Select Committee on Environmental Audit Written Evidence


Memorandum from the Henry George Foundation


  In the context of soaring house prices and record levels of homelessness, a consensus has emerged that the cause of these problems is the historically low level of new house building. The assumption, expressed in the very name of this review, is that the problem is one of supply.

  This paper argues that the problem is in fact one of excess demand, caused by the perversities of the land market, and exacerbated by the iniquitous and distortionary effects of government taxation and subsidy policies.

  Consequently, the solution lies in correcting perverse incentives and harmful market interventions, reducing effective demand and therefore lowering house prices to more affordable levels.


  It is undeniable that in many parts of the country there is a genuine crisis of affordability, but it is not clear that the problem is exclusively one of under supply. In fact, there is a tendency to read the market signals backwards, identifying effects as causes and assuming that choices made in the market represent absolute preferences. While there may be a place for perfect market hypotheses, the UK housing sector is clearly not it.

  Firstly, there is evidence that population growth may be less than predicted. The population recorded by the 2001 census was 900,000 lower than the official estimate for that year, yet predictions of housing need have followed the earlier, higher figure.

  Secondly, there is a general assumption that changing patterns of family formation mean that there is insatiable demand for smaller, one or two bedroom dwellings. This is to read the signals backward: with unprecedented rises in houses prices, it is inevitable that people will be squeezed into the lower end of the housing market, but this does not mean that this is where they want to be. Rising affluence and increased consumption makes people more likely to seek larger dwellings than previously. Also, the extremely conservative nature of the mortgage lending market means that borrowers are channeled into single person or couple-based housing, regardless of their preferences.

  There are plenty of houses in the UK—and many of them are underused. Many regions have serious problems with housing dereliction and abandonment, while the south of England faces continuous housing pressure in the opposite direction. The problem is not one of absolute shortage, but of geographical imbalance. There are plenty of affordable homes, but they are not in the right places, in other words, they are not where the jobs are. This can be seen as a northern employment shortage as much as a southern housing shortage.

  A further source of underused housing is the market in second homes. There are an estimated 500,000 second homes in the UK—and most of these are in very high value areas. This implies that the problem may be one of wealth distribution rather than housing per se.

  Almost all the attention in this debate is focused on the supply of new, affordable housing. At present, this amounts to around 20,000 dwellings per year. The Interim report suggests that this needs to be raised to 101,000 to retain the affordability levels of the 1980's. Again, the assumption is that only supply effects prices. But whether we build 20,000 or 100,000 houses each year, the supply of new build is only a tiny fraction of the total housing supply. 99% of the supply is in the form of existing houses.

  Similarly, the assumption that the solution must lie in the social housing sector is misleading. Almost 80% of the housing stock is privately owned, and despite the reduction in the right to buy, this is unlikely to change dramatically. Even if one million new homes were built for the social sector, and no new homes were constructed for the private market, the proportion of social housing would only rise from 21% to 25% of the total housing stock.


  House price growth is caused by the pressure of demand. There are good reasons for considering the level of demand to be excessive, and these imply that the housing market is impossible to influence significantly using purely supply-side interventions.

  Firstly, rising house prices represent growing levels of debt. The majority of money creation in the UK is in the form of mortgage debt. House buying is therefore the primary cause of inflation. More than any other goods, the price of houses represents not what people can afford to pay, but what they can be persuaded to borrow.

  Secondly, the main source of rapidly rising housing demand is not need, or expectations of productivity gains, but expectations of further prices rises. Demand can be considered genuinely excessive to the extent that it represents expectations of future house price growth, rather than the ability to pay off mortgages out of earnings. While speculative motivation is hard to quantify, it is undeniably a major source of rising prices in high value areas.

  Such speculation is not irrational, because houses are almost unique in that they tend to grow in value, despite wear and tear. Of course, it is not the bricks and mortar that gain value, but the land underneath them. Houseboats, it should be noted, depreciate rapidly. The unique nature of the land market is therefore one of the root causes of over inflated house prices.

  Mortgage borrowing based on expectations of future land value rises creates a dangerous bubble economy which the UK has been riding for many years. Land is uniquely suited to this sort of speculation, because of the monopolistic characteristics of land ownership. Locations are essentially monopolies that attract monopoly profits. Since Adam Smith and David Ricardo, economists have recognised the special nature of land rent, but policy makers have been slow to take on the implications.


  Given the importance of housing both for the UK economy and for wider social and environmental wellbeing, it is not surprising that the state intervenes extensively in the housing market. However, the existing tax and subsidy system actually worsens the problem.

  Housing costs the public purse around £22.7 billion each year.[2] This breaks down as follows:

    £5 billion on social housing investment;

    £2.7 billion on council tax benefit;

    £2.9 billion on foregone taxes (CGT foregone minus inheritance tax and stamp duty on housing);

    £12 billion on housing benefits.

