## _cr1658

## Source details

**Canonical URL:** [_cr1658](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1658.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1658.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1658.pdf.json)

---

### A. Why has the current account balance declined and to what extent will it improve?
- The UK’s current account (CA) deficit stood at 5.1 percent of GDP in 2014, the largest in 50 years and the largest among advanced economies in 2014 as a percent of GDP.
- From 2011 to 2014, the CA deficit deteriorated from 1.7 percent of GDP to 5.1 percent of GDP.
- Main drivers:
  - Sharply lower net investment income, particularly from FDI; the trade balance worsened by 0.3 percentage point (from 1.6 percent of GDP to 1.9 percent of GDP).
  - Shift in net international investment composition: net FDI has declined while net portfolio equity has risen.
  - Average yield differential for FDI (1988–2014), computed as the ratio of income to the previous year’s position of FDI assets minus that of FDI liabilities, has been 2½ percent.
  - Average yield differentials for equity and debt have been negative.
  - Investment income balance averaged a positive contribution of 1.1 percent of GDP to the CA balance from 2000 to 2012, even while the IIP was generally negative (except 2008).
- Corporate tax and asset-sale factors:
  - UK marginal corporate tax rate declined from 30 percent in 2007 (OECD average: 27 percent) to 21 percent in 2015 (OECD average: 25 percent).
  - The UK moved from a worldwide to territorial system of corporate taxation in 2007.
  - Vodafone disposed of its Verizon stake in 2014, reducing its size by more than 3 percent of GDP.
- Decline in FDI returns:
  - Nominal yields of FDI averaged 8.0 percent for assets and 5.9 percent for liabilities during 2001–10, differential of 2.1 percent.
  - In 2014, the differential was -0.1 percent.
- Global cyclical and sectoral factors:
  - Stronger UK growth relative to partner countries supported higher returns on foreigners’ investments in the UK than on UK investments abroad.
  - Returns are lowest in Europe (more than 50 percent of UK investment abroad) where growth has been weak.
  - Largest change in net FDI earnings came from production industries, particularly mining and quarrying—lower commodity prices contributed to weaker FDI income in 2014.
- Conduct fines:
  - Estimated conduct costs around £38 billion from 2010–2014; about £26 billion were compensation of customers for mis-selling payment protection insurance (paid largely to residents).
  - Conduct fines to nonresidents likely at most £12 billion over 5 years—average £2.4 billion per year, or 0.1 percent of 2014 GDP.
- Outlook and staff judgment:
  - Returns are expected to recover as the world economy improves, but the net stock of FDI is likely to remain low.
  - Assuming FDI assets and liabilities at 2014 levels (67.5 percent of GDP and 75.7 percent of GDP, respectively), a recovery of net yields to pre-crisis levels of 2.1 percent would raise the income balance by 0.9 percentage point of GDP (from -1.2 percent of GDP in the first three quarters of 2015 to -0.3 percent of GDP).
  - Staff judges a plausible partial recovery of net income flows on the order of 1 percentage point of GDP.

### B. How has the current account balance affected the IIP, and how is the IIP likely to evolve?
- Historical divergence and recent deterioration:
  - Since 1999, the IIP and cumulative CA diverged: CA deficits continued while the IIP remained steady due to positive valuation effects; starting in 2012, the IIP deteriorated, reaching -25 percent of GDP at end-2014.
- Valuation effects and drivers:
  - Weak partner-country growth likely reduced capital gains on investments and thus valuation effects; the decline in valuation effects coincides with large write-offs in the telecom sector in 2012.
  - External assets have a higher foreign-currency component than external liabilities.
  - In 2012, the IIP’s net exposure to currency movements amounted to 90 percent of GDP for the U.S. dollar and 48 percent of GDP for the euro.
  - A 10 percent appreciation of sterling relative to the U.S. dollar, holding other bilateral rates constant, would generate a 9 percentage point reduction of the IIP.
  - Sterling appreciation against the dollar by around 3½ percent from 2012–14 could partly explain lower valuation effects, more than offsetting the 4¾ percent depreciation against the euro, but the net effect would be modest.
- Medium-term outlook:
  - Downward pressure from a negative CA balance is projected to continue but diminish as the CA gradually improves.
  - As cyclical factors wane, more profitable investments are expected to boost valuation effects.
  - Composition of the IIP remains favorable to asset-price valuation effects: net portfolio equity positions have remained positive; net portfolio debt positions have remained negative.

### C. Implications for the external assessment
- Cyclically adjusted assessment:
  - Adjusting for cyclical factors in the income balance, IMF EBA models estimate sterling is moderately overvalued in 2015.
  - The 2015 CA balance is projected at -4.1 percent of GDP.
  - Removing cyclical factors, the EBA model estimates the trade balance would improve by 0.3 percent of GDP.
  - Staff estimates the income balance will improve by another 1 percent of GDP as cyclical conditions outside the UK improve.
  - The underlying CA balance is therefore estimated at -2.8 percent of GDP.
- CA norm and gap:
  - The EBA-estimated CA norm for the UK is -0.3 percent of GDP, implying a CA gap of 2.5 percent of GDP.
- Exchange rate implications:
  - Applying an elasticity of -0.23 (relationship between CA and exchange rate) yields exchange rate overvaluation of 11 percent.
  - The EBA REER index and levels regression estimate sterling overvaluation of 12 percent and 10 percent, respectively.
  - Averaging approaches and allowing for uncertainty suggests sterling overvaluation in 2015 of about 5–15 percent.
- Sectoral decomposition and policy implication:
  - The fiscal gap explains a large part of the overvaluation; government accounts for most of the deficit.
  - Households’ saving-investment balance turned negative in 2013, meaning the private sector is increasingly contributing to the deficit.
  - Policy implication: the finding lends support to efforts to continue fiscal adjustment.

### D. To what degree is the current account gap a cause for concern?
- Exchange rate regime and adjustment:
  - A floating exchange rate regime should help ease adjustment.
  - Current account adjustments are often accompanied by slower GDP growth and higher unemployment as reduced capital inflows depress domestic investment and consumption (Freund and Warnock, 2007).
  - Adverse effects on growth tend to be less pronounced when the exchange rate is allowed to adjust.

### The currency composition of the IIP amplifies the benefits of sterling depreciation
- Valuation and balance-sheet effects:
  - UK liabilities are estimated to have more exposures denominated in sterling while UK assets have more exposures denominated in foreign currency; as a result, a depreciation of sterling:
    - would improve the trade balance through expenditure switching and reduction;
    - would boost the income balance and the IIP through valuation effects.
- Monetary policy credibility and growth costs:
  - The credibility of the inflation targeting framework minimizes the cost of adjustment on growth:
    - Anchored inflation expectations should help the BoE look through the impact of a large depreciation on inflation.
    - This reduces the need to raise policy rates that would slow growth.
- Financing of the CA deficit and risk implications:
  - Financing has become more stable as FDI has been increasingly funding the deficit.
  - Historically:
    - The deficit was financed largely by net debt prior to 2013.
    - Being long on FDI (riskier but higher-yield) and short on portfolio debt (safer but lower-yield) resulted in larger income flows but higher risk of capital outflows.
    - This situation reversed beginning in 2012: income flows have declined but financial inflows have stabilized.
  - Nonetheless, the current stock of external liabilities remains largely short term:
    - Short-term liabilities (mainly bank deposits) now are much larger than prior to the 1976 crisis.
    - Broadbent (2014) has stressed the importance of institutional and policy credibility that are now in place.
- Net assessment:
  - The currency composition of the balance sheet implies that depreciation can deliver larger-than-typical improvements in external positions via valuation gains.
  - Increased FDI and reduced reliance on debt inflows improve financing stability, but the short-term nature of many liabilities sustains vulnerability to sudden adjustments.
- Key factual quotes preserved verbatim:
  - Reversal of the pre-2012 position began "beginning in 2012."
  - Debt financing predominated "prior to 2013."
  - Short-term liabilities are larger than "prior to the 1976 crisis."

