An Introduction to Land Value Taxes

Let’s review. As I’ve discussed before, a key parameter when discussing taxes is the elasticity of the tax base to the tax rate. For example, if you tax people’s income more, they will work less. But this is just one example of a larger idea: barring tax avoidance, if you tax something, the cost of supplying it goes up, so less of it will be supplied. The supply-side elasticity simply measures how much less of it is supplied.

I proved last time that the equation for a revenue-maximizing flat tax (like is used in value-added taxes or property taxes) is 1/(1+e), with e being the elasticity. As we can see, the revenue-maximizing rate varies inversely with e. So we would like to tax things with a low elasticity a lot, since we could get a lot of money out of them without much economic distortion, or deadweight loss as economists say. Now, it wouldn’t make sense for anything to have a negative elasticity. But what if some good has an elasticity of 0? Well, then the revenue-maximizing rate would be 1/(1+0) = 100%. In other words, we could collect all of the value of that good in taxes without any distortions.

The Perfect Tax

Crucially, these land rents don’t just include income from things like oil or being by a nice lake. Think of a property in the suburbs versus a property near New York City. Let’s say both properties have the same structures: houses, stone walls, whatever. And, say they have the same square footage and type of land. Which property will be more expensive? If you’ve ever looked at home prices there, you know the answer would absolutely be “the one in the city”. But how could this be? The structures, amount of land, and type of land are exactly the same. Well, there is one difference: the location. Demand for locations near the city are higher, so of course the property will be more expensive. The amount of locations/space is, of course, fixed.

Econ 10… something

Again, it’s important to emphasize that these agglomeration effects do not come from the landowner. To quote Adam Smith, “the landlords, like all other men, love to reap where they never sowed”. If I own land in New York City, its value comes from all of the people, business, and infrastructure around it. This framing shows why landlords can’t deserve land rents: there is no sense in which the value is due to them. Now of course, I could make my land more suitable for construction by flattening it for example, and this would increase its value. So I should be clear that when talking about land value taxes, I mean the unimproved value of land: value that comes from location and natural resources alone.

A common response to a land value tax (LVT) is: well, won’t landlords just raise rent if we tax land? It’s counter-intuitive, but the answer is no. Think of it this way: taxing land doesn’t change the demand for it. And the supply of land is constant. So, as long as supply and demand truly determine price, then the price for renters must remain the same too. The tax is therefore entirely paid by land owners. In other words, the tax doesn’t raise the profit-maximizing price, and it doesn’t lower land rents.

Rent vs. Value

Importantly, these rents are based on the most productive possible use of the land. So it doesn’t matter what you’re actually using the land for, the LVT would be the same. This makes sense: you’re welcome to misuse your land, but the community should be compensated for this loss in economic output. A LVT would also encourage efficient land usage and development. At the moment, a landowner can just hold onto a plot of land and do nothing with it, paying very little in taxes and probably selling it for a profit years later. This is why you sometimes see empty plots even in growing cities. But under a full LVT, the only way a landowner doesn’t lose money from owning land is if they put it to productive use.

Conclusion

Economics and welfare knower.