Housing and Planning

The Green interview – failed on style, but what about the substance?

The Greens have a radical policy agenda which would, if implemented, probably involve a huge transfer of power from the people to the state. The Greens must, however, be given credit for clearly laying out their policy. There is little in the way of costing, but their website is a mine of information on what they propose across a lot of areas. Of course, in the marketing, it is all wrapped up in nice words. They have, for example, taken the term “the common good” from Catholic social teaching and given it a completely different meaning. And Caroline Lucas, in particular, gives the impression that the Greens are benign – I am sure that any party would welcome somebody in their ranks with her presentational skills.

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.

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

5 thoughts on “The Green interview – failed on style, but what about the substance?”

  1. Posted 27/02/2015 at 13:13 | Permalink

    Philip – Surely the real point is that parties that are never likely to achieve power find it very easy to propose policies that some people might find superficially attractive, but which fall apart on closer examination. As they know they’re not going to win most peoples votes and will never be held to account, they only have to appeal to those who won’t examine these policies in detail. Indeed, they probably attract the sort of people as members (and policymakers) who propose policies without thinking them through.

  2. Posted 27/02/2015 at 16:18 | Permalink

    HJ – of course that is true. The interesting thing is, though, that at least the Greens have made available all their policies whereas the other parties don’t seem to have any!

  3. Posted 01/03/2015 at 13:32 | Permalink

    1. If being a landlord was just a “business” then perhaps they should pay Business Rates? i.e hand over around 50% of all their rental income in tax. Then pay income tax on top of the remainder.

    2. But, no, as this would give owner occupiers and unfair advantage in the market, so landlords do not pay UBR.

    3. Owner occupiers are not able to deduct mortgage interest off their income tax bills though are they? So, it’s not an level playing field.

    4. The value of location, which makes up 2/3 on average of rental income is not a sunk cost. Its value is created and sustained not by the landlord, but by everyone else. A huge free lunch.

    5. The value of this location rises over time faster than growth in the economy. Another huge unearned free lunch.

  4. Posted 02/03/2015 at 09:44 | Permalink

    @benji – as you know 2, 4 and 5 raise wider issues about an LVT which you favour and I don’t, so let’s leave that aside as an important but separate issue. On 3, this is true but it is because owner occupiers no longer pay income tax on imputed rent (they once did and I think they should). I would be very happy for owner occupiers to pay tax on imputed rent and offset mortgage interest.

  5. Posted 18/08/2015 at 07:41 | Permalink

    Philip you are missing one very important point. Benji is always right. He posts around the place and will never accept anyone else’s point of view. He is the ultimate guru in economics.

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