  Only 22% actually goes on social housing. 12% subsidises local authorities in the form of council tax benefit, but 66% of state housing spending effectively goes to landowners as tax foregone and housing benefit used to pay rent. This represents a massive £15 billion subsidy for landlords, and is a further source of house price pressure, pumping public money into an already overheated market.

  The harmful influence of the tax system is not restricted to the exemption on CGT—all existing taxes on property have harmful effects. Stamp duty and inheritance tax lower liquidity, and the other property taxes are specifically targeted at occupiers, not owners. Council tax is famously regressive and inefficient, while UBR is zero-rated on derelict property and half rated on unused property, a clear tax preference for dereliction over employment.

  It is clear that the effects of the property tax system are perverse. By subsidising landownership it encourages further rent-seeking and helps drive prices upward. As there is a negative tax cost of homeownership, and the realistic expectation of future price rises, houses have a negative user cost.


  Beyond the various supply-side solutions that have been proposed, it is clear that demand-side measures need serious considerations. Reforming the tax system to remove the distortionary incentives to landownership which drive prices up is essential. The most effective and efficient way to do this would be to replace current property taxes with one based on land values alone.

  It has long been noted that taxes on land rents are the least distortionary taxes possible. Replacing the current property taxes with a genuine land tax would therefore enable the housing market to function more efficiently.

  An annual charge levied on the unimproved site value of landholdings would also address most of the issues raised by the review. It would remove the incentive to hold underused land, encouraging its release into the market for more productive use. It would increase the cost of landholding, thereby removing the potential to make supernormal profits from property. It would rebalance the tax burden, ending the perverse tax advantages of landowners over occupiers.

  All these effects would, in turn, reduce the speculative pressures on land prices, which would decrease the volatility of the housing market dramatically, and would ultimately lead to lower house prices in general.

  Taxing land values makes land cheaper to buy, but more expensive to hold, encouraging a liquid market and greater allocative efficiency.


  Although there have been repeated attempts to capture land rents for the public purse, they have all been seriously flawed. This is widely interpreted as a sign that land rent cannot be captured, but in fact it represents merely the overly complex, confused and compromised nature of the acts.

  The three attempts at land taxes by Labour governments since 1945 all targeted the profits made by developers at the point of sale, or of planning permission being granted. This simply added a further distortionary incentive to hold land rather than release it, and as such cannot be considered genuine taxes on land rents, but rather development taxes. Development taxes discourage development, which is counterproductive—and place further pressure on developers who are already severely squeezed between high land prices and government interventions.

  A true land value tax would be levied annually, on the unimproved value alone. This would have the opposite effect of previous development taxes, and would stimulate the construction market by making housing cheaper to build and developers less risk averse.


  In sum, there is a lack of affordable housing in certain regions because the existing stock of privately owned houses is too expensive. That houses are not affordable because they are too expensive is glaringly tautological, yet in all the debate around this review, few commentators have expressed this simple truth. Houses themselves are not overpriced, land in the right locations is. This is because landowners can make supernormal profits, or rents, from their land, which in turn creates excess demand that is converted in to effective demand by the mortgage lenders.

  While the market remains structured in this way it is futile to attempt to improve affordability by increasing salaries or subsidising home buying, as all such attempts run into Ricardo's law of rent. While each individual home buying grant—such as those under the Starter Homes Initiative—may help the recipient enter the housing market, the combined effect of such grants is to push the market up further, making entry even harder for the next grant recipient. The same is true of subsidised development—it simply pushes up the cost of subsequent development. The solution to the problem of affordability must therefore be to reform the land market itself, with the result of reducing the cost of existing houses and of development land.

  This is a politically dangerous idea, and the government has shown themselves to be highly wary of the perceived threat from the wealthy homeowners of middle England. In particular, negative equity is seen to be unacceptable in any form. However, the consequences of this position are clearly unsustainable. For negative equity to be avoided, homeowners must be effectively subsidised ad infititum. The assumption appears to be that homeowners have a right to profit from rising prices, but no corresponding duty to carry the risk of a price fall, creating an obvious problem of moral hazard. It also implies that current owners have a right to perpetually extract wealth from first-time buyers, and that speculators on the housing market have a right to keep all their winnings, and yet also have a right to state compensation if they lose. It is hard to imagine how we would treat any other group that demanded such a settlement.

  The housing market as it stands is a brilliant device for channeling wealth away from those who do not have it and from those who created it, into the hands of those who occupy the most privileged positions in society. If we are to solve the housing problem, we have to stop being complacent about the nature of the housing market. We have to admit that the housing market as it exists is inefficient, iniquitous and ultimately unsustainable. We have to stop tinkering with the edges of the market, and tackle the fundamental issues. We have to accept that affordable housing requires house prices to come down. Taxing land values would be the simplest, fairest and most effective way to make housing permanently affordable.

March 2004

2   All figures in this section are for 2001-02 and taken from the UK Housing Review 2003-04, by Steve Wilcox, University of York Centre for Housing Policy. Back

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