Public Finance, Econ 132

Fred Foldvary

Lecture notes

Week 2

Holcombe: 324-7 site value taxation

Three categories of property: human bodies, real estate, and personal property.

Who has property rights to your body?

Real estate is also referred to as real property, in contrast to personal property.

Property taxes can be based on the property value, property size, or a lump sum.

The property value can be the current market value, or historical, based on the purchase date.

The real property tax in California is ad valorem based on the purchase date,

rising no more than two percent annually thereafter.

It is possible to separate the values or real property and tax buildings and land at different rates.

That includes taxing buildings at zero, so that the real property tax falls only on land.

Parcel taxes are based on the size of the property, either of buildings or land.

Ad valorem property taxes are based on the value of the property.

A tax on land value or land rent is ad valorem.

A tax on land value is based on the highest and best use of the land,

regardless of actual use.

An ad valorem tax on land value is equivalent to an ad valorem tax on the rent.

The equation of the value of land is p = r / (i+t)

The fraction f of rent taken is t*p/r = t(r/i+t)/r = t/i+t

So if i=.05 and t=.20, f = .2/.25 = .8 or 80% of the rent.

When t rises, p falls.

A tax on land value or rent has the effect of a lump sum tax,

because it is independent of the activity of the owner.

Graph of a tax on rent.

Two supplies: total amount, and lots offered for sale.

The tax does not change the rent.

It has no DWL.

The burden is on the title holder at the time the tax is increased.

A new buyer has no tax burden.

Ultimate Tax Reform

Since land has no cost of production, why is there rent?

Rent arises from:

1. A movement of production to less productive land,

raising the rent of more productive scarce land.

2. The generation of rent by public goods and public works.

3. The generation of rent from greater population and commerce.

If an increase in the tax on land provides a greater supply of productive public goods,

that increases rent and land value, offsetting some of the reduction in price.

The Henry George Theorem

The public revenue that provides for the optimal collective goods equals the land rent.

G is a collective and X a private good.

Output Y is a function of N workers:

Y = XN + G.

G = Y - NX

The wage is the marginal product of labor: dY/dN = X

R = Y - NX

Therefore,

R = G.

The Henry George Theorem echoes Henry George's single-tax proposal,

that not only should land rent be the only general tax,

but that it will be adequate to finance public goods

Private communities use land rent for their public goods.

User fees are similar to market prices.

Based on the benefit principle rather than ability to pay.

Land value taxation too is based on the benefit principle.

Rent reflects the benefit of land received by the title holder.

If government’s public goods are paid for by taxes on labor and capital,

the land title holder receives the implicit subsidy of rent.

Many wealthy landowners pay high taxes but get much of it back as land rent.

The subsidy is prevented by having landowners pay back the value received.

The criteria for judging a tax system:

Certainty, efficiency, transparency, equity

Economists from Adam Smith to Milton Friedman have recognized that

land value taxation best fits these criteria.

“Land” means all natural resources.

Includes space, spectrum, wildlife, minerals, water, oil, gas.

Professional appraisers have techniques for separating land value and building value:

comparable sales, the replacement costs of buildings, the capitalization of income, maps.

Land value taxation avoids record-keeping and audits.

Nobody would go to prison for not paying taxes.

How much rent is there.

Studies estimate land rent between 20 to 33 percent of national income.

Since other taxes lower the land rent, the elimination of other taxes would raise rent even more.

Political pressure from landowners to minimize land value taxation

can be overcome by include a resident’s dividend or equal share of the rent.

Land value taxation facilitates decentralized governance.

Income taxes tax honesty.

from Kenneth Wenzer, ed. Land-Value Taxation

William Vickrey

A leading theorist on marginal-cost pricing.

With LVT, government debt becomes equivalent to taxation.

More debt implies greater future taxes on land value, which reduces the purchase price.

With LVT, government debt becomes like a mortgage on the lots.

If the debt is increased, and the debt will be paid from LVT,

the debt either incurs a higher tax, or

the same tax, but without the current benefit the current tax would have paid for.

Congestion charges

Divide a city or a highway into zones and time intervals.

Each car has a transponder.

In each zone and for each time, congestion pricing prices passage just high enough to eliminate congestion. Cameras can scan the license plates to enforce payment.

