Why the Market has Moved the Way it has – What Might Happen when the Pandemic Really Passes – How Tax Affects the Economy – 28/03/2021

by Mar 28, 2021

Sunday rolls into the calendar again and the tax year only has 4 working days left in it! Those who file their own returns will be considering their wins and losses in what has been a truly incredible year. This tax year began amidst a national lockdown and around 6th April 2020 is likely where the UK was it its most despondent. Daily covid deaths were on the rise and starting to get to some very scary numbers (which were of course far surpassed in the winter wave).

Time seems to bend these days thanks to the whole Coronavirus situation and I don’t remember an event as disruptive as this to a data geek like myself, ever. It was like one of those incredible pieces of legislation that gets passed once in a generation that ends a swathe of businesses overnight, and gives the entrepreneurial reasons and incentives to open a bunch more.

This week’s supplement on the micro side is going to look at some of the difficulties that the pandemic has thrown up in actually buying a property, and why; on the macro we are going to stay on the subject of tax, what role it plays in a healthy economy, and the likely direction of travel.

Since the start of the pandemic, the time taken to sell a property following its listing on the open market is down around 12%, outside of London. (In London, it is actually taking longer to sell properties from their first introduction to the market). The budget saw a spike in around 28% almost immediately in terms of buyer demand, according to Zoopla. Average buyer demand in the first 11 weeks of 2021 is 13% higher than the whole of 2020 which will scare a few, and perhaps explain why it is seeming to be even harder out there to buy well at the moment.

I’ve written many times about the attractiveness of freehold houses over leasehold flats, and of course Covid has thrown extra spanners into the works. Zoopla’s house price index (note, this is not the same/not all taken from the land registry) is up 4.9% for houses year on year, and only 1.9% for flats over the same time period. Significantly lower than the ONS official figures, interestingly enough.

The key factor to consider is just how much stock HASN’T come to the market. The SDLT holiday will of course have enticed a few people to get their house onto the market, who otherwise would not have done so, in order to bring forward a planned house move. The same four walls will have bored, frustrated and outlasted many during the first, second or third lockdown too. However, it is my opinion that this is vastly outweighed by those who have not wanted to have people coming into their house for viewings while there is a pandemic on.

You could evidence this with your own straw poll if you wanted to. The average homeowner moves once every 22.9 years on recent figures. Put that together with the average age of a first time buyer in the UK (34) and consider those in your family and network who are homeowners – I certainly know plenty who wouldn’t even have contemplated a move during the pandemic, regardless of how attractive it might have been made, and this is the bulk of the stock that has been held off (repo stock would be another, but far smaller, consideration, I would contend).

This is where a lot of the confusion around price rises has stemmed from. Firstly this supply side constraint has simply made it mathematically harder to do deals ANYWAY because there are just fewer houses out there to be transacted on. On top of that, the disturbance to any sort of equilibrium has bumped those prices up by up to 12% in some areas as examined a few weeks ago.

That’s the economic side of it. The other challenges have of course been physically getting out to do viewings – particularly around auction properties which are critical to view, generally speaking. Then, if you need a survey, which most do (even many cash buyers prefer a survey) – surveyors have been harder to get hold of, have moved slower, have required significant extra protections, and been overworked themselves. Always consider also that the average age of a RICS valuer is 55 – and so you can imagine quite a few would be in an elevated risk category of one kind or another.

This is all evidenced by houses selling faster but taking longer to complete. The average transaction is taking several weeks longer than 12 months ago. Many mortgage lenders have lengthened the time to draw down funds, and of course a lot of the professional services still have their weakest links on furlough as they squeeze every penny out of the chancellor, not that they would admit it – despite hefty volumes of business.

What can we conclude? When will this end? We just can’t be sure. How much stock has been held off the market? That’s the key question. Transaction volume was mooted as only being down 6% year on year at the back end of 2020 (this still needs ONS clarification). However, as a stand-alone, that doesn’t work very well. 2019 was weak for transaction volume with a stalling market and ended with a general election. So year-on-year doesn’t tell the whole story there. That percentage will be bigger, is my feeling – how much bigger, we would need to look at a number of ways of modelling, estimating and extracting this. I’d suggest double that or even 15% – there were times where stock was 35%+ lower (YOY) in the back end of 2020 and that’s an absolute killer.