### E. Conclusion
- Drivers of the CA deficit:
  - The UK’s CA deficit is explained by temporary as well as more permanent factors.
  - The CA deficit widened as a result of a deteriorating income balance.
  - The income balance has declined as a result of:
    - lower returns from foreign direct investment in weak host country economies; and
    - a reduction of net FDI assets.
  - Outlook:
    - Lower returns from foreign direct investment are expected to unwind as partner economies strengthen.
    - The reduction in net FDI assets appears driven by more structural shifts in the economy, such as the reduction in corporate tax rates in the UK.
- Mitigating factors and policy implications:
  - Factors that mitigate risks from the CA deficit include:
    - the currency composition of the balance sheet;
    - the relatively high credibility of the monetary policy and exchange rate framework;
    - the increased stability of recent financing (greater FDI share).
  - Nonetheless:
    - the deficit is large by historical standards;
    - staff evaluates sterling to be "moderately overvalued," even after removing cyclical factors that are temporarily reducing the income and trade balances.
  - Policy recommendation:
    - Policies that facilitate current account adjustment, such as the current mix of a tight fiscal and loose monetary stance, will be helpful.

*Prepared by Anna Bordon (EUR); underlying data from ONS, Haver Analytics, WEO, and IMF staff calculations as cited in the source document.*

### Resource misallocation: magnitude, sectors, and productivity impact
- Decomposition and definition:
  - ln TFP_s = ln A_s –½σ var(ln TFPR_si), where σ is the price elasticity of demand and resource misallocation is measured by var(ln TFPR_si).
  - The decomposition holds if TFP_s and TFPR_s are jointly lognormally distributed.
  - Top and bottom one percent of tails removed to reduce coding errors and extreme outliers.
- Estimated impact on productivity:
  - "We estimate that increases in resource misallocation depressed productivity growth by about 0.4 percentage points per year after the Great Recession," but this estimate is sensitive to the choice of time period.
  - Annual aggregate effect of resource misallocation on post-recession productivity growth is between -0.1 and 0.4 percent per year (sensitivity to inclusion of 2008).
  - Main increase in misallocation was rapid and occurred mostly in 2008, followed by moderate increases thereafter.
  - Overall, post-recession the level of aggregate TFP was lower by about 3 percent due to increased misallocation.
  - Assuming increased misallocation lasts approximately six years, it contributed approximately 0.5 percentage points per year (about a third of the slowdown in measured growth of output per worker).
- Table 2 weighted sums (TFP impacts by period):
  - 2009-14 average: -0.2
  - 2008-14 average: 0.9
  - Midpoint estimate: 0.4
- Sectoral heterogeneity (selected midpoint estimates, percent):
  - Manufacturing: 0.4
  - Accommodation and food service activities: 4.3
  - Electricity, gas, steam and air conditioning: 3.3
  - Financial and insurance activities: 1.1
  - Education: -6.9
  - Human health and social work activities: -6.6
- Firm size and dynamics:
  - Misallocation in micro firms (1–9 employees) is about three times greater than in large firms.
  - After the recession, misallocation in small firms increased three times as much as in large firms.
  - Persistent distress in small construction firms; large reallocation in finance; relatively placid manufacturing.
  - Elevated misallocation persisted longer in the UK than in other European G7 economies among smaller firms.
- Interpretation and limits:
  - Estimates are sensitive to time-period choice and rely on lognormal assumption and tail trimming.
  - Financial frictions are a plausible driver: impaired credit channels disproportionately affected smaller firms; credit constraint can be represented by w·L_si + ζ·R·K_si < W(z_si, η) with ζ representing collateralizable capital expenses.
  - Most of the decline in TFP growth remains unexplained; other factors include measurement errors, labor hoarding, shifts in factor prices and capital deepening, sectoral composition shifts, collapse of within-firm productivity, and technological change.
- Methodological notes:
  - Regressions based on annual firm-level data for 2006–14 using ORBIS database and IMF staff calculations.
  - Distance to TFP frontier coefficients (Table A1): 0.148***, 0.148***, 0.165***, 0.165***, 0.186***.
  - Distance to K/L frontier coefficients (Table A2): 0.431***, 0.432***, 0.432***, 0.433***, 0.615***.
  - Data preparation: ORBIS database; period 2005–14; drop records missing value added or employment; deflate nominal values with NACE 1-digit deflators; convert to 2005 international dollars; re-weight to match firm size distribution; top and bottom one percent tails removed.

*Sources: ORBIS database, IMF staff calculations.*

### Property taxation and housing supply — summary findings and reform priorities
- Chapter focus:
  - Examines tax reforms to ease structural supply constraints in the UK housing market: options include reducing council tax discounts for single occupants and phasing out stamp duty land tax (SDLT) in favor of a better designed property tax.
- Context and key facts:
  - House prices in the UK have risen by more than in any other G7 country over the past two decades.
  - Since 2008, supply constraints prevented housing completions from keeping pace with new household formation.
  - UK household debt-to-income ratio is 140 percent.
  - Supply constraints include restrictive planning regulations and long-standing limits that constrained building responses seen in Ireland and Spain.
- Policy rationale:
  - Tax reforms that ease housing supply constraints could improve allocative efficiency, support financial stability by reducing incentives for high mortgage debt, and lessen wealth inequality.

### B. Property Taxes in the UK — overview and composition
- Property tax revenue as a percent of GDP is the highest among OECD countries.
- Composite indicator of tax incentives for owner-occupied housing suggests the degree of favorable tax treatment of homeownership is low in the UK compared with other European countries.
- Interest deductibility of mortgages for owner-occupied housing was phased out entirely between 1974 and 2000.
- Property-related tax instruments include: council tax, business rates, stamp duty land tax, capital gains tax, and inheritance tax.
- In FY14 these taxes comprised more than 10 percent of general government tax revenue, with:
  - council tax accounting for 5 percent of total tax receipts;
  - business rates accounting for 5 percent of total tax receipts;
  - stamp duty land tax accounting for 2 percent of total tax receipts.
- The chapter focuses on taxes on residential properties (excluding business rates).

