Thursday, 1 June 2017

A Fairly Good Policy - It Just Needs A Bit Of Tweaking

Generally I should imagine I share the same kind of views as the guys at the Adam Smith Institute when it comes to land value tax - that it is far from perfect, but better than many of the taxes we currently have. Sam Bowman has an article out today on the subject of land value tax, which is by and large on the money - but he does fall foul of a couple of blips in his reasoning, which I'll touch on in a moment.  

Firstly let me explain the plus points of land value tax, and why it is one of the least bad taxes. Some taxes hurt people more than others, and it's not always the case that the more you are taxed the more it hurts. Consider these two hypothetical taxes, for example:

Tax A: Shampoo is taxed at £0 per bottle.
Tax B: Shampoo is taxed at £10,000 per bottle.

Under Tax A, everyone pays zero. Under Tax B, nobody can afford shampoo, so everyone still pays zero. But Tax B hurts us more because it leaves us with greasy and itchy hair.  

Admittedly, that hypothetical example is an alarmingly simple one, but the same wisdom extends throughout the economy: tax doesn't just hurt in terms of what you pay; it hurts in terms of negative things you do or don't do when tax enters the equation. If you tax something, you generally get less of it. Tax ice cream consumption and people eat fewer tubs of ice cream, tax incomes and some people work less, tax profits and entrepreneurs make fewer investments.

For this reason, some people think land value tax is one of the least harmful in terms of the above criteria. Land value tax is a tax on the value of land irrespective of what has been built on it. Because the supply of land is fixed, many argue that taxing land is the least distortional source of public revenue. It was certainly liked by many great economists, from Adam Smith to David Ricardo to Milton Friedman. Institutions like the IMF, the OECD and the IFS’s Mirrlees Review have also claimed to support it, at least in principle.

The good things about it are it doesn't dissuade economic activity - the richer tend to have more land than the poor so will contribute more, and it's an uncomplicated tax because it is hard to evade or avoid, and fairly simple to administer.

Unlike the Labour Party, who just want this to be yet another tax, a better way to introduce land value tax would be to bring it in as a replacement for taxes like council tax, business tax, stamp duty, and so forth, with tax being linked to the value of the land you own.

But like all taxes, however good, it is also imperfect. For example, some people are not hugely wealthy but own land (and the house on top of it) in expensive areas. It is not ideal to tax them based on the rental value of land if they can't afford the tax.

Here's how I would work it
Despite its imperfections, I have my own ideas about how it could work, at least as a kernel of a suggestion. This is how I would pilot its introduction. Every piece of land in the UK is assessed for its rental value, based on everything from location to raw materials, and owners of the land pay a proportion of that value in tax. So a piece of land in Mayfair will be most costly than a piece of land in Ipswich.

To understand why this is so important, let me give you an idea of how the land lies (pun intended) at the moment. The UK is 60 million acres in size, and the population is 65 million people, which equates to just under 1 acre per person. However, the land is not divided up to equate to 1 acre per person. Less than 1% of people own 70% of all the UK land (mostly comprising Aristocrats, Baronets and the Landed Gentry). Yet the average Brit lives on 340 square yards which totals about 8% of the entire land, which would translate as 12.5 people per acre instead of 1 person per acre.

Let me tell you a stat I learned from Dominic Frisby: apparently each UK home pays an average of £550 per year council tax (to live on 7.7% of the UK's land) while each land owning home receives just over £12,000 in subsidies, and 158,000 families own 41 million acres of land while 24 million families live on just 4 million acres.

That means that we'd have a tax system that in some way levies people according to their land value (so as is already desired cross-nationally, the rich will pay more tax than the poor).  Then each political party could commit to a spending plan, lay down a figure (say the Conservatives quote £500 billion per year over a 5 year period), and then work out the rental value of the land, charging a proportion of that in tax sufficient to cover their spending costs.

Suppose the total land value is £5 trillion, then for a spending plan of £500 billion the annual tax ratio will be 10% of total land value, divided up by who has the most land. The tax wouldn't dissuade work or hamper innovation - it would be the only tax collected.

