The case against land value taxes

Alice and Bob were both born in 1957, and became friends after they both settled in Washington, DC. In 1986, Alice bought a 2-bedroom home in the up-and-coming Dupont Circle neighborhood. Bob thought owning a home sounded like a lot of work, so he rented a similarly-sized apartment instead. His rent was cheaper than what Alice paid for her mortgage and local property taxes, and each month he put the difference into a 401(k).

Fast forward to 2016. Alice and Bob are 59 years old. Alice’s house is now worth $750,000. She’s paid off her mortgage but doesn’t have any other savings. Bob is still a renter, but over the years the value of his 401(k) has risen to $750,000.

Neither of them is wealthy, but each figures they’ll be in pretty good shape when they retire. Since Alice owns her home outright, she won’t have to devote any of her Social Security check to paying the rent. Bob expects his $750,000 nest egg to generate an income of around $2500 per month, which will just cover his rent payment.

In November, Joe Biden is elected president. The overwhelming success of Obamacare has given the Democrats large majorities in both houses of Congress. And at the top of Biden’s agenda is a cause that’s been championed by prominent bloggers like Matthew Yglesias.

A few years earlier, Yglesias had calculated that the value of all land in the United States was worth $14.5 trillion. Four years later, the figure was $17 trillion. The income tax is projected to generate taxes of $1.7 trillion in fiscal year 2018, so Biden’s advisors propose that the income tax be cut in half, with the lost $850 billion in revenue being made up with a 5 percent land value tax.

Bob likes this idea. He makes $100,000 per year and pays about $1500 per month in federal income taxes. With taxes cut in half, he’ll be able to squirrel away an extra $750 per month, increasing his retirement savings by $50,000 by the time he turns 65.

But Alice isn’t so enthusiastic. She makes the same salary as Bob and will get the same $750-per-month tax cut. But because she’s a homeowner, she’s going to owe additional taxes. The Internal Revenue Service has determined that $600,000 of her home’s $750,000 value is attributable to the value of the land underneath the home. So her land value tax bill is $2500 per month. The net change to her tax bill is $1750 per month.

Alice doesn’t have an extra $1750 lying around each month to spend on land value taxes. She can scrape together an extra $750 per month, but beyond that she realizes she’s going to have to tap her home equity to help pay the higher taxes.

But then she encounters a big problem: the value of her home has plummeted. Before the land value tax, people would have paid her $750,000 for her home, which would have meant a mortgage payment of around $3000 per month. But now owning her home means a liability of $2500 in land value taxes alone. Potential buyers take this extra cost into account, and it reduces the amount they are willing to pay for the house from $750,000 to $150,000.

Each year, Alice takes out a home equity loan of $12,000 to help her cover the added cost of the land value tax. But by her 70th Birthday, her home equity has dwindled to the point where the bank won’t lend her any more money. She’s forced to sell, with the sale netting her $30,000.

Alice is justifiably angry about the land value tax. Over the course of their careers, Alice and Bob both worked hard and saved significant sums. While they chose to invest in different assets, their investments had similar value in 2016. It’s not fair that a decade later Alice’s choice to invest in real estate would leave her penniless while Bob’s choice to invest in stocks and bonds would give him a windfall.

Advocates of a land value tax emphasize its efficiency, but efficiency isn’t the only thing that matters for tax policy. Fairness is also important. Similarly-situated individuals should pay similar taxes. A high land value tax fails this test, imposing potentially ruinous taxes on those who have chosen to invest their savings in real estate for the benefit of those who have invested in stocks or bonds.

This story illustrates another important point too: while the land value tax is paid over time, the burden of the tax (its incidence, in economics jargon) falls entirely on the person who owned property at the time the tax was instituted. The value of future taxes gets immediately priced into the value of real estate. For those who buy property after the tax is instituted, the higher property taxes are offset by lower mortgage payments.

In other words, the economic efficiency of the land value tax comes from the fact that it operates by confiscating wealth accumulated in the past rather than taxing the accumulation of new wealth. This, too, is unfair. Society benefits when people defer gratification and save for the future. People justifiably expect that if they save today, they’ll enjoy the benefits of that accumulated savings in the future. Of course, people who generate income from their accumulated wealth should pay their fair share of taxes. But a land value tax goes way beyond that point, depriving owners of one particular asset class of the benefits of decades of thrift.