### Council tax — structure, features, and recent changes
- Introduced in 1993; about 330 local authorities set council tax levels.
- Eight valuation bands based on 1991 valuations; council tax for each band defined as a fixed ratio to band D.
- Distribution and regressivity:
  - About two-thirds of all properties are in the bottom three bands.
  - The tax is regressive relative to its base: charge in band H is set two times higher than charge in band D while the house at the bottom of band H is worth almost five times more than the house at the bottom of band D.
  - No differentiation between properties in the same band.
- Exemptions and discounts:
  - Full-time students and disabled people are exempt.
  - Vacant properties get some discount for the first few months vacant.
  - A 25 percent discount is granted if the property is occupied by only one adult (single occupancy discount).
- Council Tax Bands and Rates in England, 2015-16 (data as of September 2014):
  - Band A: Value as of April 1, 1991 — Up to £40,000; Tax rate — 6/9; Average band D rate in England (£) — 998; Number of properties (thousands) — 5,606.
  - Band B: £40,001 to £52,000; Tax rate — 7/9; Average band D rate in England (£) — 1,154; Number of properties — 4,499.
  - Band C: £52,001 to £68,000; Tax rate — 8/9; Average band D rate in England (£) — 1,319; Number of properties — 5,008.
  - Band D: £68,001 to £88,000; Tax rate — 9/9; Average band D rate in England (£) — 1,484; Number of properties — 3,544.
  - Band E: £88,001 to £120,000; Tax rate — 11/9; Average band D rate in England (£) — 1,814; Number of properties — 2,186.
  - Band F: £120,001 to £160,000; Tax rate — 13/9; Average band D rate in England (£) — 2,144; Number of properties — 1,158.
  - Band G: £160,001 to £320,000; Tax rate — 15/9; Average band D rate in England (£) — 2,473; Number of properties — 811.
  - Band H: More than £320,000; Tax rate — 18/9; Average band D rate in England (£) — 2,968; Number of properties — 132.
- Recent changes:
  - Council tax freeze grant introduced in FY11; in FY15, 240 out of 421 local authorities (57 percent of total) received the council tax freeze grant.
  - Localism Act of 2011 abolished central government cap on council tax increases and provided for referendums on excessive council tax increases.
  - From April 2013, centrally-determined “council tax benefit” replaced by locally set “council tax support.”
  - From April 2013, local authorities gained flexibility to scale back discounts for second homes and temporarily vacant properties and may charge a premium of up to 50 percent for houses empty more than two years (empty home premium).
- Nearly 40 percent of dwellings subject to council tax receive some form of discount; a large portion of discounts goes to single-occupancy homes.

### Stamp Duty Land Tax — residential and non-residential rates and reform
- Residential thresholds and marginal rates:
  - Threshold for residential properties currently set at £125,000.
  - Marginal band structure:
    - Up to £125,000 — Tax rate 0 (percent)
    - £125,001 to £250,000 (the next £125,000) — Tax rate 2 (percent)
    - £250,001 to £925,000 (the next £675,000) — Tax rate 5 (percent)
    - £925,001 to £1.5 million (the next £575,000) — Tax rate 10 (percent)
    - Above £1.5 million — Tax rate 12 (percent)
- Non-residential property rates (as shown in text):
  - Up to £150,000 - freehold or leasehold with annual rent under £1,000 — Tax rate 0 (percent)
  - Up to £150,000 - leasehold with annual rent of £1,000 or more — Tax rate 1 (percent)
  - £150,001 to £250,000 — Tax rate 1 (percent)
  - £250,001 to £500,000 — Tax rate 3 (percent)
  - Over £500,000 — Tax rate 4 (percent)
- Reform introduced December 4, 2014 (Autumn Statement):
  - Introduced marginal banding so tax rates apply only to the portion of the price within each band, reducing distortions and threshold-induced incentives.
  - Under the new system, all homes purchased for under £937,500 pay the same or less in stamp duty compared to the old system; some higher-value homes are more heavily taxed than under the old system.
- Stamp duty on non-residential property:
  - Stamp duty land tax on non-residential property is levied on the entire purchase price.
  - Example: purchase of a commercial property for £275,000 → pay 3 percent of the entire purchase price (£8,250).
  - Extending residential stamp duty reforms to the non-residential market in a revenue-neutral manner would remove distortions and improve efficiency.
- SDLT receipts:
  - Receipts moved roughly in line with house price developments.
  - Receipts dropped by about 50 percent during the global financial crisis.
  - Receipts’ growth rate went down in FY14 despite house price growth, possibly due to December 2014 SDLT design changes.

### Other property taxes and recent changes
- Capital gains tax (CGT):
  - Owner-occupied houses are exempt from CGT if main residence (subject to conditions).
  - Assets subject to CGT include buy-to-let properties, business premises, land, and inherited property.
  - Annual exempt amounts for FY15–16:
    - £11,000 for individuals
    - £5,500 for trusts
  - CGT rates in FY15–16:
    - 18 percent for basic-rate taxpayers
    - 28 percent for higher and additional-rate taxpayers
- Inheritance tax:
  - Inheritance tax due if estate worth more than £325,000 on death.
  - Inheritance tax rate: 40 percent on estate assets above the threshold.
  - Rate may be reduced to 36 percent if 10 percent or more of the estate is given to charity.
  - Transfers between spouses or civil partners and transfers made seven or more years before death are not normally subject to inheritance tax.
  - 2015 Summer Budget changes:
    - New transferable residence nil-rate band introduced from April 2017 in addition to existing £325,000 threshold.
    - New nil-rate band will apply when a main residence is passed on death to a direct descendant.
    - Allowance will increase over time and be up to £175,000 in FY20.
    - Thus, effective inheritance tax threshold for an individual will be £500,000 and up to £1 million for some surviving spouses or civil partners by FY20.
    - Phasing: up to £100,000 in 2017-18, up to £125,000 in 2018-19, up to £150,000 in 2019-20, and up to £175,000 in 2020-21.
- Rent-a-room scheme:
  - Introduced in 1992 to increase supply of private rental accommodation.
  - Exemption from income tax on rental income up to a certain amount when homeowner rents furnished accommodation in main home.
  - Threshold:
    - £4,250 per year since 1997
    - Increased to £7,500 from April 2016 (2015 Summer Budget)

### Efficiency, behavioral effects, and policy recommendations
- Transaction taxes are inefficient:
  - They discourage transactions and reduce likelihood properties held by those who value them most.
  - They create disincentives to move, reducing labor market mobility and preventing optimal size/location matching.
  - Evidence:
    - Hilber and Lyytikäinen (2013): a 2 percentage point increase in stamp duty reduces household mobility by 2–3 percentage points (about 30 percent reduction).
    - Davidoff and Leigh (2013): a 10 percent increase in stamp duty lowers turnover by 3 percent in the first year and by 6 percent if sustained over a 3-year period.
- Policy recommendations:
  - Reduce reliance on transaction taxes (SDLT) and progressively replace with value-based property taxes (tax properties as a percent of updated values), e.g., Mirrlees Review proposals.
  - Reduce council tax discounts, particularly single-occupancy discounts, and further reduce discounts for short-term empty properties.
  - Gradual phasing-in of reforms to avoid liquidity problems for illiquid property owners and to ease political economy constraints.
  - Scaling back SDLT is expected to increase transactions and household mobility and improve incentives for local governments to approve new residential construction if value-based property taxes are collected locally.
- Other considerations:
  - Increase in inheritance tax threshold might increase bias toward buying owner-occupied properties, potentially increasing demand and house-price pressure; downsizing provisions for assets inherited by direct descendants after July 8, 2015 partially mitigate this.
  - Increase in rent-a-room threshold may help increase supply of rental rooms and alleviate housing shortage to some extent.

