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Why George Osborne had to kill the mansion tax

7 October 2012

7:02 PM

7 October 2012

7:02 PM

This morning the Mail on Sunday reported that George Osborne has promised there will be no mansion tax, no wealth tax and the council tax freeze will be extended. Homeowners are safe for now, but why has Osborne made that call?

It might be something to do with a past Conservative Party Conference back in 2007 when the party was in a similarly dire situation. The then Shadow Chancellor pledged to cut inheritance tax by increasing the threshold, put Gordon Brown off calling an early election and ended the honeymoon it is now hard to believe he ever enjoyed.

Britain already has the highest property taxes of any developed economy and council tax is desperately unpopular. You could argue that a new, more progressive, property tax would win people over. Council tax isn’t exceptional though. In the United States, property taxes have led to more taxpayer revolts than any other tax. There are very basic reasons why property taxes tend to be unpopular: they are paid as big lump sums and most people feel losing £10 more than earning £10 less (a phenomenon known to psychologists as loss aversion).

The fundamental problem is that people with significant assets don’t necessarily have significant incomes. Particularly later in their life, plenty of people have built up valuable properties over time but don’t make that much money each year. You pay taxes out of your cash income, not your net wealth.

Proponents of the tax have an answer for that one. Apart from the weird idea of imposing the tax at the point of sale, which would make the tax a supplement to the already formidable stamp duty singling out family homes that people own for longer. To quote the Janan Ganesh in the Financial Times, there is “such a thing as equity release”.

Equity release essentially means borrowing to pay the tax until you die. Then it is paid out of your estate. That turns a wealth tax or a mansion tax into an inheritance tax. And, thanks to the cost of equity release policies, a very high inheritance tax. We worked out just how high for the 2020 Tax Commission’s final report, the Single Income Tax:

If someone owned a house worth £500,000 from the age of 55 till they died at 80, a wealth tax of one per cent on its entire value would mean they would have to pay £130,000 – 26 per cent of its value in tax. If they borrowed the £5,000 each year, at a typical interest rate on an equity release policy of around seven per cent, that would mean a total bill to their estate of £343,382, or 69 per cent of its value.

For a property of £2 million, under the same assumptions, the total charge on their estate would be £1,373,529. Assuming the existing Inheritance Tax remained in place, that would further reduce the total value of their estate, equivalent to a very high combined rate of 75 per cent (with no threshold).

You can see how a Chancellor of the Exchequer whose political reputation rests, in large part, on an inspired decision to cut inheritance tax might see a massive hike in the tax as a bit of a bad idea.

Matthew Sinclair is chief executive of the TaxPayers’ Alliance.

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