Private-rented property is a favoured whipping boy of this government as it becomes subject to no end of increased regulation and penal (and illogical) taxation. This new IEA paper exposes the tax regime that is in the process of being introduced.When George Osborne, the former Chancellor of the Exchequer, announced in his Budget speech of July 2015 that he would “restrict tax relief for financing costs for ‘individual’ landlords”, commentators were taken by surprise. The proposal had formed part of the Green Party manifesto at the 2015 general election and had been widely criticised . The proposals announced in the Budget became Section 24 of the Finance Act.In fact, the phrase “tax relief” was a misnomer. Landlords received no tax reliefs. Rather, the tax position of private-sector landlords involved allowing legitimate finance costs to be deducted from income when they calculated their rental profits. Under George Osborne’s proposals, finance costs would no longer be deducted from income. However, there was to be a tax “rebate” of up to 20 per cent of their finance costs.The Institute of Chartered Accountants of England and Wales (ICAEW), in their submission to the Finance Bill Committee following the Budget, declared: “The idea that landlords will be taxed on the profit of their businesses, but not be allowed to offset the costs of creating that taxable profit is absurd, unjust and unsustainable. It overturns a fundamental, centuries-old principle of taxation”.This change could lead to arbitrary and very high rates of effective taxation on rental income. Indeed, the change could lead to landlords paying taxes of 100 per cent on their income (or even paying taxes when they make losses).For example, take a landlord with income of £200,000 and various costs (repairs etc.) of £20,000. For simplicity, assume that the personal allowance is £10,000 and the first £40,000 of taxable income is taxed at 20 per cent. Further assume that these properties are part-financed by mortgages with interest of £130,000 being payable. The net income of the landlord above the personal allowance would be £40,000 which would (and should) be taxed at the 20 per cent rate giving a total tax liability of £8,000. This is how work and self-employment and other (non-incorporated) business activity would be taxed. It is also broadly how income from businesses is taxed.Under the Osborne regime, when fully implemented, tax would be charged on turnover less non-financing costs of £20,000 (i.e. on £180,000 or £170,000 above the personal allowance), most of which, of course, would be at the higher rate. There would then be a tax ‘credit’ of 20 per cent of £130,000. The total tax would be 0.2*40,000+0.4*130,000-0.2*130,000 = £34,000. In other words, the landlord would be taxed at a rate of 34/50,000 = 68 per cent. This is an average rate of tax on his income but is far higher even than any marginal rate in the UK tax system.Of course, when interest rates rise, the costs to landlords of effectively being taxed on turnover rather than income will be higher. The effects of this are likely to be the development of more complex corporate structures, higher rents, fewer properties being brought to the rental market and the removal of tenants who are on housing benefit.The impact of all this will, of course, be distressing to all those who feel the effects. But totally baffling is the response of the Treasury, both at the time of the Budget announcement and since. It seems as if any understanding of the basic principles of public finance has taken leave of the Treasury. Their response comes under a number of headings.In introducing the restriction of “tax relief” on buy-to-let property, the Chancellor of the Exchequer, George Osborne, explicitly argued that it would level the playing field between owner-occupied and let housing in relation to taxation saying: “Buy-to-let landlords have a huge advantage in the market as they can offset their mortgage interest payments against their income, whereas homebuyers cannot”[1].This statement is clearly false. Owner occupiers can be thought of as owning houses and renting them to themselves. The rent that would be paid had their home been let out on the open market is often known as “imputed rent”. Owner occupiers do not pay any tax on the imputed rent from their properties at all: such a tax was abolished in 1963. Given that owner occupiers do not pay any tax, the question of allowing them to offset financing costs before calculating taxable income simply does not arise. There is nothing against which finance costs can be offset.In a letter TO2016/23599 [2], the Treasury repeats the above argument and also argues that tax relief is not available to those who borrow to invest in shares. This argument is not totally incorrect but is hardly a reasonable comparison. The situation of personal borrowing being undertaken to finance investment in shares is unusual. But, even so, this comparison is of minimal relevance. Buying houses to let is akin to creating a business with fixed capital, not akin to buying securities such as shares, and should be treated like other businesses with fixed capital.George Osborne’s 2015 Budget speech and letter TO2016/23599 both assert that the offsetting of interest against rental income benefits landlords on higher incomes because the tax saved is greater for such individuals. Again, this is not true and, as an argument, would not be regarded as consistent with the basic principles of public finance.The ability to deduct interest payments from rental income before calculating tax is not a “relief” against taxable income because the income that is taxed is never received by the landlord – it is paid out as a business cost to the financier of the mortgages taken out to purchase the property. Allowing the landlord to deduct interest costs on mortgages before calculating taxable income does not confer any benefit upon the landlord because the landlord does not receive as income that part of the rent used to pay interest on the loans. Not allowing landlords to fully deduct interest before calculating taxable profits leads them to be charged tax on income that they do not receive.Letter TO2016/23599 also argues that the move by the Treasury to limit the extent to which finance costs can be used to determine the tax rate on rental income brings the buy-to-let sector into line with the position of incorporated landlords. The letter argues that such landlords can only obtain tax relief on interest costs that are incurred in financing housing provision at the corporation tax rate (now 19 per cent) rather than at the top marginal rate of tax. This argument is also wrong.If let property is held within a company, the company pays corporation tax at 19 per cent on profits. Interest on let property is fully deducted before calculating the profit that is taxed. That profit is then taxed at 19 per cent (and dividends taxed at higher rates in the hands of higher-rate taxpayers). The interest has been fully deducted from rental income before taxable profits are calculated and then distributed as dividends.***In conclusion, it has to be said that this is all pretty worrying. To put it at its simplest, the Treasury either does not understand the basic economics of tax policy or it is deliberately playing politics by distorting economic reasoning.[1] 2015 Budget speech.[2] See: https://www.property118.com/treasury-response-to-section-24-report-by-dr-rosalind-beck/