Land rents in lieu of taxes for public revenue：
the forgotten advice of Sun Yat Sen and Adam Smith”
Terry Dwyer & Dirk Loehr
1.
The forgotten insights of the classical economists
Land and capital: The big confusion
The theorem that a tax on rent cannot be shifted is the oldest theorem in economics, dating
back at least to John Locke (1692). As the French Physiocrats realized in the 18th century
when they sought unsuccessfully to reform an oppressive French tax system ahead of a
revolution (Turgot was dismissed as Finance Minister in 1776), this followed from the fact
that land had no cost of production and no cost of supply. The rent of land was thus a free
surplus to be taken by the sovereign as a natural revenue to sustain good government. In
addition, John Locke also formulated the proposition that all taxes come out of rent, a
proposition which was taken up by the Physiocrats and, properly understood, can be traced
through Adam Smith to twentieth century theories of the incidence of taxation as falling
on infra-marginal surplus returns to a factor of production.
Land rent as public revenue and taxation have thus been closely connected from the
inception of economic theory. The story about land and taxation starts with the perception
of the importance of land as a fundamentally free factor of production where its price
(rent) serves only to allocate it to best and highest use, not to bring it into existence, unlike
physical capital or labour supply. In the case of labour and capital, their factor returns
(wages and profits) perform two economic functions, to call forth supply of the factor and
to allocate that supply to its most productive use. By contrast, rent allocates land; rent
does not call land forth into being. As Adam Smith (1776) recognized, this was a vital
distinction in terms of revenue or tax policy and he was followed by James and John
Stuart Mill among many others, including Henry George (1912).
In contrast to the classical economists, the later neoclassical economists confused physical
capital (buildings, plant and equipment, houses, etc.) with land, despite warnings from
masters such as Alfred Marshall (Marshall 1890-1920) 1 and Eugen von Böhm-Bawerk
(von Böhm-Bawerk 1921)2. This was particularly due to the influence of John Bates Clark
(1893) and Frank Knight (1946/1951), who took a contrary stance to Henry George (1912)
on this question. Clark, in particular, was clearly trying to take a pseudo-ethical argument
(that wages invested in land should be treated as sacrosanct in the same way as wages
invested in physical capital) into a scientific argument (that land is the same as capital)3 ,
an argument which was scathingly rejected by economists as diverse as Marshall, BöhmBawerk and George. Thus the term “neo-classical” is a misnomer, it was more a “anticlassical” regression which buried important insights from classical economics (cf.
Gaffney and Harrison 1994).
1
Classical economists knew, that, in contrast to capital, “no man made the land” (John
Stuart Mill 1848, book II, chapter II). Land in the classical sense comprises all natural
resources, including the site value of land4 and the other free gifts of Nature such as water,
minerals or the electromagnetic spectrum. (Some modern writers add “intellectual
property rights” as a sort of “virtual land”, since they have many features in common with
private property in physical resources, but this confuses legislated monopoly with natural
monopoly arising from natural as opposed to man-made scarcity) . Land has features of a
monopoly, according to the classical understanding of this term. However, although land
assets are a key for market access, they are not “absolute monopolies” in the common
sense because they are exposed to competition to a certain degree (Gaffney, 1994;
Foldvary, 2008). In contrast, by capital is meant all man-made means of production, such
as buildings, machines and physical infrastructure.
The supply of physical capital can be increased, the supply of land cannot. If, for instance,
an entrepreneur producing desirable products makes a super-normal profit, competitors
may contest the market, in the absence of legislation creating or conferring a monopoly.
The supply of manufactured products will increase and super-normal profits will be
brought down by competition to a normal level, as the market is satisfied (Adam Smith‟s
“effectual demand”). Thus, profit maximization in competitive markets serves the public
interest by bring about abundance of supply at the cheapest possible price.
By contrast, this is not true where there is legislated or natural monopoly. If a higher
demand for land emerges, the supply of land remains the same (at least in case of a rigid
land use planning). However, the yields of the land (land rents) and land prices will rise.
Adam Smith thus saw land in general as evidencing a monopoly, demand-determined,
price (because no one could make it) and in some cases, where no other land would do
(such as rare vineyards), a special monopoly price.
Some may argue that this is also true with computers, machines etc. where oil, rare earths
and other resources are used in making the product. This is basically true insofar as the
production of computers, machines etc. might be restricted or their prices higher due to
such scarce resources. However, this restriction is set by land scarcity and not by capital
scarcity and the monopoly returns flow to the landholders, not the computer
manufacturers. Thus the classical doctrine was that rent does enter into the price of
particular products but rent is no part of the real cost of production. Rent serves to
allocate land to its best use (rare earths to computers) and appropriates a surplus for its
owners but, from a social point of view, that surplus does not need to be paid to
landholders to bring land (such as rare earth mineral deposits) into existence.
Adam Smith took up the Physiocratic analysis and agreed that all prices resolve
themselves into the rewards of the factors of production which make the product. Given
free competition, any disequilibrium surplus to any factor will be eventually competed
away. Thus all prices resolve themselves into the rent of land, the wages of labour or the
profits of stock (physical capital). Considering taxation, all taxes thus resolve themselves
into taxes on the incomes of the three factors of production, land, labour and capital.
However, capital and labour can wear out, die off, fail to reproduce, or emigrate. There is
only one public revenue base which cannot flee in response to a higher tax burden – this is
land. Thus collecting public revenue from the rent of land is an old idea. Already the
French Physiocrats had proposed land rents to be the financial base of governmental
2
spending (“impot unique”). Taking the land rent by land value taxation as an idea was
adopted by Adam Smith, John Stuart Mill, Henry George and other classical writers in the
past. However, later economists such as Harry Gunnison Brown, Harold Hotelling,
William Vickrey, Milton Friedman and Martin Feldstein (the Chairman of President
Reagan‟s Council of Economic Advisers), have also all accepted that a land value tax is a
theoretically ideal tax. Interestingly, land value taxation or the public appropriation of rent
has also been espoused by people as diverse as Winston Churchill, Count Leo Tolstoy and
Dr. Sun Yat Sen who said that
“When modern, enlightened cities levy land taxes, the burdens upon the common
people are lightened, and many other advantages follow. If Canton city should
now collect land taxes according to land values, the government would have a
large and steady source of funds for administration. The whole place could be put
into good order.
But at present, the rising land values in Canton all go to the landowners
themselves -- they do not belong to the community. The government has no
regular income, and so to meet expenses it has to levy all sorts of miscellaneous
taxes upon the common people. This burden upon the common people is too
heavy; they are always having to pay out taxes and so are terribly poor -- and the
number of poor people in China is enormous. The reasons for the heavy burdens
upon the poor are the unjust system of taxation practiced by the government, and
the unequal distribution of land power and the failure to solve the land problem.
If we can put the land tax completely into effect, the land problem will be solved
and the common people will not have to endure such suffering.”5
Newer insights
While the classical theorists saw that land rents could be taxed or taken as public revenue
without the deadweight loss attributable to other taxes and that land value taxation was
therefore uniquely efficient, arguments are now emerging that land values should be taxed
or collected as public revenue in order to:
- achieve an optimal financing of public goods and
- avoid a diversion of savings into sterile land speculation instead of physical capital
formation.
In particular, the question of housing bubbles (more properly described as land bubbles)
and how to deal with them has come to the fore as desperate Western central banks trying
to stimulate economies through super low interest rate regimes find themselves financing
ever-growing bubbles with increasingly shaky banking systems becoming hostage to
bubble values. (This ought to be an obvious result from the fact that land is valued by
capitalizing its rent at the market rate of interest – a hypothetical permanent zero interest
rate means an infinite land value - but seems to have taken some central banks by surprise
so that some, as in New Zealand, are now trying to limit credit for real estate purchases).