And when you think that an acre of unimproved land worth a few thousand pounds can be developed to be worth a few millions, it would incentivise people to make the best use of that land. However, this is where Sam Bowman starts to get in trouble with the idea:
"One false claim made in favour of the LVT is that it would force the land to be used ‘more productively’. But there is already a sort of ‘tax’ on owning land and not using it as productively as possible: opportunity cost. If you choose to use your land as a garden instead of a block of flats to rent out, you are ‘paying’ the cost of doing so in the rent you’re forgoing."

No, this is wrong wrong wrong - and quite unlike Sam. There are a number of glaring errors here. The first one is that just because opportunity costs exist, that does not mean they are strong enough to change the behaviour of preventing actual costs. If you don't build on your land you forego rent in terms of opportunity costs. But if you have to pay tax in order to keep the land undeveloped, then the costs play far more in your incentives, quite aside from any opportunity costs.

Sam's argument is the equivalent of saying: Every time John parks his car under the tree in his garden he comes out to find it covered in bird poo (land value tax). He also forgoes the chance to park the car one mile away and get some exercise walking back (opportunity cost). Because there is already the opportunity cost of parking under the tree in terms of foregone exercise, the bird poo will not be enough of an incentive to park the car away from the tree.

The other major error from Sam is when he says "If you choose to use your land as a garden instead of a block of flats to rent out, you are ‘paying’ the cost of doing so in the rent you’re forgoing". This is almost certainly false in the case of most people with unimproved gardens (unimproved is the term for land that has not been developed to increase its value). The reason being, it ignores the major costs associated with making yourself able to earn money from renting property - namely the capital required to build the flats on your land, the planning permission, and various other use of resources. You can't talk of opporunity cost of unearned rent without factoring in the capital costs - costs that are not available to the vast majority of home owners.

Then we move on to Sam's next dodgy statement, where he says that future taxes will capitalise into the value of the land today and be entirely borne by the land owners, not the renters. He's right that taxes will rise due to land value inflation, but there is no obvious reason I can think of why renters won't bear some of the cost of the taxation, because we already have a tax system where consumers bear the brunt of most tax increases. Corporation taxes, sales taxes and minimum wage taxes are largely borne by the patrons of the business to which they are associated, and that's what would happen in the rental sector too. Any land value tax on homeowners would be reflected in the rents landlords charge their tenants. I have no idea why Sam Bowman isn't seeing this.

You may therefore think that land value tax will push up rents - which it might in the short term, but that may well be offset by more properties available on the market as land owners are more incentivised to develop their land - so much so that long term this could actually drive down rent prices. If those 0.6% of the population that own the land want to retain it they can pay the community for it; if they don't they can sell it to others who will put it to good use.

Another benefit of the land value tax is that there would also need to be far fewer people employed by the government to collect taxes, and the system under which tax operates would be much simpler - all that would be required would be assurance that land is being valued properly.

Incidentally, Singapore has a tax system much more to my liking - an income tax that rises incrementally but has a limit of 20% for those earning over S$320,000, it has a 7% vat rate and no capital gains tax or corporation tax. And yet the World Economic Forum rates it as one of the world's best country in terms of a competitive economy, infrastructure and economic freedom (there's a pattern there)

In summary, while no tax is perfect, there are few good reasons why land value tax is one of the least bad taxes, on account that it: taxes consumption not productivity, incentivises land owners to make the use economic use of their land, spreads wealth across the country with the richer picking up a bit more of the burden, is a tax that's hard to avoid, evade or conceal, is fairly straightforward to administer, keeps a check on government spending, and taps into lots of the 'uncultivated value and unearthed economic growth that's still in potentia.

Land value tax is a tax on consumption not on production, which is a preferred way to tax people because it doesn't deter productivity. The only thing is, we should push this much further - we should work towards land value tax being the only tax in the UK, and double it up with national policy where a government has to promise to govern with tax revenue that does not exceed the total land value divided by their public expenditure pledge. That way, there'd be a tax system that encourages economic growth by encouraging productivity, and at the time holds the government to account on their spending.