Council tax 'should be replaced with home-value contribution'

Homeowners should pay an annual tax based on the value of their home in exchange for the abolition of the council tax, under a radical proposal aimed at ending booms and busts in the housing market.

But its proponent admitted there would be losers among people who bought expensive homes at the top of the market - such as Tony Blair and his wife Cherie.

Martin Weale, the director of the National Institute of Economic and Social Research, said a lenient tax regime had been a key driver behind the surge in prices that had left houses 20 per cent overvalued.

In a report published today, he proposes that homeowners pay an annual tax of 1 per cent of the value of their home. He said the scheme should be phased in over at least 10 years.

Mr Weale added that to ensure the plan was revenue neutral - that is, does not lead to a higher tax take - income tax rates should be cut and stamp duty abolished. Meanwhile, local councils should be funded by a local income tax in place of council tax.

"The owner-occupier has a very favourable tax treatment," Mr Weale said. He said homeowners had not been taxed on the imputed rent since 1960 and faced no capital gains tax when they moved home. He said the light treatment compared with investing in a business, which was subject to corporation tax and a levy on dividend payments.

"The tax advantages for housing have been one of the factors behind rapidly rising house prices," Mr Weale said. "Policies that support or at least do not discourage rising house prices have economic consequences."

He criticised the Government's latest initiative, real estate investment trusts (Reits), which would allow investors to hold property in tax-sheltered vehicles such as ISAs and pensions. "Reits are likely to attract extra money into property investment, making the position worse."

He acknowledged his tax would impinge on owners of expensive properties more heavily than council tax. "Prima facie, that seems to be fairer. However, it would meet with objections from those retired voters who live in fairly expensive homes and don't want to move." He added: "The people most affected would be those who bought expensive properties at the top of the market, such as the Blairs."

The Prime Minister and his wife bought a £3.5m house in Connaught Square in Mayfair, London, at the peak of the market in 2004. Mr Blair missed out the late 1990s property boom when he sold his home in Islington to move to Downing Street.

Experts said the proposals were unlikely to appeal to politicians. John Hawksworth, the head of macroeconomics at the accountants PricewaterhouseCoopers, said they were "practically difficult. It would lead to big winners and losers politically".