A better tax system, not subsidies, is needed to solve our housing problem

The Chancellor has announced £7bn of housing market subsidies to encourage property developers (including local authorities and housing associations) to deliver up to 400,000 additional affordable homes over the next five years. The twist is that the new homes will be aimed at the owner occupation rather than rental market. This is clearly good news for would-be homeowners and developers. But does it make long-term sense for the country?

We welcome the support for more flexible forms of home ownership. It is high time we moved decisively away from a debt-only model of housing finance. But these measures mean that even more of our national savings are directed into housing. This may not bode well for the long-term productivity challenges the nation faces.

Let’s start with the good news. The Chancellor recognises the problem created by excess demand for housing. There is a nice parallel between the national debt and house prices. The burden of servicing rising national debt and higher housing costs both fall on future generations. Even renters are not exempt. While reducing the national debt burden is said to be the “right thing to do” for the next generation, open-ended support for owner occupation without addressing supply simply pushes up prices and makes the next generation worse off. This inconsistency seems to have been recognised.

Second, some of the subsidy is for Help-to-Buy for properties specifically built for shared ownership. Tilting the playing field towards shared ownership enables potential buyers to become owners without relying on excessive debt. When house prices fall, the risk of negative equity is lower. As well as offering better financial exposure for the buyers, this also provides some sense of direction towards a more robust housing finance system. We hope that this support provides new impetus to shared ownership as a form of housing finance.

We are neutral on the clear preference to provide support for owner-occupation rather than other forms of tenure. There is little, if any, robust economic evidence that owner-occupation leads to better economic outcomes such as better education, health or fewer social problems. It is true that owner-occupiers are likely to be wealthier and healthier, but there is scant credible evidence this is caused by housing tenure.

Both potential owners and producers (developers etc.) benefit from the subsidy. Because the supply of new housing is notoriously slow to respond to changes in house prices, the biggest gainers are the developers. The overall cost is borne by taxpayers, most clearly through reductions in government support elsewhere. As with all subsidies, the cost to taxpayers exceeds the benefits to consumers and producers due to the deadweight loss: paying for outcomes which would have occurred anyway.

This public support means that even more of our national savings are directed into housing. If a greater share of national savings is being invested in property, less may be available to support the nation’s non-housing capital stock i.e. machines, intellectual property and even commercial buildings etc.  Less investment in our productive capital stock over the long term results in diminished supply and income potential.  

One option is to borrow from abroad to invest in our capital stock. But borrowing needs to be serviced which ultimately reduces income. For example, assuming we do not borrow from overseas, our national savings rate last year was 12.5 per cent, the non-residential capital to potential output ratio of around 2 and a depreciation rate of 4-5 per cent implies long-term income growth of 1.25 to 2.25 per cent – considerably less than the Office of Budget responsibility is banking on.

Another issue is that taxes and subsidies tend to generate ‘level effects’. They encourage more supply and ownership up to a certain point. But the housing market challenges we face are likely to continue to grow over time. According to the ONS, the number of new households is projected to increase by 250,000 per year over the next decade. This begs the question of what happens over the long-term. Will there be more subsidies at the end of this parliament to address the problem again?

Addressing the long-term problems in our housing market cannot rely on ever more subsidies. At some point the root cause should be addressed. In our view, this comes down to more appropriate taxation.  

Put simply, houses are the most important asset we own. UK households have more wealth invested in housing than any other asset including our pensions. It is not only British households that invest. In a world where secure assets with a positive yield are scarce, UK property is popular with overseas investors. According to Property Week, the amount of overseas investment has risen from around £6bn per year a decade ago to £32bn in 2014.

The owner-occupation rate among people under 34 has fallen by around 20 per cent while those over 75 have increased their stake in housing. Furthermore, the share of “under occupied” housing, defined as having two or more spare bedrooms, is rising. According to the English Housing Survey, 61 per cent of those who own their house outright are said to “under occupy” compared to 15 per cent of private renters. And the fall in owner occupation is of course matched by buy-to-let supply.

Indeed, housing has been a sound bet for decades. Over the last 20 years the price of an average house has risen by 7.3 per cent per year, higher than a 6.3 per cent total return (dividends reinvested) in the FTSE100 stock index. However, assuming a modest rental yield, net of depreciation and of repair costs of 2 per cent makes the return on housing significantly higher. It is also much less volatile than the stock market.

The difference is even greater when considering the after-tax return. Homeowners pay council tax and stamp duty when they move (1 per cent on the average home) and no other taxes. Owners of financial assets pay income and capital gain taxes. Therefore the after-tax and risk-adjusted rate of return on housing is far in excess of that on other investment options.

The biggest distortion to the housing market is our tax system. This not only increases demand for housing as an asset but it also encourages owners to be less flexible about allowing developments which might affect their wealth. We suspect that this is the root cause of much of the supply problem which needs to be addressed if we are to deal with the longer-term housing challenges.