So, onto everyone’s favourite 3-letter word at this time of year – Tax. So ends the first tax year with section 24 of the Finance Act as amended in 2015 in full force. The “scope creep” – Gideon Osborne’s torture rack – has cranked to its highest level and that’s in force now. The full extent is known to those who have let it happen around them. Payday is 31st January 2022 but you’d have to think only the most hands-off didn’t know what was coming now anyway.

Tax is a hugely hot topic at the moment because of the gigantic deficit being run to continue providing emergency support measures thanks to the pandemic. We will need to separate a few things here:

Is there a real need to tax? Is that immediate?
What’s more important? Politics or economics (when it comes to Tax)?
What effect does tax have on the economy and behaviour?
What does the roadmap for tax look like over the next few years, and how should we plan around that (and the unknown!)

I firstly want to start with the extreme libertarian argument. There’s no need for any tax, aside from on consumption. That should be limited to the bare minimum provision – the things without which society would not function. The market will sort out the rest. This is an argument normally favoured by those with a significant conflict of interest – the wealthy – who of course believe they should pay less tax. How do we feel about that? Personally – it is a bit of a fantasy in my view. There are many points where the market fails – education, pollution, healthcare – without going into a long diatribe, government involvement in these in the UK has some positive impact (and has plenty more it could do, I would argue, on all of these just to start!)

For those lucky enough to have income outside of PAYE, they will perhaps pay a bit more than just income tax and national insurance. In fact, if they have their tax affairs well organised, they may pay very little national insurance, and very little income tax – but instead be paying dividend taxes, perhaps some capital gains tax on occasion, and – if they are very lucky – have received a reasonable sum from a business sale taxed at only 10% thanks to entrepreneur’s relief. The structure, if well executed, offers the ability to control the level of taxation paid, depending on requirements to get money out of company or other structures in that particular tax year. Those not in the higher echelons of taxpayers – the 1% – will perhaps not understand how the tax planning generally might work for the wealthy. Warren Buffett for example often comments how his secretary pays more tax than he does, in percentage terms. A lot of the niche taxes are at lower rates than their equivalent income tax for example (e.g. Capital Gains Tax – CGT – more on this later).

Tax obviously represents the vast bulk of the revenue to the Treasury and so the need for it is fairly clear, notwithstanding the extreme libertarian position. Whether the money is well spent – of course – is a separate debate. There are many studies, usually in “real life” situations rather than sterile lab conditions, that prove the power of the market in allocation of resources, entrepreneurship, research and development. The failure that usually occurs is at the level of giving the most important areas for the future the requisite resources to succeed as the market tends to have a relatively short-term mindset. That is its strength and its weakness all in one go.

Often the conflation between public funding to provide services, but those services being delivered by the private sector, in part or full, causes huge ideological divides and resultant debates. There are many examples of this being somewhat successful or very successful when done well. In many ways, the development of the Chinese economy over the past 40 years could be framed in this way, and, from a purely economic viewpoint, their progress has to be admired.

Modern Monetary Theory (MMT) and its proponents have a potential to suggest that taxation is less important. If there is not money – print it, create debt, spend it – get a return on that money, keep the cost of debt at very low or zero, and you can’t fail. A bit simplistic, and not without some significant dangers. Tax is used as part of fiscal policy to heat up or cool down the economy. If you follow even some of the arguments in MMT, then the answer to the “do we need to do it now?” question is no. Indeed, the answer is to CUT taxes now (e.g. 5% VAT on selected sectors – this is what it is trying to achieve, a crack-up boom) in order to stimulate the economy and then raise them when things do start to move forward, the economy starts to overheat and inflation takes hold. Sounds easy, right?

It takes us into our second subject area though. Does politics win this argument, or does economics? It won’t surprise anyone who reads these with any regularity that I would rather see the economic argument prevail – my view of government, accepting that it exists and in the UK we have a system that supports x, y and z (let’s say healthcare, the elderly and those in need/welfare as the big 3), would be that the government should attempt to maximise the tax take by studying and implementing the tax rates that will fill the coffers in the most sustainable fashion. This is not just jacking tax rates up – there are countless studies of how lower rates can mean a higher take – and it is a fine balance of course.

