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Friday, January 16, 2009:

Stupid property owners

The “taxes” that property owners hate most are the ones that hurt them least and are most likely to be spent for their benefit, writes Gavin R. Putland.

Land and taxes

In any tax jurisdiction, the supply of land is fixed. From the viewpoint of the taxpayer, the supply of land zoned for any particular purpose is also fixed, as is the supply of land within acceptable distance of any particular services, infrastructure, or markets. Yet access to suitably located land is essential to economic participation. Therefore land values, expressed as rent or as interest on purchase prices, are competed upward until they absorb the economy's capacity to pay. As that capacity increases — as it usually does — so do land values [1]. That's why economic growth doesn't make housing more affordable. That's why we load ourselves with debt in order to “own” our homes as soon as possible. This much is obvious even to the unschooled; they may not know anything about economics, but they know where their money goes.

Most taxes target transactions (or the results thereof), causing otherwise viable transactions, hence otherwise viable enterprises and industries, to become unviable. In this way, most taxes take far more money out of the private sector than they deliver to the Treasury (and thence back to the private sector through public spending). The margin by which the cost to the private sector exceeds the benefit to the Treasury is what economists call the excess burden or deadweight cost of taxation. In simple terms, most taxes take more than they give. This too is obvious even to the unschooled, who typically resent taxation more than they appreciate whatever the revenue is spent on; they may not know anything about economics, but they know they're being overcharged.

These obvious premises have two obvious implications which somehow escape the notice not only of the unschooled, but also of most of the schooled:

  • All taxes fall on land values. If land values absorb the economy's capacity to pay, then all taxes, in so far as they reduce that capacity, reduce land values. A tax on the owner of the land is a deduction from the imputed rental value of the land for the owner and is discounted in the price that any alternative owner will pay for the land. A tax on any other entity is a deduction from that entity's capacity to pay for land. Either way, the ultimate burden falls on land owners. Therefore, if the owners were informed and rational, their aversion to taxes would extend to all taxes and would not be concentrated exclusively, or even mainly, on taxes payable by land owners.
  • All deadweight falls on land values. The margin by which taxes reduce the economy's capacity to pay, hence land values, includes not only the actual tax paid, but also the deadweight cost. Indeed, the final reduction in capacity to pay, hence in land values, may not include all of the tax paid, because governments not only collect revenue but also spend it; but it does include the entire deadweight cost of taxation, because governments don't get to spend the deadweight. Therefore, given that a certain amount of revenue must be collected, an informed and rational land owner will prefer that the revenue be raised with the least possible deadweight.

And the taxes with the least deadweight are those levied directly on land values (or changes in land values), because the tax bill is independent of, and therefore cannot deter, any productive activity of the taxpayer. Indeed, if the tax is a holding charge of so many percent of the land value per year, it has negative deadweight because it encourages the owner to do something productive with the land (or sell it to someone who will) in order to cover the tax bill.

It is in the macroeconomy that all taxes fall on land values. In the microeconomy — that is, from the viewpoint of the individual or firm — a tax reduces the marginal reward of the activity subject to the tax; and the macro-consequence of all these micro-disincentives is deadweight. In the microeconomy, taxing land values instead of the fruits of labour and capital would leave labour and capital with their full marginal rewards, undiminished by taxation. But the macroeconomy shifts all taxes and their deadweight costs onto land owners.

Thus we see that John Locke (1632–1704) was not exaggerating, but rather understating, when he wrote:

It is in vain in a country whose great fund is land to hope to lay the publick charge of the Government on anything else; there at last it will terminate. The merchant (do what you can) will not bear it, the labourer cannot, and therefore the landholder must: and whether he were best to do it by laying it directly where it will at last settle, or by letting it come to him by the sinking of his rents, ... let him consider.

Let him also consider what happens when the revenue is spent. Taxes on land values (or, better still, on uplifts in land values) give governments an incentive to invest in public infrastructure that raises land values for the benefit of property owners. Other taxes dilute that incentive but still ultimately fall, along with their deadweight, on property owners.

Location, location...

