The Taxable Capacity of Land
& The Dead Weight of Taxation

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& The Dead Weight of Taxation
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Mason Gaffney

Emeritus Professor of Economics, University of California (Riverside)

Glasgow, February 25, 2015

The Scottish Government has appointed a Commission on Local Tax Reform to search for fairer systems of local taxation. The Commission’s remit includes an examination of “The revenue raising capacity of the alternatives at both local authority and national levels”. I will explain that there can be no doubt that there is sufficient land-based revenue to enable government to substitute public charges on rent to replace most of the present array of taxes. I will also explain that such a reform would be better than “revenue-neutral”.  In reality, all the evidence demonstrates that fiscal reform can be revenue-positive, if implementation is not botched.

“Land” is defined broadly to include all natural resources within the sovereignty of Scotland, regardless of the form of tenure, and all exclusive private privileges with a locational component.

Treating Rent as Revenue

“Conventional wisdom” says that treating rent as the fiscal base is a novelty, thus enlisting fear of change against it.  That fear is the product of what has been called “the manufacture of consent” and “brainwashing”.

Evidence from the former British colonies demonstrates the opposite: a drastic shift away from land revenues in our times: in the U.S.A. and Canada; Australia, New Zealand, South Africa.

The texts of Scottish and other classical political economists favoured land as the base for public revenue. But there have been drastic changes in economic doctrines. A central feature of this shift has been the deletion of land as a distinctive factor.  Consequently, current estimates of taxable land values fall far short of the mark.  This is the result of a variety of devices. These include –

  1. techniques for misrepresenting the scale of land value, using the “land-residual” method of separating land from building value.  Alfred Marshall, the dominant economist of late Victorian and Edwardian times,  emphasized in his Principles of Economics that valuers should assess land values first, as though the land were for sale bare, when dividing real estate value between land and buildings.  This is the “building-residual” method.
  2. falling into the Rothbard Fallacy: the claim that “tax capitalization” destroys the land tax base faster than the tax rate rises
  3. catering to income-tax avoidance by over-allocating real estate value to depreciable building value. There are several such techniques. They originated with income-tax avoidance, and have bled over into local property tax assessments.

In the United States, property owners not only over-depreciate their buildings, to under-report their taxable incomes,  they do it again and again, quietly, each time a building changes owners.  They bleed land value into building value.

ATCOR

Taxes on wages, profits and consumption have the effect of lowering land rents and values by at least as much as what they would pay by direct taxes on rents. This means that, in reality, most revenue from conventional taxes are actually derived from the rents in the economy. This is the ATCOR thesis

“ATCOR” (All Taxes Come Out of Rents) may look novel and therefore scary, but its lineage is shown by its other name, “The Physiocratic Doctrine of Tax Incidence”. It dates at least from Quesnay and Turgot and is found in Adam Smith, their student.

Thus (for the sake of argument) if

  • government revenue was (say) 30% of national income; and
  • if the amount of rent that is circulating in the private markets is of the order of 20%, then
  • the total taxable capacity of the economy is half of national income. Rent, in all its forms, constitutes something like 50% of national income.

EBCOR: Excess Burden comes Out of Rent

But there is more – much more.  EBCOR is the acronym for the theory of “excess burden” – the losses that arise from collecting revenue by means of conventional taxes.

Taxes on wages, on profits and consumption have the effect of lowering land rents and values by MORE than what they would pay by direct taxes on rents.

Adam Smith gave a strong hint at the gains to be achieved if the State levied direct charges on the occupants of land. The Land Tax would overcome what Smith called the “indolence of landowners”.

  • Smith’s “indolence” might seem to mean their laziness and ineptitude as managers, keeping their lands from highest and best use, but he covers that elsewhere.
  • Smith’s “indolence” means the inability of landowners as statesmen to analyze tax shifting, and to see that the excess burdens of non-land taxes are shifted to them as rent-collectors.

