Published: 26 June 2012 | Author: Bernard Clarke
We have long advocated a fundamental reform of residential stamp duty, away from its current "slab" structure (under which duty is charged at the highest rate on the whole purchase price, including the parts below lower thresholds) to a marginal rate system similar to income tax.
We believe that this would potentially allow a more cogent approach to property taxation, reduce disincentives to buy and sell property, provide a more stable tax base over time and remove current distortions around stamp duty thresholds.
While HM Treasury has not run with our ideas, there is a more radical view north of the border. As a result of changes to Scotland’s devolved tax powers, the Scottish government has recently launched a consultation about reforms to residential stamp duty from April 2015.
It proposes moving away from the UK’s slab approach to a progressive system where the amount paid is more closely related to the value of the property. It has also signalled a wish to lighten the tax burden at the lowest end of the market.
This article briefly explores some of the key challenges that wider UK reform would come up against, and suggests one modest measure that could underpin the government’s NewBuy policy.
We have used our regulated mortgage survey (RMS) to explore different combinations of marginal tax rates that should, ignoring any behavioural effects, yield broadly comparable aggregate levels of stamp duty.
Although we have not formally modelled results, we are comfortable that they support the high-level analysis that follows, even after allowing for the fact that mortgaged transactions from the RMS will not exactly match the profile of all property transactions.
Reforming stamp duty
Given the UK’s challenging fiscal outlook, a key consideration is likely to be whether or not stamp duty reform can be undertaken in a revenue-neutral fashion.
Chart One: Yield from residential stamp duty, £m
This is not a straightforward question to answer, not least because significant changes in the number of transactions, house price values and levied stamp duty rates have meant considerable volatility in stamp duty yield over time.
Residential stamp duty peaked at £6.7 billion in 2007/8, but has also been below £3 billion on two occasions over the past decade. The Office for Budget Responsibility (OBR) publishes projections of future stamp duty yield. It anticipates stamp duty progressively climbing to £8.5 billion by 2016-17, primarily because it assumes that there is a sharp recovery in transactions.
We would interpret revenue neutrality as implying an annual yield of £4.5 – £5 billion, on the grounds that this would be higher than over the past decade and also be close to the 10-year average implied by the OBR’s projected figures.
Any attempt to formally model alternative stamp duty arrangements is highly sensitive to the yield target chosen, and there is huge uncertainty as to what a target of revenue neutrality might be in practice.
In almost all cases, however, an unavoidable consequence of a switch from the current slab structure to a marginal rate system would be that it creates potential winners and losers.
One of the few exceptions to this would be if one retained the current stamp duty bands and rates of duty were retained, and simply switched from a slab system to a marginal rate system. This would create only winners, because the higher rates of duty would then only be levied on that part of a property’s value above lower rate thresholds. But the downside is that such an arrangement is likely to result in much less stamp duty being collected. Other things being equal we estimate that revenue would more than halve.
Chart Two: Stamp duty liability under current slab and double marginal rate arrangements, £
While doubling the marginal rates of duty, as in Chart Two, would offer one way of addressing the resulting shortfall, this illustrates an important feature of a marginal rate regime.
The constraint of revenue neutrality means that providing relief from stamp duty for lower value transactions implies raising more duty higher up the value spectrum. But, whereas under a slab structure, this can be spread over the entire remaining value of property transactions, with a marginal rate system the revenue must be obtained from the excess value of transactions only.
In the specific example shown in Chart Two, the trajectory of stamp duty liability rises steeply, and would exceed that under the slab approach, even when the slab effects associated with the £1 million and £2 million thresholds kick in.
This risks giving rise to greater (and perhaps material) behavioural effects, as individuals seek to mitigate large potential tax liabilities through avoidance measures or abstaining from some transactions altogether.
The scale of this potential difficulty will depend in part upon the specific combination of tax thresholds and marginal rates chosen. While there is literally an infinite number of permutations, a good design feature would be to keep the marginal rate trajectory as flat as possible.
Chart Three: Stamp duty liability under current slab and 4-5-6-7-8 marginal rate arrangements, £
This search for a flatter structure would in turn lead the authorities to seek to generate a greater portion of target revenue from lower value transactions (whether this is from introducing a lower threshold that triggers a liability to pay stamp duty and/or higher marginal rate than otherwise on lower valued transactions).
Chart Three illustrates this. Here, we have retained the current UK stamp duty bands, but illustrated a marginal rate system that levies 4% on the first £250,000 of a property’s value above £250,000, then marginal rates of 5% on the next £500,000, 6% on the next £1 million, 7% on the £1 million after that, and 8% on any remaining surplus value.
Such a tax regime has the potential to create a much greater number of winners and losers, and also much further up the property value chain. In our worked example, a purchaser of a £167,000 property would be modestly worse off and one buying a £4 million property would be marginally better off.
These very real problems of winners and losers could, of course, be significantly ameliorated with a less ambitious revenue target.
Current market conditions may mean that, in many parts of the UK, liability to stamp duty represents a material factor influencing house purchase decisions.
There would be significant benefits in reforming stamp duty in favour of a marginal rate system. Stamp duty, as the Mirrlees Review, a five-year study of the UK tax system under taken by the Institute of Fiscal Studies, commented, is "highly inefficient, discouraging mobility and meaning that properties are not held by the people who value them most, and its ‘slab’ structure – with big cliff-edges in tax payable at certain thresholds – creates particularly perverse incentives."
While it would be possible to re-design the system so as to preserve government revenue, this may well give rise to substantial winners and losers. At the UK level, this may leave stamp duty reform on the sidelines, especially in a period when the government’s broader fiscal strategy makes it difficult to forego revenue.
But this does risk signalling mixed messages in the context of NewBuy. On the one hand, the NewBuy scheme assists creditworthy but cash-constrained households by supporting transactions where the deposit may be as small as 5%. But many of those targeted would at the same time face a prospective stamp duty bill of as much as 3% (on purchases over £250,000), which they still have to fund directly. There may be a case for removing this inconsistency.
We have not run a slide rule across the Scottish reform proposals, but a key consideration is likely to be whether the tax base of higher value property transactions would be sufficiently resilient as to support exemption lower down the price spectrum.