report on the local school improves. As a result my house is now worth £50k more – How is it decided what the ‘new’ LVT should be – as Merryn pointed out – a licence for distortion and corruption. It would be so much easier just to charge me CGT on the gain at the point of disposal when the gain is crystallized.

Comment on this article

MoneyWeek magazine

Latest issue:

Magazine cover
Going bust

What happens when countries default?

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues

Vote in the MoneyWeek Readers' Choice Awards

Vote for your favourite financial services companies in the inaugural MoneyWeek Awards, and you could win a year's subscription to MoneyWeek magazine. Find out more and vote here.


Which investment platform?

When it comes to buying shares and funds, there are several investment platforms and brokers to choose from. They all offer various fee structures to suit individual investing habits.
Find out which one is best for you.