Ken Gibb's 'Brick by Brick'

Housing, academia, the economy, culture and public policy

Category: house prices

Thinking about local housing market volatility

A recent paper in Bank Underground (the Bank of England’s new blog site) by Arzu Uluc uses an interesting local-level data set (325 local authorities in England covering 1997-2009) with which to examine local housing booms and busts. The underlying model draws on data including real house prices, real gross disposable household income per capita, dwelling stock per capita and various mortgage market variables like loan to income, loan to value and the share of interest-only mortgages.

The author concludes that the local research allows us to infer (and reasonably so) that volatile housing markets can ‘threaten financial and macroeconomic stability’. Credit conditions in terms of the key ratios and types of mortgage products play an important role through the ‘1997-2009 housing cycle’.

Uluc presents his empirical work by generating six stylized facts. These are:

  1. Real house prices rose on average by 150% between 1997 and 2007 and then fell 12% by the end of 2009.
  2. Changes to the proportion of high loan to income mortgages were positively correlated with local housing booms and busts.
  3. There is a negative relationship between the changes to the proportion of high loan to value mortgages and the size of local booms and busts.
  4. Changes in the share of interest only mortgages were pro-cyclical (similar to 1. above).
  5. Housing booms and busts were also associated with real drivers like real income and dwelling stock growth.
  6. The bigger the local boom, the larger the subsequent bust.

A few caveats are in order – it is not clear why local authority data is particularly appropriate rather than broader more functional geographies; nor does it appear from the blog that there is spatial dependency accounted for in the analysis. I also wondered if the London effect needed to be explicitly modelled (or indeed some sense of North and South)? On the other hand, the author is clearly concerned about attribution and possible reverse causality or confounding factors in the models deployed. These are all things that can no doubt be explored in a longer paper.

What about the bigger messages?  The model is best summarised by a quote from the post: ‘the econometric analysis…suggests that booms and busts ere associated with both real factors and credit loosening. Higher real income growth [was] associated with larger booms in [the] 1997-2004 period, and in 2007-09 areas with higher growth in the dwelling stock per capita tended to see larger price falls”.

Thus, and despite the fall in endowment mortgage volume shares after 1997, changes in the share of interest only mortgages were associated with local house price booms. Similarly, higher loan to income ratio shares of new mortgages were associated with local booms. The interesting negative relationship between high loan to value mortgages as a share of the total and local house price growth – may be explained by the growth of the share of home movers as opposed to first time buyers among total transactions and the increased financial support utilised by remaining successful first time buyers from family and other savings (which also drove down LTV ratios).

As Uluc stresses, there are reverse causality explanations and possibly confounding omitted variables that may instead better explain what is going on – but the associations found are striking. It is a reminder of how difficult it can be to disentangle the relationship between the real housing market and monetary transmission through credit variables – something well known in the wider housing and economy literature but just as striking here.

Stylised facts are useful, but as the author points out, they are the starting point that we then develop models and theories from and look at fresh data to test the ideas that originally flow from these facts. It would therefore be interesting to extend this data forward beyond 2009 and also to aggregate a sub-sample of the local authorities into clusters that approximate for sub-regional housing market areas. If we did so, would we also be able to detect the influence of the changing regulation and practice of mortgage lenders in more recent years?

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Local Taxes and the Housing Market: Learning from the Past

My first research study was about the extent to which shifting from the system of domestic rates to the community charge (or poll tax) would lead to housing market effects, namely rising house prices. In the late 1980s and for a little while after, several econometric studies confirmed significant non-zero price effects.

I was in a meeting of Scottish Property Tax Reform the other day where we realised that it was important to rehearse these arguments again in the light of the Commission on Local Tax Reform’s examination of alternative local taxes and the possibility of moving Scotland away from local taxes on property to a local income tax, supported in the recent past by both the SNP and the Lib Dems.

The conceptual argument is about property tax capitalization and runs as follows. Introducing a recurring annual tax on property values will reduce house prices because people bidding to buy a house will know that there will be annual cost in the form of property taxes and reduce their bids accordingly. The recurring tax is literally capitalised into lower house prices. This is widely recognised in the literature [1]. Economists have also looked at how differentials in both taxes and the perceived value of local services lead to constant quality house price variations across council boundaries because these net differences are capitalized into property values [2].

Now imagine that a recurring property tax like domestic rates or indeed the council tax is abolished and replaced with a tax on people or on incomes. The argument is that removing a tax on a specific commodity (i.e. housing) and replacing it with a general tax will reduce the relative cost of housing compared to everything else, and increase the demand for housing. Because housing supply is very unresponsive or inelastic, this will of itself generate higher house prices.

Normally, such studies assume that the tax change is revenue neutral i.e. the aggregate effect on incomes in unchanged as a result of the tax change. As a result, one can focus on the substitution effect as housing costs fall. In reality of course, when we disaggregate there will be winners and losers from the tax change by tenure, income, demography and location. The aggregate (even council-wide) analysis of house prices tend to gloss over this disaggregated effects.

