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Taxes are a subject that few desire to discuss, but when the topic is broached, the discussion typically centers around the tax rate, whether it should be lower, or higher, and for whom. Usually absent from this conversation are what kinds of taxes we ought to have. With the proper tax design, however, the economy will grow faster, and prosperity spread more evenly. Armed with an understanding of the “Dark Side” of property, I argue that a Land Value Tax offers a transformational opportunity to enhance future growth and accelerate human progress.
Why Do We Have Taxes?
Modern civilization levies taxes for two basic purposes. First, to raise revenue for socially beneficial public services like roads, schools, and police. Second, we use taxes to encourage or discourage certain types of economic or social behavior. As I have already discussed, taxing sugar is a good way to preserve and perhaps enhance our human capital. When it comes to taxation, governments have essentially three options or types of taxes at their disposal:
Taxes on what you earn (income, corporate income, business…etc.)
Taxes on what you buy (VAT, sales, or excise) and
Taxes on what you own (property taxes)
What is important to understand here, however, is that not all taxes have an equivalent impact on the economy; some have a more negative impact than others. Thus, to maximize growth and human opportunity, taxes should be designed with care. Economist Adam Smith outlined the four canons of good taxation centuries ago and they hold true today:
Canon of Equity: Taxes should be proportional to income.
Canon of Certainty: Taxes should be clear, not arbitrary or hidden
Canon of Convenience: They should be easy to pay (i.e. no filing fees)
Canon of Economy: They should be cheap to administer and collect
Today, we also recognize a fifth canon: taxes should minimize “dead-weight loss.” This somewhat poorly named phenomenon is the loss of economic activity beyond the tax itself. Deadweight loss is a hidden ‘tax on the tax’ that depresses productivity without raising any additional corresponding income. That is, when we tax something, whether we tax chairs, cars, or incomes, we tend to get less of it, throwing the supply and demand equilibrium out of balance. This effect, also known as “excess burden,” does not bring in any revenue and only serves to suppress economic activity (depresses our problem-solving machine).
It is also important to understand that deadweight losses do not rise linearly to the tax rate, instead they grow to the square of that rate. In other words, when we double the tax rate, we quadruple the deadweight losses. This has profound implications because it means that for maximum economic efficiency, we best keep taxes as low as possible. It also means that there is a fundamental limit to how high taxes can go before the deadweight loss completely shuts down economic activity.
Tax the Land
As I noted before, however, not all taxes are equal. There is one tax (maybe two) that meet all five Canons of good taxation. Praised by economists from Henry George to Milton Friedman to Mason Gaffney, the Land Value Tax, or LVT, checks all of the boxes. An LVT is a tax on the “unimproved” rental value of land. That is, a tax imposed on the land itself, not the property built upon it. As we will soon see, some don’t consider LVT to be a true tax at all because rather than arbitrarily extracting wealth, it’s a payment system for the use of a location, akin to a rental fee for land use.
To understand this, imagine that you are the owner of a remote tract of land. Your land has little value because of its remote location. But you get lucky a few years later, the local government builds a train line and station that connects your tract to the nearby city; suddenly the value of your parcel skyrockets. You sell your land at a handsome profit, privately capturing the fruits of a public benefit. You did nothing to create or earn this value. It would be no different had you accidentally struck oil on your land; you privately enjoy the benefits of that which you didn’t earn.
If our goal is strong economic growth and human prosperity, LVT makes a great deal of sense. I argue that LVT should form the cornerstone of any 21st-century society and should, to the extent possible, replace other kinds of taxation. Income taxes, for example, tax your labor and earnings, placing your precious time into government coffers. Most of us agree, that earning money is a good thing, and taxing it away feels like a punishment. An LVT taxes only land and the resources within it; not production or someone’s time. Land and resources (with rare exceptions) were not created by humankind; they were already there. When someone owns land, they reap the benefits of something that they did not create. In economic terms, unearned “rents.” An LVT recoups the fruits of nature and society for redistribution and public benefit.
With respect to the Canons of taxation, land is disproportionately owned by the wealthy, thus an LVT is progressive. It’s a stealth wealth tax that doesn’t punish the wealthy for success but levels the playing field by eliminating the home-court advantage. Also, unlike wealth taxes, LVT it’s impossible to evade; land cannot be hidden or moved overseas. Like property taxes, the calculation methodology and tax rates would be public. Unlike property taxes, however, an LVT does not need to account for the nuances of the building that sits on top of it, so there is no need to individually assess each property. Adjacent lots would have virtually identical tax rates, making calculation and collection faster, easier, and more transparent.
Most importantly, however, compared to a property or income tax, an LVT doesn’t punish development or productivity, on the contrary, it encourages it. With an LVT, it would no longer be rational to hold land tracts in idle speculation, as many wealthy land developers do, waiting for the value of their investment to rise. Instead, it would make sense to put it to immediate use. On the flip side, developers who make productive use of land would not see their tax bills rise simply because they built a high-rise or shop upon it. The cranes of development and bulldozers of progress would always be on the move in an LVT-based society.
