The new chancellor of the UK, Philip Hammond, will present his first Autumn Statement on November 23. There are hopes in certain quarters that he will reverse a plan by the previous chancellor to stat phasing out tax relief on interest rates for buy-to-let mortgages.
If he does reverse it, he will make a big mistake with dire consequences down the line. The previous chancellor, with various governmental programs such as Help to Buy, had already blown up a real estate bubble — helped of course by loose monetary policy and a flood of cheap money from abroad.
Perhaps realising his mistake, Osborne belatedly decided to phase out the tax deduction on interest paid on mortgages by investors in buy-to-let properties. Besides creating an unequal balance of power between investors and owner-occupiers, the tax relief was also costing the Treasury a lot in lost tax.
Before taking the final decision on the measures that he plans to announce, Chancellor Hammond should read — if he hasn’t already — a research paper recently published by the IMF highlighting the dangers of tax incentives for debt, especially mortgage-related debt.
The global financial crisis of 2007-2009 was triggered by excessive debt, and unfortunately central banks’ policies to stop the crisis have only added to the debt. We will probably have to allow some form of debt forgiveness at some point — either via high inflation or outright defaults — to ensure growth gets back on track again.
The IMF noted that “systematic tax biases run counter to regulatory and other policies that aim to limit excess leverage.” Indeed, while the Bank of England has introduced some prudential measures, these have not been mirrored on the fiscal side of the equation, at least not for buy-to-let lending.
On the regulatory side, Basel III already envisages a tougher climate for buy-to-let lending. If implemented, it would attach a higher risk to mortgages taken out for this type of investment than for owner occupancy.
Tax policy still encourages debt finance in many countries. An IMF survey found that around two thirds of advanced economies and more than half of emerging economies allow a deduction or credit for mortgage interest against income tax.
In the UK, only interest on mortgages for buy-to-let properties can still be deducted. This will be phased out starting next year, to the unhappiness of landlords who have lobbied the new chancellor to give up on the policy.
The IMF warns that “by encouraging private debt accumulation, these tax designs amplify financial vulnerabilities and raise macroeconomic stability risks…tax systems thus provide an incentive for households to maximize their mortgage debt, making them more vulnerable to economic shocks, e.g., when they lose their job and house prices fall.”
Spain and Ireland have eliminated interest deductibility on new mortgages, while Denmark and the Netherlands are gradually reducing them.
“Gradually” is the crucial word here. The IMF notes that house prices could fall rapidly if the reforms are not cautious and gradual. In a market already spooked by the Brexit vote, a sudden withdrawal of tax deductibility would not work. Still, investors have had plenty of warning about the gradual approach taken by the previous chancellor. No point in reversing it now.