This excess burden often takes the extreme form of total disuse of land. More generally it takes the form of underusing almost all land.

These excess burdens are

  • equal at least to the total of visible burdens. And
  • they are probably much more, when we trace all their indirect effects, and their extended effects over time.

The benefits from replacing the “excess burden” of taxes are trivialized by economists such as  Arnold Harberger of the University of Chicago. Harberger expounds his point in a simple supply/demand template which understate the damage inflicted by taxes. His welfare thesis treats

  • all excess burdens are only marginal.
  • His model rules out quantum leaps, as when parking lots pre-empt central land from high-rises.
  • It rules out temporal leaps, as when site renewal is delayed for decades, and sometimes forever, as when owners hope for a higher ratio of revenues to costs.
  • It overlooks the social cost of aborting the synergistic effects of complementary land uses.

As to the intent of writers who use such devices, one cannot read their minds. But some are quite overt.  James Buchanan, for example, is a Nobel prize economist who regards government as a beast. So he explicitly favors taxes with maximal excess burdens in order to encourage voters to “starve the beast”.

Aborted Benefits

To formulate alternative funding strategies, it is necessary to revisit the issue of aborted benefits. These issues include –

  • The tendency to treat all taxes, including the land value tax, as though they were sales taxes.  This is the Laffer Fallacy To Arthur Laffer and his patrons and believers, a tax is a tax is a tax, all based on gross sales, all imposing excess burdens that rise with tax rates.  One cannot impute this to innocence: because, in rising to be Ronald Reagan’s top counselor, he quoted extensively from Henry George himself.

 

  • Taxes have been called “better than neutral”: the observation by Prof. Nicolaus Tideman
    • Policy-makers need to reassess aspects of the market, such as how taxes can be devised to overcome the perverse effects of credit rationing. Rainer Schikele said it tersely: loans are not attracted by marginal productivity, but by collateral security. Thus liquid capital does not seek its own level, but flows uphill to where it is least needed.

 

  • Broadening the tax base. There are HUGE benefits to be gained by basing taxable land values on highest and best future use of land, as Alfred Marshall wrote. Bear in mind that when land buyers bid for land they subtract from any bid the present value of all anticipated future taxes on the new building, and as well, all the taxable activities that will take place in the new building. To untax all that is to raise bid prices, and thus the land tax base, by a huge factor.

The Rich Diversity of Rent-generating Services

Taxes on existing private land tenures greatly understate the tax base, i.e. the market values of those tenures. Many de facto tenures are not taxed or charged at all, although they could and should be.  Here are a few.

  • A tax or other public charge on pollutants.
  • A carbon tax to combat global warming.  Peter Barnes in Who Owns the Sky? estimates that it alone could replace most other taxes, taxes of ALL kinds.
  • Existing Pigovian taxes on all manner of air pollutants, have not raised much if any revenue, because the ideas of Pigou were perverted into the present “cap and trade” approach rationalized by theorists like Ronald Coase at the University of Chicago.
  • Pollutants that drift over property lines and cannot be measured. The dominant approach today, if any, is to pay landowners to stop; rarely if ever to charge them for continuing.

 

  • Charges for curbside parking.

 

  • Don Shoup’s book The High Cost of Free Parking estimates the revenue potential as equal to the present revenue from property taxes.
  • Charges for other private uses of city streets. Dick Netzer in his definitive Brookings book The Property Tax referred to these as “A Family of user charges”, which he would substitute for taxes on buildings (while raising tax rates on land values).  Later writers have realized that these “user” charges are mainly charges for preempting land on the public streets, which take up 30% or more of the space in most cities.

 

  • Charges for the use of water. The value varies according to whether it is surface waters, natural or recharged; used for recreation and viewing; falling, and therefore generating power Public budgets would gain by withdrawing current subsidies, which lead to the waste of water – the opposite of conservation
  • Rents from navigation and rights of way
  • Habitats Annual charges for fishing licenses. Hunting and trapping licenses.  In many states in the US, landowners rent out hunting permits.  Bird-shooting is big business in many areas.