*International Monetary Fund — United Kingdom country analysis (excerpts).*

### References _______________________________________________________________________________12

### HOW MUCH OF A CONCERN IS THE UK’S CURRENT ACCOUNT DEFICIT? AN ASSESSMENT OF THE UK’S EXTERNAL POSITION

### A. Why has the current account balance declined and to what extent will it improve?
- The UK’s current account (CA) deficit stood at 5.1 percent of GDP in 2014, the largest in 50 years and the largest among advanced economies in 2014 as a percent of GDP.
- From 2011 to 2014, the CA deficit deteriorated from 1.7 percent of GDP to 5.1 percent of GDP.
- The deterioration was driven mainly by sharply lower net investment income, particularly from FDI, not by the trade balance, which worsened by 0.3 percentage point (from 1.6 percent of GDP to 1.9 percent of GDP).
- Shift in net international investment composition:
  - Net FDI has declined in recent years, while net portfolio equity has risen.
  - Average yield differential for FDI (1988–2014), computed as the ratio of income to the previous year’s position of FDI assets minus that of FDI liabilities, has been 2½ percent.
  - Average yield differentials for equity and debt have been negative.
  - Investment income balance averaged a positive contribution of 1.1 percent of GDP to the CA balance from 2000 to 2012, even while the IIP was generally negative (except 2008).
- Corporate tax and asset-sale factors:
  - UK marginal corporate tax rate declined from 30 percent in 2007 (OECD average: 27 percent) to 21 percent in 2015 (OECD average: 25 percent).
  - The UK moved from a worldwide to territorial system of corporate taxation in 2007.
  - Vodafone disposed of its Verizon stake in 2014, reducing its size by more than 3 percent of GDP.
- Decline in FDI returns:
  - Nominal yields of FDI averaged 8.0 percent for assets and 5.9 percent for liabilities during 2001–10, differential of 2.1 percent.
  - In 2014, the differential was -0.1 percent.
- Global cyclical and sectoral factors:
  - Stronger UK growth relative to partner countries has supported higher returns on foreigners’ investments in the UK than on UK investments abroad.
  - Returns are lowest in Europe (more than 50 percent of UK investment abroad) where growth has been weak.
  - Sectoral breakdown shows largest change in net FDI earnings came from production industries, particularly mining and quarrying—implying lower commodity prices contributed to weaker FDI income in 2014.
- Conduct fines:
  - Estimated conduct costs around £38 billion from 2010–2014; about £26 billion were compensation of customers for mis-selling payment protection insurance (paid largely to residents).
  - Conduct fines to nonresidents likely at most £12 billion over 5 years—average £2.4 billion per year, or 0.1 percent of 2014 GDP.
- Outlook for income balance and CA:
  - Returns are expected to recover as the world economy improves, but the net stock of FDI is likely to remain low.
  - Assuming FDI assets and liabilities at 2014 levels (67.5 percent of GDP and 75.7 percent of GDP, respectively), a recovery of net yields to pre-crisis levels of 2.1 percent would raise the income balance by 0.9 percentage point of GDP (from -1.2 percent of GDP in the first three quarters of 2015 to -0.3 percent of GDP).
  - Staff judges a plausible partial recovery of net income flows on the order of 1 percentage point of GDP.

### B. How has the current account balance affected the IIP, and how is the IIP likely to evolve?
- Since 1999, the IIP and cumulative CA diverged: CA deficits continued while the IIP remained steady due to positive valuation effects; starting in 2012, the IIP deteriorated, reaching -25 percent of GDP at end-2014.
- Weak partner-country growth likely reduced capital gains on investments and thus valuation effects; the decline in valuation effects coincides with large write-offs in the telecom sector in 2012.
- Currency movements modestly affected valuation effects:
  - External assets have a higher foreign-currency component than external liabilities.
  - In 2012, the IIP’s net exposure to currency movements amounted to 90 percent of GDP for the U.S. dollar and 48 percent of GDP for the euro.
  - A 10 percent appreciation of sterling relative to the U.S. dollar, holding other bilateral rates constant, would generate a 9 percentage point reduction of the IIP.
  - Sterling appreciation against the dollar by around 3½ percent from 2012–14 could partly explain lower valuation effects, more than offsetting the 4¾ percent depreciation against the euro, but the net effect would be modest.
- Medium-term outlook is uncertain:
  - Downward pressure from a negative CA balance is projected to continue but diminish as the CA gradually improves.
  - As cyclical factors wane, more profitable investments are expected to boost valuation effects.
  - Composition of the IIP remains favorable to asset-price valuation effects: net portfolio equity positions have remained positive; net portfolio debt positions have remained negative.

### C. Implications for the external assessment
- Adjusting for cyclical factors in the income balance, IMF EBA models estimate sterling is moderately overvalued in 2015.
- The 2015 CA balance is projected at -4.1 percent of GDP.
  - Removing cyclical factors, the EBA model estimates the trade balance would improve by 0.3 percent of GDP.
  - Staff estimates the income balance will improve by another 1 percent of GDP as cyclical conditions outside the UK improve.
  - The underlying CA balance is therefore estimated at -2.8 percent of GDP.
- The EBA-estimated CA norm for the UK is -0.3 percent of GDP, implying a CA gap of 2.5 percent of GDP.
- Applying an elasticity of -0.23 (relationship between CA and exchange rate) yields exchange rate overvaluation of 11 percent.
- The EBA REER index and levels regression estimate sterling overvaluation of 12 percent and 10 percent, respectively.
- Averaging approaches and allowing for uncertainty suggests sterling overvaluation in 2015 of about 5–15 percent.
- Sectoral decomposition:
  - The fiscal gap explains a large part of the overvaluation; government accounts for most of the deficit.
  - Households’ saving-investment balance turned negative in 2013, meaning the private sector is increasingly contributing to the deficit.
- Policy implication:
  - The finding lends support to efforts to continue fiscal adjustment.

### D. To what degree is the current account gap a cause for concern?
- A floating exchange rate regime should help ease adjustment.
- Current account adjustments are often accompanied by slower GDP growth and higher unemployment as reduced capital inflows depress domestic investment and consumption (Freund and Warnock, 2007).
- Adverse effects on growth tend to be less pronounced when the exchange rate is allowed to adjust.

*Prepared by Anna Bordon (EUR); underlying data from ONS, Haver Analytics, WEO, and IMF staff calculations as cited in the source document.*

### 15.      The currency composition of the IIP amplifies the benefits of sterling depreciation.

### 15.      The currency composition of the IIP amplifies the benefits of sterling depreciation.

### Valuation and balance-sheet effects
- UK liabilities are estimated to have more exposures denominated in sterling while UK assets have more exposures denominated in foreign currency; as a result, a depreciation of sterling:
  - would improve the trade balance through expenditure switching and reduction;
  - would boost the income balance and the IIP through valuation effects.

