As we reported in New Build: Foundations for a successful housing policy? the Autumn Statement heralded significant reforms to Stamp Duty – the UK tax on house purchases. The result is the introduction of a graduated system of tax, along the lines of the income tax system. A similar regime will continue to operate in Scotland when the Land and Buildings Transactions Tax replaces Stamp Duty next April. Here we consider the impact on the effective rates of tax following the changes to Stamp Duty.
Under the old system any house purchase involving a property whose value was £125,000 or less incurred no Stamp Duty liability. Thereafter, one of five tax rates applied: 1% above £125,000 to £250,000, 3% above £250,000 to £500,000, 4% above £500,000 to £1m, 5% above £1m to £2m and 7 per cent for properties over £2m. The important point was that the whole of the purchase price was subject to one of these five progressively higher tax rates.
The new system sees the introduction of a graduated system of tax which means that the amount paid by house purchasers will be dependent upon the proportion of the value of the property that falls in each of the tax bands. Again, for properties up to £125,000 there will be no liability. There will then be four bands: 1% above £125,000 to £250,000, 5% above £250,000 up to £925,000, 10% above £925,000 up to £150,000 and 12% above £150,000.
One significant impact of the changes is that the liability will be more proportionate to the value of the property. To see this we can compare the average rate of tax under the new and old tax system. The average rate of tax is simply the amount of the tax liability relative to the price of the property.
From Chart 1 we can see how the new average rate of tax under rises progressively with the price of the property. (Click here to download a PowerPoint of the chart). Under the old system, the profile of the average rate of tax looks like a series of steps with a slab at each tax rate. Unsurprisingly, the system was sometimes referred as the ‘slab system’.
A second significant change will be the removal of the significant spikes in the marginal rate of tax around each of the tax bands. For example, the tax liability on a property costing £125,001 was £1,250.01 compared with a zero liability on a property costing £125,000. Therefore, a £1 rise in the price of property was accompanied by a £1,250.01 rise in the purchase tax. In percentage terms this is a marginal rate of tax of 125,001. Chart 1 shows how the marginal rates now match the progressively higher tax rates that become payable between each threshold.
The principle of removing the significant distortions to pricing created by the old system of Stamp Duty is likely to receive general approval. However, there may be some unease around the short-term implications for house prices of the bands and rates under the new system. This is largely because nobody purchasing a property at £937,000 or less will see their tax liability rise. The reduction in the liability raises concerns about a potential boost to house prices.
Chart 2 show the percentage change in the Stamp Duty liability for properties of up to £2.5 million. (Click here to download a PowerPoint of the chart.) The average UK house price, excluding London, is currently £235,000. The stamp duty saving in this case is £150 or 6.4 per cent.
But there are more significant savings than this from the reforms, including in London where inflationary pressures in the housing market have been more significant. Here annual price inflation ran at close to 20 per cent in the second and third quarters of the year. Given that the average house price in London is currently £510,000, this means a Stamp Duty saving of £4,900 or 24 per cent. Of course, for premium London markets (and other similar markets elsewhere) a quite different effect could arise. The liability on a £2m property rises by 53.75 per cent. Nonetheless, for most markets it is the boost to prices that is most concerning.
In the East Midlands, which is a good barometer of the market in the rest of the country, there will be a saving of £610 or 32 per cent on the current average property purchase of £189,000. Therefore, even in markets where house price inflation is more subdued there is the potential that the changes to the Stamp Duty system will, in the short term at least, boost housing demand and fuel house price growth.
Stamp Duty/Land and Buildings Transactions Tax
Rates and allowances: Stamp Duty Land Tax Gov.UKLand and Buildings Transaction Tax Revenue Scotland
Autumn Statement: documents Gov.UK
The home owners cashing in on stamp duty reforms Telegraph, Dan Hyde (2/12/14)
Christmas comes early for estate agents after stamp duty changes Guardian, Nigel Bunyan (7/12/14)
Stamp duty: House price boom and mansion bust Telegraph, Anna White (6/12/14)
£200m house deal stampede by wealthy to beat stamp duty hike: Reforms spark one of busiest periods for estate agents in 25 years Daily Mail Online, Louise Eccles and Ruth Lythe (5/12/14)
Stamp duty changes boost housing market and push up prices Guardian, Hilary Osborne (5/12/14)
Stamp Duty revamp blow to SNP property tax reforms Scotsman, Tom Peterkin and Jane Bradley (4/12/14)
Autumn Statement: What do stamp duty changes mean? BBC News, (3/12/14)
House Price Indices: Data Tables Office for National Statistics
- What is the tax base of Stamp Duty and the Land and Buildings Transaction Tax?
- How does Stamp Duty distort choices?
- Under the old Stamp Duty system, why might a seller be reluctant to put their property on the market at £251,000?
- What is meant by the average and marginal rates of tax?
- What is meant by a progressive tax?
- What is the connection between the average rate of tax and how progressive a tax is?
- Calculate the marginal rates of tax (in percentage terms) under the old Stamp Duty system following a £1 rise which results in a property’s value moving into the next tax band (start with a £1 rise from £125,000 to £125,001).
- Using a demand-supply diagram show the effect of the Stamp Duty reforms on house prices in most UK housing markets. What characteristics of supply would make the change in price particularly large?
- Are there any housing markets where demand could fall following the introduction of the reforms to Stamp Duty? Illustrate the possible effects using a demand-supply diagram.
- How might an economist go about evaluating the Stamp Duty reforms? What factors will affect the judgement formed?