Thursday 19 May 2011

X/Y times Y = X (Part 2)

Sobers, commenting on part one:

If you recalculate the LVT rate in year 2 to 10% to get the same amount of income, what will happen? The people at the bottom of the pile will see their gains eroded and many will tip into losses. Those at the top will be even greater losers and thus have even greater incentive to sell their houses thus reducing the price.

The house prices get pushed into a smaller and smaller band in the middle (because most incomes are in that middle band) and thats where the majority of the LVT burden will eventually fall, on the same people tax does now, the masses.


As I explained in the footnote, LVT is a tax on rental values and what Sobers thinks will happen will not happen to any great degree.

Let's boil all UK houses down to two sample houses, one Up North in a low wage area costing (presently) £100,000 (HUN) and one Down South in a high wage area costing (presently) £200,000 (HDS). The main reason for the difference is because the higher net wages bids up the price of HDS (there is a very close correlation between wages and house prices).

So the rental value of HDS is clearly (say) £4,000 a year more than the HUN, which is because net wages are (say) £5,000 higher. And with a marginal tax rate of about fifty per cent, that means the person buying or renting HDS is paying £9,000 more in [rent + tax].

Let's say in Year One, the tax on the house Up North is £8,000 and Down South it's £16,000 and all other taxes are scrapped. What happens if Sobers is right, and the HUN rises in price to £120,000 and HDS falls to £150,000?

Answer: not much.

In Year Two, our required tax take from those two houses 'X' is still £24,000, and the tax base 'Y' is now as follows:

HUN: [selling price x 5%] + [current LVT bill] = £14,000
HDS: [selling price x 5%] + [current LVT bill] = £23,500
Y, total tax base = £37,500 (rental value, not selling prices).

So X/Y now becomes 64% (£24,000 ÷ £37,500)

The tax on HUN is adjusted to £14,000 x 64% = £8,960
The tax on HDS is adjusted to £23,500 x 64% = £15,040.

We see that because it is a circular calculation, in Year Two, despite the large change in relative prices, in absolute terms, the tax on HUN goes up £960 and the tax on HDS goes down £960, and so on every year in ever smaller increments, because people will anticipate the changes

Now, let's also focus on the difference in the total tax bill; if you live in HDS, in Year Two you are paying £6,080 a year more in LVT than the bloke in HUN. Under current rules, you would be paying £9,000 more in [tax + rent], and that balance of £3,000 (in round terms) will still feed into a higher rent receivable by the landlord of HDS, clear of all taxes, which, capitalised at 4%* still means that HDS will be worth £75,000 more than HUN - so it's clear that the difference in price between HDS and HUN would not fall significantly.

* I used 4% for consistency with the example above; you could just as well argue that under current rules, £4,000 rent before tax = £3,000 after tax, and the capitalised amount is £100,000. Therefore under LVT, £3,000 extra rent before tax = £3,000 after tax, so the capitalised amount remains £100,000, and there is no change in the price differential between HUN and HDS.

It's all very simple, really. As a general rule, not much will happen apart from some people trading down and others trading up.
---------------------------------
"People have a natural aversion to paying tax, so while the people losing out will definitely want to downsize to something they can afford, the people below will not want to upsize to somewhere they can't afford."

Simply not true.

Rich people are happy to spend £60,000 on a flash new car, even though the price includes £10,000 VAT. (While I'm on the topic, the total taxes paid by car drivers is over £50 billion a year; twice as much as Council Tax!) Rich people are happy to pay £10,000's a year in rent (or mortgage interest) to live in a flash house. If all people had such an aversion to paying tax or rent or interest, why don't rich people all drive round in battered old VW Beetles, or live in bed sits?

7 comments:

Bolivia Newton-John said...

Hi Mark, I'm enjoying the blog.

One question that has been worrying me recently though re: LVT (of which I am otherwise an avid supporter) after reading mention of it somewhere:

In a democracy with a range of (excessive) taxes, there is at least pressure on the government to restrain their spending, as even though costs are dispersed people still feel the pain of income tax/high prices etc. If this were to be removed, and a single tax, or something approaching it, imposed, a large number of people would be entirely exempted from tax, but presumably still have representation. Witness the way unemployed hippies always feel able to call for higher income tax; I know land value tax would in theory make government spending less necessary due to everyone being richer, but wouldn't the politicians' benefit from providing pork drive the LVT rate up and up and cancel this out?

I'd be grateful for any thoughts you've got on the issue.

Mark Wadsworth said...

BNJ: if in doubt, apply commonsense:

"a large number of people would be entirely exempted from tax"

No they wouldn't (unless you sleep on the streets). Everybody has to live somewhere! Seventy per cent of the UK population is homeowners (who would know exactly how much they are paying); ten per cent of people are private renters (and their total rent bill would be > LVT, or landlord could split the rent bill up into "rent" and "LVT", thus passing the risk of increases/reductions on to the tenant; and twenty per cent are social tenants).

Mark Wadsworth said...

