Stupid taxes are nothing new – but that doesn’t make them any less stupid (Part 1)
Inheritance Tax (IHT) was one of 20 taxes that the Institute of Economic Affairs recommended abolishing in a report last year, which made the case for a radical simplification of Britain’s complex and often counterintuitive tax system.
IHT, as unpopular as it is ineffective, represents a form of “double taxation”, because the inheritance is derived from income that has already been taxed – during the bequeather’s lifetime. The policy is riddled with loopholes and opportunities for avoidance, including nonsensical exemptions on everything from expensive artworks to agricultural land.
In many cases, IHT can be avoided altogether by gifting assets above the threshold to relatives well before death. This is, of course, easier for the rich to achieve than the moderately well-off, whose main bequeathable asset remains their home.
We also singled out Stamp Duty Land Tax (SDLT), another poorly considered levy with destructive side effects. It might raise revenue for the Exchequer, but it causes enormous distortions in the process, which is why Stuart Adam of the IFS termed Stamp Duty “a strong contender for the UK’s worst-designed tax”.
By penalising any move from one property to another, stamp duty creates harmful bottlenecks in the housing market by, for instance, discouraging older couples from selling family homes and downsizing. The knock-on effect of this is to reduce the availability of appropriate housing for younger people, such as couples hoping to start or expand their families. Consequently, two groups of people are left worse off.
This is a “stupid” tax. A non-stupid tax would be one that transfers a certain amount of money to the government in a straightforward, predictable and relatively painless way. A stupid tax is one that makes you behave in ways which you would otherwise have considered absurd – like staying in a house that is clearly too big for you. A tax is stupid if it makes you do stupid things, to reduce your tax burden.
But a badly designed tax system is not confined to contemporary politics. A glance at the history of taxation in Britain reveals that myopic policy-making is nothing new. Here’s my pick of the most misguided of them.
The Wallpaper Tax
This tax was introduced in 1712, during the reign of Queen Anne, to capitalise on the growing popularity of wallpaper as an alternative to tapestry or panelling. In an attempt to target wealthier citizens, the levy was directed at “painted, printed or stained” wallpaper favoured by the middle and upper classes, rather than cheaper plain paper, which remained untaxed.
It was initially priced at the rate of a penny per square yard of wallpaper, which had risen to one shilling by the time the tax was abolished in the 19th century.
Unfortunately for the government, the tax was widely and easily bypassed. Canny decorators avoided paying the charge by simply buying untaxed plain paper and painting or stencilling patterns on by hand. But the tax still came at a cost: it hampered the division of labour. It meant that people had to waste their time stencilling patterns into paper when they might otherwise have simply bought ready-made wallpaper.
The Window Tax
The infamous window tax, supposedly the origin of the term “daylight robbery”, was introduced by William III in 1696, and lasted for over 150 years. And much like Stamp Duty, Window Tax was structured in a perverse and illogical way.
Until last year, Stamp Duty featured what economists call “cliff-edges”, that is, a point at which the tax rate suddenly shoots up. For example the rate of stamp duty, until recently, would jump from 1 per cent to 3 per cent of the entire transaction price at the £250,000 cut-off point – thereby creating an increase in tax liability of £5,000 as the house price crossed this threshold.
Unsurprisingly, these notches created strong incentives for reducing house prices to a point just below the cut-off; whether by vendors underinvesting in interior decoration, or simply selling their property at a reduced price.
The same was true of the Window Tax.
Houses with fewer than 10 windows were, at first, exempt from the fees altogether – the tax was an attempt to target the wealthiest, after all.
But, as Adam Smith observed at the time, windows were an inaccurate proxy for wealth.
“A house of ten pounds rent in the country may have more windows than a house of five hundred pounds rent in London. Though the inhabitant of the former is likely to be a much poorer man than that of the latter, yet so far as his contribution is regulated by the window-tax, he must contribute more to the support of the state”, Smith noted in the Wealth of Nations (1776).
Homeowners with 10 or more windows, however, were liable to pay – and at a hefty rate of sixpence per window per year. In other words, having a 10th window meant that you then had to pay tax on all of the other nine windows as well. The rate of tax was banded – rising to ninepence at 15 windows, one shilling at 20 windows, and so on.
It was a powerful incentive for people to alter their behaviour.
Many of the period’s surviving buildings (including the IEA’s own HQ in Westminster) still bear the legacy of this policy; bricked up windows were a common practice used by middle-income families to alleviate their tax burden. When, in 1797, PM William Pitt the Younger tripled the rates to help cover the spiralling costs of the Napoleonic Wars, thousands of windows were boarded or bricked up by thrifty homeowners.
The policy affected much of the architecture from this period, as new builds began to feature fewer windows, or “blind” windows that were actually painted facades. Between 1810 and 1851, UK glass production remained static, despite significant increases in population and buildings – a testament to the far-reaching impact of the impost.
The poor suffered especially. Landlords, responsible for paying the fees on owned properties, now had a vested interest in reducing the number of windows, while builders were incentivised to build smaller dwellings, or homes with fewer windows. Tenants lived in increasingly dark and cramped conditions as a result.
This example provides yet another lesson for modern policy makers. As previous IEA research has outlined, there is a strong correlation between the introduction of rent controls into the property market and a corresponding underinvestment in housing stock and property maintenance.
The reason? Squeezing the profit margins of landlords – whether through capping rents, or taxing windows – obliges them to recoup their profits elsewhere. Ultimately, these costs are likely to be passed onto tenants, in the form of worsened living conditions.
This article was first published on CapX.