A car driver or owner would pay the social cost of adding to congestion.

The charge should be just high enough to prevent congestion.

Cars can carry a device to record entry into a zone.

There are scanners at zone boundaries or along a highway.

Those who wish to be anonymous can be equipped with prepaid meters.

Pollution charges

Remote sensors can detect pollution as cars drive by,

and send pollution charges to card that exceed a threshold.

This would replace the gasoline tax and regulations.

Cameras take pictures of cars’ licences.

Those who want absolute privacy should ride in a car they don’t own.

Parking

Similarly, congestion pricing would use electronic meters to charge just high enough so that there is an available parking place within a block, with no time limit.

Parking meters with a fixed time use rationing rather than pricing.

Land taxes and congestion charges promote the efficient use of space.

They also provide the revenue needed to finance services with economies of scale,

goods with high fixed costs and low marginal costs, such as public transit.

That enables marginal-cost pricing.

A parking meters is a user fee and also a rent and an externality charge.

Fixed cost meters ration by time rather than by cost.

Rationing by price is more efficient.

Congestion pricing requires a universal and flexible system.

The meter charge should be just high enough to usually have a parking place within a block.

Modern technology can provide electronic charging, including in-vehicle devices.

Transit

The marginal cost of riders in mass transit is zero except when congested.

For public transit, as natural monopolies, services with large economies of scale,

it is most efficient if the user pays only the marginal cost.

That is how hotels charge for elevators and escalators.

Land taxes are adequate to finance the rest.

If not, then the services are inefficient and should not be built.

Some people think they don’t benefit from a service such as city busses,

but rents in wealthier areas are higher because of the service to poorer areas.

For peak hours, an extra person imposes the cost of depriving others of space.

That is a marginal cost. Fares should be zero when not crowded,

and then rise to the peak use, and then decline.

Monthly fixed-cost passes are inefficient.

They do not provide an incentive to shift away from rush hour.

The fixed can be paid efficiently, from the rental the transit generates.

Land value is higher because of the services.

Fire protection

The immediate beneficiaries are owners of buildings and personal property.

But the cost of responding to alarms is a small portion of fire departments.

The availability of the service increases site values.

Vickrey puts the costs chargeable to land value at 80 percent.

Why should non-users pay community rent?

A landlord can charge a higher rent.

Stores have a greater amount of business.

Also, it is common to pay for a package.

People stay at hotels without using the swimming pool or exercise room.

People rent a car without using all its features.

You pay because the package is worth it overall.

You choose a community with the best package for the cost.

Urban sprawl

Meaning?

The amount of land used relative to that which would be used in a pure free market.

Sprawl exists because extensive land use is subsidized, and

urban land speculation is subsidized.

Site-value taxation diminishes urban sprawl by taking the profit out.

There is more in-filling and less fringe development.

Harry Gunnison Brown,

Land speculation and land-value taxation

Speculation: the purchase of an asset (or short sale)

with the goal of profiting from a favorable change in its price.

Commodity speculation is market-enhancing by thickening the market,

But speculation can make price swings more extreme.

Land speculation in some cases holds land out of use, free-riding on the future,

and in other cases, overbuilds, forcing the future.

Rising land values stimulates speculation in land values.

Government-provided infrastructure, gains go to landowners, which fuels land buying.

In a pure free market, landowners would pay the costs, reducing land gains and speculation.

Holding land vacant or used suboptimally makes development leapfrog further out,

reducing productivity and wages.

LVT eliminates market-hampering land speculation.

Mason Gaffney

Real estate gets tax breaks and implicit subsidies.

Subsidies that seem to apply to buildings end up applying to land value.

IRS practice allows repeated depreciation.

The law recognizes that land does not depreciate

But the ability to reduce the tax increases the site value.

It is an IRS practice to accept the local assessor's allocation of value between land and buildings. Local assessors, by undervaluing land relative to buildings, thus help their constituents depreciate land and so avoid a large share of the income tax due on real estate.

This creates a strong local bias to underassess land

The effect of raising building costs is to reduce building or

to make submarginal everything about a building that is marginal.

Every individual site is less intensively improved.

Chopped off are marginal increments in quality, beauty, safety, pollution control, convenience, fireproofing, quake-proofing, insulation, durability, height, and all aspects of intensity.