The nature of land rents
But what are land rents? Land rents emerge due to differences of the location, the
intensity of use or the quality of the land compared with marginal land, where the yields
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just cover the costs (von Thuenen, 1842; Ricardo, 2004). A share of the differential rent
may turn out to be an absolute rent if land gets so scarce that even marginal land can earn
rent (Damaschke, 1916). The theory about differential rents was originally created for
agricultural land, but can be applied to any kind of land if certain modifications are made.
Differential rents arise because there are extensive and intensive margins of cultivation (in
the agricultural case) or use (in the urban case). Neither differential rents nor absolute
rents can be tackled by market entry of new actors or by an extension of supply of land
and therefore have semi-monopolistic character, an insight of Adam Smith developed by
Damaschke (1923).
As Adam Smith observed, many countries had historically raised public revenue from land
rents without resorting to taxes and this, in fact, was the basis of the English legal tradition
that taxes were not ordinary revenue of the sovereign but were extra-ordinary “aids” or
“subsidies” granted by the common people to the Crown. In fact the phrase “real estate”
in English originates from “royal estate”: the old maxim of English law was that “the King
should live off his own” and not seek tax contributions from the common people. But
after the abolition of feudal tenures in 1660, the English Crown resorted more and more to
taxing the labour or capital of the common people and merchants. Interestingly, there are
still countries such as the Gulf States and the Sultanate of Brunei which largely finance
themselves through natural resource rents (oil revenues) and therefore keep other taxes
low, thereby encouraging capital formation and their rapid development. Similarly Hong
Kong was able to stay an attractive tax haven with low tax rates on salaries and profits
because it retained land revenues through leasing.
2.
Market failure and state failure
By contrast, most Western states have one feature in common: Land rents have long since
been lost by the sovereign and have been privately appropriated by powerful and well
organized political actors. Thus the English Reformation, the Revolution of 1688 and the
Enclosures had the effect of shifting de facto land ownership or use from the Crown and
the peasantry into the hands of the aristocracy, while the French Revolution of 1789 did
not achieve what Turgot and the Physiocrats had wanted, namely that the landed nobility
pay for running the country, but enriched the haute bourgeoisie. In the USA and
Australia, as the public lands were sold off, a similar situation emerged – governments
have sold off land once for all and found themselves forced later to levy taxes to make up
the rent lost to the public revenue from selling off the land once for all.
There are costs or opportunity costs incurred and which have to be met when land is made
more productive and valuable (for example, by infrastructure or provision of nearby
schools, universities or hospitals – indeed it is hard to think of any public goods provision
which does not add value to land). Whereas the benefits are reaped mostly by strong
private actors, these costs are pushed to a high degree onto poorly organized groups (cf.
Tullock 2005). The group with the poorest organisation is the society as a whole. Hence,
privatization of land rents goes hand in hand with a lack of equivalence – those who hold
the lands reap where other men sowed, they get the benefits of public investment which
users and taxpayers are forced to pay for. We will illustrate with an example why in
particular the taxation of labour and capital goes along with the privatization of economic
rents:
4
Let‟s assume, Jack is looking for a flat to rent in a large city (e.g. London, Munich, New
York, Sydney) in the West. First, he has to join a long queue of competing applicants for
the flat. However, let‟s assume that Lucky Jack gets the ring, and he is selected as tenant.
As a result, he has to pay a high rent to the landlord. For instance, in Munich the rent is
maybe five times as high as for an equivalent flat in a more peripheral city. But why does
Jack have to pay such an enormous rent? Are the houses in cities as Munich, London,
New York or Sydney better or are they better built than those in smaller cities? They are
not – on the contrary, often the houses in countryside are better built and better equipped.
Are the mortar, the steel, the bricks, the workers in Munich, Sydney or New York so much
more expensive than in a city at the periphery? If this were true, a property owner, would
take mortar, steel, bricks and workers from the peripheral region. No, Jack is paying the
high price for the advantages of the location, and for nothing else. The high charge of the
landlord is due to the high land rents, which are paid in Munich.
However, who or what is “creating” the land rent? The owners of the sites? Or are the
high land rents paid due to the wonderful location in Munich? Of course, Munich has a
wonderful view of the Alps. However, more fascinating is the view on the Hindu Kush.
Sydney, London, and New York have wonderful views over water. However, just as
fascinating are the landscapes of the coasts of Somalia or North West Australia or Alaska.
So why are land rents and land values in Sydney, London, New York and Munich
obviously much higher than at the coast of Somalia or in the Hindu Kush or the coast of
Alaska?
In Sydney, London, New York and Munich there is public security, a working health
system, and other infrastructure. Moreover, there are people – lots of them – employers,
customers, workers and suppliers of inputs – a whole agglomeration of diverse industry,
commerce and services. If you live in Munich, whether as a worker or employer, you
have many more opportunities – whether economic, social, cultural or educational.
These and other advantages exist due to collective public and common efforts, and not
through the individual efforts of any particular landholder. Jack has to pay the high land
rents due to these public or common efforts – but he pays it to the private landlord, not to
the public. Yet the private landlord of any site did not put a market of several million
employers, workers or consumers or suppliers at the doorstep of his tenant – he does not
contribute at all to the public value of land – a fact noted by Adam Smith, Henry George,
Alfred Marshall and many other economists.
Now let‟s further assume that Lucky Jack has got a job. From his salary he has to pay his
wage tax. From time to time, Jack goes shopping. However, on every transaction value
added tax (VAT) has to be paid (which amounts to an extra tax on his wages). In many
Western states wage taxes and VAT are the main sources of public revenues.
How are the tax revenues used? A high share of the money is spent on public goods such
as infrastructure, security, education, health etc. – all these are value drivers for his
landlord‟s site.
Even current expenditures such as payments for pensions increase
effective demand by pension recipients for landlords‟ rental accommodation.6
5
Hence, Lucky Jack is, in fact, not so lucky: he pays twice; on the one hand, he pays
directly the land rent to his landlord, and on the other hand, he pays indirectly to increase
in the market value of his landlord‟s site – via his wage taxes paid to the state. His
landlord is always the beneficiary, without having done anything.
The example illustrates why the taxation of labour and capital as opposed to taxing land
rent or land values is responsible for the decoupling of the financing of public goods and
economic rent. It is efficient that all those who benefit from public expenditure pay for it
– and the beneficiaries may not be just the immediate users: thus, a road or Very Fast
Train (VFT) track adds value to the lands serviced and benefits landholders often much
more than those who take the train or drive the trucks. They can only get the normal
return on their capital and labour. Land rent might also be interpreted as social surplus
that remains after deducting the costs for labour and capital from the aggregate income
(Harrison, 2006) – in effect, restating the Physiocratic thesis, largely adopted by Adam
Smith, that land rent is the only true net national income once one recognizes that wages
and profits are not true long-term surplus incomes.
According to the Henry George Theorem (also known as the George-Hotelling-Vickrey
Theorem), under certain ideal conditions (optimal population size etc.) the whole of public
goods could be financed out of the (land) rents (Arnott and Stiglitz, 1979; Atkinson and
Stiglitz, 1987). However, the Henry George theorem can also be interpreted the other way
around: (Land) rents are created by public goods and services. The land rent emerges due
to the economic advantages of agglomeration and labour division, the opportunity costs of
leaving certain plots occupied by certain users, and last but not least by infrastructure,
which is put in place by the public.
Without public infrastructure the advantages of agglomeration couldn‟t be used. Public
infrastructure might even be interpreted as a “fourth production factor”. Alfred Marshall
already recognized the connection between land rent and public goods and described land
rents as “the annual public value of the land” (Marshall, 1920). Thus, the state can be
considered as a “rent creating institution” (Harrison, 2006) – again reflecting Adam
Smith‟s notion that since ground rents arise solely from the good government of the
sovereign it is natural that the sovereign should collect them as his natural revenue for
maintaining the state and supplying public services (Smith 1776-1784)7 The sovereign or
the State is what creates value for rent-bearing land assets – to take examples, what
happened to land values in the city of Rome between 400 AD and 1100 AD and what
would happen to land values in London if the British Government collapsed and was
replaced by Somali warlords?