In the real world meanwhile…..often politics takes over and when in a populist time, feeling and sentiment are more important than results, sometimes, it seems. This is dangerous. I’ve lost track of times where the solution that “sounds right” is not the best solution, and sometimes it is utterly disastrous. That situation has been recurring for many years, and continues to be a mistake made at individual and governmental levels. At this time, there’s no doubt in my mind that whilst economics is at the heart of Rishi’s policies, the political influence is extremely strong from number 10. We will no doubt see this play out with sub-optimal taxation decisions over the next few years.

The third leg is always an interesting one and often has an agenda. It is proven and of course, unsurprising, that when taxes change, people’s behaviour changes. In property we could point to section 24, once again – many smaller landlords have indicated their desire to exit, or exited – or at least stopped buying property. Meanwhile, on the quiet, some corporations and funds have started buying, getting involved in the PRS sector – the dog whistle went back in 2015 when George Osborne said to the corporates “Come in, the water is warm” (masquerading under taxation of a sector that was delivering returns that were too high). Economically of course buy-to-let had returned far more than even the stock market since the advent of the AST and the BTL mortgage, so that made the case even more watertight.

This extends even to some leaving the country when section 24 was announced, to take up non-habitual residencies or repatriate to countries with no dividend taxes on UK company profits. The point being – this is a real thing. Rates change, behaviour changes. Think of a corporate which has no concern over its brand. So, although much maligned, NOT a starbucks who, when enough pressure is put on, might be shamed into paying some extra taxes. If tax moves from 20% to 25% and they can spend 24% on a legal but aggressive avoidance measure – the measure is unviable at 20% but becomes viable at 25%. A clunky example but you see where I am going.

This is why lower tax rates can lead to higher tax takes. It isn’t as simple as this of course because some such “schemes” carry high levels of risk and thus companies would seek higher risk premia for entering into them. Go back to my “maximise the take over time” theory and this would provide the right guidance in these situations. However, it isn’t even as simple as that. Tax is a massively important part of fiscal policy and absolutely influences spending. The key taxes are on income, spending and then to a lesser extent, businesses. (businesses are also paying significant amount of income taxes via national insurance, of course). Anyone who has studied the history of tax will tell you where the majority of the take comes from – it started off just taxing the rich, but then realised it is a lot easier and more lucrative to take £10 from a million people than a million £ from 10 people, because one of those leaves the country, one doesn’t pay, etc. etc. The million do not rebel over the £10 and it isn’t enough to avoid in any number (it costs more to administrate, of course). The reality is that the million (or 50 million) can pay £100 rather than £10 and that scales the take upwards quite significantly.

If VAT goes down, spending moves up – and vice versa. VAT is always analysed as a regressive tax – if I have a large income and you have a small one, VAT moving to 25% from 20% might not hurt me in the pocket too much. If you are living on universal credit and rely on that extra £20 from the government to feed the family, you’ve got a huge problem because things have just gone up by 4% (120% of the net price to 125% of the net price) and you haven’t got that 4% to find. Supermarket margins are 1.5-2.5% so they can’t pay it.
Its impact is large and everyone pays it somewhere and somehow (although not on everything in the supermarket, by any means).

So tax policy influences spending. Spending drives our economy and our businesses. If VAT is going down in 6 months time, many people would defer high-ticket purchases – new kitchens, extensions, cars, etc. This can be quite damaging to an economy, particularly one in a fragile state. We already have a gigantic amount of deferred spend (particularly on holidays abroad, of course) and that is one of the components of such a significant drop in GDP (the others include hoarding cash anyway because of fear and structural impossibility of certain types of consumption during a pandemic). Tax policy affects money in our pockets, and behaviour and spending. So it isn’t as simple as setting rates for long term maximisation of government coffers (even if you accept that is the role of government, which the libertarians wouldn’t).

