Home > Mythbusting > UK households enjoy £125bn “tax break”!

UK households enjoy £125bn “tax break”!

Via Mr. Worstall, the Guardian reports on a “shocking discovery”, that landlords pay tax on their profits rather than revenue:

Landlords are allowed to deduct a wide range of expenses, on top of mortgage interest costs, before they have to pay tax on their rental income. These allowable expenses include the cost of insurance, maintenance and repairs, utility bills, cleaning and gardening, and legal fees. Ordinary homeowners are not entitled to similar privileges.

The idea that “ordinary homeowners” do not enjoy the “privileges” of landlords in the tax system is wrong; in fact the opposite is true.  Owner-occupation is slightly favoured over rental, since the imputed rent of the owner-occupier is tax exempt, whereas the actual rent received by landlords is taxable income.  In addition, capital gains are taxed for landlords and tax exempt for owner-occupiers (with some minor caveats).  That’s just taxation: the long list of direct government subsidies for residential mortgage lending surely further skew the balance of subsidy towards owner-occupation; an NAO report from March 2014 lists (Figure 2) six different schemes since 2006, and then we could move on to bank regulation, and so on.

The ONS estimates owner-occupiers’ imputed rent at £125bn in 2014, so perhaps a more accurate (though still nonsense) headline would be that homeowners receive a “£125bn subsidy” over landlords?  I suppose that wouldn’t fit as neatly into the standard Guardian workers vs capitalists zero-sum narrative.  I highly recommend Chapter 16 of the Mirrlees Review for a thorough discussion of land and property taxation.

The “Generation Rent” group (who claim to campaign on behalf of renters) seems to be firmly embedded in the long tradition of completely insane British housing market policy, proposing in their manifesto both rent controls and the extension of a weak form of “Right to Buy” to the entire private rental sector.  They are a reliable source of silly quotes in any article about the housing market, this time coming up with:

“The tax system also puts landlords at an advantage over potential owner occupiers when competing for the limited supply of houses and it’s those thwarted first-time buyers who end up paying off the mortgage anyway in rents. “We need to stop subsidising property investment and use that money to build more homes instead.”

We need to stop subsidising investment in property… so we can invest more in property?  A cunning plan.

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Categories: Mythbusting
  1. Luis Enrique
    May 27, 2015 at 12:37

    excuse my ignorance, but what does this mean: “the imputed rent of the owner-occupier is tax exempt”

    if I own my own home, what does imputed rent have to do with the taxes I pay?

    • May 27, 2015 at 12:49

      Luis – currently nothing, that’s the point! Consider there are just two homes and you and I lived in them. If we rented from each other we’d both have taxable rental income, if we were both owner-occupiers there is no tax due. That’s true even if everything else is equal, and we consume the exact same “flow of housing services” from the same physical houses. Hence the tax system favours owner-occupation over renting.

  2. Luis Enrique
    May 27, 2015 at 13:45

    I feel like I understand your answer but not your point. But maybe your point is that these comparisons are all absurd.

    To make matters worse, It think I can see the point that the Generation Rent lot are making.

    Consider an owner occupier and a buy-to-let investor, who are both deciding how much they can afford to pay for a house. I don’t think it does any harm to my argument to also suppose they both have the same sum to hand for a deposit.

    For the owner occupier, the constraint is wage income. For the investor, the constraint is rental income. For the owner occupier if house prices rise, they are less affordable. For the investor, if house prices rise they are no less affordable because higher mortgage payments are tax deductibles. I can see an argument that the expansion of buy-to-let investing,perhaps assuming a housing stock that isn’t keeping up with population growth, pushes up both house prices and rents (because as buying a house becomes less affordable, and more properties are owned by landlords, you have no choice but to pay higher rents). I don’t mean to suggest that dynamic can go on forever, or that property investors face no risks, but I think there’s a nugget of truth in the idea that buy-to-let investors can outbid owner-occupiers for houses, because for them higher house prices per se aren’t a problem, so long as rents are rising too, which they probably will be if house prices are rising.