Table: Henry George theorem (simplified version, own presentation)
National income
Composition
Distribution
Wages (labour)
Private goods and services

Interests (capital)
Public goods and services (fixed costs)  Rents (land in a broad sense)
If the costs for the financing of the provision of public goods were covered out of the
(land) rents, there would be a natural coupling and correspondence between benefits and
costs. If, instead, the land rent is privatized (by private land owners and corporations), it
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cannot be used for the financing of public goods. As a consequence, the costs of the
production of the public good have to be shifted onto the payers of income tax and value
added tax. Thus, benefits and costs of public goods are decoupled.
The alternative to taxation of wages and profits would be a reduction of public goods, such
as infrastructure investment. Hence, in many Western states, infrastructure is outdated,
decaying and poorly maintained. Public services cannot be sustained, due to a supposed
lack of finance while the private finance will only supply infrastructure on a “cherry
picking” principle which favours over-centralization and over-urbanization, leaving
provinces under-supplied – and even urban infrastructure under-supplied.
In virtually all jurisdictions, taxes are by definition unconditional, compulsory, payments
to the state with no quid pro quo. There is no claim to any individual counter-performance
and no equivalence between performance and consideration. (This, by the way, contrasts
with Adam Smith‟s notion that the expense of government is akin to the management of a
large estate where all tenants are obliged to contribute in proportion to their interest in the
estate).8
Moreover, according to the rule of non-assignment of revenue and expenditure, taxes flow
into a “big pot” (or consolidated revenue fund) and may be used for any purposes. The
administration is spending money, which is not bound to any purpose – thus the money of
other people, namely the taxpayer, may be used to benefit anyone else (in particular strong
organized interest groups).
Hence, the tax-based state, unlike the land rent collecting state9, essentially represents a
decoupling of benefits and costs, and of revenues and expenditures. This “double
decoupling” causes, on the one hand, avoidance or evasion of taxes, because taxpayers
don‟t see benefits (and can, and will, avoid taxes on mobile transactions unlike taxes
attached to land titles). On the other hand, the public administration may tend to a
wasteful and socially counter-productive behavior, since it is tempted to pursue egoistic
objectives or the private agendas of corrupt state-influencing magnates, by employing the
money of the taxpayer for private profit.
Decoupling of benefits and costs in private markets causes market failure, due to external
effects. In almost the same manner, decoupling of state revenues and state expenditures
causes state failure in the market for public goods and state services. Market failure
means that too many goods with external costs and not enough goods with external
benefits are produced. State failure includes careless politicians who spend too much for
unnecessary things (it is not their money), not enough for necessary things and results in
taxpayers resorting to tax evasion. Even those who are benefited by State expenditure
will not pay anything for it if they can find an effective way of getting something for
nothing (and that is often possible under income tax regimes where deductible
expenditures or offshore asset holding regimes can be put in place to erode domestic tax
revenues, something which cannot occur under a simpler land value based charge attached
to the land title).
At the same time the income tax-based state is safeguarding a matching property rights
system which ensures private appropriation of economic rents. However, the legal
precondition for such a decoupling is not necessarily absolute or freehold private property
7
on land. It is also possible within a corrupted State leasehold system, if the private lessee
is given a concessional rent and then allowed by the State to reap most of the market rent
from others – at the expense of the public.10
These phenomena are closely connected with rent seeking (Tullock, 2005): economic rents
are reaped by powerful corporations and other vested interests which are in close collusion
with authorities (state capture). The costs of publicly-increased value of exclusive key or
monopoly assets (e.g. airports) are shifted onto weakly organized groups (such as
commuters).
What has to be done? Benefits and costs, expenditures and revenues have to be coupled
and re-linked. According to the Henry George Theorem, land rents may serve as the basis
of the revenues meeting the fixed costs (as opposed to short run marginal costs) of the
provision of public goods. If the land owner is charged, he only gives back to the public
what the public gave to him. This is just and mutual, since, the rent is publicly-created
value. This is also efficient, since the land owner cannot and will not reduce his land
supply, due to any levy or charge for land rent. On the contrary, if the burden is a lumpsum charge based on land value and independent of anything the landholder has done or
might do (being fixed by the market value placed on the land by his competitors) , the
landowner has a high incentive to bring the land to its highest and best use, as reflected in
the market valuation of his site. Land hoarding is made expensive and the effective supply
for land for productive use is increased.
Strictly speaking a land value tax is not a tax at all but a re-appropriation of land rent by
the sovereign. A tax is a payment without any remuneration, and the taxed-based state
also accepts the private appropriation of the land rent. However, subsequently we will use
the terms land “tax”, land “charge” and land “rates” as synonyms, since the cited literature
does not stress this basic difference between land taxes and other taxes.
If, according to the Henry George Theorem, the fixed costs of infrastructure are covered
by land rents, public goods and services could be provided to citizens for their short run
marginal costs (as envisaged by Vickrey). As Hotelling (1938) and Vickey (1977) argued,
land value taxes and rates are an ideal method of covering fixed costs of infrastructure so
that users can be charged the economically efficient short run marginal cost (SRMC). Site
(land) value rating operates as a lump sum access charge for the privilege of being able to
connect to network infrastructure. It is reasonable that landholders pay in proportion to
land value (often called site value, since land in urban areas owes its value mainly to
location). The value, for example, of a city block which was denied access to water,
sewerage, electricity etc. would be far less than the value it has when there is access
available to those services. It is not unreasonable that infrastructure access charges reflect
such a value-adding benefit. For railway traffic this principle means in practice that train
tickets only need cover the costs for the operation of the trains, but not the costs for
investments and maintenance of the tracks, the stations and so on.
Attempts to cover the fixed costs of infrastructure through user charges alone are
economically inefficient, as recognized by Hotelling and Vickrey among many others.
What businesses need in order to be nationally and internationally competitive is the
lowest possible marginal cost of production. Low road and rail costs, low costs per
kilolitre of water, per kilowatt of electricity etc. are important in securing low costs of
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production. To the extent that network infrastructure can be funded from fixed access
charges levied on the land values benefited and sustained by the existence of the
infrastructure, then volume or usage charges can be kept low. Charges for volume or
usage should only reflect incremental cost (SRMC).
Land or site value rating also overcomes a common “freeloader” difficulty faced by
private providers of infrastructure. For example, if a private gas company plans to extend
its reticulation infrastructure into an area, it surveys householders and asks whether they
wish to have gas available. It is in the interests of every householder to say yes, whether
or not they intend to connect.11 If the gas pipeline is laid, the value of his site is increased
without any requirement to pay unless and until he chooses to connect. This “freeloader”
behaviour is not possible when faced by an infrastructure provider which has power to rate
all land to make landholders contribute towards the costs of services available to their
lands. The infrastructure provider is not deterred from providing infrastructure by the fear
that its investment may be under-utilised.
The adoption of replacement cost valuations in the form of depreciated optimised
replacement cost and the allowing by regulators of a rate of return to private investors on
such notional costs (which no one pretends were ever borne) has created in the UK,
Australia, Germany and other countries a whole new infrastructure industry based on tax
farming. In the UK, Australia and Germany consumers and producers have been forced to
pay charges incorporating a rate of return on infrastructure assets which in many cases
they had previously paid for (prior to privatization). Infrastructure charges in excess of
short run marginal cost (SRMC) should really be considered as being in the nature of
taxes.
Public finance – the fundamental inefficiency of taxation
3.
Economists have a reputation for being obscure and always having bad news. But the
history of tax theory gives us two key points.
-
Tax policy is really quite simple - there are only three things you can tax - land,
labour and capital and only one of them can’t run. Labour can demand higher
wages, go on strike, slack off, stop breeding or leave the country. Physical capital
can be allowed by its owners to wear out and run down, business profits can be
hidden or buried under creative accounting while financial capital can hide or flee
across borders. By contrast, land cannot escape and is there for all to see. You can
even Google down block by block.