 

Taxable Capacity of Rent-generating Resources

 

Rental value must be imputed to owner-occupied land.  The value is what can be realized in the market. This means the constraints of zoning (planning) affect taxable value of land that may be used for residential purposes, or confined to recreational use.

 

Loopholes that allow the unearned part of personal wealth need to be removed. For example, exemption of capital gains at death (aka “The Angel of Death Provision”).

 

Preferential access to public domain is of value, for which the beneficiaries should pay.

 

Locational value of farmland near cities.  What are called “Agnew Laws” in most U.S. States place a cap on the taxable values of peri-urban farmland, thereby reducing the assessed values well below current market values.  (Agnew was a prominent Maryland politician and later vice-President under Nixon who pushed through the first such law.)  Lazy researchers then tote up assessed values as measuring the market value of farmland.  The “Agnew Premium” includes:

  1. advantage of being near farm supplies and storage in cities
  2. Advantage of access to urban commodities and amenities and services
  3. Advantage of access to urban labor pools
  4. Proximity to markets, wholesale and retail, for farm outputs
  5. Premium value of prospect for conversion to urban use
  6. Premium value of riparian locations for recreation

 

Assessing the value of access to wind that generates power. With the increasing diversity towards “clean” energy, such as capturing the wind, land located in situations exposed to those winds will rise in value, in the way that a premium is already paid for land that gives access to sunshine and southern exposures. A premium is already paid for photosynthesis as a farming value, but we are just beginning to see the market value of photovoltaics – as Fred Harrison and I observed on our trip to Vegas. $1,000 per acre for “worthless” desert scrub land! There is already a war between environmentalists and power developers for Death Valley itself!  It is a perpetual, inexhaustible mine of solar energy.

 

All land value premia enhanced by use of land for collateral. The value premium is a part of the market value of every piece of land.  Some lands (e.g. “trophy” properties) provide greater premia than others, explaining why they trade at higher Price/Rent ratios than others.

Unrealised capital gains: as with the appreciation of land values in the year of appreciation (known as Haig-Simons income).

Remember: Land rents can be taxed by methods other than property taxes

  • Severance or yield taxes on extractive resources
  • Rents for leases of public land: cf Hong Kong
  • Adding to tax base the premium value added to private lands that give preferential access to public lands
  • Personal Income taxes
  1. a) —-State and local
  2. b) —-Federal or national
  • Corporate income taxes

Transitional Arrangements

If, as an interim measure before switching to a full rent-based revenue system, it is necessary to raise a tax, then better to raise corporation tax than, say, the VAT; because the corporation tax

  • derives more revenue from rent-generating assets, and
  • reduces the regressive burden on low-income earners.

 

 

Summary & Conclusion

North America is full of ethnic Scots, descendants of crofters who were “cleared” from their ancestral homes to make way for lairds, first, and now for the super-rich of every nationality. There is no good reason for today’s Scots to grant lower taxes to the current usurpers to help them under-utilize Scottish lands.

 

An enlightened reform of the financial system requires a systemic approach. Piecemeal treatments may be needed for the initial steps, but there is a clear and present danger of politicians being happy to settle for those small changes.

 

The people have to remain alert, and that means they must have a clear vision of what they want to gain out of tax reform.

 

I have argued that, by definition, there is sufficient revenue to facilitate the transformation of the taxes that damage the economy.

 

Under the present tax regime, governments are irresponsible, locked into a fiscal system that is smoke-and-mirrors. They are ultimately raising their revenue from rent, but they are doing so by using other names, and by other routes. This, consequently, causes extreme losses to the wealth and welfare of the people. The people of Scotland need to examine all of the implications of that current approach to High Finance, to decide whether they want to break away from the legacy that has been bequeathed to them by those who vanquished them from their birthrights.

 

 

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