Alexander Bowen: The landlord tax is (probably) fine – try housing benefits next

Alexander Bowen is a trainee economist based in Belgium, specialising in public policy assessment, and a policy fellow at a British think tank.

Your name’s Luke. You’ve worked hard, you’ve studied nuclear physics at Oxford and Imperial and now you work at Rolls Royce earning £60,000 a year, designing and building in Britain the Small Modular Reactors that look set to be the future of the British energy industry. On every £1 you now earn you’re paying 57p of it in tax. If you add in what Rolls Royce pays the government to employ you, something that economic research tells us would otherwise be your pay, on every £1 in new earnings you’re paying 72p.

Luke’s girlfriend, Nicole inherited a few properties and derived her £60,000 a year income from profiting from renting them out, for every extra £1 she makes from her tenants she pays the taxman just 40p. Even better, she gets a nice equivalent income every time the value of her property rises, which they always do.

Does this make any rational sense? Are Luke’s “shoulders” 80 per cent broader than Nicole’s? Is Nicole taking more risks or working harder? Whose behaviour is socially optimal? Who represents the future of a growing economy?

No, and one need hardly be David Lloyd George barnstorming on how landlords did not put the tin in Cornwall or the coal in the Welsh Valleys to question the UK’s current tax setup.

Why should Luke pay more than Nicole is a legitimate question, and it is one the Treasury to much furore has finally looked at fixing by applying national insurance (and not even the full tax wedge gap) to landlords’ incomes. It’s been met by so much furore from landlords, you’d think Chairman Mao had been appointed Minister for Landlord Welfare.

There has been a more reasonable criticism though – that landlords would just pass on the national insurance to their tenants via higher rents. That a landlord tax would just be a renter tax. It’s a reasonable criticism, given what we saw with “employer” NI, but it’s a wrong one.

If it were true that landlords would simply raise prices to pass on the cost then that would need one of three things: a market where housing supply has a strong response to rents; the absence of a market, with landlords determining price based on whatever they want rather than whatever the market can bear; or a market with no price coordination.

The latter two we know are not the case – the increase in interest rates from 0.25 per cent to 5.25 per cent with the subsequent fall have had little effect on rents (bear in mind that a 5pp fall in interest rates essentially doubles the monthly affordability of a mortgage) and don’t generally in supply inelastic markets as detailed by economists at BIS and the BoE. As for the first point, that housing supply is inelastic, it is almost so obvious that it barely bothers documenting with supply elasticities in most of Britain’s urban areas and London in particular touching 0.

Both interest rate changes and recent expansions in tenant protections have the same mathematical function as a tax on landlord profits, reducing the real return of property, and neither appear to have been offset with high rent. Regulations applying universally, and thus a price coordination device automatically, can disprove that latter theory that coordination levels alone are enough to justify the pass-through theory. Put simply because UK housing and rental supply is practically as inelastic as demand itself, your classic shift on the supply-demand diagram doesn’t take place. There’s no reason to think NI alone would be an exception to that rule.

The general principle though, that there is tax incidence and it matters, is of course the right one even if misapplied here. Frankly it’s refreshing to see people care about it when it is exactly what I was screeching at journalists the whole time Rachel Reeves was jabbering through the election campaign promising “no taxes on working people”.

So yes whilst the “employer” national insurance tax rise ended up being almost entirely born by workers (£16bn of the £19bn to be precise) this is not the case here. The instinct is right though – that costs will be borne elsewhere – it’s just that it will come from property generally. All else being equal, a £1mn asset that goes from having say a 5 per cent real return to a 4 per cent one is actually an £800k asset – the tax then has not cannibalised in the forms of higher rents but cannibalised in the form of lower property prices. Forgive me if I shall not weep for the absence of slightly higher house price growth in an already overinflated property market.

The UK’s terrible property market, and inelastic supply, does offer one nice opportunity for reform though. One that could raise far more money than a piddly £2bn change to national insurance, that as several tax lawyers have pointed out could well be avoided by becoming a small business, and one that has a solid base in pre-existing evidence.

I am of course talking about housing benefit reform.

Much as tenants’ rights have the same mathematical function as a tax on landlords, the UK’s inelastic market means that tenant subsidies (housing benefits) have the same mathematical function as a negative tax (or subsidy) for landlords. If Rachel Reeves really wants to be in her “Welsh Wizard Era” then she should look at housing benefit reform too.

As detailed in two classic papers of the genre, both of which study what actually happened as a result of housing benefit reforms, one on expanding eligibility in France and one on cutting payments in the UK, housing benefits don’t make housing more affordable, they just make landlords more money. In the French example, out of every 1€ extra spent on housing benefits, 78 cents were absorbed by landlords in the form of higher rents thanks to more money chasing nearly the exact-same supply. In the British paper again the same – for a 15 per cent fall in benefits there was an 11 per cent fall in rental prices. Some three-quarters of the housing benefit bill then is, ultimately, just a landlord subsidy.

In a country that spends £12.3bn a year on housing benefits, and a little over £8bn a year on maintenance loans to students which are in practice just a weird housing benefit-esque arrangement for young people, that’s something like £15bn a year paid by the government to subsidise landlords or 7x the much talked about landlord NI-raid. Both will be borne by the same people, they’re both functionally the same policy, only one actually raises revenue and one will require some actual political will.

If it requires political will, Labour will of course do neither – when it ought, no need, do both.

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