    I may spot the flaw in that after hitting post comment

    • May 27, 2015 at 16:33

      You are taking a simple point about bias in the tax system and over-complicating it. Maybe you will say I am over-simplifying :)

      The article presumes that these “tax breaks” for landlords are evidence of bias in the tax system toward landlords. This is wrong because it ignores imputed rents. That untaxed imputed rents are a distortion in the current UK tax system toward owner-occupiers is a really very very conventional argument, and there are lots of papers about this – if I have mangled the argument it is only my bad writing.

      I am trying to follow your example: you seem to be arguing that an increase in the supply of rental properties will “push up rents”, which seems unlikely. I would agree that an increase in demand for rental properties because of population growth will push up rents and house prices (I’m looking at you, London).

      But again, the effect of the tax system under population growth in the UK is skewed toward owner-occupiers because landlords are taxed on their windfall gain (higher asset prices) but owner-occupiers are not taxed. If it “seems” unfair, that landlords alone get the benefit of higher rents in that case, again it is just because the rising imputed rent is unseen.

  3. Luis Enrique
    May 27, 2015 at 16:49

    instead of “and more properties are owned by landlords” I should have written something like “as more people are pushed into renting” – that’s really just the other side of the coin that share of housing stock owned by landlords rising because fewer can afford to buy houses whilst BTL investors are able to keep buying more properties (that’s really the point in dispute). Cannot interpret that as an increase in supply of rental properties that should push down prices, that’s the outcome of rising prices. I think there is still a point that because mortgages are deductible, rising house prices hurt (first time) buyers more than BTL investors, or that BTL investment might accelerate a rising house prices / rents dynamic.

    • May 27, 2015 at 17:25

      I think you are still assuming that yields for BTL/landlords are fixed despite shifts in demand for rental properties (versus some other investment?), but I am not sure why that assumption would ever be true.

      • Luis Enrique
        May 27, 2015 at 19:02

        No, more like I am asserting that we have been / are in a phase where rents are rising sufficiently to keep btl investment attractive whilst house prices rise, in part made possible by tax treatment of mortgages, a dynamic that hurts most sections of society other than btl invesotors . I said already I don’t claim this’ll go on forever. As it might if yield constant.

  4. Luis Enrique
    May 27, 2015 at 16:51

    if the current tax laws are distorted towards owner-occupiers, what would an undistorted tax system look like – no tax on profits from BTL?

    • May 27, 2015 at 17:11

      The suggestion in Mirrlees which removes the distortion is to tax both imputed and actual rents, but only above a “normal” rate of return determined as e.g. 5% of the property value. That chapter I linked to is only 38 pages and is quite readable, I really do recommend it, perhaps chapter 13 first.

      • Luis Enrique
        May 27, 2015 at 19:03

        Thanks. Will do.

  5. Lord
    May 27, 2015 at 18:52

    In the US, property can be operated at a loss and used as a tax deduction, something you can’t do as an owner occupier. I wonder how much of that imputed rent would actually be profit, and how much loss.

  6. ChrisA
    May 28, 2015 at 09:03

    IMHO the best way to tax property to avoid distortions like imputed rent tax breaks, is to go with the Georgist land tax approach. So the tax paid is related to the expected rent for the land (not the property), so same tax paid if owner occupied or rented out.

    A couple of other points – don’t read anything in the Guardian off the news pages, all their commentary is usually economically illiterate, like assuming people don’t respond to incentives.

    Second point is that there is a hidden assumption in this argument about what the causes are of high property prices – that landlords are buying instead of owner occupiers which is pushing up prices. This is not true. High property prices are due to restrictions on building. The people making property investments in BTL may benefit from the trend but are not causing it. A simple thought experiment assuming that there were no restrictions on building anywhere, would BTL be a good idea as an investment then?

    • Luis Enrique
      May 28, 2015 at 09:53

      Chris A – I agree restricted supply is the fundamental cause, but also think that in an environment of restricted supply, BTL helps inflate house prices. Things can have more than one cause, and things can interact

      • May 28, 2015 at 19:02

        If everything you say about BTL landlords is true it’s doubly true for housing associations: BTL landlords *with a state subsidy*.