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23 Responses to The case against land value taxes

  1. 1) This is a great, thoughtful post.

    2) How much of this could be mitigated through a long, incremental phase-in?

    3) I know the District of Columbia does a lot of property-tax mitigation for seniors. Could this be done nationally?

    4) Alice tremendously benefitted from the mortgage interest tax deduction and the property tax deductions. How does that factor in?

    5) Alice’s nominal payment was fixed from 1986 to 2016, which means in real terms it declined by more than half. I can’t imagine Bob was locked into his rent for three decades.

  2. borg says:

    That’s easy – if you own a property, you will be against this tax. If you rent, you will be pro this tax. At least as long as number of owner voters exceeds number of renter voters, there will be no land tax.

  3. Thanks for commenting Squarely Rooted!

    (2) An incremental phase-in might reduce the burden of Alice, but I think the fundamental issue is the same: the incidence of future taxes still falls on people who own real estate on the day the tax is announced. This is *why* the tax is non-distortionary: people can’t change their behavior to avoid it.

    (3) You could do this but I could tell the same story with a 30-year-old who just bought a $750,000 house and then can’t make her $2500 LVT payments on top of her $3000 mortgage payments. I think a high LVT is unfair to everyone who owns property, regardless of age.

    (4) You can think of the home mortgage deduction as a kind of reverse LVT: its value is priced into the value of existing homes to some extent. I suppose that mitigates the unfairness to Alice to some extent, but I don’t think it comes close to justifying a LVT that wipes out the majority of her equity.

  4. Evan Jenkins says:

    I think your assumption that the value of Alice’s house will drop drastically under a land-value tax is way off base. The whole point of a land-value tax is that Alice’s valuable land is being drastically underutilized by having a single-family home sitting on it. She should be able to sell it to a developer who will tear it down and build something useful on it—unless DC’s zoning laws prevent useful development. But this is a problem with local zoning laws, not with a land-value tax.

    If anything, the land-value tax should increase the value of Alice’s home, as it will turn homeowners from anti-development to pro-development, since they will need to sell to developers to remain solvent. I suppose forcing people to sell their homes in this way may seem “unfair,” but it’s certainly no more unfair than coercing them to make these terrible investments in the first place.

  5. Alex Bartik says:

    I think the analysis is a little bit off because you have to include the property value drop when calculating how much the land-tax would be. If you’re willing to assume immediate capitalization, then she will only be paying taxes on the new value of the house, rather than the old value. If the house value actually drops to only 150,000, and we assume the value of the land is the same fraction of total costs as before (4/5), then she will pay the 5% taxes on the new $120,000 land value, which comes to only $500 per month. Netting out the income tax-benefits, she actually gains $250 a month in this scenario.

    It’s true that the incidence of a new land tax would fall on existing land-owners, but it’s important to count both changes: i.e. you have to pay the tax, but only on the new land-values, not the old land-values.

  6. Wonks Anonymous says:

    The tax is efficient because the thing taxed is inelastic with respect to taxation. Taxes difficult to avoid are more inelastic. They are also more hated!

  7. Alex, that’s a fair point, but that’s another way of saying that a land value tax would generate dramatically less revenue than LVT advocates assume.

  8. Chris says:

    Wonks Anonymous is right, and this is just incorrect: “The economic efficiency of the land value tax comes from the fact that it operates by confiscating wealth accumulated in the past rather than taxing the accumulation of new wealth”. The efficiency comes from the fact that the supply of land is inelastic, not the fact that land accumulation happened in the past.

  9. I think those are two different ways of putting the same point. The perfect inelasticity of supply comes from the fact that you’re taxing already-existing stuff rather than new stuff.

  10. Chris says:

    The perfect inelasticity of supply comes from the fact that you’re taxing already-existing stuff rather than new stuff.
    No. No one (sensible) is arguing for ex post wealth taxes on the basis that that is “already-existing stuff”. The non-distortionary nature of land taxes is intrinsic to the nature of the good, not to the timing of the economic decisions.

  11. OK, consider the following annual tax: 5 percent of the value of each share of stock in an S&P 500 company that existed on January 1, 2014. This is perfectly inelastic in exactly the same way that a land value tax is. The only difference is that people make new stock shares, while they can’t make new land.

