Land Value Taxes are Distortionary

May 14th, 2014
econ, money, tax
In Land Value Taxation (LVT) you tax the value of land. This is very similar to property taxes, where you tax the value of the land and everything built on it, but its proponents claim it's better. Specifically, it's supposed to be better because it's "non-distortionary," avoiding the deadweight loss of property taxes. The idea is that the supply of land is essentially fixed so by taxing it you won't cause any less to be supplied. On the other hand, if you also tax the value of buildings on the land, those are not fixed and you can cause supply to decrease. For example, if I'm considering building a new house on a vacant lot or repairing an old one, under an LVT system that would have no effect on the tax I would pay, while under a property tax I would need to pay more tax in proportion to the increase in the value of my buildings.

So let's say we institute a land value tax and I decide to go fix San Francisco's gentrification problems by building a new city for the tech industry. I identify a nice large area in rural New Mexico with decent natural resources and low land values, invest a bunch of money, and build the bones of a nice walkable city. I sell lots to other developers, put in an excellent subway system (cut-and-cover is cheap if there's not already lots of stuff in the ground), run fiber to every door, and generally make it awesome. I convince Google, Facebook, Apple, Amazon, etc to relocate their headquarters. No one is displaced by this new development except the initial farmer who happily sold me the land, all is well. But then I get my tax bill. It's incredibly high! I was being taxed at an average of $2k/acre for rural land in the middle of nowhere, but now the land is in the middle of a city and it's $500k/acre! I thought land value was supposed to be fixed?

LVT proponents are using two different senses of "unimproved land". One sense would be the value of the land if all buildings everwhere disappeared. Under this definition an acre in downtown Philadelphia and an acre across the river in Camden would have equal value. In this sense, the total amount of land-value available really is fixed, and a tax would be non-distortionary. In the other sense we're just talking about the value of the land if all buildings disappeared from it alone. Under this definition, as you can see in my silly story above, the total amount of land-value available is not fixed.

The basic problem is that the kind of land value that LVT proponents would like to tax may be the unimproved value of your lot but it's based on the improved values of adjacent lots. Which suggests an interesting question: what if I had kept my city as one single giant lot, leasing sections out instead of selling them? Then the "unimproved value" of my land wouldn't go up as the city was built, would it? Alternatively, imagine we start having an LVT and someone buys up all the land in an existing city and merges it into a single parcel? All the things that previously made that land valuable have now become "improvements" on it, right? And are not taxed? You could say the land value is the marginal value, what the market price would be if we took each individual acre and sold it on its own, but then you'd say the land value of my two-acre home would go up if I built something beautiful on one half because the other half now would, considered on it's own, be next to that beautiful thing. So much for not taxing improvements. I'm just not sure "unimproved value" is coherent enough to tax.

Now, LVT may still be better than property taxes, and as wealth taxes go it's good to tax things that can't leave the jurisdiction, but the Wikipedia article and discussions I've seen of LVT tend to make too much of the theoretically-valid-but-inapplicable "non-distortionary" claims.

(I've always wanted a map of the whole country colored by land value. I expect it would look a lot like my apartment price map but better representing the underlying variable of "how desirable is this location, given all other existing development?")

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