### Monetary policy credibility and growth costs
- The credibility of the inflation targeting framework minimizes the cost of adjustment on growth:
  - Anchored inflation expectations should help the BoE look through the impact of a large depreciation on inflation.
  - This reduces the need to raise policy rates that would slow growth.

### Financing of the current account (CA) deficit and risk implications
- Financing has become more stable as FDI has been increasingly funding the deficit.
- Historically:
  - The deficit was financed largely by net debt prior to 2013, which reflected high income balances and capital gains enjoyed prior to 2012.
  - Being long on FDI (riskier but higher-yield) and short on portfolio debt (safer but lower-yield) resulted in larger income flows but higher risk of capital outflows.
  - This situation reversed beginning in 2012: income flows have declined but financial inflows have stabilized.
- Nonetheless, the current stock of external liabilities remains largely short term:
  - Short-term liabilities (mainly bank deposits) now are much larger than prior to the 1976 crisis.
  - Broadbent (2014) has stressed the importance of institutional and policy credibility that are now in place.

### Net assessment of balance-sheet and financing channels
- The currency composition of the balance sheet implies that depreciation can deliver larger-than-typical improvements in external positions via valuation gains.
- Increased FDI and reduced reliance on debt inflows improve financing stability, but the short-term nature of many liabilities sustains vulnerability to sudden adjustments.

### Key factual points (verbatim where provided)
- Reversal of the pre-2012 position began "beginning in 2012."
- Debt financing predominated "prior to 2013."
- Short-term liabilities are larger than "prior to the 1976 crisis."
- Broadbent (2014) referenced as stressing institutional and policy credibility.

---

### E.   Conclusion

### Drivers of the CA deficit
- The UK’s CA deficit is explained by temporary as well as more permanent factors.
- The CA deficit widened as a result of a deteriorating income balance.
- The income balance has declined as a result of:
  - lower returns from foreign direct investment in weak host country economies; and
  - a reduction of net FDI assets.
- Outlook:
  - Lower returns from foreign direct investment are expected to unwind as partner economies strengthen.
  - The reduction in net FDI assets appears driven by more structural shifts in the economy, such as the reduction in corporate tax rates in the UK.

### Mitigating factors and policy implications
- Factors that mitigate risks from the CA deficit include:
  - the currency composition of the balance sheet;
  - the relatively high credibility of the monetary policy and exchange rate framework;
  - the increased stability of recent financing (greater FDI share).
- Nonetheless:
  - the deficit is large by historical standards;
  - staff evaluates sterling to be "moderately overvalued," even after removing cyclical factors that are temporarily reducing the income and trade balances.
- Policy recommendation:
  - Policies that facilitate current account adjustment, such as the current mix of a tight fiscal and loose monetary stance, will be helpful.

*International Monetary Fund staff summary of Section titled "The currency composition of the IIP amplifies the benefits of sterling depreciation."*

### 11.      The magnitude of resource misallocation is proportional to the variance of TFP under

### _cr1658 - 11.      The magnitude of resource misallocation is proportional to the variance of TFP under

### Decomposition of sectoral TFP and definition of resource misallocation
- The logarithm of actual sectoral TFP, TFP_s, can be decomposed as:
  - ln TFP_s = ln A_s –½σ var(ln TFPR_si)
  - σ is the price elasticity of demand. “Clean” TFP is A_s.
  - Resource misallocation is measured by var(ln TFPR_si), the variance of the logarithm of TFPR_si (total factor revenue product of firm i in sector s).
- The decomposition holds if TFP_s and TFPR_s are jointly lognormally distributed.
- Empirical support: the joint lognormal assumption is supported at least approximately by sample histograms (Hsieh and Klenow approach). The top and bottom one percent of tails are removed to reduce coding errors and extreme outliers.

### Estimated impact of resource misallocation on UK productivity
- Estimated contribution to productivity growth slowdown:
  - "We estimate that increases in resource misallocation depressed productivity growth by about 0.4 percentage points per year after the Great Recession," but this estimate is sensitive to the choice of time period.
  - Annual aggregate effect of resource misallocation on post-recession productivity growth is between -0.1 and 0.4 percent per year (sensitivity to inclusion of 2008).
- Timing and persistence:
  - The main increase in resource misallocation was rapid and occurred mostly in 2008, followed by more moderate increases in subsequent years.
  - Overall, post-recession the level of aggregate TFP was lower by about 3 percent due to increased misallocation.
  - Assuming increased misallocation lasts approximately six years, it contributed approximately 0.5 percentage points per year (i.e., about a third of the slowdown in the measured growth of output per worker) to the post-recession slowdown.
- Table 2, weighted sum of TFP impacts by period:
  - 2009-14 average: -0.2
  - 2008-14 average: 0.9
  - Midpoint estimate: 0.4
- Sectoral heterogeneity (selected outcomes from Table 2, percent):
  - Manufacturing: 2009-14 average -0.6; 2008-14 average 1.4; Midpoint estimate 0.4
  - Accommodation and food service activities: 2009-14 average 3.9; 2008-14 average 4.8; Midpoint estimate 4.3
  - Electricity, gas, steam and air conditioning: 2009-14 average 3.3; 2008-14 average 3.2; Midpoint estimate 3.3
  - Financial and insurance activities: 2009-14 average 0.3; 2008-14 average 2.0; Midpoint estimate 1.1
  - Education: 2009-14 average -7.8; 2008-14 average -5.9; Midpoint estimate -6.9
  - Human health and social work activities: 2009-14 average -7.0; 2008-14 average -6.1; Midpoint estimate -6.6
- Aggregate statement: misallocation in some (mostly public) sectors actually reduced (e.g., education and health and human services), while financials suffered a large increase in misallocation.

### Firm size, distributional patterns, and dynamics
- Misallocation by firm size:
  - The level of misallocation in micro firms (1–9 employees) is about three times greater than in large firms.
  - After the recession, misallocation in small firms increased three times as much as in large firms.
- Sectoral/time patterns:
  - For the economy as a whole, misallocation peaked at the onset of the recession.
  - Sector-specific trajectories:
    - Persistent distress in small construction firms.
    - Large reallocation in finance.
    - Relatively placid picture for the manufacturing sector.
- Comparative persistence:
  - An elevated level of resource misallocation persisted longer in the UK than in other European G7 economies among smaller firms.
  - Large UK firms fall within the G7 misallocation range; micro and small UK firms show greater persistence of misallocation post-recession.