  12. Chris says:

    “The only difference” is the *crucial* difference. Yes, I mean you’re right that an ex post tax is non-distorinary, but not in the sense people mean land taxes are non-distortionary. Yes, there’s a transfer involved in moving to land taxes, and fairness probably dictates not making such changes instantly. But there’s no inefficiency involved there. Pure transfers that do not induce behavioral changes are not inefficient. There is DWL involved in taxes on capital on labor, and this is intrinsic to the product, not to the timing.

    Think of it this way. How much land would you fail to produce if you think there’s a possibility of an LVT? Zero. (What would it even mean?) But would you produce less capital? Yes. That’s what DWL loss is. It is not about timing.

  13. benj says:

    “Alice and Bob were both born in 1957, and became friends after they both settled in Washington, DC. In 1986, Alice bought a 2-bedroom home in the up-and-coming Dupont Circle neighborhood. Bob thought owning a home sounded like a lot of work, so he rented a similarly-sized apartment instead. His rent was cheaper than what Alice paid for her mortgage and local property taxes, and each month he put the difference into a 401(k).”

    Are you sure Bob’s rent was that much cheaper? An annuity worth $750,000 over saved 20 years with the difference? I presume Alice’s mortgage only last 20 years? Can you please produce those figures as your argument hinges on it.

    Rent is a 100% LVT. Only it is collected privately. So Bob’s been paying it all the time.

    This is also true of mortgages. They are 100% LVT privately collected. Alice paid that for 20 years.

    The capital gain in rising house prices is 100% LVT privately collected. Alice doesn’t mind pocketed that nice little bit of unearned income.

    Land/home owners do not create land values( land has no cost of production). So that value comes purely from the right to exclude, as granted by the State(that’s all of us). So if that value is privately pocketed, it is de facto a massive State subsidy. Naturally, the right to this subsidy(a title) gains a capitalized value.

    Subsidies are economically distorting. As are taxes on work and enterprise that need to be raised to support these subsidies. A real double whammy.

    Now of course, some groups do very well out of subsidies, at the expense of the vast majority.

    Poor Widows in Mansions are the human shield of bankers, landlords and the wealthiest 1% of households. Those three groups being the only real losers (although even the richest if they pay enough income tax at present would be better off under LVT).

    The number of true hardship cases are likely to be very low. They should be offered roll up and deferment.

    But, it should be remembered, that even these few cases are only transitional. The benefits of LVT are permanent.

    Economist Nic Tideman calculated the expansion in GDP of such a shift would be over 35% GDP.

    Anyway. All your Poor Widow concerns, and many more killer arguments you may have against LTV are refuted here.

    http://kaalvtn.blogspot.co.uk/

    Please feel free to get in contact if you have any questions.

  14. John Thacker says:

    I understand the point Tim, but that applies to any sort of deregulation. Do you follow that same train of logic and, for example, fully favor the tobacco farmers getting a buyout of their quota instead of it being reformed? Should the owners of NYC taxi medallions be compensated if the city decides to add more taxis? Should we explicitly pay off sugar cane and beet farmers (as well as corn farmers) if we increase the sugar import quota?

    Donald Trump, and others, hated the 1986 Tax Reform because people who had put a lot of money into tax shelters lost a lot when the laws changed.

    In practice, there are ways to distinguish the situation, but it’s not always easy.

  15. Sure, any change in policy has distributive consequences, and we should take those into account. I would have some sympathy for small businesses who invested in medallions and then were driven to bankruptcy when the medallion system was abolished. Still, I don’t think these cases are exactly parallel. Liberalizing taxi licensing rules dramatically expands the economic pie, and reduces the wealth of existing medallion owners incidentally. In contrast, the explicit purpose of the LVT is to take cash out of the pockets of land owners. It seems to me the former is both more compelling morally and also is likely to produce larger efficiency gains.

  16. benji says:

    The value of stocks and shares are the result of work and enterprise. Taxes on those means less investment, means lower growth.

    No work or effort by landowners produce the value of location. Only the right to exclude does that. As granted by the State.

    Which is why, asking landowners to pay the full market rate for this privilege is not a tax (with the associated dead weight costs). It is a user fee.

    Indeed, by ending what is an implicit State subsidy, you get a more efficient allocation of property resources. This helps grow GDP.