-
Because land can’t run, when you shift taxes off labour and capital onto land, you
get a bonus. Your land value tax base does not shrink as you shift to taxing land
values – it grows stronger! There is such a thing as a “free lunch“ in economics.
Why do you get a bonus from land value taxation?
-
First, the value of land is determined by the demand for it – that demand comes
from labour and capital wanting to use land. When taxes on labour and capital are
cut, their net returns increase so you get more labour supply and more capital
investment. But labour and capital need land to work on. So they bid up the price
of land. Land‟s underlying value rises and so does your tax base.
9
-
Second, to the extent that you spend your land revenues on public infrastructure
such as bridges, roads, gas, water, electricity and telecommunications networks
connecting land, you make land more productive for labour and capital, further
adding to the land‟s economic value. (If you finance infrastructure this way, you
get a competitive advantage over countries which try to finance infrastructure by
trying to load all the costs on the immediate users. High user charges for
infrastructure are just like internal tariffs and discourage production and commerce
just as the robber barons on the river Rhine in mediaeval times used to discourage
trade by taxing merchants at each bend in the river).
-
Third, by taxing land values, you squeeze out the speculative element in the market
price for land. This makes it cheaper for Government to acquire land for
productive public works, such as roads. Similarly, land value taxation makes land
more easily available to industry, farmers and others who want to put it to good
use. It ceases to pay for a lazy landholder to sit on unused land, holding the
community to ransom.
That is pretty amazing when you think about it – a tax which, instead of damaging
prosperity, can actually promote it. Genuine economics is not such a dismal science after
all.
Having set out the key points which we should bear firmly in mind, we can now step back
and put taxation in its broader social and economic perspective.
The importance of taxation
The power to tax is the power to destroy. Ever more oppressive taxation is generally cited
as one of the causes of the decline of the later Roman Empire and its attendant
depopulation. Conversely, a wise taxation policy can be the engine of prosperity. Very
few people in the 1960s would have predicted that Hong Kong and Singapore would ever
overtake most Western countries in per capita living standards. Hong Kong was a place
where beggars slept overnight in doorways and where Western tourists went to buy cheap
goods. In less than 45 years, the political, economic and demographic map of the world
and of Europe has changed enormously. Much of this change has been caused by often
unnoticed but pervasive changes or trends in taxation systems.
Nothing in this world is fixed except, perhaps, the folly of man. In a world where most
countries are run according to logically flawed economic theories, the country that can see
clearly the fundamental nature of the problem of revenue raising is one that can rapidly
surpass its neighbours.
Nothing in this world condemns any country to be a poor nation: the choice for prosperity
or poverty lies in each country‟s own hands.
Turning to the problem of taxation, it can be stated very simply.
With no revenue, governments can do nothing. In fact, civil society becomes impossible
and the country may end up becoming the plaything of warlords or oligarchs. For
example, it is fairly clear that one of the first tasks Mr. Putin set himself was to restore the
revenues of the Russian state in order to have some semblance of effective government.
If you cannot pay your soldiers or your police, your grip on power becomes very
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ephemeral indeed as successive Roman emperors discovered. Hence governments must
have money, not because pieces of gold, silver, nickel, plastic or paper are ends in
themselves but because they have been the media of exchange through which you buy the
services of soldiers, policemen, civil servants, doctors, teachers and with which you pay
the builders of bridges, roads, railways and all the other useful public works which make
efficient production possible.
Governments can raise money by printing it, by borrowing it, by renting assets, by selling
assets, by stealing it, or by taxation (some would argue the latter two options are the
same).
Borrowing, as governments are finding out, has its limits and eventually seems to lead to
explicit repudiation or implicit repudiation as governments turn to printing money and
eventually debasing its internal or external value.
In the 19th century, the Australian colonies did not have much taxation. They just sold
land to settlers. The sale of the Crown lands fed the colonial treasuries for decades and it
was only as governments ran out of things to sell off that they increasingly turned to
taxation in the 1880s. Similarly, from 1980 on, in Britain, Australia and Germany,
national and State governments fiddled their budgets by selling off assets, such as banks
and insurance companies, postal and telecommunications bodies and even roads or
railways.
But selling assets must come to an end. Furthermore, if the assets you sell are monopolies
such as airports or ports, you may do enormous damage to your economy. You can end
up putting strategic monopoly land assets into the hands of rapacious monopolists and
their financiers. For example, if Beijing airport were privatized, the owner could levy a
tax on most commercial traffic in and out of the city. Selling monopolies is like selling a
privatised tax system. It is much like the old salt tax monopolies that were sold to
financiers and tax farmers in pre-Revolutionary France.
Adam Smith (1776) pointed out that governments do not really need to raise taxes and that
some governments have subsisted from the revenues of their lands. Just as Arab countries
today live off their oil revenues and Norwegians have a huge oil fund, so mediaeval rulers
lived off the rents of their feudal lands. It was the land tax which helped finance the
industrialization of Meiji Japan in the nineteenth century. Land has thus been at the centre
of many successful revenue systems.
The Economic Arguments for Land Value Rating
To tax and to please, no more than to love and be wise, is not given to man.
Edmund Burke (1774)
Edmund Burke‟s sober reflection is a reminder that in any tax reform there are winners
and losers. However, while the reform of an existing tax system is perhaps more difficult
than the simple introduction of a new tax, it does have the advantage that, in abolishing or
reducing other taxes, one may please more people than those who are offended by the new
tax.
11
Where an economic change allows for greater efficiency and productivity, it is possible to
come out ahead, and ensure that the gains of the winners exceed the losses of the losers.
There is a “free lunch”.
In tax reform it is, therefore, vitally important to ensure that the tax being introduced or
increased is more efficient than those which are being reduced or abolished. Not all taxes
are equally efficient. Many have long since gone by the wayside - the 18th century British
Window Tax for example.
The basic principle of an efficient tax is that it should raise the revenue required without
distorting the decisions of producers or consumers.
A tax should thus be unavoidable in both the economic and legal senses. Neither a change
of actual conduct nor a shuffling of paper should alter tax liabilities. Taxes such as
transfer taxes which can be avoided or deferred through economic responses (such as
delaying transactions) or legal responses (such as indirect changes of ownership) are
therefore not efficient.
On November 7, 1990, thirty prominent United States economists including Nobel Prize
winners James Buchanan, Franco Modigliani and Robert Solow wrote to Mikhail
Gorbachev urging that, in moving to a market economy, the Soviet Union raise its revenue
from land. These economists wrote that “It is important that the rent of land be retained as
a source of government revenue. While the governments of developed nations with
market economies collect some of the rent of land in taxes, they do not collect nearly as
much as they could, and they therefore make unnecessarily great use of taxes that impede
their economies - taxes on such things as incomes, sales and the value of capital. ... The
component of land value that arises from community growth and provision of services is
the most sensible source of revenue for financing public services that raise the rental value
of surrounding land. These services include roads, urban transit networks, parks, and
public utility networks for such services as electricity, telephones, water and sewers.”12
Tax and Rent
Taxes on capital and labour are both distorting – they suppress factor supplies to the
economy and create deadweight loss. Yes, you can tax labour and capital but only at the
cost of creating “tax wedges” between gross and net returns to these factors of production,
which in turn adversely affects economy-wide factor supplies. Some production activities
which would be undertaken if labour costs $1 per hour to employ will not be undertaken if
taxes mean it now costs $1.50 per hour to employ labour. But if the 50 cents tax cost is
passed back to labour by employers, labour may find other, non-taxed, things to do, such
as working in untaxed market gardens rather than work for 50 cents per hour. What was a
less productive use of labour is thus favoured post-tax over a more pre-tax productive use.
In this way, taxes on labour and capital create deadweight loss (also known as excess
burden).
