Higher property taxes will cool the housing market

I have a friend who has been trying to sell a central London flat for eight months. Another has had a large house on the market for six months. They can't understand why these one-time money machines aren't selling.

What happened to the hot London housing market, the one in which you could sell any dark, noisy, mini-Victorian conversion for a million quid?

It seems it is fading. A quick look at news from Strutt & Parker gives some background. The overall value of the transactions the agent conducted in the third quarter of this year was down 21% on the same period last year. Those of houses under £2m were down 21% and those of over £2m down by 27%.

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Similar news comes from Foxtons, which says that transactions in London in the second half of the year will end up "significantly below" their level in the second half of bubbly 2013. Prices aren't rising as they were either; they are, says Strutt & Parker "being adjusted down by about five to 10%."

Anecdotal evidence suggests prices are down rather more than that, but 10% is still a significant number. I've been writing about the madness of London prices for a while now, so this comes as more of a relief than a surprise.

But it is still worth asking: why now? What makes the prices Foxtons euphemistically calls "constrained" in 2014, when they were so very unconstrained in 2013?

The answer: politics. Lastweek brought us news that the UK public sector deficit is not falling, but rising. The very next day brought us a report on the NHS, making it clear that unless we can persuade the population to take some tiny personal responsibility for its health, the service is and will remain a bottomless money pit.

There appears to be no real appetite in the UK among voters or politicians to finding other ways to shift towards a significantly smaller state. Given that, taxes can only rise.

They aren't going to rise for the low-paid. It'll be tough to put up income taxes on middle income earners, too. The competition is not about which party can broaden the income tax base the most, but which can narrow it the most.

Adding a few more points to the rates on the rich and you'll see avoidance related falls in revenue that more than cancel out any gains. Capital gains tax is already an extortionate wealth tax, due to the absence of indexation, while corporation tax appears all but uncollectable. The thresholds for inheritance tax are more likely to be raised than cut and I can't imagine any politician would suggest a sharp rise in VAT.

What does that leave? It leaves property taxes as pretty much the only way of paying for political promises. Ed Balls may say that his planned take from a mansion tax is for the NHS, but if he is like any other politician, he will have already earmarked rising future revenues for hundreds of other vote winners too.

Property taxes aren't just about the deficit. They're also a symptom of a horribly distorted market. Successive governments have done everything they can to push house prices up with super-low interest rates, tax breaks for buy-to-let, Help to Buy and so on.

That's why, measured by interest burden, UK houses prices have rarely been more affordable. But on measures of earnings they have rarely been so high.

The state can't let this huge market distortion go too far, particularly in London. So, in the absence of the courage required to normalise interest rates, the government is forced to put bad policy on bad policy to dampen prices. Hence, new affordability tests on mortgages and another reason why rising property taxes are inevitable.

The threat of higher property taxes pushes down house prices, because buyers mentally capitalise the tax. They calculate the long-term costs of the tax in the future and subtract that lump sum from the price they are willing to pay for the house and its attached burden today.

High-end London buyers have probably also spotted the suggestion that any mansion tax scheme should be based on the mansion tax the UK already runs the Annual Tax on Enveloped Dwellings, or Ated.

Most of us haven't really noticed this levy it's charged annually on houses bought inside companies to avoid stamp duty but it rises sharply in bands. From £3m-£5m, it is £15,000. By £20m, it is £150,000 a year. That's real money.

Capitalising the Labour mansion tax as it stands would mean a fall of around 16% in the value of a house over £10m and one of two to 3%in one worth £2-3m (about £60,000) according to Capital Economics.

There's more. Ated is to be charged on houses worth £500,000 or more from 2016, so owning a house worth £1.5m less than £2m is no guarantee of safety in the new world of property taxes.

And with Ated, it's not the threshold that is indexed, but the payment: "The annual chargeable amounts for Ated are increased each year in line with the consumer prices index", states HMRC's website.

So, if you pay on a £2m house, you will keep paying on a £2m house, regardless of what inflation does to its real value. You will just pay more each year. It's double indexation in the taxman's favour. Look at it like this and you might wonder why transactions and prices in London haven't already fallen rather more.

Sooner or later, and regardless of who wins the next election, wealth taxes in the form of property taxes are going up. It might not be the Lib Dem version, it might not be the current Labour version, or the SNP's insanely self destructive stamp duty rises in Scotland. You might not be ready to accept this yet but the buyers of London property clearly have.

This article was first published in the Financial Times.