Published: 15 March 2011 | Author: Bernard Clarke
Understandably, the Chancellor of the Exchequer, George Osborne, hopes to position next week’s Budget as focused on promoting enterprise and economic growth. However, the reality is that myriad tax rises and benefit cuts are due to take effect from early April, and public spending cuts will also begin to bite in earnest this year. With household finances already under pressure as a result of consumer price inflation persistently above target (largely reflecting higher global food and fuel costs and January’s increase in VAT to 20%), anaemic earnings growth and job losses, 2011 is set to be a challenging year for households and the housing market.
New rate of duty
One change that is likely to attract few press headlines is the already announced introduction of a new and permanent higher rate of stamp duty on residential property purchases of more than £1 million. Seasoned Budget watchers may recall that the outgoing Labour government heralded this change last March, when it announced a two-year suspension of stamp duty for first-time buyers on residential property purchases up to £250,000.
The introduction of the 5% stamp duty band will probably not evoke a great deal of public sympathy or interest. Given the weak state of public finances, wider economic uncertainties and lingering dis-satisfaction about how the burden of economic re-balancing is being shared across society, most people will dismiss it as a fairly innocuous tax on the rich.
But it is by no means trivial from an overall fiscal perspective. Although the introduction of the new 5% stamp duty rate will initially affect just over 1% of residential property transactions, our back-of-the-envelope calculation is that it will generate an extra £250 million yield in a full year.
An arbitrary tax?
Unfortunately, perhaps the greater significance of the move is that it exposes both the increasingly arbitrary nature of residential property taxation and the increasing reliance of the government on the yield coming from higher-value property transactions.
Chart One: Proportion of yield from residential stamp duty, by duty band
By 2009-10, the latest financial year for which figures are available, 86% of residential stamp duty came from tax paid at higher rates (on property sales of more than £250,000). We accept that the previous stamp duty holiday – on transactions of up to £175,000 (which ended in December 2009) – exaggerates this effect, but not by much. And, with first-time buyers for the time being exempt from paying stamp duty on sales of up to £250,000 and the new higher rate of 5% only days away, the clear trend over recent years will intensify.
In the decade prior to the credit crunch, the Treasury enjoyed substantially higher yield from residential stamp duty, as a result of strongly rising house prices, fiscal drag and the "slab" structure of the duty (under which duty is charged at the highest appropriate rate on the whole purchase price, including the parts below lower thresholds).
More recently, as the CML forewarned, stamp duty yield has collapsed. It has averaged a little more than £3 billion over the last two tax years, less than half the peak level of £6.7 billion seen in 2007-8. A similar outturn can be expected for 2010-11. This sharp fall reflects the substantial drop in property sales over the period.
Weak housing demand
While the slowdown in housing market activity stems principally from the limited availability of mortgage funds and from weaker consumer demand against a backdrop of economic uncertainty, high transactions costs as a result of stamp duty have almost certainly suppressed demand further. Whereas in a strongly rising housing market, buyers were able and willing to absorb high transaction costs (and in many cases simply add them to the mortgage), the current situation is markedly different. In many parts of the UK, where house prices are static or weakening moderately, the high level of stamp duty is certainly more "visible" to buyers. And it can also look daunting, especially if the restricted availability of mortgages means that stamp duty has to be financed from their own savings.
Notwithstanding the temporary boost reported by some up-market estate agents, as individuals try to buy ahead of the new 5% band, stamp duty more generally may well be exerting considerable friction in the middle and upper reaches of the housing market. This probably helps to explain why house purchase activity has fallen to a similar degree for both first-time buyers and movers.
Chart Two: Recent trend in first-time buyer loans
A negligible impact
A year on from the introduction of the stamp duty concession for first-time buyers, it is reasonable to ask what impact it has had in stimulating first-time buyer numbers.
While we have yet to see any impact analysis from HM Revenue & Customs, prior estimates suggested that nine out of 10 first-time buyers would pay no stamp duty at all. In more normal times, we would expect a give-away of up to £2,500 to represent an appreciable stimulus to activity.
But, as far as our figures show (see Chart Two), the impact appears to have been negligible so far. According to our regulated mortgage survey, both the number and value of loans to first-time buyers continue to stagnate at barely half the levels prevailing before the credit crunch. Admittedly, CML figures for first-time buyers capture households that are also returning to home-ownership after a period abroad or in a different tenure (who would not be exempt from stamp duty), but the underlying picture is similar for those aged under 30 (where the distorting effects of "returners" are pretty negligible).
Our view is that the failure to ignite first-time buyer demand reflects the deep-seated nature of problems in the housing and mortgage markets, and not least the significant step-increase in deposit requirements since the credit crunch. And, as we have set out in our response to the Financial Services Authority’s mortgage market review and elsewhere, regulatory changes risk making mortgages even more costly and restricting permanently the availability of mortgage credit to a narrower group of households.
This is not the same as saying that the stamp duty exemption has been a waste of time. It is entirely feasible that first-time buyer numbers might have been materially lower without it. It is, of course, also possible that, as with the stamp duty holiday that ended in December 2009, the main impact of the policy will be felt in its closing months, as activity picks up in anticipation of stamp duty being re-imposed. But, whatever the case, the time-limited nature of the stamp duty concession may present something of a dilemma for the government.
Although the prevailing view among forecasters is that the housing market will be relatively weak this year, but then stabilise or recover modestly through 2012, we should not lose sight of the likelihood that household finances will still be pretty shaky and consumer confidence subdued, especially if – as seems likely – interest rates have started to rise.
Against such a backdrop, it is far from certain that the government would re-introduce the 1% stamp duty band for first-time buyers from April 2012. And so the haphazard approach to stamp duty that we have seen from policy-makers may continue.
We see a strong possibility that residential property transactions do not recover as strongly over the next few year as implied in the Office for Budget Responsibility’s November’s Economic and fiscal outlook. It is quite possible that the volume of residential property transactions does not recover strongly over the next few years, and that government revenues from stamp duty will disappoint.
Given this, we believe that there continues to be a strong case for reforming stamp duty. In particular, a switch away from the "slab" structure to a marginal rate system similar to income tax, would create fewer disincentives to purchase properties near tax thresholds, improve the liquidity of housing and labour markets and deliver a more stable tax base over time. It would also allow the government to articulate a more credible, coherent and longer-term policy in relation to first-time buyers and home-ownership.