To bring it home, what about the future of tax? How can we plan for this? Well, we do know we have 2 certainties in life – death and taxes. Beyond that, we don’t know much more for certain but we would be smart to make some observations. Massive, sweeping changes are rare. Section 24 was a blindside to many landlords, although a similar policy had already been enacted (and then repealed) in Ireland. Some commentators always eschewed the limited company and from the start cried “companies will be next! Don’t go into a limited company”. This is irrational, and shows a lack of understanding of corporation tax and the corporate structure in general – it also missed the seminal point that there was a WANT to drive companies into the private rented sector by the government of the time. It also isn’t how the game works, in terms of tax, historically.

Let’s look at big tech, for example. This is a typical economic story of progress. At the start, the first movers have high failure rates but the unicorns that survive create billionaires like never before. The successful big tech firms employ comparatively few people but on average 6-figure incomes. Right now, they are in their pomp. Cash cows, pumping out tens of billions in profits held mostly in offshore tax havens (always remember, the one country that controls or has sovereignty over the most tax havens in the world, is the UK!). Then, a spanner is put in the works. There actually is appetite to tax them! The conspiracy that was suggested is once again proven to be untrue! If you are successful in the long term, more successful than the average by a significant margin (what the economists call supernormal profit) – it will be taxed away. The digital sales tax is underreported and underimplemented at this time, and is an innocent little 2% on revenue to prevent the tax optimisation that takes place in big tech. But it is there, and do you think when they play with the spreadsheets at the treasury, that that figure will go up or down over time? Once you have deployed massive infrastructure in a market like the UK, what choice will you have when taxation hurts your margins? None at all, and other countries worldwide are following or have followed suit themselves.

My larger fear than interest relief being disallowed in propcos has been the use of the Annual Tax on Enveloped Dwellings to attack buy-to-let. This was introduced for “good reasons” (weren’t all taxes?) but this one was an easy sell. If a property was worth over £2m then it would need to pay a levy each year if owned within a corporate structure. This was to stop oligarchs putting a house into a limited company, and then selling the limited company rather than the house itself, thus limiting stamp duty to 0.5% on sale of shares rather than the margin rate being in double figures for these sized transactions. Who wouldn’t support that?

Well, remember, tax started by being levied on the rich before it got to the middle class and eventually the poor. So, ATED has already crept down to houses over £1m and then houses over £500k – and we are already a long way away from its “raison d’etre”. Currently, if those houses are let out, ATED does not apply. Currently. But the point is – the mechanism is there. It is simply a case of using it. This is somewhere where I see more safety in more lower value stock than a smaller number of higher value stock – regardless of any yield-based arguments.

We’ve also seen the introduction of the “property rate” of CGT – 18 and 28% – versus the marginal rate of CGT – 10% and 20%. We are lucky in my view to have a CGT rate that is lower than the income tax rate, and there has been chatter about redressing this balance. Some feel that the writing is on the wall. Not very Conservative to play with this stuff though. So there are further policies likely IF property companies are making supernormal profits.

The likelihood is, however, they won’t be. They often make good margins on their turnover (if you consider rent as their only income stream). Good but not great. There are also massive tax writeoffs (for example, replacement costs when maintaining or refurbing a house may be considered against the trading account whereas improvement spends are capitalised/added to the balance sheet). There doesn’t appear to be a gigantic amount to take.

The other major threat to consider is property taxes or land taxes. There is an element of protection here – the last change to this system brings up the words “poll tax” and many will remember how popular that was and how easy to implement it was……..however, what’s to stop government at a central or local level implementing a “second property” or rental property tax? Not a lot. The incidence of course would go back to my article a couple of weeks back about price elasticity and 60%+ of any tax rise like this would end up on the tenant, and cause many companies to reconsider forays into the PRS.

In summary I would steal a quote from a business partner of mine – “Buy to let is still in its infancy” – this is often forgotten. There is a “build” phase yet to come (such as the one that big tech has been through, very quickly, but is still going through) before the “cash cow” phase of the business. At maturity, when the cash cow is there for all to see thanks to the stock market and the transparency of public limited companies – THAT is when the screw gets turned (and indeed, when the lobbying becomes a valuable activity for the shareholders to encourage their directors and managers to undertake or outsource!) So my expectation is a comparatively quiet life, with only the occasional arrow to dodge, for the next few years.

Perhaps I am too optimistic on this one – but hopefully not! Until next week……