Friday, November 10, 2017

Taxing Land

I’ve been meaning to highlight this, but better late than never (excerpt):

Faster Growth Begins With a Land Tax in U.S. Cities
This would lower land costs, encouraging affordable housing and more density.
By Noah Smith

…In cities, especially large metropolises like New York and tech hubs like San Francisco, the land under a building is often worth a lot more than the buildings itself. When a city gets denser or more desirable, lucky landowners reap windfalls as land prices appreciate. But these windfalls aren’t just unfair -- they raise both rents and housing prices, pushing potential new residents out of a city and choking off its growth.

So it makes sense to tax the value of land. A land-value tax, or LVT, is like a property tax, but with a deduction for the value of buildings and other improvements. The tax would reduce land prices and increase the incentive to build more, which in turn will help drive down rents, making a city more affordable. And because land is a fixed quantity, taxing it doesn’t shrink the economy like taxes on wages and capital sometimes do. Also, since you’re taxing a windfall, it’s hard for landowners to argue that the tax isn’t fair. The money raised with a land-value tax can be spent building affordable housing for the poor.

Therefore, a land-value tax is an efficient and fair way to take a city that now works only for lucky prosperous landowners, and turn it into a place where the working class can afford to make a decent life….

…In the U.S., Pennsylvania is the LVT trailblazer. More than a dozen cities in that state use split-rate taxation -- one tax on land value, and a lower rate on improvements, such as buildings. Some of these experiments, like the one in Altoona, have failed, probably due to ineffective implementation and businesses’ failure to understand the novel tax structure.

But in Pittsburgh, a large city where valuable locations are scarce, the tax has been a success….

I’m thinking about this because the way property is taxed in Malaysia is grossly inefficient. Quit rent shares some features of an LTV – higher quit rent for higher value added land – but it’s too low to be effective and doesn’t scale with investment in structures nor does it vary with location (much). Assessment does vary, but is also too low, and is based on estimated rental income not the value of the land. As a result, there’s no incentive to increase density or build affordable housing, since that increases the tax liability, not reduce it.

A land value tax (LVT) operates differently. The tax is levied on the total market value, less the value added of the structures on top. That automatically creates an incentive to increase density in the most valuable locations, improving access to housing.

More importantly, an LVT captures the positive externalities of rising land and house prices. Land valuations are benchmarked against current transactions. What that means is that the sale of a house or office in a particular locality would raise the value of ALL the houses and offices in that locality, thus adding to the net wealth of land owners without them lifting a finger. That windfall  can and should be taxed. The alternative is to have a more or less permanent wealth transfer from new home buyers to existing home owners, and by extension, from the poor to the rich, from the young to the old and from all future generations to the current generation.

Adding a tax credit for land improvements and structures takes it one step further. The more value you add to the land, the less tax you pay, thus creating an incentive to maximise the total value of the property. Or to put it another way – a street of bungalows in central KL would pay more tax than if a set of townhouses or condos were built on the same street. An LTV automatically taxes the rich more than the remaining 99%.

It’s an elegant solution, but comes with a big caveat – valuation. Valuation of the total market value, valuation of structures and improvements, and sticky questions like what happens if valuations actually fall (i.e. procyclicality of tax revenues) and who is doing the valuation. Nevertheless, even these caveats are worth confronting, because the current system is that much worse.

2 comments:

  1. Wow, sound like this form taxation is really worth a closer look.

    I always learn that taxation always lead to deadweight loss and in this case, what are the potential deadweight loss?

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    Replies
    1. @CJTeh

      That's largely the beauty of land taxes - there isn't any deadweight loss, because the supply of land is perfectly inelastic.

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