The following blog reproduces written evidence submitted by Prof Jim Gallagher, Nuffield College, Oxford to the House of Commons Scottish Affairs Committee Inquiry – Land Reform in Scotland. The oral evidence provided by Professor Gallagher and Stuart Adam of the Institute for Fiscal Studies on the topic can be read from Question 743 here.

By Professor Jim Gallagher

This evidence suggests an approach to the reform of property taxation in Scotland.

Constitutional background

Most matters related to land reform and property taxation are devolved to the Scottish Parliament at Holyrood. The Scotland Act 2012, deriving from the (Calman) Commission on Scottish Devolution devolved Stamp duty land tax, based on the analysis that property taxation was the most suitable for devolution, for the simple reason that its geographical location was not subject to uncertainty. That is why council tax and non-domestic rates are already devolved, and the devolution of Stamp Duty Land Tax means that all property taxes (apart from capital gains tax to the extent that it relates to real property) are now devolved. This gives the Scottish Parliament unrivalled opportunity to mould taxation of land and property in a way which is sensitive to Scottish concerns, efficient to operate, and economically wise.

Taxation of land and property in Scotland

The present taxes on land and property in Scotland have grown rather than been designed. Council tax, applying to domestic properties, arose from the debacle of the poll tax essentially as a modified form of domestic rates. It embodies a number of pragmatic compromises, and is none the worse for that, but suffers from the increasing disability of the unwillingness of any Scottish government to sanction a revaluation. It is wholly absurd that the values on which council tax bandings are based still refer to 1991 property values. Something should be done about that, but such a change ought to be put in the context of a long term strategy.

Non-domestic, or business, rates do not suffer from the revaluation problem, but still have some serious defects. The most obvious is that they do not apply to most real property in Scotland, as agricultural land has been de-rated since the 1920s. Whatever the justification offered for that then, it certainly merits revision now.

Stamp Duty Land Tax, by contrast, is a tax on transactions based the value of the property, but does not recur. Its main advantage is that it raises revenue, and for that reason alone, caution is needed in amending it. However the economic arguments against a tax on transactions are quite strong – essentially that transactions, freely entered into, allocate resources more efficiently, and making them less attractive reduces utility overall.

A strategic framework

Property ought to be taxed. It is a convenient source of revenue, with very low collection costs compared with other taxes, and ought to be subject to taxation in the same way as other economic assets. Scotland, like the rest of the UK, fetishises home ownership (land ownership too) with the result that property is overvalued, and households over-borrowed in order to finance ownership. The causes of this are complex, and it will be very difficult to escape from the situation in which we find ourselves. In the long term, part of the answer will be a rational system of property taxation.

A rational system of property taxation would have as its broad general principle the taxation of all real property, principally on the basis of taxing the value of the land on which the property sits. This has two advantages. The first is that it reduces the disincentive to investment in new buildings (whether residential and non-residential) insofar as the value of the house, office or factory will not itself be subject to additional taxation. The second is that it recognises that much of the value of land is not intrinsic, but is created by the rules which apply to its use, enforced principally through the planning system: this is easily seen in land which has been redefined to housing rather than agricultural use which immediately increases in value: there is an argument of equity for some of that benefit coming back to the wider community through taxation.

It would, however, be unwise as well as politically impossible to abolish the present systems of property taxation and move immediately to a system of land value tax. The short term distorting effects could be great, and would produce winners and losers on a scale which would be politically very difficult to manage. That does not mean that the property taxation system could not gradually be shifted in that direction.

Such a system of property taxation would have a much smaller role for transaction taxes (though as suggested below, these should continue in the short run, and should have a long-term role) but a wider base, of all real property, which should, ideally, allow for a lower rate.

The direction in which to move

Three steps would be needed to move in the long term towards a more rational system:

1. The system of domestic property taxation – Council Tax – should be reviewed, with a view to assessing how much difference there is between present relative values and a system of relative values more closely related to land value. At this stage his should be a purely theoretical exercise, based on a sample: the aim would be to see what adjustments could be made to the valuation system to approximate more closely to land value, rather than match it exactly, and to devise options for phasing such a change in. It is quite possible that the relative tax burden on different domestic properties would not change markedly (land values are a significant element of total property value).

2. A similar exercise should be undertaken for nondomestic rates, with a view to ascertaining how significant a change values more related to the capital value of land would represent, and options for phasing such a change in. The main challenge will then be to what extent the tax rate on domestic and nondomestic land of similar value should be equalised. In principle it should, but a very long transition is likely to be needed

3. An exercise should also be undertaken to plan for the entry into the new valuation roll of land currently exempt from any property taxation, notably agricultural land, and an assessment made of the scale of taxable resource thereby created and the economic effects of gradually taxing it.

Taken together, these steps would enable approximations to be made to the size of change to a wider property tax, and the time needed to phase in such a change. (Politically, this would need to be a cross-party project, so that the temptation–seen in the experience of other countries–for individual parties to court popularity by promising to persist in irrational tax policies can be reduced.)

Implications for Stamp Duty Land Tax

In such a rational system of property taxation, recurrent tax would replace transaction tax. This has two advantages. First, it provides a more predictable stream of revenue, (from a valuation basis approximating to land value in some rough and ready way). Second, it provides no disincentive to economically efficient transactions, and indeed provides a strong incentive for land to be transacted so as to be brought into productive use.

One of the principal political issues raised by a recurrent tax on property is that it is a tax on wealth, rather than income. The UK is unusual in European terms by having little taxation on assets rather than income, and no doubt many people will think in principle this should be amended. But of course there is a problem: there will be a group of people who are property-rich, but income poor. (In the debate over domestic rates this was traditionally presented as an elderly lady living on a small pension in a big house, formerly the family home.) The way to deal with this is to allow the recurrent tax to accumulate so that it becomes a tax to be paid when the house is eventually transacted. Similar arrangements might be made for businesses or even agricultural land, though the rules would be more robust for nondomestic property, where there are much stronger economic arguments for requiring it to be sold and brought into productive use. This could mean that the transaction tax became paid by the seller, rather than the purchaser.

Until such a transition is complete, however, a transaction tax should remain, and it may continue to provide a small additional source of revenue, perhaps at lower rates, even once a comprehensive system of land taxation is eventually brought into effect.

October 2013