        Yet I am sure you will argue that HAs actually do increase the housing stock, because they have some unique ability to cause planning permission to rain from the sky. Rather than crowding out owner-occupiers, like the nasty BTL landlords. Which makes no sense, and will send me into another wave of despair about UK housing debates.

  7. Nick
    May 28, 2015 at 09:41

    I dont blame the Generation Rent. They are in a difficult position and for the moment it is easier to target the BTL (which are part of the problem) instead of targeting the home owners.
    The situation is very bad out for any family renting while home-owners (debt-owners) are being supported both from BoE/Government.

    Sometimes I wonder if the productivity problem we are facing is due to the high house prices/rents.

    • May 28, 2015 at 19:03

      The BoE oversaw wage growth falling from 4% p.a. in the decade to 2008, to less than 2% in the years since 2008. Recent monetary policy does not in any way “support” debtors – quite the opposite.

      • ChrisA
        May 29, 2015 at 08:24

        Of course in absolute numbers owner occupiers have not dropped, 17.7m in 2001 vs 17.8 now. http://www.ons.gov.uk/ons/dcp171766_373513.pdf. The number of owner occupiers is now 28% of the population versus 30% 15 years ago, which is not significant I would argue to drive house price changes that we have seen over this time period.

        From the same report we can see that more than 2 million of new homes have been created during that period, on a net basis all of these have been privately rented. Lets say that the fantasies of the left were realised and BTL was banned (only one house allowed!). I would argue that much less houses would have been built since the marginal buyer would have been poorer (lower prices causes less supply is a fundamental law of economics). So there would be less houses rented but assuming the same number of renters, there would have to be more people per rented house and rents would also be higher (less supply same demand means higher prices).

        So restricting BTL would not help and would probably make the situation worse for renters.

        Again what is needed is deregulation both in house building and in schools. I mention schools as even in expensive cities like London there are areas that are cheap. People don’t want to live in those areas though because the schools are bad. This is an issue not just for people who have children, but also for those who don’t, since if the schools are bad they know that their chances of selling are less. If we moved to a voucher system, where someone can send their child to a private school if the state schools are bad, this would free up people to buy in those areas.

  8. Nick
    May 29, 2015 at 09:42

    ChrisA,
    There is no need to ban BTL. You force them off-plan.

    Brit-Mouse,
    FLS/HTB seem to say the opposite. If we suppose the FTBs are savers, they get hit with high inflation on essentials and low rates on their savings. While debt-owner have low mortgage rates and capital appreciation through the demand solutions applied by the gov/BoE.

  9. Luis Enrique
    May 29, 2015 at 09:58

    Well I am rather nervous about asserting that the Mirrlees authors are wrong, and expect to discover that it’s me who is wrong, but here we go …

    The report says we must carefully distinguish between consumption and investment (asset) aspects of housing.

    First, we might wish to tax consumption expenditures in the same way that we put a VAT on other items. Fine. So that would be a tax paid by both owner-occupiers and renter-occupiers.

    Next, we want to tax housing as an asset too. Here’s where it seems to me the Mirrlees report is going wrong: it wants to classify the flow of consumption services as part of the return from owning the house as an asset. This seems to me in direct contradiction of the principle of distinguishing between consumption and asset characteristics.

    If we were to tax housing as an asset, we might expect both owner-occupiers and landlords to be taxed on their returns. For an owner-occupiers the returns are capital gains, for the landlord they are capital gains plus rental income.

    now I read this quickly on the train, so I might have missed them then saying that consumption taxes have already been dealt with so shouldn’t be double taxed, or emphasizing that if the flow of consumption services are to be taxed under the “returns to assets” heading, then they wouldn’t be taxed under the “consumption” heading *and* that consumption services would also need to be taxed on landlord-owned rental properties somehow.

