War was declared on those who supply properties to the private rented sector back in 2015.
Stamp duty is now being levied at a higher rate on properties bought to be rented; most properties bought by private buy-to-let investors pay an extra 3% in tax.
From 2017 the rate at which interest on mortgages used to acquire buy-to-let properties can be offset against tax on rental income was reduced from an investor’s marginal income tax rate down to the basic rate.
These policies were justified on the grounds that they would reduce tax distortions which favoured buy-to-let purchasers and drove prices up for hopeful first time buyers and reduced their welfare.
That argument was incoherent back then and it remains so today. But the policy remains in place.
There are signs it is beginning to reduce the supply of rental properties; there are few signs it has benefited those hoping to become home owners and who are meanwhile left in a rental sector with reduced choice and where rents are likely to be higher as supply gradually shrinks.
The tax distortion arguments are nonsense.
Rather than being a move towards tax neutrality – as was claimed – they in fact represent a further penalty against private provision of rented properties by potential suppliers who cannot (or chose not to) invest via a corporate entity.
Even before these changes were announced in 2015 the tax system already favoured owner-occupation over renting. This is because:
- Capital gains on owner-occupied homes are not taxed; landlords pay tax on capital gains
- Landlords pay tax on that part of rental income which exceeds allowable costs; home owners do not pay tax on any part of the implicit income they receive from living in their own home
The full tax deductibility of all expenses (including interest payments on mortgages) against landlord’s rental income offset much, but certainly not all, of the advantage that immunity from tax of owner-occupier’s implicit rental income brings.
This non-neutrality in the taxation of housing, and the ways in which it favours owner occupation over renting, has long been recognised.
The authoritative Mirrlees Review of 2012 into the UK tax system, organised and managed by The Institute for Fiscal Studies, was clear on this:
“At present, the tax system treats rented and owner-occupied properties differently, creating a distortion in favour of owner-occupation.
..investing in buy-to-let housing is currently discouraged by the tax system for no good reason…..Income tax and capital gains tax create a significant bias against the rental market in favour of owner-occupation.”
Mirrlees Review, chapter 16:available at: https://www.ifs.org.uk/uploads/mirrleesreview/design/ch16.pdf
The tax changes announced in 2015 increased this distortion against renting. They were a move in precisely the wrong direction and are likely to harm most those who they might be intended to help – that is people who are not (yet) home-owners. They do so by:
- Not allowing appropriate tax deduction of legitimate expenses to many landlords (which in a non-distortionary system should be fully deductible at the marginal tax rate on income)
- Levying an extra cost (via a higher rate of stamp duty) on those buying property to rent
Were there good arguments for the tax changes?
The main argument was that the changes would help aspiring first-time buyers.
But aspiring first-time buyers are hardly helped by squeezing the supply of rental property and driving rents up.
Aspiring first-time buyers need to live somewhere; a large proportion rent. Nor is there anything intrinsically wrong with people being in the rented sector for an extended phase of their life.
We should want to avoid a situation where people feel pressurised into taking big mortgages relative to their income early in life because the rental option is so poor.
The whole thrust of the Mortgage Market Review (MMR) was to ensure that people could afford mortgages; the Bank of England’s limit on the quantity of lending at loan to income ratios above 4.5 goes in the same direction, as do moves to increase the amount of capital lenders need to hold against mortgages.
A property market in which people in their 20’s borrow 5 or more times their income at what are a currently very low interest rates, and then struggle a few years down the road, is something we should not want.
The view that owner-occupation is a form of tenure that people should aspire to at the earliest possible point in their lives is deeply flawed.
A tax change that has reduced the incentive to supply rental property is entirely counter-productive here.
In a world where house prices might be consistently higher relative to incomes than in the past we might naturally expect the period in which people are in the rented sector is longer.
And there are good economic reasons for believing that in a country with a rising population and where real incomes tend to increase over time house prices might well rise at least as fast as incomes.
To have then introduced measures that reduce the supply of rented property is perverse.
Can the tax changes be defended on the grounds that it is not appropriate for the private rented sector to be significantly supplied by small scale landlords? It is not at all clear that it can.
There is no compelling reason to think that private landlords with a small number of properties are bad landlords.
Nor is there any reason to think that investing in property to rent is an inappropriate thing for people to do with part of their saving.
It is strange to believe that having households channel more of their savings into US equities, German government bonds or shares issued by companies in fast growth Asian companies is to be preferred to their investing in providing rented accommodation in the UK.
This article draws on some analysis I did in conjunction with Paragon back in 2016 not long after the tax changes that negatively affected many private landlords first started to come into effect. However, the arguments developed here are my own and in no way should be attributed to others.