Finally, taxation decreases the land rent – as the social surplus. The discouraging of
economic activities has been earmarked by Gaffney (2009, p. 376) with the term
“EBCOR”: Excess burden comes out of rent, because there is a remarkable loss of GDP
and national income due to taxation, which differs according to different legislation. This
12
means, the “cake” GDP gets smaller.13 A second effect is “ATCOR” (Gaffney 2009, p.
370): All tax comes out of land rent. That is, that in the final analysis, all tax has to be
paid out of surplus, which gets smaller, due to taxation. On the other hand, lower taxes on
labour or capital don‟t mean a loss of revenue base. Instead, such tax reductions mean
higher land rents land rents and values, which can then yield more revenue through land
value taxes (public appropriation of rent). This is most obvious with taxes on buildings.
When we exempt buildings, and raise tax rates on the land under them, we are still taxing
the same real estate; we are just taxing it in a different way and better way which
encourages maximization of total social value.
This leads us to the fatal flaw in most modern tax policy prescriptions.
Income and consumption: Not final tax bases
It is a fundamental conceptual mistake to talk of “income” or “consumption” taxes as if
they were separate tax bases apart from the three original tax bases of rents, wages and
profits. A universal flat-rate consumption tax is a tax upon the earnings of land, labour or
capital which are not saved. A universal income tax is a threefold tax on the earnings of
land, labour and capital. A company tax is a tax on income from land, labour or capital
accruing to companies (and, through it, to the shareholders).
Unfortunately most modern economists slip into talking of “capital income” as if that term
comprehends income from both land and capital. They also talk of “income” and
“consumption” taxes as if they were taxes on separate and coherent things.
Tax on economic rent as a non-distorting lump sum tax
Taxes on capital and labour are both distorting – they suppress factor supplies to the
economy. Wherever there is a possible supply response (that is, factor withdrawal) there
will be economic distortion. Wherever there is distortion there is “deadweight loss”,
which creates a “lose-lose” situation. Someone who might have worked more or invested
more does less of it and is worse off, but so also is the treasury which misses out on any
tax from the abandoned activity. Since neither the supply of labour or capital to an
economy is fixed (supplies of labour and capital depend on migration, fertility, work
effort, savings and investment in tangible reproducible goods), every tax on labour or
capital is distorting.
Note that this is true also of so-called non-distorting taxes on inelastic goods or services.
Why? A tax on a good or service operates as a tax on the factor income used to purchase
it. So an apparently “non-distortionary” tax upon a good in inelastic demand (such as
water) may well end up like a poll tax (a head tax) on labour income with all the
associated distortionary effects such as wage demands. Ultimately, it is inelasticity in
factor supply which counts, not inelasticity of demand for good and services.
All taxes are thus distorting, save a tax on economic rent. An annual land value tax is a
tax on economic rent.
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Economists regard a lump sum tax as uniquely efficient. The idea is that the taxpayer has
no choice but to pay. Nothing that he does can eliminate the tax liability. Often, in text
books, a lump sum tax is portrayed as a fixed money sum (e.g. not calculated by reference
to income or assets) which the taxpayer has to pay. This is one example of a lump sum
tax, but the idea is a little broader than that.
The real idea of a lump sum tax is that the tax liability does not change with the behaviour
of the taxpayer. For example, the rates or taxes on my land may change with its value, but
I personally cannot change the market valuation of my unimproved land by my own
actions. A rate or tax on my unimproved land value is thus an efficient lump sum tax.
There is nothing I can do to avoid the tax. There is nothing I can do to alter the amount of
the tax. Not even bankruptcy can avoid it. The tax liability is fixed by external forces and
can be enforced against the land if I try not to pay.
No tax evasion
It might be thought that a land value tax can be shifted by selling the land. That is not
correct. A person who buys the land knows that there is an annual tax liability which goes
with the land. The price the purchaser pays to the seller wishing to avoid the tax will
therefore be discounted to take account of the annual tax burden on the land. The tax is
said to be capitalized or amortized in a reduced market price for the land.
This is a virtually unique aspect of a pure land value tax. Once imposed, it stays with the
land it is imposed upon and cannot be avoided by changing the ownership of the land.
This is because any attempt to avoid such a tax creates a one-off loss for the seller. The
purchaser, by allowing for the tax, does not pay the tax at all - either then or in the future.
In that sense, a known, established or anticipated land tax is said to be a “burdenless tax”.
Everyone who has bought land has bought it knowing what the tax is and has allowed for
it. Every future buyer knows about it and will allow for it. It is therefore no more a
burden than buying a leasehold, knowing that one has to pay rent to the head landlord.
You allow for that rent when you take over the lease from the previous tenant.
The fact that a land value tax is capitalized demonstrates that it is not distorting: it is
capitalized precisely because it cannot be avoided and sticks with the land, regardless of
the owner.
Another way of putting it is that the imposition of a land value tax amounts to a reclaiming of ownership of the land by the State as representative of the community and the
land value tax is nothing more than a rent charge reserved to the State.
No shifting of taxes onto lessees
If a land tax cannot be shifted or avoided by selling the land, some may ask whether it can
be, if not avoided, at least shifted to lessees and tenants.
The argument is sometimes put (by business people, not by economists) that a land value
tax can passed onto the tenant and becomes an extra cost of production. It is sometimes
said to act thereby as a disincentive to business activity. For example, lessors of land may
demand the tenant pay all taxes and charges, including land value tax.
14
But, in the long run, the incidence of a land tax is upon the landholder (which includes
long lessees on fixed rents). In the short run, an increase in land tax may be passed on to
lessees but that will cease to happen as rent contracts are renegotiated.
Taking a long run point of view, it is important to ask what the value of land represents.
The value of land represents the flow of rents it can command. The amount of those rents
in the future represents the increased returns, over and above the norm, which capital or
labour may earn by using that site.
A tenant is willing to pay rent to a landholder because by using that land he can be more
productive than elsewhere (e.g. there are more passing customers). Now suppose that the
landholder tries to make the tenant, in the long run, pay extra rent for the land. By
definition, the tenant‟s labour and capital are no longer earning more than the norm they
could get elsewhere. The tenant will, therefore, in the long-run, quit and look for other
land on which to ply his trade.
It may be argued that he will not leave because other land is also subject to land value tax
which the tenant will have to pay. But there is always other, less valuable, land. By
moving there, he would face a lower land tax liability if that landlord also tries to shift the
tax. Thus, by shifting to lower valued land, the tenant, unlike the landholder, can reduce
or eliminate any impact of the landlord‟s attempt to pass the tax on to him. The tenant can
move to avoid the tax, but the landholder cannot move his land or change its market value.
To put it another way, those who assert that a land tax can be passed on to the tenant in the
long-run are really saying that landholders are so stupid as not to be extracting the
maximum rent they could from the tenants in the first place. Such a proposition has only
to be stated to see its falsity.
In the short run, however, there can be a shifting of an increase in a land tax burden to the
tenant. Contractual obligations cannot be terminated or varied at will, without explicit
statutory authority (which is sometimes provided in taxing legislation). In the case of a
long term fixed lease eg. a thirty year leasehold at a fixed rent, the tenant may be forced by
contract to bear part of the burden of the land tax imposed on his landlord. He may, for
example, be subletting further to other tenants on short leases. He shares in the burden of
the land tax with the landholder just as he shares in the rents to be obtained from the short
lessees. In such cases, a long tenant is really like a co-owner of the land.
Another way of seeing why, in the long run, a land tax cannot be passed on to tenants is to
look at the concept of the real cost of production. The reason for taxing land is the same
reason for buying it - they aren‟t printing any more of it. Land is in fixed supply, and its
maker is not charging for it. Unlike labour and capital there is no human cost of
production involved. Thus land acquires value not from its cost of production but from
competition from its scarcity value. The value of land is determined by the demand for it
and by nothing else.
The value of the output in excess of the remuneration of capital and labour required to
produce the output flows to the landholder. Potential users bid against each other only so
far as they can generate a surplus over labour and capital costs from using the land.