### Interpretation, robustness, and limits
- Sensitivity and robustness:
  - The estimated impact of resource misallocation is sensitive to the choice of time period (notably inclusion/exclusion of 2008).
  - The lognormal assumption and tail trimming are used to permit formal variance-ratio tests of allocative efficiency changes.
- Relation to financial frictions:
  - The analysis suggests resource misallocation may have been driven by impaired credit channels following the crisis; smaller and medium-size enterprises may have been disproportionately affected due to stronger financial frictions and higher reliance on collateral.
  - Note in-text formulation: financial frictions can be mapped into the Hsieh-Klenow framework by imposing a credit constraint of the form w·L_si + ζ·R·K_si < W(z_si, η), with ζ representing collateralizable capital expenses.
- Remaining unexplained decline in TFP:
  - The estimated effect of resource misallocation still leaves most of the decline in TFP growth unexplained.
  - Other proposed explanations (Appendix I) include measurement errors, labor hoarding, shifts in factor prices and capital deepening, sectoral composition shifts, collapse of within-firm productivity, and technological change.
  - The chapter does not disentangle these other factors; doing so is beyond the scope of the analysis.

### Key regression and methodological notes (selected)
- Regressions are based on annual, firm-level data for 2006–14 using ORBIS database and IMF staff calculations.
- Distance to TFP frontier coefficients shown in Table A1:
  - Distance to TFP frontier: 0.148***, 0.148***, 0.165***, 0.165***, 0.186*** (coefficients reported in Table A1)
- Distance to K/L frontier coefficients shown in Table A2:
  - Distance to K/L frontier: 0.431***, 0.432***, 0.432***, 0.433***, 0.615*** (coefficients reported in Table A2)
- Data preparation highlights (Appendix II):
  - Main source: ORBIS database (Bureau van Dijk).
  - Period covered: 2005–14 (more than 30 million observations for the UK, but far fewer records include added value and employment).
  - Preprocessing steps: drop records missing value added or employment; remove implausible observations; deflate nominal values with NACE 1-digit level deflators; convert to 2005 international dollars distinguishing tradable and service firms; re-weight data to match firm size distribution.
  - Top and bottom one percent of tails removed following Hsieh and Klenow.

*Sources: ORBIS database, IMF staff calculations.*

### References

### References

### Key citations on productivity, banking, and housing
- Arrowsmith, Griffiths, Franklin, Wohlmann, Young, and Gregory (2013), ‘SME forbearance and its implications for monetary and financial stability’, Bank of England Quarterly Bulletin, Vol. 53, No. 4, pages 296–303.  
- Barnett, Chiu, Franklin, and Sebastiá-Barriel (2014a), ‘The productivity puzzle: a firm-level investigation into employment behavior and resource allocation over the crisis’, Bank of England Working Paper No. 495.  
- Barnett, Broadbent, Chiu, Franklin, and Miller (2014b), ‘Impaired capital reallocation and productivity’, National Institute Economic Review, No. 228, pages R35–R48.  
- Benito, Neiss, Price, and Rachel (2010), ‘The impact of the financial crisis on supply’, Bank of England Quarterly Bulletin, Vol. 50, No. 2, pages 104–14.  
- Bernard, and Jones (1996), ‘Productivity and convergence across US states and industries’, Journal of Applied Economics, Vol. 21, Issue 1, pages 113–35.  
- Bernard, Redding, Schott, and Simpson (2002), ‘Factor price equalisation in the UK’, Institute for Fiscal Studies Working Paper No. WP02/11.  
- Bloom, Bond, and Van Reenen, J (2007), ‘Uncertainty and investment dynamics’, Review of Economic Studies, Vol. 74, No. 2, pages 391–415.  
- Blundell, Crawford, and Jin (2013), ‘What can wages and employment tell us about the UK’s productivity puzzle?’, Institute for Fiscal Studies Working Paper No. W13/11.  
- Broadbent (2012), ‘Productivity and the allocation of resources’, speech given at the Durham Business School, September 12 2012.  
- Broadbent (2013), ‘Conditional guidance as a response to supply uncertainty’, speech given at the London Business School, September 23, 2013.  
- Bush (2008), ‘Answering practices survey of CBI Industrial Trends Survey respondents’, April.  
- Caballero, Hoshi and Kashyap (2008), ‘Zombie lending and depressed restructuring in Japan’, American Economic Review, Vol. 98, No. 5, pages 1,943–77.  
- Criscuolo and Haskel (2003), ‘Innovation and productivity growth in the UK: evidence from CIS2 and CIS3’, CeRiBA Discussion Paper No. EBPF03-3(10).  
- Disney, Haskel and Heden (2003), ‘Restructuring and productivity growth in UK manufacturing’, Economic Journal, Vol. 113, No. 489, pages 666–94.  
- Gal (2013), ‘Measuring total factor productivity at the firm level using OECD-ORBIS’, OECD, Economics department working papers no. 1049, May 2013.  
- Goodridge, Haskel, and Wallis (2013), ‘Can intangible investment explain the UK productivity puzzle?’, National Institute Economic Review, No. 224, R48–R58.  
- Grice (2012), ‘The productivity conundrum: interpreting the recent behaviour of the economy’, Office for National Statistics, August.  
- Griffiths, Huergo, Mairesse, and Peters (2006), ‘Innovation and productivity across four European countries’, Oxford Review of Economic Policy, Vol. 22, No. 4, pages 483–98.  
- Haddow, Hare, Hooley, and Shakir (2013), ‘Macroeconomic uncertainty: what is it, how can we measure it and why does it matter?’, Bank of England Quarterly Bulletin, Vol. 53, No. 2, pages 100–09.  
- Hall (2011), Innovation and productivity, paper prepared for the Nordic economic policy conference on productivity and competitiveness, Helsinki, Finland, 29 April.  
- Hughes and Saleheen (2012), ‘UK labour productivity since the onset of the crisis — an international and historical perspective’, Bank of England Quarterly Bulletin, Vol. 52, No. 2, pages 138–46.  
- Kalemli-Ozcan, Sorensen, Villegas-Sanchez, Volosovych, Yesiltas (2015), ’How to Construct Nationally Representative Firm Level data from the ORBIS Global Database’, NBER Working Paper No. 21558, September 2015.  
- King and Millard (2014), ‘Modelling the service sector’, Bank of England Working Paper No. 500.  
- Martin and Rowthorn (2012), ‘Is the British economy supply constrained II? A renewed critique of productivity pessimism’, Centre for Business Research, University of Cambridge.  
- McCafferty (2013), ‘Monetary policy in a changing economy’, speech at Bloomberg, London, January 2013.  
- Miles (2012), ‘Monetary policy and the damaged economy’, speech at the Society of Business Economists Annual Conference, London, May 2012.  
- Nelson and Tanaka (2014), ‘Dealing with a banking crisis: what lessons can be learned from Japan’s experience’, Bank of England Quarterly Bulletin, Vol. 54, No. 1, pages 36–48.  
- ONS (2014), ‘National accounts articles — impact of ESA10 changes on current price GDP estimates’, June.  
- Oulton and Sebastia-Barriel (2013), ‘Long and short-term effects of the financial crisis on labour productivity, capital and output’, Bank of England Working Paper No. 470.  
- Patterson (2012), ‘The productivity conundrum, explanations and preliminary analysis’, Office for National Statistics, October.  
- Pessoa, and Van Reenen (2013a), ‘Decoupling of wage growth and productivity growth? Myth and reality’, CEP Discussion Paper No. 1246.  
- Pessoa and Van Reenen (2013b), The UK Productivity and Jobs Puzzle: Does the Answer Lie in Labour Market Flexibility?, CEPR Special Paper No. 31, June 2013.  
- Pessoa and Van Reenen (2014), The great British jobs and productivity mystery, CEPR Policy Portal, June 2014.  
- Relleen, Copple, Corder, and Fawcett, (2013), ‘The Agents’ company visit scores’, Bank of England Quarterly Bulletin, Vol. 53, No. 1, pages 59–67.  
- Riley, Rosazza Bondibene, and Young (2014), ‘Productivity dynamics in the Great Stagnation: evidence from British businesses’, Paper No. CFM-DP2014-7.  
- Weale (2012), ‘The labour market, productivity and inflation’, Speech at the Manchester Economics Seminar, November 21, 2012.

