Bill Jamieson: LBTT folly demonstrates law of unintended consequences

Of the many predictions leading economic forecasters got wrong in the past ten years, interest rates – that most fundamental of indicators – must rank at the top. Back in 2009, the resort to “emergency” low rates was widely seen as a temporary measure to forestall a plunge into recession. Few imagined they would last more than a year.

The average price of a home in Scotland has risen by just 17 per cent since the financial crisis. Picture: John Devlin
The average price of a home in Scotland has risen by just 17 per cent since the financial crisis. Picture: John Devlin

But today interest rates are still in “emergency” terrain at just 0.75 per cent – and with little expectation that they are likely to move up any time soon. Indeed, such is the collective apprehension over a “no deal” exit from the EU that the next move may well be downward to avert a widely predicted economic setback.

The idea that interest rates would be confined to such a historically low range for such a prolonged period would have been incredible before the 2008-09 financial crisis – and indeed, for most of the period since. The frequent signals from Bank of England Governor Mark Carney of a return to “normality” and that interest rate rises were on the way have been confounded – at a cost to his credibility.

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Rates being at such an extraordinary low and for such an extraordinary length of time has not had a transformational effect on economic performance as many would have expected . For most of the past 30 years, rates at 0.75 per cent would have been regarded as a miracle cure for our ails, lifting business and household spending and borrowing. But economic growth across Scotland and the UK has remained subdued, and with growing evidence that activity is slowing.

The main effect over the decade has been to drive up asset prices – shares, government bonds, and commercial and residential property. Despite concerns that equity prices have been driven to unsustainable highs, the FTSE100 is still 21 per cent above its pre-EU referendum level in February 2016. Investors, faced with continuing derisory rates of interest on their bank and building society deposit accounts, have been reluctant to abandon a market standing on an average yield of more than 4 per cent.

But it is the housing market where the biggest reaction to ultra-low rates and behavioural change has been looked for. Average house prices across the UK have risen 42 per cent since 2009 – though markedly less so in Scotland. And over last year average prices in Scotland have risen by barely 4 per cent, with transactions notably less buoyant than in other parts of the UK.

Where has the boom gone? The average price of a home in Scotland at £181,760 has risen by just 17 per cent since the financial crisis. Now, average figures in housing statistics should be treated with caution. They disguise wide variations in regions and in price segments of the housing market. But why should price and sales activity be so subdued here, after a decade of record low borrowing costs?

Whatever accounts for the relatively subdued house price performance in Scotland, it is not the cost of mortgages. Nor can unemployment be cited as a factor – numbers in work are at a record high. And average earnings are rising by 3.4 per cent, the fastest rate since 2008, with average real after-inflation earnings rising by 1.2 per cent.

Various factors have been at work here to suppress what might otherwise have been a much more buoyant housing market. Prominent among these have been the constraints on young first-time buyers, including subdued pay growth until very recently for those entering the labour market, and tighter policies by lenders after the bank excesses of 2003-07. Not only do first-time buyers have to find a much bigger deposit, but the process of regulatory checks on buyers’ incomes and wealth is much more rigorous.

Now add to this the new Land and Buildings Transaction Tax (LBTT) in Scotland. Legislators wasted no time in hiking up the tax take on sales of more expensive properties. For properties changing hands at £325,000, accounting for some 8 per cent of the overall market, LBTT was levied at 10 per cent, and for transactions above £750,000 this rises to 12 per cent. This, it was thought, would boost government coffers and hit the rich with no adverse consequences for the market as a whole.

But this overlooked the fact that if you hit one part of the housing market, it reverberates across the whole. For first-time buyers to clamber aboard, existing home owners – the first-time buyers of yesteryear – have to be willing and able to move up the ladder as their families grow.

LBTT has discouraged many from trading up, constraining activity across the chain, with a psychological blow to the confidence of both buyers and sellers. The result so far has been a marked fall in the number of higher priced housing coming on to the market. Since the pre-crisis peak in 2007-08, housing transactions in Scotland have fallen by a third. Few might shed tears for the job consequentials for estate agents and conveyancing lawyers. But jacking up LBTT has fulfilled the law of unintended consequence – more than countering any uplift that low interest rates would otherwise have provided.

And this has had a wider, knock-on effect of its own – fewer house moves translate into lower demand for home improvements, from new kitchen fitting to living room furniture, curtains and draperies. As if higher effective tax rates on higher earners is not depressing enough, it is a further suppressant to aspiration and a better quality of life.

But surely the era of sub 1 per cent interest rates must come to an end? While there is a slow recovery in house sales, there is little reason to expect a return to the “old normal” of interest rates any time soon. Inflation is down to 2.1 per cent, the lowest since January 2017. The price of Brent crude, even after a recent mini rally, is still 30 per cent down on its level three months ago and a far cry from its pre-2013 level. A global slowdown is under way, as the IMF warned last week. And the Brexit nightmare of uncertainty has still to resolve itself.

So much for a low-rates boost. And given this backcloth, rates look unlikely to raise above 0.75 per cent for the foreseeable future.