If we accept the fundamental idea, it then becomes an empirical question as to how much prices rise. We can look at four studies of these house price effects following on from rates abolition in the late 1980s. What do they say?

  • The Department of the Environment provided an annex on house prices in the Green Paper that introduced the world to the poll tax in 1986. The DoE accepted the capitalization argument and concluded that in national (UK) terms house prices would rise by 15% in the short run and 5% in the long run.
  • Gordon Hughes at the University of Edinburgh estimated (1987) the medium term price effects at standard regional spatial scales. He argued that house prices would rise by between 11.6% (South East excluding Greater London) to 23.1% in Scotland (the high figure presumably in part the result of the 1985 Scottish rates revaluation) with a national average of 14.4%.
  • In 1988, Peter Spencer wrote a report for Credit Suisse First Boston Bank arguing that we should distinguish between cash-constrained and unconstrained households and estimated that in the short run house prices would rise by 13% and in the long term by 7% for those who were cash-constrained (and presumably would have limited access to mortgages), whereas the unconstrained households would see house prices rise by 85% in the short run and by 30% in the long run.
  • Finally, a later study by Leslie Rosenthal in Fiscal Studies in 1999 found that house prices would rise by between 10% and 17% as a result of rates abolition.

Now, there are quite a few technical questions to consider. One is how house prices and the so-called user cost of capital or something similar, are calculated in each case. Another is the thorny question of just how unresponsive or inelastic housing supply is and whether or not it is formally modeled in each of these studies and across different spatial levels. At the time I certainly found Spencer’s work particularly convincing but clearly all four studies predicted non-trivial long run price effects as a result of rates abolition.

Why is this important in the context of the council tax or local property taxes more generally in 2015 in Scotland? First, there is the tax base argument i.e. diversifying the tax base away from income to a less productive tax base – property – is better as a way of reducing revenue risk and lowering incentives problems associated with higher tax rates on income. However, the main housing market points, second,  are surely about affordability and wealth inequality.

Higher house prices clearly make it yet harder for people to access home ownership or move upmarket when they need to. It makes properties more expensive to build and invest in. Higher house prices translate into higher rents as well. This may all sound good to NIMBY home-owners and buy to let landlords but acts to merely reinforce the gap between property insiders and outsiders. This cannot seriously be considered to be a sensible direction of travel when government espouses widely shared policy goals to reduce inequality and make housing work better.

I am not saying that abolishing the council tax in favour of a non-property solution would lead to the same house price effects as suggested in the late 1980s scenario, only that the logic of the capitalization process remains and we should expect higher house prices to an extent as a result. And that should be factored into future discussions about the future of local taxes in Scotland.

  1. Topham, N (1983) Local Government Economics, in Milward, R (ed) Public Sector Economics. Longmans: London.
  2. WE Oates (1972) Fiscal Federalism. Harcourt Brace Jovanovich: New York.

Monstrous and Unique

In a recent piece in the Financial Times [A Fiscal Fix for a Pecuiarly Flawed Property Tax], John Muellbauer continues his long term campaign to improve the working of the housing market. His belief is that fiscal levers could play a more coherent role and could on the one hand improve economic efficiency and productivity, while at the same time increasing fairness of tax outcomes.
The piece is about the ‘monstrous and unique’ council tax system of local taxation. Muellbauer provides a clear case in favour of reforming rather than replacing council tax. This short paper is, to my mind, the clearest and strongest defence of such a strategy and is consequentially worth closer scrutiny. What does he say, are the consequences and how does this play into the ongoing Scottish local tax commission?

Muellbauer begins with an increasingly familiar litany of council tax problems: the failure to have regular general revaluations and the fact that banding (and weighting the bands to dampen tax payment differentials) means that households in low value properties pay more as  proportion of their property value than do high value property owners [indeed, measured against current income, the Burt Review evidence in 2006 suggested that Scottish council tax payments were straightforwardly regressive over large parts of the income distribution]. He also criticises the council tax reduction system which through the 10% reduction in support, has brought many low income households into paying the tax for the first time (shades of the poll tax) and has created a forest of different local means tests into the bargain. As he notes, council tax debt now exceeds credit card debt as the most common debt-related problem according to the Citizens Advice network.

John Muellbauer argues that, instead, council tax could be more progressive. He would make the first £40,000 of property value free of tax taking ‘hundreds of thousands out of the poverty trap’. At the same time he would add a higher band for properties over £5 million. He recognises that a key problem with property taxes is the asset rich but cash poor household. He argues for offering all council tax payers a tax deferral in return for a government equity share in the property (1% per year) with a small discount for continuing to pay in cash.

From an economic point of view, Muellbauer argues that this would increase the efficient use of the housing stock. More revenue from council tax could be used to reduce reliance on stamp duty (following the Mirrlees Review agenda of seeking to cut stamp duty), and capitalisation effects would raise house prices in areas of low value and reduce them at the upper end of the market. Overall, this would reduce expected capital appreciation which is argued to be better for younger households, economic performance and the wider housing system. It might also deter speculative foreign investment in high value property.

