IEA Breakthrough Essay – October 2018 ________________________________________________________________

Unshackling our building capability and meeting housing priorities

1 – Where we are now, and how we got here. Policies that led to the confused and incoherent property market that threatens the very fabric of our social wellbeing.

2 – Removing existing obstructions and avoiding a repetition. A brief skirmish through the bureaucratic nightmare called planning and its direct and indirect impact on the smaller housebuilding sector.

3 – Proposing two transformational tax initiatives to replace the cumbersome and officious web of tax rules that impede delivery of housing.

The subject matter of this competition is a search for solutions to the social evil of deficient housing provision. Before launching into potential policy initiatives, however, we should stand back and consider how we landed in this predicament in the first place – lest the same errors are repeated.

In a free-market economy capital finds its way to meet any need that, once fulfilled, is likely to yield a profit. This is a natural process that requires no government involvement – other than to remove earlier government-inflicted obstacles!

Offering a novel panacea is not necessarily the best answer: it is perfectly possible that the removal of hindrances may lead to a lasting solution.

Misdirected government involvement

This can be observed in a variety of channels, such as directing taxpayers’ money into (i) new infrastructure projects that are primarily populist vote- catchers; (ii) unaffordable welfare commitments whose financing is ravaged by wasteful management and government’s own inflationary policies; or (iii)instances of virtue-signaling, such as advertising the ills of alcoholism, fatty foods, sugary drinks, and comparable targets, a role for government that is, to say the least, of questionable validity.

Government expenditure beyond the essentials of protecting life, property and civil liberty is, by its nature, not susceptible to economic analysis or calculation. Yet these become essential considerations when the provision of private capital enters the equation. If Carillion-style catastrophes are to be avoided we need to be clear about the role of private capital in the provision of affordable housing. Assuming building land is available and a competent building sector is ready to provide the construction, what gets in the way of bringing these factors of production together in fruitful combination?

House prices

Prices of houses in the market we are here considering have been rendered unaffordable to many low and middle-income families by the twin effects of (i) increases in immigration and (ii) government policies pursued in the wake of the financial crisis of 2008-9. The latter factor is one of the key ingredients of the malaise that led inexorably to the housing shortage, in terms of both new builds and rentals. It must therefore be properly understood if it is not to become a cyclically phenomenon, particularly since the symptoms that triggered the crisis of 10 years ago are ominously reappearing amid plausible forewarnings.

Post-crisis policies of quantitative easing (QE) and the deliberate slashing of interest rates caused a massive inflation of the money supply and equivalent credit expansion. The Bank of England’s policy of purchasing government bonds in the financial markets, and paying for them with swathes of fiat money, led its first receivers in City institutions such as banks and insurance companies to funnel it into asset purchasing on a massive scale – causing prices of land, property, equities and a host of luxury paraphernalia like yachts, cars and Bond Street baubles to reach unprecedented “highs”.

But the inescapable “Cantillon effect” took hold, causing this high-end price inflation to filter down into the High Street and, more to our point, into property prices across the spectrum, obviously most keenly felt by the families critically affected. [Richard Cantillon,1680-1734, French-Irish economist, remembered for identifying the distributional impact of inflationary policies]

A recent analysis by the Bank of England showed that even by 2014 the impact of QE on house prices and equities was to lift them, respectively, to 22 per cent and 25 per cent above what they otherwise would have been, when measured against incomes [Bank of England statistics 2014-2018 – various].

Considering housing in particular, QE cannot be written off as merely a temporal phenomenon. Worldwide QE expansion thrust $20 trillion into banks and financial markets with no democratic checks or balances. Taking the UK on its own, it put home ownership beyond the reach of tens of thousands of young professionals.

More government money? Not the answer

Thus far we have been considering the impact on house prices of government policies rather than the more directly involved economic actors such as population growth, wage levels and relative purchasing power, land availability or building skills and innovation. The “disconnect” between the government’s target of building 300,000 new homes a year by the mid- 2020s and its own obstructive policies is truly astonishing. It is almost as an act of contrition that the Chancellor has this year pledged to increase funds of the Housing Growth Partnership to £220 million for small and medium-sized (SME) housebuilders.

How many believe, in the light of experience, that government’s familiar knee- jerk response of spending more taxpayers’ money on well-intentioned infrastructure projects will actually assist private sector contractors to deliver to target? Or is it more likely to introduce more damaging and lasting market distortions?

In a free-market economy, availability of the working capital needed to oil the productive work of smaller housebuilders should not be a problem. Why, then, are so many lenders reluctant to meet the funding shortage? The answer is that banks and private equity sources are understandably risk-averse, and the particular risks for this sector arise chiefly from the costly delays and complexity of the pre-building process rather than risks associated with construction itself. There is therefore an overwhelming case to be made for reducing the red tape that gums up the route from initiative to completion.

Regulatory overload

The volume and intricacy of rules on planning, safety, building regulations and the appeals process are legion. If it had been the intention of central and local government to place as much bureaucratic lumber in the way of a smooth process, they could hardly better the existing set-up. Whether it relates to right- of-way, tree or hedgerow preservation, party walls or scaffolding – the scope for simplification is immense.