BNJ (cont): " I know land value tax would in theory make government spending less necessary due to everyone being richer, but wouldn't the politicians' benefit from providing pork drive the LVT rate up and up and cancel this out?"

Not in theory, in practice as well. And remember that LVT is a completely in-your-face tax, it is politically far more difficult to e.g. increase council tax than it is to sneak in a 2.5% VAT rise and a 2% National Insurance rise.

So that's what they just did, and they then boast about using a tiny fraction of those extra VAT, NIC receipts in order to 'freeze' council tax.

That's one of the benefits of LVT, it would be completely transparent and wildly unpopular, so tax increases would be few and far between.

Sobers said...

Hang on a minute! Now you are creating your LVT bills from the rental values (which I accept are fundamentally linked to wage levels, so fluctuate less than capital values.). Previously you were taking selling prices and creating a sq yardage value for LVT tax that way. Selling prices are NOT as linked to wage levels as rents are, especially at the higher price levels, because at those higher price levels people don't tend to borrow money to buy houses, they already have the cash, or a large % of it. Equally rents aren't that linked to prices. If you get X rent for a £100K house, you don't get 2X for a 200K house and you certainly don't get 3X for a £300K house. There is a tapering off effect. You can rent a mansion in the country for a fraction of what it would cost if you had to borrow 80% of the price. Why? Because there aren't enough people with the income to purchase all the expensive houses, on borrowed money. So rents are (relatively) low for very expensive houses.

Thus if you now use rental values rather than capital values, yes, as the expensive houses lose value, their rental value will not drop as much, and the rental value of the cheaper houses will not rise as much either.

But that's not how you calculated it before, when you produced figures for various postcodes in the Swindon area. If you had done it that way the values for would have been squeezed into a much smaller range - those those at the bottom would have paid more and those at the top less.

For example the rental value of my house is probably £1000/month or £12K/pa. You can tax that at 100% if you like, I'd be quite happy with a total tax bill of £12K. Your previous method gave me a bill of £30K+.

So which is it to be?

Mark Wadsworth said...

S, the phenomenon that rental yields are higher on small/cheap homes and lower on expensive/big homes has often been observed, whatever the reason is, so I agree with the first bit.

But similarly, a larger proportion of the capital values of larger houses is bubble value, so is most at danger from interest rate hikes.

Of course in the long run, LVT is on rental values, that's what everybody says, I just used capital selling prices because they are easy to understand. This is just to the ball rolling.

As to the Swindon exercise, as I explained, these were done on the assumption that all semi-detached houses are on the same size plots, which is unlikely to be true.

IF (for example) it turns out that semis in the cheapest sector (SN2 5..) worth average £90,000 are on 300 sq yard plots; and thos in the most expensive sector (SN6 8..) worth average £230,000 are on 767 sq yard plots, then, applying the basic rule "X/Y times Y = X" we would observe that the tax/sq yard is more or less exactly the same all over Swindon,

To wit:

SN2 5.. £90,000 x 8% = £7,200 ÷ 300 = £24/sq yd

SN6 8.. £230,000 x 8% = £18,400 ÷ 767 = £24/sq yd.

"The rental value of my house is probably £1000/month or £12K/pa. You can tax that at 100% if you like, I'd be quite happy with a total tax bill of £12K."

Seems fair enough, but remember: if your potential tenants no longer had to pay income tax, NIC, VAT, corp tax, council tax, TV licence etc etc, and got the CI as well, their disposable income would double, so it's reasonable to assume the rental value would double, to (say) £24,000.

If we also assume that there is a single rate for the whole of Swindon of £24/sq yard and your plot is 1,000 sq yards (I think you said), then using the two different methods gets us to the same figure, so that looks pretty reasonable to me.

PS, £24,000 sounds like a lot (it is a lot!) but under current rules, your hypothetical tenant is paying £12,000 to you, and is earning gross (say) £40,000 is paying/bearing the following taxes:

PAYE £10,400
Employer's NIC £4,500
VAT (7% of gross) £2,800
Council Tax £2,000
TV licence £140
Total = just under £20,000.

That gives him a [tax+rent] bill of £32,000 (quite how the tax is split between him, his employer and the shops where he spends money and his landlord is unknown).

Under LVT, the bill for that house is £24,000 (or £30,000 or whatever) minus his household's Citizen's Income (i.e. personal allowances). There'd still be plenty left over to leave you, the hypothetical landlord with £5,000+ net rental income.

Paul Lockett said...

Sobers: Hang on a minute! Now you are creating your LVT bills from the rental values (which I accept are fundamentally linked to wage levels, so fluctuate less than capital values.).

As the rate of LVT increases, the difference between using rental values and capital values becomes progressively less relevant, as the LVT becomes the driver of the residual capital value, rather than the other way around.

Mark Wadsworth said...

PL, indeed.

I know I count as a heretic in LVT circles for mentioning selling prices/capital values, but you have to keep an eye on them; Golden Rule = if selling prices fall as low as pure rebuild cost, then that is a 100% LVT rate.

In my worked example, the tax base 'Y' incorporates both values into the equation, for safety. Using just one or just the other would be pretty stupid.