Clearly, the author is writing a polemical piece aimed at pushing council tax reform into the election debate. However, the ideas regarding the tax free allowance and the deferral/equity stake are of genuine interest. I think to fill the idea out as a policy option, we would need to know:

– How regular general revaluation would take place and be enforced?

– What would the bands look like after the reform and would there be a re-weighting of the bands relative to D?

– Would council tax reduction continue to work in essentially the same way, net of the tax allowance? How would it interact with the deferral?

The proposal involves a further element of nationalising council tax with the government rather than councils operating the deferral system (although councils would receive a cash sum equivalent to the deferred payment each year). This does not really do anything to increase local democratic accountability or to help councils raise more revenue locally. Along with pressure to continue with council tax freezes, it does not reverse the process of centralisation of local government finance that goes back to the 1980s.

In previous writing John Muellbauer has argued in favour of a new national property tax to take on some of the ideas described here. New taxes and a reconfiguration of existing ones can be revenue neutral and need not increase overall tax burdens. They can reallocate resources more efficiently and I can see the in-principle case for better local property taxes more related to current property market values alongside a national tax on land values. This could shift taxes away from more productive activities like work and investing, it might reduce taxes on mobility like stamp duty and/or reduce marginal rates of tax while widening the tax base, thereby reducing revenue risk.

The tax free allowance and the deferral/equity stake ideas are interesting and useful for the Scottish local tax commission. Inevitably, talk of reform raises important wider questions for local government, accountability and autonomy. While this might not be strictly part of the remit of the commission it does remind us that successful policy reform has to be credible to its key stakeholders and that includes local government and advocates of more local democracy and responsibility.

International Evidence on Housing Booms

This post authored by Alex Marsh and Ken Gibb

A recent NIESR paper by Armstrong and Davis (November 2014) compares the last two booms and busts in major OECD country housing markets. The authors present a thoughtful macroeconomic analysis of national housing markets and from there conduct panel data analysis of the determinants of house prices focusing on financial, debt and related variables.

The authors argue that comparison of the two most recent housing market cycles (1985-94 and 2002-11) can test the hypothesis that there was something unique about the most recent boom and its aftermath. They state that the housing market is widely considered to be the main cause of the global financial crisis (quoting such authorities as the IMF). However, the authors come away from overall reading of the data for the two cycles unconvinced. In their view the two cycles are sufficiently similar that it difficult to draw the conclusion that the most recent cycle is different in meaningful ways: it is certainly not unique. The implications is that if the received wisdom is incorrect and other factors were important in causing the crisis then macro-prudential policies in countries like the UK may be incorrectly targeted at the control of house prices and mortgage lending.

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We are interested in this broad area for several reasons: why did economists miss the bubble nature of the housing market and its departure form fundamentals? Why did they miss the downturn in national housing markets? How plausible are the microfoundations of the models being used to analyze the housing market and explain what is actually going on? What do these analytical weaknesses tell us about the health or otherwise of economics and its capacity to evolve and learn for future challenges?

On reading the Armstrong and Davis paper we were struck by several points that we felt warranted comment. First, is there something of a straw man at the heart of this paper – do we really consider the house price boom to be the source of the GFC? Second, while the descriptive analysis is valuable and the technique is sound and well-derived from the literature, might it have been done differently? Third, does the principal policy inference, regarding the greater regulation of house prices and mortgage lending, stand up on the basis of this analysis?

Do analysts really generally view the housing market boom as the cause of the GFC? It is surely more that the sub-prime securitization and its exposure in the market for US mortgages in 2003 or 2004 onwards left the housing market vulnerable. Accelerating default contagion both collapsed the US housing market nationally (and that was different from the previous cycle) and spread through those exotic mortgage securities to stifle the wholesale money market and create the credit crunch which negatively impacted in many national housing markets across the OECD. Housing, and more particularly lending for housing, triggered a national market downturn which undermined wider international banking and thereafter fed back into other national housing systems.

Unfortunately, the data and analysis offered by Armstrong and Davis does not allow for this type of argument to be tested. In some senses, it requires a reconceptualisation of the housing (finance) market to recognise interdependence and network effects. It certainly requires a stronger focus on institutional innovations that is possible with the data available. To be fair, having presented their analysis, Armstrong and Davis note a range of factors and hypotheses ripe for further investigation. These include some of these institutional changes. So from our perspective it feels a little like the paper stops before it has a chance to grapple with some of the most interesting questions.

The analysis, understandably, constrains itself to using standard periods in order to attempt to capture national housing market cycles. Yet, despite the widely recognised increase in the synchronisation of housing market cycles cross-nationally, there is no reason to think that the OECD countries examined had similar period market cycles. The UK for instance moved into housing market downturn much later than the US. Moreover, downturns had different implications because of different default laws and bankruptcy implications. Getting a stronger sense of the timing of the turning points of these national cycles would itself be a useful contributor to the causal story being constructed.