A demonstration that rent is a price determined by demand, not a real cost of production,
occurs when shops are empty in a recession. Landlords have no choice but to cut their
15
rents, whether in the central business district or elsewhere, or leave their premises empty.
This phenomenon shows that landlords are not free to simply increase rents - if they could,
they would already be doing it.
Land value rate: Effective marginal tax rate of zero
Because a land value tax cannot be avoided it has an effective marginal tax rate of zero.
Clearly, a land value tax does not affect the marginal returns from working or saving.
This means it is uniquely efficient if used as a source for funding universal social
payments. The equivalent marginal tax rate (EMTR) in such a case is zero as there is
neither an effective tax rate on labour income nor any income-test taper on social security
payments. Equivalent marginal tax rates can be very high when tax rates and social
security eligibility restrictions pile up on each other. For example, if your income tax rate
is 26% but you lose a benefit of $1,000 for earning another $2,000 your EMTR is 76% (if
social security contributions are also payable EMTRs would be higher still). What most
Western economists ignore is that true effective marginal tax rates on capital and labour in
Europe and elsewhere are much higher than often quoted. A marginal income tax rate of
35% matched by employer social security contributions of 15% when combined with a
VAT of 20% can mean a true marginal tax rate of 55%. Eurozone unemployment and
productivity woes are not necessarily surprising.
Short and long run effects of shifting to a land value rating
An abstract discussion of tax theory is not very interesting to busy policymakers,
legislators and Ministers. It is more interesting to see what happens in practice when land
taxes or land revenues are used to keep other taxes down. Hong Kong illustrates that land
revenues can help keep tax rates on wages and profits low and thereby promote long-term
growth of per capita income in a territory. Hong Kong has long enjoyed a tradition of
using land revenues through a leasing system of Crown land to keep tax rates low. This
goes back to the advice of Lord Aberdeen to Sir Henry Pottinger, the first Governor of
Hong Kong. Pottinger was advised that “if, as a result of the establishment of a free port
and the introduction of those liberal arrangements by which foreigners would be
encouraged to come, a great commercial entrepot were created, then H M Government
would feel justified in securing to the Crown the increased values that the land would then
have.” (Rabushka 1979, pp. 62-63). The Hong Kong example is far from being a perfect
blueprint. The value of the leases is not reassessed currently, and most of the incremental
value and land rent goes into private pockets. Since not the annual land rents are taxed,
the public revenues from land have not been enough to prevent other taxes from being
introduced, as Hong Kong forgets the origins of its prosperity.
International tax competition and the taxation of an immobile base
Tax competition occurs within a country between States, provinces or cites. But it also
increasingly applies between countries. For example, pressure to reduce stamp duty on
Australian share transactions came from Hong Kong. As Australian companies listed
overseas and Australians could invest in the shares of overseas companies or use banks
16
overseas, the ability to tax financial transactions became less – the buyers could avoid
local transfer taxes by buying shares on foreign stock exchanges.
Internationalisation of tax competition arises as labour and capital are increasingly free to
move and thus shift the burden of any tax which it is proposed to be put upon them – their
actual and formal elasticities of supply are increasing. The theoretical observation that
there are only three factors of production – and two of them can run – thus becomes of
profound political and economic significance for the development of a nation‟s economy.
Given that financial taxes and taxes on financial capital are taxes on the most mobile of
economic activities they should be avoided. By contrast, a land value tax is immune to
international tax planning and ensures non-residents contribute to the treasury. Nonresidents do not pay VAT, and they can often use source rules or tax treaties to lower the
amount of income tax they pay, but they cannot avoid paying a land value tax if they use
the facilities of a country.
The OECD response to tax competition has been to try to outlaw it by international
consensus in favour of income tax and VAT (which suits European states). It has
therefore promoted “multilateral” information exchange (more properly, surrender) to help
Western countries levy tax on extra-territorial income which may accrue to their residents.
A land value tax renders this OECD paradigm irrelevant by imposing tax on an immobile
factor – a land value taxing country has nothing to fear from tax competition and every
reason not to join such OECD efforts but rather to profit from the stupidity of other
countries seemingly intent upon driving investment in its direction. Why should China, for
example, help the US, UK, Germany or France levy tax on profits from investments made
in China? Rather than surrender its sovereignty, a country can use its sovereignty for its
own people‟s benefit, instead of becoming a tax vassal to capital-exporting states. What it
certainly should not do is surrender land as a tax base, whether through so-called “free
trade” or “investment” or “tax” treaties, so that its power to charge land rents from
foreigners is in any way diminished.
Who ultimately bears a land value tax?
It is worthwhile to consider in more detail who bears a land tax.
The introduction of a new tax on land in isolation really amounts to an assertion by the
government of a claim to a larger part of the rent for land. Therefore the market value of
land tends to fall. The government is taking more of the rent and the private landholder is
left with less. The true economic rent of the land, of course, remains unchanged but the
private landholder is getting less of it. The fall in market value reflects the value of the
reduced private share of rent. In the static case where V is the private market value of
land, Vˊ is the private market value after tax, R is the annual rent, i is the interest rate and t
is the tax rate on land value:
pre tax
T, the public value of land is given by
17
and
That is the public and private market value of land equals its economic value. The higher t
in relation to i the more the State asserts its rights as paramount owner on behalf of the
people. This process of private land values falling in response to the imposition of a land
tax points to a set of identifiable losers. From the Government‟s point of view, if a land
tax does lead to a slowdown in land value speculation or even a fall in land values there
are some advantages. For example, there is the advantage that the cost of resuming land
for public works is reduced. A land value tax thus not only raises revenue, but reduces the
cost to the Treasury of necessary resumptions for roads, rail or other public infrastructure.
It can also be shown that an increase in a land value tax increases the cost of holding land
out of production. This squeezes out unproductive speculative activity and forces
speculators to make land available for development and act as useful re-allocators of idle
land rather than mere idle squatters. If they do not do so, they cannot meet the land value
tax as a holding charge on the land.
This is of some significance for employment and economic activity especially when one
considers the amount of false credit which has been staked on an ever-expanding real
estate bubble. The 2008 collapse in financial markets can be seen as directly linked to a
self-perpetuating cycle where easy credit made the capitalization of future rents ever more
valuable and drove up land prices which created more collateral for further borrowing and
buying. The process cannot continue forever without a general debauching of the
currency through unchecked money supply expansion. Attempts to reflate land prices by
monetary easing do nothing to stimulate productive trade or commerce and create another
bubble and bust yet again.
An elegantly expressed argument in favour of a shift from transfer taxes on land to a tax
on holding land was given by John Stuart Mill (1848, book 5, chapter 5, section 1), who
wrote “All taxes must be condemned which throw obstacles in the way of the sale of land,
or other instruments of production. Such sales tend naturally to render the property more
productive. A seller, whether moved by necessity or choice, is probably someone who is
either without the means, or without the capacity, to make the most advantageous use of
the property for productive purposes; while the buyer, on the other hand, is at any rate not
needy, and is frequently both inclined and able to improve the property, since, as it is
worth more to such a person than to any other, he is likely to offer the highest price for it.
All taxes, therefore, and all difficulties and expenses, annexed to such contracts, are
decidedly detrimental; especially in the case of land ... too great facilities cannot be given
to enable land to pass into the hands, and assume the modes of aggregation or division,
most conducive to its productiveness. ... All taxes on the transfer of land and property
should be abolished; but as the landlords have no claim to be relieved from any reservation
which the state has hitherto made in its own favour from the amount of their rent, an
annual impost equivalent to the average produce of these taxes should be distributed over
the land generally in the form of a land tax.” Mill‟s argument means that transaction taxes
on land sales should be eschewed and revenue raised instead from a neutral land value tax
on landholding, not land transfers.
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Which taxes should be cut to produce the best dividends? Once it is seen that there is a
possibility of a “win-win” situation in shifting from other taxes towards a land value tax,
the next question is which taxes could be the first to be cut. Bearing in mind the basic
principle that all taxes fall on land, labour or capital, the initial answer is that the taxes on
the most footloose activities should be cut first.