### PROPERTY TAXATION AND HOUSING SUPPLY — chapter summary
- Chapter focus: examines how tax reforms could help ease structural supply constraints in the UK’s housing market. Options include:  
  - reducing council tax discounts for single occupants to encourage more efficient use of residential properties; and  
  - phasing out stamp duty land tax and replacing it with a better designed property tax.
- Key introductory findings and context:  
  - House prices in the UK have risen by more than in any other G7 country over the past two decades.  
  - Since 2008, supply constraints have prevented housing completions from keeping pace with new household formation.  
  - High house prices have contributed to household leverage; the UK’s household debt-to-income ratio is 140 percent.  
  - Supply-constraining factors highlighted include restrictive planning regulations and other long-standing constraints that limited building responses seen in countries such as Ireland and Spain.
- Policy rationale: tax reforms that ease constraints on housing supply could:  
  - improve allocative efficiency;  
  - support financial stability by reducing incentives for households to take on high levels of mortgage debt; and  
  - lessen wealth inequality, since higher house prices have contributed to wealth inequality in the UK in recent decades.

### B. Property Taxes in the UK — overview and composition
- Summary points:  
  - Property tax revenue as a percent of GDP is the highest among OECD countries.  
  - Revenue from recurrent immovable property tax is also relatively high (blue bar in text chart).  
  - The composite indicator of tax incentives for owner-occupied housing (European Commission, 2014) suggests the degree of favorable tax treatment of homeownership is low in the UK compared with other European countries.  
  - Interest deductibility of mortgages for owner-occupied housing was phased out entirely between 1974 and 2000 in the UK.  
  - Property-related tax instruments in the UK include: council tax, business rates, stamp duty land tax, capital gains tax, and inheritance tax.  
  - In FY14 these taxes comprised more than 10 percent of general government tax revenue, with:  
    - council tax accounting for 5 percent of total tax receipts;  
    - business rates accounting for 5 percent of total tax receipts; and  
    - stamp duty land tax accounting for 2 percent of total tax receipts.  
  - The chapter focuses on taxes on residential properties (excluding business rates).

### Council tax — structure, features, and recent changes
- Structure and administration:  
  - Introduced in 1993; main source of income for many local governments.  
  - About 330 local authorities set council tax levels.  
  - Eight valuation bands based on 1991 valuations; council tax for each valuation band is defined as a fixed ratio to band D.  
- Features (Mirrlees and others, 2011):  
  - About two-thirds of all properties are in the bottom three bands.  
  - The tax is regressive relative to its base: the charge in band H is set two times higher than the charge in band D while the house at the bottom of band H is worth almost five times more than the house at the bottom of band D.  
  - No differentiation between properties in the same band; e.g., band H includes all properties whose values were higher than £320,000 in 1991, including properties now worth many times more than £320,000.  
- Exemptions and discounts:  
  - Full-time students and disabled people are exempt.  
  - Vacant properties normally get some discount for the first few months vacant.  
  - A 25 percent discount is granted if the property is occupied by only one adult (single occupancy discount).  
  - Discussion: single-occupancy discounts are based on viewing council tax as a user fee; however, such discounts may encourage inefficient use of the housing stock if property taxes are viewed as a tax on housing services.  
- Council Tax Bands and Rates in England, 2015-16 (data as of September 2014):  
  - Band A: Value as of April 1, 1991 — Up to £40,000; Tax rate as a proportion of that in band D — 6/9; Average band D rate in England (£) — 998; Number of properties in band in England (thousands) — 5,606.  
  - Band B: £40,001 to £52,000; Tax rate — 7/9; Average band D rate in England (£) — 1,154; Number of properties — 4,499.  
  - Band C: £52,001 to £68,000; Tax rate — 8/9; Average band D rate in England (£) — 1,319; Number of properties — 5,008.  
  - Band D: £68,001 to £88,000; Tax rate — 9/9; Average band D rate in England (£) — 1,484; Number of properties — 3,544.  
  - Band E: £88,001 to £120,000; Tax rate — 11/9; Average band D rate in England (£) — 1,814; Number of properties — 2,186.  
  - Band F: £120,001 to £160,000; Tax rate — 13/9; Average band D rate in England (£) — 2,144; Number of properties — 1,158.  
  - Band G: £160,001 to £320,000; Tax rate — 15/9; Average band D rate in England (£) — 2,473; Number of properties — 811.  
  - Band H: More than £320,000; Tax rate — 18/9; Average band D rate in England (£) — 2,968; Number of properties — 132.  
- Recent changes to council tax policy:  
  - Council tax freeze grant introduced in FY11; in FY15, 240 out of 421 local authorities (57 percent of total) received the council tax freeze grant.  
  - The Localism Act of 2011 abolished a central government cap on council tax increases and provided for referendums on excessive council tax increases.  
  - Centrally-determined “council tax benefit” replaced by locally set “council tax support” from April 1, 2013.  
  - From April 2013, local authorities gained more flexibility to scale back discounts for second homes and temporarily vacant properties and may charge a premium of up to 50 percent for houses empty more than two years (empty home premium).

### Stamp Duty Land Tax — residential and non-residential rates and reform
- Residential property (current thresholds and rates as described):  
  - Threshold for residential properties currently set at £125,000.  
  - Stamp Duty Land Tax rates apply to the portion of the property price that falls within each band (marginal bands similar to income tax).  
- Residential band marginal structure (as shown in text):  
  - Property values: Up to £125,000 — Tax rate 0 (percent)  
  - The next £125,000 (the portion from £125,001 to £250,000) — Tax rate 2 (percent)  
  - The next £675,000 (the portion from £250,001 to £925,000) — Tax rate 5 (percent)  
  - The next £575,000 (the portion from £925,001 to £1.5 million) — Tax rate 10 (percent)  
  - The remaining amount (the portion above £1.5 million) — Tax rate 12 (percent)
- Non-residential property rates (as shown in text):  
  - Up to £150,000 - freehold or leasehold with annual rent under £1,000 — Tax rate 0 (percent)  
  - Up to £150,000 - leasehold with annual rent of £1,000 or more — Tax rate 1 (percent)  
  - £150,001 to £250,000 — Tax rate 1 (percent)  
  - £250,001 to £500,000 — Tax rate 3 (percent)  
  - Over £500,000 — Tax rate 4 (percent)
- Reform introduced December 4, 2014 (Autumn Statement):  
  - Prior to reform, stamp duty on residential property was charged on the entire purchase price once the price exceeded a threshold, creating sudden increases at thresholds. Example given: under the old system, a house for £250,000 would pay £2,500 (1%); at £250,001 the buyer would pay an extra £5,000 because 3% applied to the entire price.  
  - The reform introduced marginal banding so that tax rates apply only to the portion of the price within each band, reducing distortions and threshold-induced incentives.  
  - Under the new system, all homes purchased for under £937,500 pay the same or less in stamp duty compared to the old system; some higher-value homes are more heavily taxed than under the old system.