The benefit of an infrastructure project can be measured only by the price that people are willing to pay for it, and whatever part of that price is not paid in user charges (fees, fares, tolls, etc.) is paid for access to locations serviced by the infrastructure. In other words, the benefit of infrastructure (net of user charges) is manifested as uplifts in land values — not values of buildings, which are limited by construction costs, but values of land, because land has a location (and therefore a locational value) even if no buildings stand on it.

Therefore if the benefit of an infrastructure project exceeds the cost, whatever part of the cost is not offset by user charges can be covered by taking back a sufficient fraction of the uplift in land values, without burdening taxpayers who do not share in the benefit.

More generally, the cost-benefit ratio of a project is the cost-uplift ratio. So if a government claws back a certain fraction of every uplift through the “tax” system [2], any project whose cost-benefit ratio equals that fraction is self-funding, and any project with a lower cost-benefit ratio is more than self-funding, yielding net revenue that can be used for (e.g.) cutting other taxes or paying off debt. The remaining (“after-tax”) fraction of each uplift is a net windfall to the affected property owner [3]. But the owners' gain is not a loss of affordability, because it reflects greater locational utility — not higher rents or prices for the same utility [4]. And because it does not depend on expansion of debt backed solely by faith in the greater fool, it does not destabilize the financial system.

This is not a call to raise taxes in order to pay for infrastructure. It is a call for a change in the tax mix (which in itself can be revenue-neutral) so that future investment in infrastructure pays for itself by expanding the revenue base without any further changes in tax rates or thresholds. If, in the initial change, the new or increased “taxes” are levied solely on subsequent uplifts in land values — exempting present values — then no property owner loses in the change or in the subsequent operation of the new system.

Of course, if 100% of the rental value of land were taken as public revenue in lieu of other taxes and charges, then property owners would be worse off as land owners, but better off in other capacities (e.g. as workers, shareholders, consumers, users of infrastructure, or owners of buildings). And if 100% of future uplifts in land values were taken as public revenue, then property owners would be worse off in terms of their future gains as land owners, but again better off in other capacities. Under these two scenarios, land owners gained as land owners from their successful campaign against selective taxation of land (as described in the 2005 essay “Cuckoo Economics”). But if a moderate fraction (e.g. half) of future uplifts in land values were taken as public revenue, this fraction being high enough to induce governments to invest heavily in infrastructure, but low enough to leave land owners with an attractive share of the windfalls, then property owners would be winners not merely on balance, but even as land owners.

But property owners don't want to hand back any of their unearned uplifts. They want somebody else to pay for their infrastructure, so that

  • infrastructure projects that would increase property values are blocked for want of funding, and
  • other government services are funded by taxes that depress property values through deadweight costs.

And what property owners want, property owners get — even if it's stupid.


[1] What of other assets which, due to government action, are limited in supply and essential to certain types of economic participation — for example, taxi plates? For economic purposes, such assets are land-like. If the above reasoning is to be strictly valid, the category of “land” must be construed as including all “land-like” assets.

[2] Technically, a public impost on uplifts in land values is a charge rather than a tax, because it is a payment for benefits received; the uplift is not created by the owner who pays the impost, but is a benefit conferred on the owner by the community, and only those who receive the benefit pay the impost.

[3] One successful property investor who understands this is Don Riley, author of Taken for a Ride: Trains, Taxpayers and the Treasury (Teddington, Middx: Centre for Land Policy Studies, 2001). Riley in turn drew his central argument from William Vickrey, winner of the 1996 Nobel Prize in Economics; see Vickrey's contributions in K.C. Wenzer (ed.), Land-Value Taxation: The Equitable and Efficient Source of Public Finance (New York: M.E. Sharpe, 2000).

[4] The affordability of land is the bargaining strength of renters and buyers relative to landlords and sellers, and is improved by tax reforms that make it uneconomic to hold land for purely speculative purposes, so that genuine users do not need to compete with speculators and under-utilizers. Holding charges on land values (or on uplifts in land values) meet this requirement while encouraging and enabling governments to invest in infrastructure.

[Reposted August 29, 2012; reformatted November 9, 2012.]

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