Time to turn off the subsidies to well-off homeowners

Diane Coyle on fairness in the Housing market
Click to follow
The housing market is one of those perennially fascinating subjects of conversation, at least for anybody in the middle of buying or selling. After all, it is one of the most important financial decisions any of us takes, second only to the choice of a pension. It is a big gamble, too, given the violence of typical cycles in house prices.

If you were in a position to buy in the early 1980s, you will still be sitting on a huge capital gain and a large amount of equity. If you bought in 1989, on the other hand, you are one of the losers. It is only recently that the market's recovery has rescued a majority of those people lumbered with negative equity. No wonder house prices rank with the weather as one of the British obsessions.

New forecasts this week predict a slower increase in prices next year after the mini-boom of 1997. Both the Nationwide building society and economists at investment bank Merrill Lynch put the likely increase in 1998 at 6-7 per cent after a rise in the region of 10 per cent this year. Even the slower pace will represent a healthy performance compared with underlying inflation likely to be less than 3 per cent.

But prospects in this particular house price cycle, which will depend on how far interest rates need to climb to keep inflation low, are less interesting than the outlook for homeowners in 10 or 20 years' time. A report published yesterday by the Joseph Rowntree foundation addresses the long-term issues and, in particular, what policies the Government should be considering to ensure the sustainability of home ownership.

One of the key factors is the expected rise in the number of households. With a growing number of smaller households, demand for homes is forecast to rise by something over 4 million between now and 2016. This compares with an existing housing stock of just under 25 million dwellings. If this 16 per cent increase does materialise, it will be similar in size to the addition to housing that has occurred during the past 20 years.

It is not too surprising to find that a rise in demand on this scale has been accompanied by a 40 per cent increase in house prices in real, inflation-adjusted terms despite the slump in the early 1990s. The economics of long-term housing trends are straightforward. Demand is rising, real incomes are growing, yet the supply of land is more or less fixed. In the long term, you would expect real house prices to grow at about the same rate as real incomes, or 2.5 per cent a year. This is exactly the prediction of Merrill Lynch's economic model.

There are several reasons why this should concern the Government, as the Rowntree report spells out. One is how to meet the demand for housing from those who will not be able to buy their own home. While the rate of ownership might edge higher, it is already high in the UK compared with many other countries. The Government and local planning authorities therefore need to consider how to increase the supply of both social and private rented housing.

Although Labour's manifesto promised to allow local authorities to release pounds 5bn over five years for new housing, many housing experts fear the amount actually made available will be smaller. Current plans pencil in spending of pounds 900m by the end of 1998/99, implying a surge to pounds 1.4bn a year after that if the pledge is to be fulfilled - and even that might not be enough to plug the gap.

There is also very little discussion in policy circles about how the availability of private rented accommodation could be increased, even though there is a clear gap between the two extremes of the commitment of ownership and the need for subsidised social housing.

A second question is how to adapt the housing market to changes in the jobs market. While employment has become more flexible - or insecure - the patterns of paying off a mortgage have not changed. Most borrowers have loans with a variable rate, likely to rise precisely when the risk of unemployment increases. The two safety nets - private insurance and housing benefit - are full of gaping holes. The private insurance is expensive and least likely to be on offer to those at most risk of interruptions to their income. The soaring housing benefit bill is on the Government's target list of social security spending for the chop. One suggestion is that it will be capped.

Some alternative is needed to avoid a fresh surge in repossessions during every recession. The Rowntree report suggests two policies: redirecting the pounds 3.5bn a year spent on mortgage interest tax relief and income support for mortgage interest into a mortgage protection premium for low-income households; and giving a subsidy for vulnerable buyers to take out fixed- rate mortgages.

Certainly, some kind of government backing for insurance will be part of the solution. So will an element of redistribution, for those at highest risk are those who can least afford to take out insurance. The rates charged for insuring low-risk borrowers will have to subsidise the premiums paid by high-risk borrowers.

Beyond these pragmatic considerations there are, too, questions of distribution and fairness. Although the share of housing in total personal wealth has shrunk, in the long term a home will continue to be an appreciating asset.

In the late 1980s there was much interest in the creation of a new category of the wealthy, those who inherited their parents' homes, especially in London and the South-east. The attention has faded, but the phenomenon has not. As real house prices continue to rise over the years, the wealth penalty for being off the homeownership ladder will grow.

The Rowntree report recommends taxing capital gains on principal homes as the best way to address this. But an alternative approach to the fairness or exclusion issue would be for the Government to formalise the use of housing equity to pay for long-term care or health costs.

If it could ever get round the inevitable middle-class outcry, this could free government funds to pay for the same benefits for lower-income households. But a recent report from the Council of Mortgage Lenders on the potential for "equity-release" loans - offering cash in return for title to the property - notes that the tax system, DSS rules and consumer credit regulations all pose serious constraints.

The underlying message is that the shortage of supply and the uncertainties of the modern labour market mean housing policies will need to do something really controversial. They will have to stop subsidising the well-off through Miras, the capital gains tax exemption, and even health and social security spending on those with a high-value property asset, in order to direct resources to the minority who can not buy their own castle.

"Fixed Commitments, Uncertain Incomes: sustainable owner-occupation and the economy" by Duncan Maclennan, Geoff Meen, Kenneth Gibb and Mark Stephens. Joseph Rowntree Foundation, pounds 11.95 + pounds 1.50 p&p, 01904 430033.