Finally, the paper draws the policy inference that greater caution may be justified regarding the strength of the macroprudential case for regulating house prices and mortgage lending. It is important here to be clear what macroprudential regulation is seeking to achieve. Setting aside the macroeconomic stability arguments for a moment, isn’t there a housing-specific case for moderating the volatility of house prices and reducing market cycles? Whether macroprudential policy instruments are the right levers to use or are effective in damping price cycles are separate – and bigger – questions.

It may be that financial instruments are less effective than more direct housing policies in stabilizing the housing market. Or it may be that such policies can be complementary and work in tandem. Yet, in reality we face a context in which there is a willingness to consider active macroprudential regulation but a reluctance to intervene directly to generate greater housing market stability – if not an inclination among politicians to introduce policies that are more likely to increase volatility. Macroprudential tools can have more or less targeted impacts on housing markets. We should be cautious about bypassing them as a policy option. There is, of course, much more to learn about the most effective design for macroprudential policy instruments. This is an area in which a number of countries are experimenting with different approaches and there is undoubtedly scope for cross-national policy learning.

Alex Marsh is at the University of Bristol and is the purveyor of Alex’s archives at http://www.alexsarchives.org/

Housing, the Economy and the Election

I was a late stand-in at the Scottish Chartered Institute of Housing conference in Glasgow this afternoon. The session was about the economy’s uneasy relationship with the housing system. Also speaking were a business economist (Lloyds chief economist Donald MacRae) and a leading business and economy media representative (Douglas Fraser from the BBC). I was the filling in the middle.

We all agreed on the need for more homes and that housing supply should be much more responsive permanently (and I echoed the RICS Commission’s suite of land supply, planning and national land agency proposals, as well as many of those ideas that came out of the Lyons Review in England). We also agreed that there was an opportunity in Scotland  to reshape property taxes more positively but that it would be far from easy. There was surprising (to me) common ground about replacing the council tax with another form of property taxation such as a land value tax (although I am still unsure about whether it should be a national rather than a local tax). There was also some common ground about the inefficiency of any kind of transaction tax but at the same time the recognition that we cannot realistically cut the overall tax take in the present fiscal context of austerity. There was also a shared assumption that short run volatile but long term rising real house prices made no sense for the economy or for the people living there.

And there is the rub, We kind of know what the problem is and can see a set of different combination of progressive policies that might help us get where we want to go to but the politics, institutions and incentives operating make it awfully hard to get started.

This was the essence of my presentation. In a recent Knight Frank post there was a helpful matrix summary of the UK parties’ housing policies prior to the launch of manifestos. While they individually made noises towards more supply and a range of ancillary and sometimes plain ideological proposals, the parties’ proposals generally lacked two key things. One, it was not always clear how stated claims were actually to be achieved. Second, there was simply no recognition of the long term nature of the housing problem, and that it is not doing it justice simply to call it a crisis. Rather, it is an endemic, chronic set of underlying problems that periodically flare up into specific panics.

Economists talk about time inconsistency problems and I think that is what we have here. As I have said many times before: housing policy, tax and social security reform require carefully developed and transitioned policies that protect and compensate losers. This will take more than  one Parliament to achieve so there has to be credible buy-in to a broad consensus about policy aims, means, resources, timescale and what success looks like.

There are only two ways to get this sort of positive situation. One is something like a New Labour one party state for three Parliaments, a situation which led to comprehensive social rent restructuring introduced over more than a decade (even it was undermined by the knock on effects of the Coalition’s remaking of affordable homes programmes). The alternative is to build an all party, civic society coalition, as was the case with homelessness in Scotland which is then phased in over a decade.  

So, it can be done but why should it? One good reason that is not articulated enough is to stress the upstream preventative benefits of more supply-side interventions (shifting the balance back from the demand side over a period of years). Better quality low cost housing stock can improve health, reduce carbon emissions and energy costs, encourage people into work because they have security in their home, and it can be used to provide more tailored solutions that can keep older tenants safe in their homes and communities for longer. Of course, we need better evidence about these effects (and a plausible theory of change to bring it about) but one does not get the sense that the housing sector is clearly making this case in a unified way but rather is doing it strand by strand in separate sets of intervention narratives. The Scottish Government wants a decisive shift to prevention. Might this be part of the way that the housing sector makes the case for the long term refocusing of its policy framework?

A final thought. I reprised the argument this afternoon that it is simplistic to describe Scottish housing as wholly devolved because of  the UK mortgage market, the rules governing public finance, most of social security (and also post-Smith) being run by DWP and the fact that plenty of the taxation (and non-taxation) of housing remains at the UK decision-making level. I believe this is this both true and significant. It means that the Scottish Government  has surprisingly little influence over the home ownership sector as a whole, for instance. Social housing, and to a lesser extent private renting, is diverging from rUK but it is constrained by this underlying hybridity. I worry that UK and Scottish governments’ housing policies can all too easily come into conflict or simply not work together well. Incomplete devolution of housing is perhaps inevitable in our present constitutional settlement (and perhaps would also have been under the Yes campaign’s economic independence lite) but it could be a real constraint to progress. Unless we believe that a future UK Government does the right thing. Holding one’s breath is not an option. 