Labour is less mobile than financial capital which may be moved electronically. Abolition
of tax on mobile transactions such as financial transactions should be among the first
candidates for abolition. In the case of such footloose activities there is the greatest
chance that the revenue lost from abolition of taxes would be compensated for by an
offsetting induced increase in other revenue.
Land values reflect all spatial externalities, for good or ill. Land value rating is thus a
uniquely efficient way of recapturing the benefits that Government services or
infrastructure may confer on land values.
Just as using a land value rating to cut other taxes can offset any adverse effect on
landholders, so the same is true where land rate revenues are used to provide benefits to
land (e.g. infrastructure).
This can be seen from the origins of the English word “rate.” Originally the idea behind a
rate was to secure a pro rata contribution from landholders towards infrastructure which
provided common benefits - such as a dam, a road or a bridge. Rates were often voted for
by landholders in their collective interest. Similar phenomena can be observed today
when municipalities or agricultural co-operatives levy their members for rates to
contribute to roads or building weirs etc.
Since site rents reflect spatial externalities (and most externalities which can be thought of
are spatial in nature), a land value rating can both capture the benefit of desirable spatial
externalities and compensate for adverse spatial externalities.
Where government provides infrastructure such as roads, railways, water, sewerage, etc.
and pays for it through a land value rating on site values it is really acting in the same way
as an improving landlord. A land value rate used to service land through the provision of
beneficial infrastructure need not adversely affect landholders - quite the reverse. Indeed,
as Brennan (1971) observes, the original vision for the Australian capital city of Canberra
was that the land values created would pay for the cost of the new Federal capital without
enriching passive speculators. In the long run, taxes would not be necessary to pay for
public works, the city would pay for itself in increased land rents accruing to the Federal
Government (as the landowner) leasing out its land to businesses and residents enjoying
the facilities of the developing city.
Adam Smith observed that it is often desirable that the sovereign undertake works which,
while of the greatest public benefit, are not sufficiently worthwhile for any individual.
This is commonly the case with land and infrastructure. With divided landholdings no one
landholder finds it sufficiently in his interest alone to pay for the costs for major
infrastructure, even if collectively all would benefit.
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Land value rating also deters harmful speculation and real estate bubbles. The interaction
between land values and the financial system has become a matter of large public interest.
The public and central bankers naturally desire easy credit to keep employment and
industry thriving. Easy credit also means land rents can be borrowed against and
capitalized at higher values.
Thus what was intended as an expansionary monetary policy for encouraging production
of goods and services with full employment becomes an inflation of asset prices (really,
land prices) into a bubble where speculative hopes of “capital gain” overwhelm any
concrete ideas of putting land to its most productive use. Such a state of affairs is never
stable and a crash inevitably comes. Unfortunately, the crash also means labour and
capital are thrown out of productive employment as a general credit withdrawal
undermines business.
One of the merits of land value rating is that it squeezes out harmful speculation. It makes
sure that landbuyers do their sums. They are forced to look carefully at current and
projected land use to be sure they can meet the holding charge which a land value tax
represents. Thus a land value rating tends to prevent speculative real estate bubbles from
forming. A land value rate forces landholders to use the land or lose it. By forcing
landholders to monitor continually their plans for land use, it encourages them to make
land available to the market and to allow labour and capital to make use of it. This
naturally encourages full employment.
Land value rating and competition
Kirzner (1978) observed that monopoly and anti-competitive behaviour can only occur
where there is selective access to superior natural resources. Access to land, whether as
sites, minerals or electromagnetic spectrum, can create incumbency advantages. A system
of land tenure based on “first come, first served” means that future generations cannot by
definition have access to what turn out to be superior resources on the same terms as the
first generation. This has implications for competition policy. How can one expect a
competitive market when some market participants start with superior access to natural
resources needed for production? For example, a retailer with a large number of superior
sites can engage in thinly disguised predatory pricing to defeat new entrants at the margin
(Dwyer and Larkin 1993).
One of the hidden virtues of land value rating is that, just as it squeezes out harmful
speculation, it also squeezes out monopoly advantages. By charging on the current market
value of natural resources, it exerts a gentle pressure on oligopolists or monopolist not to
withhold sites from production or under-utilize them with a view to gaining monopoly
advantage in downstream product markets. The rate reflects not the return the oligopolist
or monopolist actually gets from his sites but what he could get. If he seeks to enjoy “the
best of monopoly profits, a quiet life” and to rely on the infra-marginal fat in his imputed
rents to under-cut competition he will find himself still left with the same tax liability on
his land or site values. This is simply another instance of how land value rating pushes
resources towards their highest and best use and discourages uneconomic withholding of
resources. What the tax does invisibly, and with increasing effectiveness as it is raised, is
to ensure that each member of the community has access to resources on equal terms – a
sine qua non of an effective competition policy.
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4. Social aspects: Access and distribution
Those have lived or live in a Western country know about the high prices for craftsmen or
the poor service which is provided by companies, due to their small number of staff. This
is caused to a high degree by the high non-wage labour costs (social security levies, for
example). In average, in the European Union the non-wage labour costs are more than 30
% of the gross wages. Adding it all up VAT, employer and employee social security, the
effective marginal tax rate may easily exceed 50 % - and in some countries, even the
average tax rate exceeds 50%.
These high non-wage labour costs cause a labour tax wedge. Labour is a high cost burden
for companies. However, although companies are trying to substitute labour by capital,
many goods and particularly services are either unaffordable for customers, or the
remaining net salary is too low for living (e.g. jobs in hairdressing). Western politicians
try to reduce the non-wage labour costs by cutting the social security network, again at the
expense of weak organized groups. Instead, charging rents would be a preferable
mechanism to reduce non-wage labour costs without such consequences. Shifting taxes
off labour taxes (such as VAT, income tax, employer and employee social security
contributions) to land rents or land values substitutes a charge with no tax wedge for a tax
wedge which reduces living standards and which reduces international labour
competitiveness
As mentioned above, the main Western pillars of taxation are the tax on wages and the
VAT. This taxation is done (unconsciously, it seems) in order to safeguard privatized land
rents. We illustrated above that Lucky Jack pays two times: First, he pays the land rent
directly to his landlord; second, he pays taxes to the State in order to add value to the land
assets of his landlord. Hence, the actual Western taxation system works regressively, in
favour of the rich and powerful – but, more importantly, to weaken the State as against its
powerful subjects much as the Late Roman Empire lost its fiscal base and its ability to
protect and govern the Empire in favour of the nobility which held low-taxed or untaxed
latifundia. The decoupling principle of the tax-based state causes at the same time the
redistribution from the bottom to the top – a redistribution which undermines its fiscal and
material strength. Instead, charging the land rents (land values) would be a sensible
public policy approach to make the landholders as beneficiaries of the public goods pay
for what they really get, and remove the burden from other people, such as low income
workers or peasants with little or no ability to pay.
The value of land may be roughly calculated by discounting the future land rents. If all
the land rent is transferred into the public purse, the market value of land for privates is
zero (though its real value may in fact be increased). Land is decapitalized (in the sense
that it is less an object of private asset ownership or speculation). This means easier
access to land for private persons (in particular young families) as well as for young
companies, since land which is taken on a rental or no equity basis is affordable. Those
with the best ability to use the land will prevail, not those who got the land on a
primogeniture or “first come, first grabbed” basis of prior advantage.
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If the land rent were charged according to the potential highest and best use, the land users
would try to bring it into the highest and best use. Today, the scarce resource, land, is
often used inefficiently. For instance, land is hoarded, due to speculative motivation.
Speculators can sit without major holding costs on unused or under-used land. This means
nothing but a reduction of the effective supply of land – and an increase of scarcity. More
scarcity means higher land rents charged for such land as is available. This exacerbates
income distribution problems such as young families being locked out of housing
affordability as access to land gets more difficult.