Alleviation of the housing shortage must therefore begin by recognizing the crucial role played by SME developers who are less resourced than the larger players. Indeed, the Home Builders Federation (HBF) estimates that in the past 10 years the number of firms that erect up to 30 housing units per year has fallen by 50 per cent, while the number of big builders has increased [HBF publication: “Reversing the decline of small housebuilders: Reinvigorating entrepreneurialism and building more homes”, 2017]

Private housebuilding in Britain is regulated by the Town and Country Planning Act. Its first incarnation entered the statute book in 1947, primarily to protect the countryside. But the Act of 1990 is an overburdened regulatory tome of 337 sections and 17 schedules, occupying 550 pages. All good stuff no doubt, but it presents a veritable minefield in the way of anyone who wants to build a house!

The obfuscatory role of local councils

Owners’ rights to develop their land are strictly controlled. Local councils are the arbiters on the purposes land can be used for and planning permission to build houses is granted only in accordance with a strictly applied local plan. Green belts (thus designated over 70 years ago) that surround large cities are especially problematic. Even though government reforms in 2012 made it easier for developers to build on open countryside and green belt, there is an understandable aversion for siting building projects on land that has been designated as such.

However, Campaign to Protect Rural England (CPRE) recently commenced investigations into how much “brown field” land is available for new housing. The results, extrapolated from submissions from 53 local authorities, showed that there is space for at least 1 million new homes on brown field land, equivalent to four years’ supply of housing. This would also save thousands of acres of green belt and open countryside from being lost to the community. By relaxing the current regulatory asphyxiation more brown field land could be made economically viable for developers [CPRE report on brownfield availability for housing, November 2017].

Despite the administrative cost and inefficiency that deters so many small building enterprises, the HBF has stated recently that a record number of planning applications are being submitted and approved, citing this as “a clear demonstration of the industry’s commitment to ramping up housing supply” – but more land needs to come through the planning process more quickly if this commitment is to be realized. The HBF complains, however, that the complexity of legislation works against smaller firms and start-ups, and against delivery of specialist housing such as care homes and retirement homes [ HBF Report May 2018].

Barriers to building

The recently published Letwin Review, an independent government appraisal intended to identify barriers to building, focuses primarily on land banks with planning permission that are hoarded by the largest housebuilding companies pending improved absorption rates. Absorption rates represent the ability of new builds to enter the local housing stock without “rippling” into a wider price distortion.

Although councils favour larger scheme designs put forward by major housing giants, there is a drawback: the time taken until the entirety of the site is developed causes great delays in housing delivery, effectively rendering smaller builders uncompetitive and their efforts uneconomic.

If (i) local authorities were more rigorously challenged when they refuse new planning applications, and (ii) planning procedures were made less complex, the small building firms would be less affected by planning delays and refusals, reducing costs and enabling them to compete with national housebuilders on a level playing field.

The final obstacle is the “viability assessment” loophole exploited by builders after being granted planning consent on the condition that a guaranteed percentage of their houses will meet criteria for affordability, obviously yielding less profit. These contract conditions are vulnerable to being reassessed for viability, under which the developer trots out changed financial circumstances that militate against its ability to meet the affordable housing criteria.

The viability loophole allows developers to lower the affordable housing commitment into which they have entered, in order to guarantee them a 20% profit margin. This undermines affordable housing provision, especially when developers, knowing about the loophole, can factor it in when making bids on new sites. Again, the loser is the availability of affordable housing.

The absurdity of this system is obvious, especially when so many of these cases are privately heard, away from any public scrutiny [“Shelter: Financial Appraisals”, November 2017]. Susceptibility of viability assessment to corrupt practices should be obvious.

Tax reform initiatives

No initiative seeking to remedy the dearth of affordable housing in Britain can succeed if it omits the need for reforming a tax system that militates so heavily against councils and citizens alike.

The manic complexity of tax rules that impinge directly and indirectly on the housebuilding sector serves to obscure the desperately needed reforms that could replace regressively unfair council taxes, stamp duty, and inheritance tax, at the same time giving local councils an irresistible incentive to make vacant UK properties habitable. Even three years ago the number of vacant properties exceeded 600,000 [BBC News Magazine, December 2015].

When revenue authorities are bogged down in a system that has hundreds of different tax “reliefs”, is rife with rule-stuffed nonsense such as how to tax disguised remuneration, holiday lets, Boris bikes and whether private bets placed by an on-course bookmaker are part of his trade – and even pretending to “tax” thousands of people who are paid out of taxes – some “blue sky” innovation is clearly overdue.

Tax initiative 1: Site value taxation

I refer, of course, to a tax on land values, based on the value of the land alone – not on buildings or other improvements. Under this system development is encouraged because it has absolutely no effect on the amount of tax payable.

It has been in successful operation in Australia for many years and it gives the clue to the most natural provision of infrastructure finance, including housing development. The government of New South Wales (NSW) saw the light many years ago. It collects an annual property tax (from which existing private residences are exempt) based on land values above a pre-set threshold. Today in Australia, Denmark and South Africa land tax is one of the main sources of infrastructure funding.