Order and the British Housing Market

Yesterday’s FT ran a lengthy editorial on the woes of the UK housing market (‘Britain needs to set its housing market in order’), following earlier analysis on the same subject. The discussion leads onto other linked analysis yesterday by the BBC News on house building [1] and a blog by Gavin Smart of the CIH on private renting [2].

The FT argument runs something like this. Rising house prices, despite the great recession, have pushed stock housing values to nearly a trillion pounds, much of this accruing to existing owners or landlords, at the expense of tenants and would be buyers. And ‘there is nothing illusory about the divisions this creates’. They do not lay the blame at faulty monetary policy regarding interest rates or indeed wish to overstate the role of oligarchs holding their savings in the form of London homes; instead the problem is lack of housing supply and fiscal policy that provides tax breaks to private landlords, the absence of capital gains taxation and Housing Benefit maintaining rents in the private rental market. They are critical also of Help to Buy and Funding for Lending (the latter described as a ‘vast credit subsidy’ for buy to let landlords). Guarantees for housing construction on the other hand have remained ‘in the pipeline’. The FT argues that policy has been more successful relaxing the planning system but that political will is receding with economic recovery and as the election nears. So, both the priorities for housing and the lasting commitment to see it through have been lacking.

Looking forward, the editorial argues that (1) HM Treasury should scrutinise all forms of support (including one presumes implicit tax breaks) to home owners; (2) local government should be free to set property taxes; (3) the planning system has to favour those in housing need and seeking new homes rather than the ‘comfortable homeowners’. They conclude: ‘What Britain needs is a government brave enough to trumpet the virtue of falling house prices, and to make it happen’.

The BBC News magazine story by Tom de Castella asks why it is so difficult to achieve the Labour party’s 240,000 UK housing supply figure. Along with Government proposals to help, the main supply suspects, largely based on the Lyons Review analysis, are set out in summary. The planning system and local opposition to development; lack of available land; the slow build out of land held by builders with planning permission, the fact that the state no longer builds to scale and social housing is financially constrained in different ways, supply capacity shortages in terms of labour and materials and the decline of small builders.

Turning to the private rented sector, Gavin Smart presents an array of surprising numbers. He quotes the recent Savills figure that private landlords have enjoyed an increase in capital values of £177 billion in the last five years during a period when the rental market stock grew by 57% in the UK (2009-14) and as noted by the FT private tenants pay 2/5 of their income on their housing, yet one in three rental market homes would have failed the English decent homes standard if applied to them in 2012. The issue of the moment seems however to be the fiscal one. Private landlords receive of the order of £7 billion per annum in tax allowances (manly mortgage interest tax relief and allowances for repairs and maintenance). Gavin notes the current debate regarding whether these should be halted or moderated and argues instead that they ought to be targeted more effectively incentivising landlords to sign up to accreditation, carry out repairs and improve management in return for the tax breaks.

My thoughts? First, as I have written before I would on balance favour a long term target of stable real house prices but to pursue that in a context of a concerted long term uplift in housing supply, fairer and more efficient housing taxation, more lending intervention and support, probably along the lines suggested by CIH, for a higher quality private rented sector (and by setting these ground rules, this may also hasten rather than further impede more institutional investment).

Second, I am a little wary of tax tinkering and second best solutions. Yes, there may be significant tax allowances going to the rental market but Gavin is right to stress the open-ended nature of the repair and maintenance allowances – these do need to be incentivised and linked to standards. The loan interest tax relief on the other hand is after all an offset for businesses that pay income and capital gains tax (unlike those other ‘asset speculators’, our nation of home owners). The problem at one level has been the previous fiddling with housing taxation (going back to the 1960s) that has broken what was once a relatively consistent treatment – taxing the housing income of home owners and offsetting with mortgage interest tax relief alongside a local property tax. Schedule A income tax was abolished followed later by the Rates and mortgage interest tax relief, without anything comprehensive taking their place. And viewed as an asset, owner-occupation of a main residence remains very lightly taxed with all the bad things that flow from it for the economy and society.

That is where the main inconsistency primarily lies in this second best world, not with the business taxation of private landlords. But I am the first to recognise how difficult it is to buy an argument of taxation principle in an ongoing context of austerity, welfare reform and housing market failure.

Notes:
[1] ‘Why can’t the UK build 240,000 homes a year’ http://www.bbc.co.uk/news/magazine-30776306
[2] ‘A chance to boost standards in the private rented sector’ http://www.cih.org/news-article/display

The House Price Hockey Stick

A couple of housing-related things gave been going round my head in recent days and I thought it might make sense to link them, however, realistic or useful that might be.