    There are those who have grown fat on the free lunch of Land values. Naturally, like most people, they don’t like the idea of going on a diet :)

  17. benji says:

    @John Thacker

    The economists who set up the Chicago School, funded by JD Rockefeller, were not only against the Single Tax as proposed by Henry George.

    They also though the abolition of slavery, without compensating the Slavers, was an illegal act that infringed property rights. The rights of humans to a) be free b) be compensated for their labour, seemed to take second place.

    Imagine the Poor Widow who had bought her slaves out of earned income, and was looking forward to her retirement. Her equity cruelty snatched away by iniquitous do-gooders. Most un-American. At least us Brits got that right and paid full compensation ;)

    Men like Frank Knight had their noses in the trough and morals in the gutter.

  18. Wonks Anonymous says:

    The University of Chicago was founded in 1890, well after the abolition of slavery. A bit odd for them to be complaining about it at that point. Do you have a cite for that claim? I’ve read some Frank Knight on ethics, and don’t recall him making any such argument.

    Also, Milton Friedman called Henry’s George’s single tax the “least bad tax”.

  19. benj says:

    @Wonks

    http://homepage.ntlworld.com/janusg/coe/cofe08.htm

    Knights position wasn’t about the ethics of slavery per se, rather the definition of Capital and property rights.

    Knights misanthropy was certainly not along racial lines, to be sure.

    The only reason I’ve brought this up is to illustrate the same reasoning as those who think LVT is unfair because it takes away someone’s equity.

    It never was their equity. Legal title or not.

  20. John Thacker says:

    To take a more relevant recent example, what about efforts to end the large subsidization of flood insurance for people who own (often expensive vacation) homes in flood prone areas? Obviously people who own those homes would see their property values go down as their taxes shoot up if reform happened– which is why the Congress just postponed, in a bipartisan fashion, the reforms it adopted just a year or two ago. (The opposition to repealing the reform was almost entirely Republicans; the reform was only adopted in the first place because of threats to block reauthorization of NFIP if there weren’t reforms.)

    Do you think that the NFIP reform under Biggert-Waters was a bad idea for that reason?

  21. Your supposed like-for-like comparison with A and B is quite laughable as they have not behaved the same at all.

    I assume they earned the same and paid the same taxes on their wages, but

    a) Anne bought a home, you can index prices backwards, it cost her perhaps $200,000 in 1986, so her mortgage payments would be about $1,000 a month for twenty years and then she’s paid off – what has she been doing with her spare income since 2006?

    b) Bob’s rent must have started at about $800 a month and is now $2,500.

    “His rent was cheaper than what Alice paid for her mortgage and local property taxes, and each month he put the difference into a 401(k).” which is now worth $750,000.

    You are going to have to rework this! Don’t tell me that $200 a year for ten years or so when Bob’s rent was cheaper is enough to give you a fund of $750,000!!!!!

    So Bob has clearly been paying in a lot more in rent + savings than Anne has paid in mortgage.

    Secondly, apart from the fact that Anne has clearly spent more of her cash income month by month (Bob pays $2,500 rent, she has no mortgage, Bob is saving money, she isn’t) she has also consumed twice as much in housing services since 1986, as she has a house and Bob has a flat.

    So without land price inflation (gaining her $550,000 tax free) we would expect her to be far worse off than Bob – she has consumed much more and spent much more and Bob has consumed less and spent less.

  22. Pretzalcoatl says:

    From a market perspective, it’s impossible for Bob’s rent to have been cheaper than the mortage + property taxes on his apartment, otherwise his landlord would be losing money on the deal.

    So Bob’s rent is necessarily higher than Alice’s mortage + property taxes, and Bob doesn’t actually have savings with which to invest in a 401(k), and therefore after 30 years, Alice has an asset worth $750,000, and Bob has much less.

  23. Derek R says:

    Pretzalcoatl, you need to read the posting more carefully. It clearly states that Alice lives in a house while Bob lives in an apartment. That is one reason why his landlord is making money on the deal even though Bob’s rent is less than Alice’s mortgage + property taxes.

    Another possibility is that Bob’s landlord bought the apartment many years ago and paid it off long before Bob moved in, so Bob’s landlord only has to cover the property taxes and a little profit. There are reasons why a landlord might do that for the right tenant. And Bob sounds like the right tenant to me.

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