Building owners neglect exterior appearance because they believe it influences assessors.

Land taxes build a fire under sleeping owners.

Some cities have a two-rate or split-level tax

Several Pennsylvania localities do have lower rates on man-made capital than on land.

Their permits for new construction have been larger in the localities that have adopted the reform

T. Nicolaus Tideman

Taxing Land is Better than Neutral

The “winner’s curse” is the regret by a winner at an auction because he realizes he paid too much.

Properly administered taxes on land are neutral when credit and speculation markets are perfect,

with complete knowledge of the borrowers’ capabilities and the future value of assets.

Since market participants lack perfect knowledge,

LVT improves decisions about land development

and by reducing imperfections in lending markets.

If there are different beliefs about the optimal future use of land

then a tax on land helps prevent a "winner's curse"

from generating an artificial scarcity of land for current use.

And if there is dispersion in lending rates because of imperfections in lending markets,

a tax on land helps to put land into the hands of persons with more uncertain credit.

The quantum leap effect.

Quantum mechanics is a branch of physics that studies units of energy called “quanta.”

The amounts of energy in a particle such as a photon of light have particular numerical values

rather than a continuum.

The quantum effect in physics is a leap from one energy state to another,

Mason Gaffney adopted the quantum term in physics as an economic analogy

when one land use replaces another, and there is a huge jump or fall in production.

The deadweight loss of taxation is even worse, much greater than the effect from higher prices.

For example, people can buy books from catalogs and World Wide Web sites.

When there is a global price for a book, the local seller cannot raise the price,

The taxes come out of his profit, and if profit becomes less than normal,

the owner shuts down the firm.

The land won’t remain empty, as the use would shift to something else, possibly a use that generates less output and employment.

Suppose a gas station replaces the book store, and with self service, requires only one worker instead of the 20 who worked at the book store.

Since one can’t buy gas from far away places,

the tax on the gasoline can be passed on to the customers.

The 19 workers who lost their jobs would have paid taxes,

so that revenue is now lost to the government.

Those workers would have bought goods; now they have moved away,

so there is less business in the area.

The bookstore would have generated a greater market value of services than the gas station, and more taxes, so there has been a great reduction in output and taxes due to a shift in land use.

That is the quantum leap effect.

Possibly a firm that generates a high output but also has high costs is replaced by a firm that has much less output and employment, but a higher profit per item.

The second firm, with the higher profit, will use the land.

There is a quantum leap down to much less production, because the land use has shifted to one which has less output.

The loss of production due to quantum leap effects is unknowable, but most likely enormous,

and increasing.

Any shift from market-based output to punitive-tax-induced output will be

to a less valued and less productive use.

In a global economy, goods sold world-wide impose a market price ceiling,

making it impossible to pass on tax costs to the buyers.

The taxes eat into profits, and those enterprises with lower profit margins get squeezed out.

This could be happening on a colossal scale.

Taxes on gross revenues are especially destructive,

as they squeeze out the profit more than taxes on income, which is gains minus costs.

With taxes on gross revenue, costs are irrelevant to the tax.

Sales taxes are on gross income, which makes sales taxes much more destructive than income taxes, due to the greater quantum leap effects.

But taxes on income also have quantum leap effects, since if a firm was only making normal profit before taxes, and it can’t raise prices,

the tax will squeeze profits below normal, and the firm shuts down.

Only if the land rent the firm pays gets also reduced can the firm survive.

Thus with quantum leap effects, much of the tax is at the expense of land rent,

since reduced profitability generates less land rent.

The reduction in rent depends on how much of added cost they can pass on

to customers and workers.

The income tax also falls on wages to the extend that workers worldwide

are not perfectly mobile, as they indeed are not.

The only way to eliminate the Gaffney quantum leap effect is to directly tax rent instead of indirectly taxing it via taxes on revenue and profits.

A shift to land-value taxation would therefore not just eliminate the deadweight losses caused by a reduction of the quantity of goods produced,

but also the much greater quantum losses due to shifts to less productive products.

With the elimination of taxes on wages, sales, buildings, and entrepreneurial profits, the economy would take a quantum leap up to much higher productivity.

The demand for labor would surge and wages would jump to higher levels.