First of all, a couple of weeks back I was at the Scottish Housing Event in Edinburgh, a government-led housing policy and practice conference about delivering the Scottish Government’s housing strategy, building out of a series of workshops and roundtables. It was all very inclusive and participative, if not, as yet decisively conclusive. However, apart from the interesting nuggets and networking that went on there was, for me, a striking contextual presentation by David Signorini from Communities Analytical Services (a written up version of the presentation is on the Government website dedicated to the conference: http://www.scotland.gov.uk/Topics/Built-Environment/Housing/reform/housing-event,) The slides covered a range of important background trends and themes but the one that struck me the most concerned house prices and affordability.

The Communities ASD diagram (based on ONS data for Scotland) shows that while real house prices have come down since 2010, the impact on the house price to earnings ratio has been moderated by first falling and then flat earnings. Moreover, the absolute level of the ratio, falling from just over 9.0 to a little less than 8.5, remains very high, historically (i.e. 2010 was I think the modern record high).

Despite the recent moderating trend, it is quite hard to overstate how bad these numbers really are but some voices will no doubt say: don’t worry; there will be a correction once interest rates rise and some process of mean reversion will kick in. I, for one, am pretty sceptical that we will get back to stable price to income ratio values of 4 or even 5 and that is where the second issue comes in.

Via a retweet at the weekend of Tim Hartford’s blog I read the excellent paper by Katharina Knoll and colleagues, summarised in the VOX CEPR portal at http://www.voxeu.org/article/homes-prices-1870.
In their paper, Knoll, Schularick and Steger present a new house price index for 14 developed economies using a consistent data series from 1870 to 2012. This provides a fascinating long term house price series. Now, I would be the first to recognise the difficulties of pooling international house price data but it is intriguing reading and raises some big questions.

First of all, they find in general what they call a hockey stick pattern – real house prices were relatively stable till the middle of the 20th century when they started an (ongoing) strong and accelerating increase in value – tripling since 1900. This is despite the relative stability of income growth – i.e. the price to income ratio especially in recent decades has been increasing sharply.

Much of this real house price growth is associated with booming land prices (some four-fifths of house price growth is explained since 1950 by rising land prices). They argue that this has become more pronounced because of the long term effects of reduced transport costs making more land economically usable (increasing supply) until the post-war period when land became more like Ricardo’s fixed factor of production. They also point to the importance of restrictions on land use at the same time that economic (income elastic) demands for housing space increased.

Second, Hartford like Knoll et al also link this to the Picketty thesis that capital has become much more important in recent decades because in part of the growing role of private housing wealth and rising real estate asset values. Rising price to income ratios stretches unaffordability and reinforce inequality by locking more and more people out of home ownership who might previously have been able to get on the ladder – but tighter lending rules and unreachable price to income ratios serve to segregate further insiders and outsiders. And as others like Beverley Searle have previously noted, this is likely to have all manner of ramifications as cohorts of people have no assets to turn to meet risks and care costs, etc. in later life – the long term neglect of house prices will end up in part increasing public spending and higher taxes or at least putting further pressure on budgets to support care and other age-related services.

The historical record suggests that rising real house prices (and relative to incomes) are a long term feature of capitalist economies – so, to the extent that the future remains similar to our recent past couple of generations, do not expect a sustained mean reversion to earlier more affordable days any time soon.

At the Shelter Scotland Annual Lecture

This evening, Danny Alexander gave the annual Shelter Scotland lecture. It was entitled Housing and the UK Economy. Well-attended by the Scottish housing fraternity, it was chaired by Richard Holloway. He made the point that the 1951 Tory Government delivered 300,000 units a year and they justified this massive output achievement (and its contrast with recent lowly efforts) on the basis of the then Government’s desire to boost economic productivity as well as tackle the acknowledged crisis in housing. It should however be noted that Holloway later berated the poor aesthetic quality of postwar UK and Scottish urban housing stock – these two facts may be related?

Danny Alexander defended his own Government’s record both on the deficit reduction and on welfare reform, the latter primarily as work incentivisation. He then went on to argue that housing was a source of macro financial instability and that this was best tackled by radically increasing housing supply (indeed to the 300,000 figure). He also argued that policies to do with localism, help to buy, planning reform and other supports (a ‘blizzard’ of policies) had contributed to significant growth in units developed – but still well below 200,000 even in recovery phase.

It was an understandable though not an entirely convincing defence of the Coalition core policies. It remains the case that deficit reduction could have been managed in a much less dramatic and austere way that did not risk the slow and postponed economic recovery that followed. And deficit reduction was less successful in its own terms than was promised. The welfare reform proposals have struggled under most reasonable analyses: the failure to roll out universal credit in anything but the simplest of cases, the racheting-up of sanctions, the treatment of the ill and disabled, the faulty behavioural assumptions about private landlords cutting rents or under-occupiers moving to smaller units. All not borne out, let alone the growing empirical picture of hardship and loss brought by these measures and the huge growth of in work poverty and reliance on benefits in work. None of this was mentioned tonight.

Turning to housing, Alexander’s big idea was to contemplate the state as a housing commissioner. What this would mean, he seemed to say, was looking at the proposition that if the housing system can generate say 180,000 units, the state would commit to building 120,000 (to get to that magic annual total of 300,000) and would then sell them off, presumably to a range of providers across the market and non-market sectors. In this sense, it would financially be like a short term equity loan – fronted by government but repaid on resale.