    From the discussion above, I got the impression you thought that to make treatment of neutral, owner occupiers would need to be taxed more whilst nothing changing for landlords. But I think logic is that if you think owner-occupiers need to be taxed on flow of consumption services then so do renters, and that’s going to hit landlords one way or another.

    • May 29, 2015 at 10:39

      Yes there are two parts in the Mirrlees proposal. The HST which taxes the flow of consumption like VAT, and the RRA which handles taxation of “housing as an asset” in a way that is neutral over rental versus owner-occupiers, addressing the current subsidy to owner-occupiers.

      You made me doubt my memory of reading this but it is very clear, p402, the RRA regime “would bring the tax regimes for rented and owner-occupied housing much closer together, completely eliminating the bias towards owner-occupation for property that generated a normal return.”

      I don’t know what you mean specifically by “hit landlords”, in the long run the burden of a consumption-of-housing tax will fall on the consumer (renter) as you’d expect?

  10. Luis Enrique
    May 29, 2015 at 11:51

    yes, that’s what they say, but either I don’t yet understand it, or they’re wrong

    so as you see it, the flow of consumption services would be taxed both under HST and RRA? how is that not double taxation of housing consumption?

    and how is the flow of consumption of housing services going to be taxed in the case of rental property?

    I may have overstepped with “hit landlords” – dynamic general equilibrium analysis is beyond the powers of my intuition – but if a tax on the flow of housing consumption is introduced for rented housing, as it must be if you want to do that for owner-occupiers and also maintain neutrality between the two ways of consuming housing, then it seems to me some of the incidence would fall on landlords via lower rents. I certainly couldn’t afford to pay the rent I am currently paying to my landlord and a new tax the flow of housing consumption, and I’d have to move somewhere cheaper.

    It looks to me like a neutral housing system would

    1. tax the flow of consumption services equally for both owner and renters
    2. tax returns on assets equally for both owners and landlords

    and I would classify the returns on assets as capital gains only for owners, capital gains plus rent for landlords. I do not see the justification for inserting the flow of consumption services into the RRA for owners.

    • May 29, 2015 at 12:27

      Ah, I see what you are saying. Yes, I confess I did not appreciate this either, but I think you are right, there is double taxation of consumption in the case of an *above-normal* return on the asset – that paragraph at the top of p401. I am not sure I understand the intuition either!

    • May 29, 2015 at 12:30

      Also on this: “I’d have to move somewhere cheaper” they model the HST specifically as a replacement for council tax, there is a whole section on that.

  11. Luis Enrique
    May 29, 2015 at 13:42

    ah yes (on the council tax replacement) thanks for pointing out.

    more fundamentally – and I know this is begging the question on “generation rent” style arguments – but I am not convinced that neutrality between owners and landlords is what we are after here. Standard economic models of optimal taxation usually have pretty simple set ups, but housing has some pretty non-standard characteristics. Supply is more or less decoupled from prices, and you have people who want to own a house to live in and people who want to own a house to make money from it competing over the same stock, it’s not clear we want a fair fight in that battle. I am not claiming that UK house price trends are completely down to people treating housing as an investment, but if some part of it is, that has some large negative-externalities characteristics, you could make the case for the tax system to push back against that.

    • May 29, 2015 at 14:21

      In “people treating housing as an investment”, do you mean people-as-landlords or people-as-owner-occupiers? Isn’t Britain (or… London?) full of the latter type of people more than the former? :)

      I have seen more often the argument that public policy should have a bias toward rental over owner-occupation (the opposite of today) because you’ll get a more flexible labour market.

      • Nick
        June 1, 2015 at 10:34

        Tenants are a majority in London so suspect that it is owned by people-as-landlords but it is full with people-as-tenants.

      • June 1, 2015 at 10:48

        Interesting, Nick, I had not realised that. The region with the highest GVA per head has a significantly lower proportion of owner-occupiers than the rest of the country – at least that backs up my second point!

  12. Luis Enrique
    May 29, 2015 at 14:19

    and also – please see your twitter notificatons, hopefully this will make sense when you do

  1. June 1, 2015 at 01:45

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