Tuesday, 29 May 2007

How the “Asset rich, income poor” can afford their Land Value Tax

Julian H. has asked a perennial question about Land Value Taxation, which I will seek to answer below, namely

…how it's possible to tax something so illiquid.

For example: suppose I have owned the land my house is on since 1990 - in which time its value has increased from £100k to £1m. Yet I am a school teacher and my income during that period has merely risen from £18k to £28k per annum; enough to live off but no more. I have no money investments beyond my pension. How do I pay a LVT on the £900k that my land's value has increased by? I have not seen that £900k cash and never will do because my lazy kids are still living at home and anyway I am sentimentally attached to the house so I'll live in it until I die.

In doing so, he has highlighted the one serious obstacle that land value taxation faces, which is how it affects those with big assets but small income: fashionably called the “Asset rich, income poor”. The most obvious example of these people are pensioners – those whom we cite so often when criticising the Council Tax (which is, when all is said and done, a property tax, albeit a badly flawed one).

There are two possible solutions to the knotty problem of paying tax on an illiquid asset. One would be to permit the taxpayer to defer payment indefinitely, with a proviso that the debt must be paid when the asset is sold, including giving the tax debt priority in the estate of deceased landowners still owing land tax debts. This would result in low yields from LVT in the first few years, but after a while it would begin to settle down and average out. It would also reduce house prices, as profits would be significantly curtailed as significant portions of any profit earned could be owed in back tax.

The other solution would be to create a far more sophisticated market for turning illiquid into liquid assets. Better than the above – which is effectively a government loan scheme – would be for markets to lend money secured on the property. This would require only a small change to existing rules. One can currently withdraw equity on a property; the only difference would be for asset-rich, income-poor households that would wish to defer payment on the new loan. That problem is hardly insurmountable.

Creditors (be they state or private) could either charge a set return, as they do now (5% per annum; 0.75% over the base rate; etc.) or take a stake in the premises (perhaps without charging a fee, as they would then be sharing in the impressive return on the land values themselves). After all, if LVT was set at 1%, and fell only on the land value rather than improvements (considered to average less than two thirds of property prices), then even if one bought a house and lived in it for 30 years, never paying one’s own LVT, when one came to sell/died after 30 years one would only have ceded less than a fifth of the (value of the) property to the person or institution that had paid 30 years of LVT on your behalf.

In answer Julian’s specific example, then:

Assuming a typical property, £60,000 of Julian’s original £100,000 was the stake for the land rather than the building on it. This has grown to £600,000 over 17 years, giving Julian half a million pounds in unearned growth. Consequently, either:
a) 17% of the land (but not the buildings thereon) is owned by somebody else – government or financial institution, or
b) Julian borrowed the money at a commercial rate of interest, and currently has a financial commitment (which I can’t be bothered to calculate because it is complex) which he has no need to pay until he sells the house or dies.

Either way, Julian need not worry. If, as he says, he is “sentimentally attached to the house so [will] live in it until [he] die[s]”, he need never pay off the debt. Instead, he can die still owing the tax/debt, and his “lazy kids” can pay it off out of the enormous sum of money they make selling the family home.

Even if Julian lives for 100 years after he buys the house, his children will still get the return on the buildings (a third of the overall value - £400,000 so far according to his original example), which will still provide a nice start in life now that they have to go out there and fend for themselves.
I hope that explains how LVT might be affordable for the asset-rich, income poor. It’s a better position than they currently find themselves in when the Council Tax bill arrives. And it would help damp down the housing market, too.


Kit said...

Only a LibDem could worry about becoming £100k richer;)
The purpose of LVT is so that land is used efficiently. The school teacher should knock down his house, build a block of flats, and sell-up and retire to Barbados.
Note: if all land has risen in value then the government should cut the tax rate so its tax income stays the same. In other words, don't blame LVT for government greed.

Julian H said...

Ah, fame at last. Thank you for the very comprehensive reply, Tom. I'm still on the fence wrt LVT but this will help to mull it over a tad more.

Sadly, Kit, I write this from a rented bedsit on a plot of land not my own. Thankfully I do not have any kids, lazy or otherwise.