For many Conservatives, any tax on home ownership seems an unfair wealth tax. But a number of real estate taxes are both justified and pro-growth. It’s the absence of those taxes that distort choices, reduce productive investment in businesses, and push up taxes elsewhere.The UK’s current property taxes – stamp duty, council tax and business rates – are in need of significant reform or abolition, and no party has presented a complete solution. But there are strong arguments for taxing property in a number of ways.

Firstly, there’s VAT. It is sometimes claimed that taxing property is wrong as it is bought with income that has already been taxed. But if true, this should apply to VAT too. As it is, we levy a consumption tax on most spending but not on property construction. Why should the state favour the enjoyment of a slightly larger house over other goods and services? VAT exemptions are a poor way of targeting help at those who need it, but exempting all housing is especially inefficient.

Introducing VAT as a one-off charge on some housing comes with a number of problems. A better route is to tax the ‘service’ that housing provides. In practice, this would mean a 1% annual charge on property value (equal to 20% on rental value). We could in fact call the ‘mansion tax’ a form of VAT on expensive housing. But the debate about the most expensive properties has also distracted us from homes at the bottom end. Compared to this progressive and justifiable 1% rate, council tax leaves those in the least valuable properties paying too much while the richest pay too little. Realistically, replacing council tax with a cost-neutral rate of 0.6% would make a large majority better off and halve the tax bill of the poorest households. After the poll tax and reducing council tax benefit, the Tories should seek to be the ones to make council tax more progressive.

We should also tax housing as an investment. The returns from investing money in a first property come in two forms: capital gains and the savings from no longer paying rent. In the UK, neither of these returns is taxed for primary residences. Both should be, following the way we tax other capital gains, dividend income and rental income (even if these taxes are themselves in need of broader reform). The tax system should not distort investment decisions best left to the market, and possibly the worst option is to hugely favour property market investment – already a low-risk choice – over decisions to start a business, lend to an entrepreneur or expand a company.

Those taxes are justified based on how we treat other consumption and investment. To do otherwise should be considered a distortionary tax expenditure and means higher tax rates in other areas. But it may even be wise to levy a tax on land values specifically, in addition to those above. Most taxes cause some loss of employment or other activity that does not then take place. Taxing the UK’s fixed area of land does not suffer from this problem. For this reason, land value taxation was described as “the least bad tax” by Milton Friedman. It taxes those profits that simply come from the uncompetitive nature of land and – by taxing plots no matter how they are used – promotes productive use. What’s more, as unimproved land values are the result of public investment and the community around it, it’s fair for those communities to reap part of the reward. Replacing business rates with this tax would be a good start.

None of this is to argue for a higher tax burden. There’s no doubt Conservatives want lower taxes, but what are the priorities? Is it reducing taxes on jobs or businesses, enabling more people – no matter what their background – to work hard and do well? Or is it protecting unproductive property investment and those who are already wealthy? Some may argue that owning property is a key part of family and society, but those who want the state to push people into spending their money in this way should not be under the illusion that such tax breaks represent a pro-entrepreneur, free market approach. A non-distortionary, free market tax system requires property taxation.

Many of the ideas here are explored in detail in Tax by Design from the Institute for Fiscal Studies.

Originally published at http://www.conservativehome.com/platform/2013/03/for-many-conservatives-any-tax-on-homeownership-seems-an-unfair-wealth-tax-but-a-number-of-real-estate-taxes-are-both-justi.html