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Trams, taxes and cliff edges

Why taking the Edinburgh tram is like buying a house

I was in Edinburgh a few weeks ago and my trip happily coincided with the opening of the new Edinburgh tram.  With a bit of spare time before my return flight, I resolved to be one of the tram's first passengers, even though the tram takes an almost identical route to the express bus and seems to be marginally slower. (The words white and elephant come to mind.)

I had bought an all-day bus ticket for £3 earlier in the day, and asked the conductor if it was valid on the tram. He had to check, because in the (very) brief history of the Edinburgh tram nobody had asked this before.  "Yes," he revealed after checking his notes, "Your bus ticket is valid until the penultimate tram stop, which is the airport Park & Ride car park.  But if you want to go all the way to the airport terminal, it will cost you an extra £5".  In other words on that last leg of the journey the tram costs £5 for one stop. 

On a point of principle I decided I would save the fiver and make the short walk from the Park & Ride to the airport. It turned out to be a rather circuitous ten minute march, and clearly the transport management haven't planned for people doing this walk because much of the entry road to the airport has no pavement.  Next time I'm in Edinburgh, if I don't have time on my hands, I will probably pay the fiver for the tram.  But it still felt a rip-off.

This sort of sudden jump in prices across a boundary is known as a cliff edge.  And the trouble with cliff edges is that they can trigger perverse customer behaviour - such as encouraging people to walk on roads without pavements. 

There's a much more extreme and anomalous example of cliff edges in the stamp duty paid for buying a house in the UK.  If you buy a house for £250,000, you pay 1% stamp duty, or £2,500.  But if you pay one pound extra for the house, then you have to pay a staggering £5,000 more in tax, as the rate leaps to 3%, of the entire cost of the house.  The result is a significant distortion to the housing market.  I used to look up how many homes have sold for between £220,000 and £290,000 in my postcode in the last 15 years.  The number sold, in bands of £10,000 starting at £220,000, were as follows:

£221-230k     22

£231-240k     16

£241-250k        52 

£251-260k        3            

£261-270k      14

£271-280k      18

£281-290k      22

Notice the two anomalies?  52 is the number of homes that sold for between £241,000 and £250,000.  Meanwhile the number that sold for between £250,001 and £260,000 was just three - and not one sold in the range £251k-£255k.  Well, why would it?  The buyer knows that by haggling an asking price of £251k down by just £1,000 they will save £6,000.  It means that in the range £240,000 to £260,000 many homes are not selling for the "right" price.  There are similar anomalies at £500,000 and, for the very wealthy few, at £1,000,000.

It would be easy to remove these cliff edge anomalies if the higher tax band only applied to the price paid above £250k.  The price distortions would vanish, and it wouldn't be hard to tweak the tax rates so that the government would get roughly the same overall stamp duty revenue. For example the rate could be set at zero up to £100k, then 2% for the part above £100k up to £250k, then 5% of the excess from £250k to £500k, and 10% for everything above that.   A £200k home would be liable to £2000 tax (just as it is now) and a home bought for £450k would incur stamp duty of £13,000 (a little lower than the current £13.5k).  Homes bought at other prices would incur a bit more or a bit less tax than they currently have to pay, but it would all even itself out.

Why has this anomalous tax remained in place for so long (it's 15 years since Gordon Brown introduced it)?  The answer is almost certainly political.  While the actual revenue from the tax might end up the same, the individual tax rates would have to be higher.  To make up for the current cliff edges, one or more of the current 1%, 3% and 4% band rates would have to increase, and the media and public would focus purely on the individual rates, rather than the overall cost. Buyers of cheaper homes would cry foul if suddenly they were now in a 2% tax band instead of 1% ("First-time buyer tax doubles" would be the misleading headline).  If the 3% rate went up to a marginal 5% the home-owning middle classes would claim they were yet again victims of an attack on the squeezed middle.  And so on.

So while the Edinburgh transport authorities will probably fine tune their charging structure before long, if they haven't done so already, it looks like there are strong political arguments why the cliff edges of Stamp Duty won't be changing any time soon.

UPDATE - 3rd December

George Osborne surprised everyone in the Autumn Statement (especially me) by changing the stamp duty rates with immediate effect today.  The cliff edges have been scrapped.  The marginal rates he's chosen are similar to the ones I suggested in the blog above - zero tax up to £125k (I suggested £100k), and 2% from there up to £250k.  His 10% rate doesn't cut in until £925k (I suggested £500k) but he's compensated for that by having a 12% marginal tax for homes above £1.5m.  It's politically a clever change, because its impact on most people will be that their stamp duty will fall, or change very little.  Only the very wealthy will be hit with more tax.  So this is the Tory 'mansion tax' and it's far more workable than Labour's ill-thought through proposal for a tax with that name.