Although the land might be completely without privatized market value, the land rent does
not disappear – it goes to the State and the community, which create its value, not to
private landholders. However, land users now pay only once. They don‟t pay the private
landlords, but they pay rent into the public purse. The rental payments will usually rise
over time as land becomes more valuable with social expenditures and improvements.
However, this development of rent over the time is more in line with the life-time earning
e.g. of a young family or company. Regarding a family, income is low after marriage.
However, the financial burden, due to young children and a loan on buying a house at
privatized land values is high in the absence of land rent charging by the State. When the
parents are getting older, the income is rising and the financial burden of dependents
reduces. By contrast, financial performance and the financial burden move in opposite
directions over the lifecycle where land rent is privatized. If the State as ultimate
landowner collects rent in lieu of taxation for revenue, it permits a more desirable adaption
of economic contribution to State revenue to the economic performance and ability of
working families to pay.
According to the Henry GeorgeTheorem, under certain conditions (such as optimal
population size) the fixed costs of the public goods and services could be paid out of the
land rent, whereas the short run marginal costs should be covered by the user in user
charges. If, however, due to rents of natural resources or other advantageous endowments,
there is an excess of public revenues, such rents might be redistributed onto the public by a
social dividend. Such redistribution mechanisms are used e.g. in Norway or in Alaska
(Alaska Permanent Funds).
It is also far more efficient to charge the fixed capital costs of such infrastructure against
land rates than try to drive user charges above short run marginal cost to cover an “access
deficit” (cf. Hotelling 1938, Vickrey 1977, Kanemoto 1984), that is, the loss the utility
would make if it charged very low (but economically efficient) short run marginal costs
for the use of large sunk capital investment. If infrastructure such as a Very Fast Train
(VFT) tries to recover all its costs, including fixed or sunk costs, from passenger ticket
sales instead of rating the lands benefited, costs to users may be so high as to be selfdefeating with low passenger traffic. A VFT may become a loss making white elephant.
Infrastructure which is so over-priced that usage collapses and losses result (as has
occurred with the Australian Capital Territory water system. This represents a massive
social waste as public assets are effectively sterilized and the “user charges” become
another tax burden on production or wages.
5. The role of the state
22
In a naive view, the State might be regarded as a neutral trustee of the common wealth.
As such, if the State is doing land use planning as a sovereign owner of all its resources,
the competing stakes of the different interest groups should be weighted and balanced in a
neutral way so as to benefit the State as a whole. This is a picture of a strong State, which
is above the special interests of his citizens. A strong State doesn‟t intervene – or need to
intervene - into the economic game (Eucken 1990). It only needs to set the rules for the
economic game, provides an equal playground and cares for those, who are not able to
care for themselves while collecting a ground rent for providing the market facilities. In
effect, this is a natural version of a socialist market economy. Common resources are
retained and charged for at market rates to provide public goods and benefits to the
community as a whole.
However, we showed that the actual situation in Western countries is quite different. The
Western State is typically protecting privatization of publicly created land rent by pushing
taxation onto workers (which explains to a high degree the massive dissatisfaction in the
Euro zone). Moreover, in Western countries there is often a bias in land planning, in favor
of strong and well organized pressure groups. For example, land developers can reap high
shares of the land rent and the incremental value, which is caused by a change of land use
planning. At the same time, the costs (of infrastructure and other land value creating
expenditures and opportunity costs) are pushed upon poorly organized groups. Hence,
developers have a high incentive to capture the planning authorities, in order to get this
free lunch. However, a captured planning authority is not neutral any more. And, even
more, a captured State is a weak State. “Neutral planning”, executed by a strong State, was
a key concept of the German land reform movement, more than 100 years ago.
Unfortunately this concept is almost forgotten.
Moreover, many Western authorities cannot be neutral, since their interests are in line with
the developers and vested interests of landholders. For instance, many Western
municipalities lack revenues. By attracting industry and inhabitants, they try to increase
their tax revenues. But doing this, they often sacrifice agricultural land, public space etc.
in favor of new developments. The result is urban sprawl and a loss of farmland.
Municipalities cannot be a neutral trustee of the common wealth, if they have a direct but
narrow interest in the results of the planning. If municipality A negotiates with an
investor for setting up a new retail business, this investor may negotiate at the same time
with municipality B and C. The result is a destructive competition of the municipalities, at
the expense of the common wealth, if the competition means they all end up surrendering
their public land values to privatized interests. A shrewd municipality would rate its land
values and leave its low costs and charges for services generally as its natural attraction to
all comers, not just a few big boys wanting special deals.
6.
Conclusion
Regarding the funding of public goods, Western States are a poor blueprint for China to
follow. China has a unique chance in history to set up a different financial system. China
can look to her own history and go her own way, as envisaged by Dr Sun Yat Sen, and the
West might come to re-learn from China – instead of the other way around. As the
privatization of public assets in Russia showed, the shift from socialism to capitalism may
create adverse social and economic outcomes if the State does not ensure that natural
23
resources such as land and their rents are kept in State ownership. A socialist market
economy – and a tax competitive one - can work quite well (and more efficiently than
wholly privatized capitalist economies) - if public assets are rented out at market prices to
entrepreneurs instead of being sold off or given away outright.
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25
1
“Volume II, Notes p 567, see also p 482.
2
“J. B. Clark‟s concept of „true capital„ leads to aberrations far more subtle and deceptive and for that very
reason far more dangerous.“ “Positive Theory of Capital“, I, iii, p 55.
3
This is very clear when one reads his contribution in American Social Science Association (1890). The
Single Tax Discussion. The Single Tax Discussion, Saratoga, New York, American Social Science
Association, Concord, Massachusetts.
4
Often referred to as unimproved value. This does not just mean prairie value but can represent salvage
value as when a developer buys a site to tear down an old structure, the “improvement” on which site is now
a useless impediment.
5
In the Principle of the Peoples' Livelihood, published in 1924.,
6
Such has been noted by social welfare agencies in Australia looking at who benefits from rent subsidies to
students or age pensioners and was remarked upon years ago by Winston Churchill (1909) “Some years ago
in London there was a toll bar on a bridge across the Thames, and all the working people who lived on the
south side of the river had to pay a daily toll of one penny for going and returning from their work. The
spectacle of these poor people thus mulcted of so large a proportion of their earnings offended the public
conscience, and agitation was set on foot, municipal authorities were roused, and at the cost of the taxpayers,
the bridge was freed and the toll removed. All those people who used the bridge were saved sixpence a
week, but within a very short time rents on the south side of the river were found to have risen about
sixpence a week, or the amount of the toll which had been remitted!“
7
“Nothing can be more reasonable than that a fund which owes its existence to the good government of the
state, should be taxed peculiarly, or should contribute something more than the greater part of other funds,
towards the support of that government” Book V, ii, e at p 844.
8
In his first canon of taxation Book V, ii, b at p 825 in Smith, A. (1776-1784). An Inquiry into the Nature
and Causes of the Wealth of Nations. Oxford 1976.
9
Land value taxation is merely a form of land rent collection by the State.
10
An example of a corrupted public leasehold system is Canberra, the Federal capital of Australia, where
landholders lobbied and were allowed to renew expiring leases for 50 years for $200 and for 99 years for
$2,000. Naturally, they did not afford the same indulgence to their sub-tenants. Also the spreading
phenomenon of land grabbing is done to a high degree based on corrupted public leasehold (Loehr 2012).
11
One of the authors naturally voted in a survey in favour of a gas line being put in his street in 1981 even
though he had solar-electric hot water at the time.
12
Open letter to Mikhail Gorbachev by Nicolaus Tideman and others (1990), 7 November
http://en.wikisource.org/wiki/Open_letter_to_Mikhail_Gorbachev_(1990) (accessed 3 January 2014)
13
Envisage two countries: one taxing rents at 100%, wages and profits at 0%; the other taxing rents at 0%
and wages and profits at 100%. What will happen to their tax bases?
26