Land Value Taxes Are Naive

Vox has recently posted a long interpretive journalism piece about Land Value Taxes, which are taxes on the value of the land that property is built upon that ignores the value of its improvements.

The basic theory is that a land value tax will encourage development by not disincentivizing property owners from improving their land more fully, and thus, will encourage desirable investments in things like higher density housing that addresses housing shortages.

Often, idealist economists will push Land Value Taxes as alternatives to income taxation or sales taxation, rather than, as this article does, largely conceptualizing it as a property tax alternative.

There are problems with the theory, however.

One is that it builds its intuition, in part, on the idea that the supply of land is constant, which, while not 100% (see the Netherlands), is close enough to true to be a reasonable assumption for these purposes, and that therefore, the aggregate amount of land value (controlling for inflation) should also be constant. But this is not a sound assumption.

Aggregate land value is not constant, even when aggregate land supply is constant. 

Aggregate land value goes down when land is subject to restrictive land use regulations, even though restrictive land use regulations often make the value of existing homes in the area that is downzoned more valuable, because the neighborhood is more exclusive.

Land value per square foot for a particular parcel of land tends to go up, however, based upon the extent to which neighboring parcels of land are improved.

Aggregate land value goes up when populations rise because more people need it, and fall when people find more land efficient ways to achieve something. Generally speaking, land value taxes tend to rise at precisely the same moment that people who need to use real property are being squeezed by rising property values and rents already.

Land is worth more per square foot in Denver's central business district, which is full of skyscrapers, or Denver's Capitol Hill neighborhood, the highest density residential neighborhood in the mountain west region, than it is in Bear Creek, a neighborhood in the far Southwest corner of Denver where they built suburban style single family detached homes on largish suburban lots, primary to satisfy the desires of city employees who were required at the time to live within the city limits as a condition of employment but wanted a suburban lifestyle, like many police officers (earning the neighborhood the unofficial sobriquet "cop town").

So, land value indirectly taxes improvements to land, because land values are a function of improvements on neighboring parcels.

Land value taxes also do less to create the desired incentives when they are local, which is the way that existing institutions for the taxation of land value and property value are set up. Each locality meets its spending needs from its own tax base, and the land value tax is just one of many ways of allocating tax burdens within that locality. But land value taxes don't necessarily or even generally lead to arbitrage and the proper incentives between development in localities where land values are low, and development in localities where land values are high, because tax rates are based upon local spending requirements.

Locally imposed land value tax rates would be lowest in places with a low demand for government services, and a high aggregate land valuation tax base, like ski resorts and incorporated localities that are mostly business parks, while they would be highest in places with a high demand for government services, and a low aggregate land valuation tax base, like low income suburbs and rural small town.

Another problem with a land value tax is that it has multiple features that make it unattractive as a revenue source.

* Land value taxes are harder to set values for accurately than property taxes, since it depends upon distinguishing total property value from land value in a model dependent manner, and all models have flaws. To the extent that models are based upon sales of vacant land, the models have much smaller sample sizes that are unrepresentative of land that has already been developed. To the extent that models are based upon total property value reduced by construction costs, they are basically adopting a Marxist labor theory of value that ignores the value created by using inputs into production where they are more valuable than they would be if used elsewhere, a distinction which is the foundation  of modern capitalist economies.

* Land values are inherently less stable than the value of land plus improvements.

* Land value taxes tend to force high rates of foreclosure for taxes on property with significant development value like vacant lots, parking lots, and farm land, if it isn't held by a tax exempt owner like a government or a church. But while individually it can be a good idea to encourage owners of land with development value to develop it, not all undeveloped land can be developed all at once, and a land value tax tends to force the other property to cycle through tax sales. 

* Yet, taxation is the art of getting the most revenue from the people able to pay it with the least complaint. It makes more sense to structure taxes in a way that more inherently establish that the people taxes will be able to afford the tax and have the liquidity to do so. This is why we usually tax wealth from appreciation in property values for income tax purposes when gains are realized upon the sale of the property, rather than on a mark to market method. Taxes that don't track the true factors of production of economic value will also tend to distort economic decisions.

* Land value taxes create incentives for land owners to decrease the value of their land, for example, by having it downzoned, exactly the opposite of their intended consequence. 

* Similarly, it encourages people who own open space that currently want to use it for that purpose, to subject that land to conservation easements locking in the use and limiting the market value of the land, rather than holding it open for now but developing it if future circumstances make development of the property make more sense.

* Another bit of gamesmanship that already exists would surge if there was a land value tax. High rise apartment buildings and skyscrapers frequently have an ownership structure in which the land is owned by a non-profit that is exempt from property taxes and income taxes, while the building has private owners who pay a fair market value land lease rent to the non-profit land owners. This reduces property taxes as land values rise when the neighborhood develops further, muting property value tax increases for the owners of the improvements, and also allows the owners of the improvements to take depreciation deductions on 100% of their investments (since land value is not depreciable, but improvements to real property can be depreciated).

* Yet another dubious incentive that a land value tax creates is to encourage mobile businesses like food trucks, which can be stored on low value land when not in use, and parked on public land or untaxed parking spaces, relative to brick and mortar fixed site businesses like restaurants.

* Land value taxes are based upon a smaller tax base than property taxes, which means that to fund the activities currently funded with property taxes, land value tax millage rates must be much higher than property taxes.

* Land value taxes are more regressive, because they tax people who can afford expensive houses more relative to the value of what they own, than people who can only afford a less expensive house.

* Land value tax advocated overestimate the extent to which property taxes simply aren't an important incentive driving the economics of transactions because other factors predominate over tax rates on real property in providing incentives to property owners because they are larger in magnitude.

Property Taxes As Taxes In Lieu Of Income Taxes On Impute Income

There are also more theoretical reasons to disfavor land value taxes. In the case of "use property" like a residence with is owned by the occupant, property taxes serve as a tax in lieu of an income tax on the imputed economic benefit that the property owner receives from owning it, equalizing tax policy between people who own investment assets and used the income produced by investment assets to pay for their living expenses, and people who own use property.

For landlord owned residential property, property taxes that are passed onto tenants by the owners of the property, and the tenants are effectively taxed on the use value of their leases, which is also a property interest being used for consumption rather than further production.

This same analysis also helps to explain why almost every jurisdiction provides tax breaks for agricultural property, which is an investment whose economic benefit to the owner is fully captured through the owner's income tax.

Property taxes effectively double tax commercial property tenants to whom commercial property landlords pass on their property taxes (and owners of owner occupied commercial property), who pay income taxes and sales taxes on the activities conduct at those properties, in addition to property taxes on property that does not provide untaxed imputable income from its use.

In the case of retail businesses, some of this excess taxation in the form of sales taxes and property taxes can be passed upon to customers, but in the case of uses like office buildings, it is significantly harder to pass on the incidence of excess property taxes to the clients of these businesses.