I would suggest that the Treasury thinks hard before pursuing this sort of line. First of all, it suggests a degree of market-second guessing, knowledge and planning on the part of the state that would have Frederick Hayek spinning in his grave. Second, via lags and other cycles it may serve to exacerbate the development cycle and actually restrict the role of the market developing via over-building. There is considerable and extensive scope for unintended consequences here and I would suggest going very warily. Third, there is a real numbers fixation here with building targets but little sense of the economics going on around it particularly how the demand side responds. I had the sense this evening that Mr Alexander could evidently recognise the macro argument that the housing sector can be financially destabilising but he could only seem to see supply as the answer not, for instance, to also seek to minimise the culture of speculation and be more creative with taxation and consider more work on mortgage regulation.

Later on Duncan Maclennan asked in the Q&A session what advice Mr Alexander would give to help the housing lobby make a productivity case for more housing investment. His response was telling in that unlike transport infrastructure or telecom broadband, he could not see housing having the same impact on the economy. Duncan used the arguments popularised by US economists like Don Haurin to argue that there is evidence that good housing improves parenting and educational attainment (let alone supporting labour market functioning and large construction multipliers). It does seem that there is definite scope in this area to make a stronger economic argument.

I also managed to ask a question in this case about the bedroom tax. In his lecture Danny Alexander said he supported the affordable housing bill and hoped it would get into law and thereby significantly weaken the spare room subsidy. I asked him if this happened or indeed other future governments chose to abandon the bedroom tax – would there still be point in devolving Housing Benefit? His reply indicated that he (and the Lib Dems?) have bought the IPPR argument (as Labour has) that housing policy is devolved and HB should therefore be too. Regular readers will know I do not really accept this: housing is not completely devolved and reserved elements such as private housing impact on the rest of the system so there is not such a degree of devolution in reality. Moreover, the second IPPR benefit devolution requirement was stability in benefit spending – yet the larger part, local housing allowances for the rental market are important, growing and volatile. I don’t think this even therefore makes the IPPR’s own case for justifying the devolution of HB. Will the Smith commission look closely at the details and not just the big picture – devolving social security, as experts like Paul Spicker has stressed, is not at all straightforward.

An interesting and thought-provoking evening. Richard Holloway described it and courteous and candid. Apart from the politics as normal defence of government (always odd within the Coalition’s particular strains), Danny Alexander was considered and thoughtful and he clearly has a substantial interest in housing and making innovative housing policy. While I didn’t agree with aspects of what he had to say, it is positive that the Government, the Lyons Review and people like Kate Barker are promoting housing prominently, rightly, in the run up to next year’s election. It is a momentum that needs to be sustained – initiatives like the Shelter Scotland Housing and Well-Being Commission will be essential (1).

Note
(1) I should declare an interest in the Commission as I act as an advisor to it.

Leave our dysfunctional housing market alone!

A week after the European elections it is perhaps not surprising that the news that the EU is critical of the UK’s housing market should be ill-received in some quarters. However, as with all these things, it does makes sense to actually look at what our friends in Brussels have actually said.

They identify that demand and supply side measures have been taken to influence the housing market. But combined with low interest rates, greater willingness to lend and continuing excess demand, house prices continue to rise, especially in overheating London.

In response to this diagnosis, they argue that supply is viewed as a structural imbalance and an area where action to boost supply is deemed to be required. The Commission goes on to argue on the demand side that prices and mortgage debt should be carefully monitored and intervention including adjusting the terms of Help to Buy 2 should be readied for action if required. they also think the financial policy committee of the Bank should be deployed to address these housing market problems via macro-prudential regulatory changes as and when required. They also suggest considering reforms of housing and land taxation and point out oft-rehearsed arguments about weaknesses with the council tax (based on 1991 values, regressive banding and higher burdens on lower valued property).

ONS also published latest official house price levels and rates of house price inflation today. To summarise:
UK £252,000 (annual rise of 8%)
England £263,000 (8.5%)
Wales £164,000 (4.9%)
Scotland £181,000 (0.8%)
Northern Ireland £132,000 (0.3%)
London £459,000 (17%)

With inflation variously measured at 1.8% to 2.5% in April, real house price inflation, highly regionally varied, is back with a vengeance. I heard a Welsh estate agent last week on the radio say that locally house prices were only rising by 6-7% i.e. 4-5% in real terms – nothing to worry about then? The Barker Review, a decade ago, focused on the long term economic cost of real house prices rising by a 2.7% rather than the EU average of 1.1% accumulating over time, let alone the distortions of wider amplitudes or volatile prices.

Reflecting on the European Commission report in the context of the latest house price data, it is hard not to agree with the thrust of what they say – I am sure most housing policy commentators do. We also would probably welcome the Bank’s more activist stance, even if we are not convinced that they can do all the things hoped for them in certain quarters.The means, not the ends, are what are in more doubt. Should we tinker with the council tax or undertake more broad based tax reform along the lines proposed by Mirrlees? And how are we to make this structural shift (on a more permanent basis) to housing supply?