*Italic source attribution: _cr1658 - References (source PDF content)._

### 13.      The stamp duty land tax on non-residential property continues to be levied on the

### 13.      The stamp duty land tax on non-residential property continues to be levied on the

### Stamp duty on non-residential property
- Stamp duty land tax on non-residential property is levied on the entire purchase price.
- Example: purchase of a commercial property for £275,000 → pay 3 percent of the entire purchase price (£8,250).
- Extending the residential stamp duty reforms to the non-residential market in a revenue-neutral manner would remove these distortions and improve efficiency.

### Recent changes to stamp duty on additional residential properties
- 2015 Autumn Statement announced an increase in stamp duty land tax on additional residential properties.
- Starting from April 2016, higher rates will be charged on purchases of additional residential properties (above £40,000) including buy-to-let properties and second homes.

### Capital gains tax (CGT)
- Owner-occupied houses are exempt from capital gains tax in the UK if they are the main residence of the owner (subject to other conditions).
- Assets subject to CGT on disposal include buy-to-let properties, business premises, land, and inherited property.
- Annual exempt amounts for FY15–16:
  - £11,000 for individuals
  - £5,500 for trusts
- Capital gains tax rates in FY15–16:
  - 18 percent for basic-rate taxpayers
  - 28 percent for higher and additional-rate taxpayers

### Inheritance tax
- Inheritance tax is due if a person’s estate is worth more than £325,000 on death.
- Inheritance tax rate: 40 percent on estate assets above the threshold.
- Rate may be reduced to 36 percent if 10 percent or more of the estate is given to charity.
- Transfers between spouses or between civil partners and transfers made seven or more years before death are not normally subject to inheritance tax.
- 2015 Summer Budget changes:
  - A new transferable residence nil-rate band introduced from April 2017 in addition to the existing threshold of £325,000.
  - New nil-rate band will apply when a main residence is passed on death to a direct descendant.
  - The allowance will increase over time and be up to £175,000 in FY20.
  - Thus, the effective inheritance tax threshold for an individual will be £500,000 and up to £1 million for some surviving spouses or civil partners by FY20.
  - Note on phasing: the new allowance will be increased as follows: up to £100,000 in 2017-18, up to £125,000 in 2018-19, up to £150,000 in 2019-20, and up to £175,000 in 2020-21.

### Rent-a-room scheme
- Introduced in 1992 to increase supply of private rental accommodation.
- Exemption from income tax on rental income up to a certain amount when homeowner rents furnished residential accommodation in main home.
- Threshold:
  - £4,250 per year since 1997
  - Increased to £7,500 from April 2016 (2015 Summer Budget)

### Property taxation and the residential housing market — council tax
- Complexity and country-specific details of property tax system have implications for housing supply.
- Some council tax discounts can encourage inefficient use of residential properties (e.g., single-occupant discounts, short-term empty property discounts).
- Reducing these discounts could facilitate more efficient use of residential properties and help alleviate supply constraints.
- Nearly 40 percent of dwellings subject to council tax receive some form of discount.
- 2013 changes to discount rules (including introduction of empty-home premium) appear to have reduced vacant properties, though empty dwellings remain substantial.
- A large portion of discounts goes to single-occupancy homes.

### Stamp Duty Land Tax (SDLT) — receipts and effects
- Stamp duty land tax receipts have moved roughly in line with house price developments.
- Stamp duty receipts depend on house prices and the number of transactions; receipts dropped by about 50 percent during the global financial crisis.
- Stamp duty receipts’ growth rate went down in FY14 despite house price growth, possibly due to December 2014 changes in SDLT design.
- Evidence from other countries:
  - Singapore introduced an additional buyer’s stamp duty in December 2011, effective in reducing demand from foreigners.
  - Hong Kong SAR introduced a special stamp duty in November 2010 on residential properties resold within 24 months.
- Transaction taxes are known to be inefficient:
  - They discourage transactions and reduce the likelihood that properties are held by those who value them most.
  - They create disincentives for people to move, reducing labor market mobility and preventing optimal size/location matching.
  - Hilber and Lyytikäinen (2013) find that a 2 percentage point increase in stamp duty reduces household mobility by 2–3 percentage points, implying a reduction in mobility of about 30 percent.
  - Davidoff and Leigh (2013) find in Australia that a 10 percent increase in stamp duty lowers turnover by 3 percent in the first year and by 6 percent if sustained over a 3-year period.

### Policy recommendations on transaction vs. value-based property taxes
- Reduce reliance on transaction taxes (SDLT) and progressively replace with value-based property taxes (tax properties as a percent of their updated values), e.g., along the lines recommended by the Mirrlees Review.
- Expected effects of scaling back SDLT:
  - Increase transactions and household mobility, facilitating more efficient use of current housing supply.
  - Improve incentives for local governments to approve new residential construction if value-based property taxes are collected by local governments (local benefit from larger property tax base).
- Addressing liquidity concerns:
  - Gradual phasing-in of higher property taxes can avoid liquidity problems for illiquid property owners by giving time to secure financing (example: in the US, property tax payments are often bundled with mortgage payments at mortgage financing).

### Other taxes and housing market implications
- Recent increase in inheritance tax threshold might increase bias toward buying owner-occupied properties, potentially increasing demand for owner-occupied housing and putting further pressure on house prices; partially mitigated by downsizing provisions for assets inherited by direct descendants after July 8, 2015.
- Increase in tax-exempt threshold for the rent-a-room scheme may help increase supply of rental rooms and alleviate housing shortage to some extent.

### Conclusion — reform priorities and implementation
- Property taxation in the UK delivers larger revenue as a percent of GDP than any other OECD country.
- Composite indicators suggest preferential tax treatment of owner-occupied housing in the UK is limited compared with other European countries.
- Reforms to reduce constraints on housing supply and risks from high house prices include:
  - Reducing council tax discounts, particularly single-occupancy discounts, and further reducing discounts for short-term empty properties where applicable.
  - Gradually reducing reliance on stamp duty land tax and shifting toward better-designed property taxes (e.g., Mirrlees Review proposals) to improve efficiency of housing stock use and increase incentives for local governments to develop new homes.
- Political economy considerations:
  - Careful design and gradual phase-in of reforms can ease transition costs and lessen opposition.
  - Gradual changes are feasible, as evidenced by measures adopted in recent years.

*International Monetary Fund — United Kingdom country analysis (excerpts).*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1658.pdf_