I emphasise that the amount on which tax is assessed relates only to the unimproved value of the land: buildings and other structures on the land are simply ignored. There is thus a huge incentive to improve properties in order to realize their full rental potential, and refurbishing or adding structures has no effect on the amount of tax payable each year. And being based on land, it cannot be hidden, dodged or shifted! [Classical economists including Smith, Ricardo and Mill recommended a tax on land values, and Henry George in his seminal work “Progress and Poverty” strongly advocated taxing land. All of them recognized that such a tax is both efficient and equitable.]

Compare Islington

To highlight the importance of these features just consider, by way of contrast, what is happening closer to home, where hundreds of thousands of homes across the UK are unoccupied despite widespread concern over the housing shortage. Why on earth would someone own a property and leave it vacant?

Islington Council complains that a high percentage of its housing units have no registered voters living in them. The authority blames a phenomenon known as “buy-to-leave” whereby investors, often from abroad, buy property and leave it empty, thus exacerbating the capital’s housing shortage.

This is undoubtedly a significant factor behind the travesty of having 216,000 homes in England empty for more than six months [Research published by Liberal Democrats, January 2018]. Their owners don’t have to do anything – they just watch and wait. The shortage they have helped to create guarantees higher property values, providing them with a source of wealth they have done nothing to earn but which they can access if and whenever they choose.

London’s Jubilee Line cost £3.5 billion to construct, yet added £13 billion to land values along its route. The £10 billion bonus went into private hands, having contributed nothing to the cost [Fred Harrison quoting Don Riley in Wheels of Fortune, 2006. See also Don Riley, “Taken for a Ride”, Centre for Land Policy Studies, 2001].

]Even a modest land value tax would cure this aberration at a stroke, as it did in NSW, and later throughout Australia, over 100 years ago. They have never looked back.

Hong Kong, where housing density is far more acute than England, has always recognised that the benefits of highways, bridges, tunnels and mass transit systems easily outweigh their capital outlays funded from resulting incremental rental values. Although Japan and China also base property taxes on notional rental values, only Australia and Denmark have the critical ingredient of not taxing improvements.

OECD studies concluded that a shift from taxing employment (see my final section) to land values would provide a significant boost to public finances and pay for a huge housebuilding programme. An annual tax of even 0.5 % of land values in 2012 would have raised £25 billion even then [OECD studies, April 2012].

Is the UK government open to such an obvious initiative? On a visit to the USA in 1980 I succeeded in talking the Chairman of the House “Ways and Means” Committee, Hon. Al Ullman, out of introducing VAT as a federal tax, freeing Americans from one of the indiscriminate and inflationary taxes ever invented.

But the question for now is this: can the incumbents of the UK Treasury, today, be talked in to introducing a tax with potential to transform the housing landscape.

Tax initiative 2: Relieving homebuilding from employment taxes

While considering tax reforms relevant to housing we should reflect on the insidious effect of employment taxes on the building industry. If we were starting from here we would recognise that the construction industry is one of the most labour-intensive – and hence that a payroll tax would discriminate most heavily on the many building firms hovering on the margin of viability. Any attempt to inflict such a tax would be rejected as quickly as Congressman Ullman dropped his VAT intentions!

Yet – when you think about it – isn’t that indiscriminate payroll tax exactly what we have today? We inflict it on industry through the PAYE rigmarole that acts out a charade showing employers simply acting as tax collectors, the pretence being that the tax is an “income tax” borne by the employees.

It is, of course, calculated by reference to an amount called “gross pay” – but this cannot be called income when no employee has ever seen it, let alone spend it. Those who reason that, because the tax is calculated on this imaginary figure of gross pay it must be the employees’ liability, conflate apparent incidence with where it is finally borne. It is the employer who bears the burden in the form of a monthly cheque to HMRC, and if the cheque is for any reason not forthcoming it is the employer that will be sued – not the employee to whom the notional wage spuriously related.

A low-rate corporate tax on added value, post wages

We should carefully consider what a positive breakthrough the builder on the margin would experience if our pernicious payroll tax were to be replaced by a low-rate tax on the company’s whole “product”, or added value (sales revenue less direct input costs and wages). Is that an initiative too far?

Not if our authorities could be made to see that employees work for their real pay – pay that they can spend – and hence that the chimera of “income tax” via PAYE is in fact a corporate burden.

Only then will it be possible to structure the tax so that low added value, labour intensive businesses, fighting for their existence in adverse economic periods, no longer face the threat of extinction on a daily basis.

Conclusion

We end as we began – by recognising that much progress towards our objective can be made by removing the dross in the machine, giving us an opportunity to take a fresh approach, untrammelled by all the usual notions of how things should work – and why they often don’t!

Much needs to be done clear a more rational and practical path through the regulatory minefield, not hesitating to discard complex and obstructive rules that no longer stand scrutiny on a balanced value-for-money measure. This process allows us to salvage the most practical and intelligent stipulations and guard against excess, while affording a smooth passage towards more abundant provision.

Finally, the reform of destructive tax policies is key to the hope of any meaningful progress toward the goal to which this essay competition is dedicated.

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