Lastly, because the supply of land is fixed, taxing it doesn’t alter the supply. Thus, there is negligible economic deadweight loss from an LVT. This means we can raise revenue without negatively impacting economic growth as most other taxes do. An LVT is as close to a “free lunch” as policymakers could ever possibly get. It is simply irrational not to try and utilize LVT as much as possible.
Infrastructure Dreams
LVT also presents an incredible opportunity to sustainably fund public infrastructure. Today much of that infrastructure is funded through taxation and/or debt. A portion of your income tax, for example, might be used to fund an expressway project. However, due to the indirect nature of this financing, it’s difficult for taxpayers to see the connection between their hard-earned money and the facilities they actually use. This naturally makes raising funds for public infrastructure politically difficult, leaving much of it chronically underfunded and/or the government permanently in debt to it. On the other hand, those who do benefit from an infrastructure project, such as a hotel located near an expressway exit, reap disproportionately in the form of higher land values and better business opportunities.
Ideally, we want a funding mechanism that doesn’t indebt the government (the public) and imposes the cost of financing infrastructure upon those who benefit most. Traditionally, this has been attempted through “user fees” in the form of tolls on roads, fares on subways and trains, or water/electricity usage fees. This makes sense, why not charge the people who use a road to help pay for its maintenance and recoup the cost of construction? The problem is that user fees alone cannot fund infrastructure because the positive externalities of public infrastructure go beyond the people using it and spill over onto land adjacent to it. This is where LVT becomes vital as an LVT can capture those spillovers and return the value created to the government (the public) that paid for it.
While not LVT per se, this is the basic concept employed by the Hong Kong Metro (MTR) system. The MTR is unique in that it is perhaps the only profitable underground transit system on planet Earth. The MTR employs a strategy that they call “Rail + Property.” The Metro partners with developers of land adjacent to their stations and depots. Since the presence of a metro station raises the value of the land nearby, the partnership allows the metro to capture some of this value by selling or leasing the property around the station. This works so well that not only is the MTR profitable, but it also charges significantly lower fares than similar systems in other cities. Additionally, the MTR requires no government subsidies to operate. On the contrary, because the system is partly owned by the Hong Kong government, it pays the government hundreds of millions of dollars in dividends every year.
How Much Revenue Can LVT Raise?
It seems too good to be true, a tax that can raise revenue without hurting the economy. Purist advocates of LVT argue that we should set the tax rate at 100 percent to fully capture economic rents. To be clear, this is not a 100 percent tax on the land value (despite the name), but rather a 100 percent tax on the “rental value” of land. As a practical matter, I find this unworkable. As with property taxes, the science of valuation is fuzzy and imperfect. At a 100 percent rate, we risk unintentionally overshooting rent capture, causing economic harm. For this reason, striving for an 80-85 percent tax rate seems appropriate. This lower rate could also reduce concerns about “searching costs” or the costs incurred by landowners for finding better uses of land. Some argue that a high LVT may disincentivize searching costs, slowing growth.
An 80 percent LVT could raise enough revenue to fund a large portion of government expenditures. More importantly though, because LVT engenders no deadweight loss, it can replace less efficient sources of revenue, such as income/corporate income taxes, accelerating overall economic growth and prosperity in the process. Indeed one 2002 study found that the elimination of taxes on production in the US could raise national output by some $1 Trillion a year. Interestingly, some of that increased wealth and output will raise the value of land further, and when captured by the LVT, we would raise even more revenue at no cost to society.
Critics contend that, despite the near “perfect” economics of LVT, it remains unworkable in practice because it is very difficult to determine the value of land and to disentangle that value from the improvements built upon it. I counter with two points. First, a Harberger Tax, which I mentioned previously, could be used to aid in this valuation with simple self-assessment. It would also improve the allocative efficiency of land use by eliminating the aforementioned “holdout” problem. Second, perfect need not be the enemy of the good here. We already tax property and land imperfectly. If we cannot disentangle the property entirely, we can invert the current methodology and emphasize the land over the improvement value.
Land is not human-made, there is no moral rationale or justification that any individual or corporation should privately reap the benefits of it. This unearned rent can, and should, be captured and redistributed for societal good. Using this revenue, at the very least, we can eliminate income taxes, allowing workers to retain the full fruits of their labor. Going further, should the budget allow, we could redistribute this revenue in the form of a Negative Income Tax, UBI, or other socially beneficial schemes. Therein lies the beauty of LVT, it captures the bounty of the Earth and society for the benefit of all, rather than the few. Taxes shouldn’t be a punishment, they should be an opportunity to build a more equal, just, and inclusive society.
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Where would the revenue come from to replace income tax with the LVT? Isn’t it just an unimproved property tax? In that case, wouldn’t taxpayers be paying less on the land they own or would this be on top of property taxes?
Interesting. I hadn't realized that the land tax meets all four criteria of Smith's good taxation policy.