This is an edited version of the winning entry for the 2020 FT Schools/Royal Economics Society’s Young Economist of the Year essay competition, written by Marco Minasi-Smith, Fortismere School

The time has come for a mansion tax to generate revenue and address inequality. All forms of taxation need to be considered as the pandemic pushes the UK to its largest decline in annual GDP in 300 years and record levels of national debt. Structural issues such as climate change, healthcare and social provision for an ageing population will put further pressure on government finances.

A recent ONS study revealed that the richest tenth of the UK population saw their wealth rising at more than three times the rate of the poorest 10 per cent. Property contributes more than a third of all wealth, with an increasing proportion generated from inheritance. The Office for Tax Simplification reports that of 591,197 deaths, only 21,850 estates paid inheritance tax in the 2018/19 financial year.

These taxes are disproportionately paid by middle-income earners who do not use the trusts and other avoidance strategies that are now standard practice among the wealthy. The untaxed transfer of wealth to the next generation accelerates social inequality. Large homes and land holdings are widely viewed as an unfair intergenerational tax management system for the richest.

Effective tax rates are also higher for income derived from work than wealth. Researchers at the LSE and Warwick University found that for the 2015/16 tax year, the average person with £10m in taxable income and capital gains paid an effective tax rate of 21 per cent, much less than the tax paid by people living solely from a £30,000 salary.

A study by City University concluded that while job income in 2011-18 was taxed at an average of 29.4 per cent, wealth from house-price increases and pensions had been taxed at just 3.4 per cent — a missing £174bn if income and wealth effective tax rates were aligned.

One way to address revenue shortfalls and inequality would be a new tax on the most expensive properties: ‘mansions’. This would have the added advantages of affecting only a small proportion of the population and normalising higher taxes on unearned income.

To function effectively, there must be a visible price/value point that makes clear which homes are ‘mansions’ and which are not. This is important because recent purchase and sales data are only available for a limited number of properties.

Council Tax bands are progressive but based on 1991 house prices. An updated, fair and clear evaluation system covering all higher value properties would need to be established by the government’s Valuation Office.

Charging each year is likely to generate more revenue in the long term than a one-off payment. It would reduce the spending power of the owner, although this is less likely to impact the very wealthy.

A mansion tax payment threshold would have to be low enough to include sufficient homes to generate significant revenues, but would need to avoid penalising people with lower overall wealth. For example, in London and the south-east, where house prices are highly inflated compared to the rest of the country, many people own expensive homes but may not be financially secure because of large mortgages.

Similarly, pensioners who bought homes a long time ago may have since seen the value of their homes skyrocket while they remain on low incomes. Both of these groups would struggle to pay an annual property tax. However, they could easily pay higher capital gains tax at the time of sale or through inheritance tax on their estates.

Regardless of what threshold is set for a mansion tax, it will inevitably become a cliff edge and distort buyer and seller behaviours. Homes valued around the threshold will gravitate to just below, and people may choose to rent out their property instead of selling it. Others may choose to hold property within a trust to minimise taxation.

A fundamental characteristic of inequality is that the wealthy have access to expert advisers and the financial flexibility that allows them to avoid taxes, regardless of their structure. If a mansion tax becomes payable on £2m houses, the wealthy may buy three homes valued at £700,000 to avoid the tax and distort prices.

A more pragmatic approach would be systematic reform of all forms of property taxation to target the top 10 per cent of properties. This end-to-end reform including stamp duty, council tax, capital gains and inheritance tax, will minimise the challenges and limitations of each individual measure.

Digital tools for assessment, calculation and payment need to be at the heart of reform. Tax simplification and ease of payment will encourage and enable compliance. Reform must identify opportunities to reduce costly avoidance. A gradual phasing out of trusts and complex tax mechanisms would be an obvious step. They have no place in a society that is serious about tackling inequality.

Economists like Thomas Piketty have long argued that inequality is bad for everyone, including the rich. While some may never accept this argument, the idea is no longer considered radical. At Davos this year, an international group of wealthy individuals calling themselves the Patriotic Millionaires lobbied for higher taxation on wealth. Changing perceptions of inequality should result in stronger future support for more progressive taxes on all wealth, including so-called ‘mansions’.

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