We have discussed these points many times before on this website – at least there is a growing consensus, even from the Eurocrats, the Bank of England, many economists and other policy analysts that rising real house prices are self defeating economically and socially divisive as well. The Coalition Government may well be inching this way too but it is less than 12 months before the general election so lets not hold our breath during the Queen’s Speech.

More Discussion of Reforming Property Taxation

Fresh from a recent post on land value taxation I am writing on this subject again, this time in response to my colleagues at Heriot Watt who have just published a report for the Joseph Rowntree Foundation (After the Council Tax: Impacts of Property Tax Reform on Places, People and House Prices by Glen Bramley, Chris Leishman, Mark Stephens, David Watkins and Gillian Young). Their report critiques the current council tax, runs  comparative analysis of a revalued council tax and contrasts it further with a flat rate percentage tax on property values (similar to current arrangements in Northern Ireland). They also discuss a policy trajectory to move from the council tax to a better local property tax and ultimately to a national tax on property, one that looks a bit like Schedule A imputed income tax and also the excess returns tax proposed in the Mirlees Review.

What is the critique of the council tax? This is well known ground but in essence the tax is a higher proportionate burden on cheaper properties than on more expensive ones. Second, it has not been revalued since 1991 and is hopelessly out of date both regionally and within local housing markets. Third, we now have something like a third of all tax units (households) benefiting from the single adult discount. Fourth, there is the insidious effects of long term council tax freeze and now also the localising of council tax reduction.

What are the authors’ empirical findings? First, a shift to a flat rate property tax (or indeed a progressive one) would shift the tax burden toward high value London and the South East. The authors deem this redistribution so large that it would require to be phased-in or damped. Second, the flat rate percentage property tax would be progressive with respect to the burden on different income groups with considerable benefit aimed at lower income groups. Middle income groups would also see a reduction in their liability in general. The authors argue that for those who do lose out in the low to middle income brackets it would be possible to compensate them with savings made from reduced rebate bills. Fourth, the authors argue that a property tax is generally not deemed to be fair and that some form of income tax would be required, preferably embedded in a hybrid property and income tax structure. Finally, they report econometric results that suggest reforming property tax could make a modest but statistically significant contribution to moderating house price volatility.

How would they implement tax reform and overcome obstacles? These are in many respects the key questions. First, the authors suggest a cap on London property taxes as part of the transition and consider ways to help low-income losers from the tax change in that part of the country. They also consider the Housing Market Task Force to transition the local property tax to a national tax based ultimately on the old Schedule A imputed rental income tax.

What do I think? The purist response would be to go for a land value tax and to rehearse the argument of my recent post and that might lead one to support the comprehensive Mirlees review position on the tax on excess returns (a variant of Schedule A). But if we were to start from the present position and work towards something coherent and possibly enduring what needs to be done? First I would revert to a national system of council tax benefit – I don’t accept either the localism argument for it or the idea that it allows a lower Universal Credit taper (it patently does not if we consider the total taper facing low income working age households). Second, I would legislate for 3-4 yearly automatic revaluation of property. It is one thing to bring the council tax data base up to date – it needs to be done regularly and consistently, forever more that there is such a tax.

That is the easy bit(!). I think we then need to consider what kind of local taxation we want and what kind of general taxation on housing/property. Locally, I was always taken by the idea of having multiple local taxes (i.e. two) – a property tax (like the Northern Ireland one) associated with paying for amenity or facility services that are fundamentally local and a local income tax related to national redistribute services that are delivered locally like education (as was suggested in a report Alternatives to the Community Charge written for the JRF more than 20 years ago by a number of experts including Tony Travers). Nationally, we are back into the territory of tenure and tax neutrality and the Mirlees Review – but the point is to develop taxes that do not favour owner occupied housing per se and do not do inefficient things like tax at the point of transaction. These are bigger questions than for this post.

The big difficulty in all this is persuading those that need to be convinced that we should on efficiency and fairness grounds unpick the council tax. We need to develop a political consensus around reform and one that has a place for a sensible property taxation and try to make revaluation normal and boring instead of completely beyond the pale. Any reform programme would need to be one with a lengthy transition and protection period for losers and would thus need bipartisan support. While I do not minimise the difficulty of achieving this – it can be done as phasing out mortgage interest tax relief showed. But first we must convince the men and women from the Ministry that the council tax is so bad and that the problems it is creating for local government and the housing market – do indeed require us to invest treasure and time to try and fix it on a long term basis.

Unfortunately, this is one of those rare policy questions where the infamous previous experience of a botched and cataclysmic attempt to reform local government finance brought down a prime minister and is simply an area where it is incredibly difficult to build any sort of institutional commitment to reform. The report by Glen Bramley and colleagues is both thought-provoking and a welcome effort to move this debate forward thereby staking a claim for a more humane and workable form of housing taxation and local government finance.