Whereas David Cameron or Ed Milliband might plan two or three significant policy deviations from the status quo that they may have to explain to a ferocious interviewer and on which they will have to be “prepped”, Green leader Natalie Bennett proposes a complete re-engineering of the country. She would have to combine the economic genius of a Milton Friedman with the wiliness of a Harold Wilson to navigate her way through tough questioning of her policies. She has given herself a high hurdle to jump, and the whole world now knows that she failed to jump it. However, in the discussion of the interview blunder, nobody has analysed the Green Party’s housing proposal. People should, because it is a policy I could imagine other parties adopting.
Bennett argued that the building of 500,000 new state homes could be financed by abolishing “tax relief” on interest for private landlords.
Private landlords generally take out loans, add some of their own equity capital, buy houses and let them out – that is how any small business works. They receive income (rent) and they deduct costs (wear and tear, alterations, depreciation and the interest on the loans they take out). On income less costs they pay tax (corporation tax if they incorporate; income tax if they do not). Being able to deduct interest from the rental income is not a “relief”, it is recognition of a cost of doing business. The landlord is providing some capital (the equity) and paying tax on the returns on that capital; the bank is providing the rest of the capital (funded by issuing securities or taking deposits) and the interest earned by those who provide the bank with the funding will be subject to tax. This is absolutely the correct way to tax returns for buy-to-let landlords, though believing that the tax deductibility of interest is a “concession” is an easy mistake to make – George Osborne flirted with abolishing it for corporations before the 2010 general election.
Consider a buy-to-let landlord with £1m worth of properties in Leicester which yield rents of £70,000. Assume they are financed by an 80 per cent loan at 5 per cent interest (total interest of £40,000) and there are other costs of £10,000. Let’s say the tax rate is 20 per cent. The landlord’s profit is £20,000 on which he would pay £4,000 in tax leaving a net profit of £16,000. Now assume that the landlord cannot deduct interest from his income before tax. The taxable profit would be £60,000 and tax £12,000. After tax and interest the landlord will be left with £70,000 less £10,000 other costs, less £40,000 interest less £12,000 tax: in other words £8,000. The effective tax rate on the landlord’s profit will be 60 per cent. The interest, of course, will then also be taxable in the hands of those who hold the instruments used to fund the loans.
What will be the result of the Green policy? Any combination of the following could occur:
· There might be a replacement of debt capital by equity capital to fund buy-to-let properties. But this can only be a partial replacement because few will have access to sufficient equity capital. Institutions may take over some of the slack in this market but this is unlikely given that it is still regarded as a political football (it was repeated political interventions that led to the wholesale withdrawal of institutions from this market in the first place). There will be no gain to the Exchequer because the gain from the Green policy comes from the fact that interest is taxed twice (both the landlord who will pay the interest and whoever funds the loan will have to pay tax). If buy-to-let is only financed by equity capital, the returns will only be taxed once.
· Houses for let will be sold and we will see a decline of the rental market again. Here, there will be no gain to the Exchequer because owner-occupied property is not taxed at all (indeed, there will be a loss to the Exchequer).
· Rents will rise to restore the investors’ return on equity – in this case by nearly 15 per cent.
It should be borne in mind that the response to various forms of double taxation that are imposed on investors is normally the development of complex tax avoidance mechanisms. In fact, the most likely outcome of the Green policy is that there will be no new revenue for socialised housebuilding and a lot of revenue for bankers designing tax efficient funding products.