One of economics’ most elegant taxes is also its least understood. For a more efficient and equitable tax system, this should, but probably won’t, change.
“The annual produce of the land and labour of the society, the real wealth and revenue of the great body of the people, might be the same after such a tax as before.”
It is perhaps unsurprising that the quote above was written by none other than Adam Smith in The Wealth of Nations. It is surprising, however, that the almost implausibly efficient levy Smith is referring to is practically unknown and largely untested in economies across the world: the land value tax (LVT).
Unlike the property tax, a mainstay of local governments worldwide, the LVT is not assessed on the value of real estate, which is comprised of both land and the property on top of it. Instead, it is solely imposed on the value of land, which means owners would not be penalized for investing in improvements to their property. Rather, they would see their land value/tax liabilities increase when beneficial infrastructure, such as a transit station or a high-achieving school, is constructed nearby.
Moreover, since the supply of land is inelastic (one cannot produce more of it in response to higher land prices, for instance), virtually all economists agree that a tariff on land would result in zero deadweight loss on the production of goods or services.
In plain English: the tax is borne entirely by the landowner, there is no distortionary impact on consumption or production, and the property price or rent decreases by the amount of the tax. In fact, housing and rent prices should fall in the short-to-medium term as companies move forward development on idle land they own.
“The LVT comports perfectly with all the textbook principles of sound tax theory — it’s the perfect tax,” says Bill Batt, former member of the New York state legislative tax committee.
Why then does one of the most economically efficient levies (arguably second only to Pigovian taxes on negative externalities), and one that has been championed by John Stuart Mill, Winston Churchill, Milton Friedman, and the OECD, continue to go under the radar?
One potential reason is that neoclassical economists like Alfred Marshall and Irving Fisher largely ignored land as a unique factor of production, choosing instead to incorporate it into capital. This may have led to a marked decrease in the amount of scholarship on land taxation.
A more satisfying and parsimonious explanation deals with interest groups, in this case landowners, and the disproportionate sway they have held throughout history. In the US, this was especially true in the late 19th and early 20th centuries, when banking and railroad interests successfully quashed the public debate on land taxation and gave the green light to unfettered land speculation.
“Landed interests in every country have had and continue to enjoy enormous influence over changes in law, taxation, and public policy,” notes Edward Dodson, a LVT specialist at Temple University. “In much of the world land speculation has become part of our economic DNA.”
Nevertheless, there have been a few notable examples of municipalities employing some form of LVT. Local governments in Denmark charge a variant of it (in addition to progressive residential property taxes). More common is the split-rate property tax, where a property’s land is taxed at a higher rate than that which is assessed on actual improvements to the buildings. This has been implemented in cities as diverse as Honolulu, Sydney, Hong Kong, and Johannesburg.
Split rates are especially commonplace in Pennsylvania, including in Harrisburg, Scranton, and until recently, even in Pittsburgh, where the rate assessed on land was six times that on property. Indeed, several studies have shown this LVT-like structure had a significant effect on Pennsylvania construction booms in the 1980s and early 1990s.
Yet, the LVT has potential problems of its own. Its relative effectiveness in smoothing out incentives seems to only work when it is of a significant size compared to other taxes. Given citizens’ loathing of “salient taxes”, or those levies which are more noticeable (particularly once-a-year property tax bills), this does not seem too likely to occur.
Further, since non-revenue-producing land is discouraged under a LVT, amenities like yards and open spaces (which make a city more inviting) are also discouraged. A LVT may cause an economically depressed area to further deteriorate as owners of vacant lots have a greater incentive to simply abandon their land. And it would favor urban construction over development in outlying areas.
Complicating the situation is the difficulty of even assessing the LVT were it in place. Most tax authorities have decades of experience in calculating the market value of a property, inclusive of the land value. Few would be able to immediately switch to a consistent method of assessing land, not what is above it, be it crops, buildings, or drainage installations.
For two structures which are exactly the same, only miles apart, the technique would be simple enough. The difference in land values would be given by merely subtracting their respective real estate values. But real-world examples are clearly much more difficult to assess.
What we are left with is a tax that can appeal to progressives (increases in land value have nothing to do with the owner and everything to do with society) and conservatives (many argue that a broad version of LVT is robust enough to replace most other taxes) both, yet whose implementation may be rare enough to empirically call into question some of its merits.
Regardless, this assertion is vehemently protested by the pro-LVT community, which has gained a number of influential supporters in recent years while still remaining firmly on the outskirts of mainstream economic debate.
“It makes no sense to dismiss a tax that will not only benefit business, workers, the environment and the economy, but help to rectify an injustice inflicted on people over centuries,” argues Dave Wetzel, President of the International Union for Land Value Taxation and Free Trade.
In spite of some modest momentum, the economic injustice of dismissing the land value tax looks set to continue.