On the necessity of a land tax

Constantin Gurdgiev gave a good overview of why a land tax is essential if Ireland is to build a smart / knowledge economy a few months back on the Renegade Economist. It’s probably worth reviewing his arguments today, the day Fianna Fail ruled out a (admittedly unfair) flat rate property tax. Gurdgiev blames the disparity in taxation between investments in human capital (e.g. increased education) – typically each additional Euro earned is taxed at 53% – and investments in land, where the return on investment is taxed at a much lower 26% or so (sometimes even 0% because of various tax breaks).

Meanwhile in the Financial Times, American progressive left economist Michael Hudson argues that there is an alternative to austerity – the burden of taxation should be moved from labour to resources such as land –

Facing these two unpalatable options, some of eastern Europe’s leaders have begun to realise that there is, in fact, a third option: radical reform of the tax system. Taxes in most post-Soviet eastern European economies, along with countries such as Greece, are regressive. They add to the price of labour and industry while under-taxing property. Latvia is an extreme example: its flat taxes fall almost entirely on employment, meaning workers take home less than half of what employers pay.

The good news is that these high taxes on labour leave open the option of shifting taxes on to other areas, in particular land. Lowering taxes on wages would reduce the cost of employment without squeezing take-home pay and living standards. Raising taxes on property, meanwhile, would leave less value to be capitalised into bank loans, thus guarding against future indebtedness.

A longer version is freely available on Michael’s website.

Martin Wolf echoes many of his points in another FT article

So I am a land speculator – a mini-aristocrat in a land where private appropriation of the fruits of others’ efforts has long been a prime route to wealth. This appropriation of the rise in the value of land is not just unfair: what have I done to deserve this increase in my wealth? It has obviously dire consequences.

First, it makes it necessary for the state to fund itself by taxing effort, ingenuity and foresight. Taxation of labour and capital must lower their supply. Taxation of resources will not have the same result, because supply is given. Such taxes reduce the unearned rewards to owners.

Second, this system creates calamitous political incentives. In a world in which people have borrowed heavily to own a location, they are desperate to enjoy land price rises and, still more, to prevent price falls. Thus we see a bizarre spectacle: newspapers hail upward moves in the price of a place to live – the most basic of all amenities. The beneficiaries are more than land speculators. They are also enthusiastic supporters of efforts to rig the market. Particularly in the UK, they welcome the creation of artificial scarcity of land, via a ludicrously restrictive regime of planning controls

and

If “a crisis is a terrible thing to waste”, here is an urgent case for action. Socialising the full rental value of land would destroy the financial system and the wealth of a large part of the public. That is obviously impossible. But socialising any gain from here on would be far less so. This would eliminate the fever of land speculation. It would also allow a shift in the burden of taxation. Perhaps as important, with the prospects of effortless increases in wealth removed, the UK might re-examine its planning laws.

, ,

  • Aldamir

    In Greece and Eastern Europe a land tax makes some sense as tax evasion on income is rife, while land and other assets are much more difficult to hide from the taxman. It would help place more of the tax burden on those who have evaded it in the past. In western Europe it seems less sensible. All of the individuals that bought their buy-to-lets could receive a massive tax bill on top of the losses that they are likely to accumulate from the collapsing property market. It seems to be a tax aimed at the least stable part of the economy which could lead to even more property losses with consequent bank instability due to undercollateralised housing loans. I’m not sure that it is a good idea in Ireland.

  • Mack

    Land is useful but in and of itself unproductive – while labour and capital produce wealth. Heavily taxing labour, while giving landowners a free ride is to favour the rentier over the worker or entreprenuer / businessman. We know where this leads. To the Irish and British madness of thought that says we can all get rich through property speculation / investment. Having just saddled future generations with massive banking losses – surely we can all have the common sense now to say, “No thanks!”. Anglo-saxon Western Europe and USA is exactly where this type of response is neccessary. If we don’t learn from it, history will repeat.

    Apart from disastrous bubbles land oftens acts as a parasite on the productive economy through rent extraction. The landowner jacks up rents when a profitable business locations nearby, thus extracting a large portion of the value created for themselves? And for what? They have created little value (beyond a commodity service)? All they have is the title / ownership deeds? The super-profitability of fuedal land speculation and rent-seeking must be stamped out.

    Encouraging the most productive use possible of available land also make sense. Preventing large landowners sitting on large land-banks in order to profit from a scarcity of supply (driving prices higher) as happened during the Irish property boom, also make sense. The best way to do this is to apply a high tax on the value of the land. That way if you have valuable land, you’d better put something valuable on it – or sell it to someone who will.

  • Alias

    “The EU, IMF and major banks are telling governments to run budget surpluses by cutting back pension and social security programs, health care, education and other social spending. Central banks are to reinforce austerity by reducing credit.”

    The other alternative to allowing vested interests turn nations into serfs is for people to change the constitution to make it illegal for government to underwrite the debts of private businesses, thereby forcing those vested interests to engage in responsible lending rather than engage in reckless lending in the knowledge that states will force taxpayers to repay the debts borrowed by others when the boom and its bubbles created by inappropriate expansionist monetary policies inevitably bursts. Another alternative is to reclaim sovereignty over monetary and macroeconomic policies and over banking regulation from the EU governance that devised the inappropriate monetary and macroeconomic policies and over banking regulation that duly wrecked the economy.
    Incidentally, I was watching a feature of government attempts to control land hoarding on the China news channel last night. The government charges a 20% tax on the value of the land for every year it is not developed with the developer forfeiting the land and incurring a 100% loss of it if it is not developed within 4 years of purchase. However, the developers get around this by digging a giant pit on the land and then claiming that development work has become. The result of that government intervention in the free market? Lots of land around Chinese cities with great big holes in the middle of them.

  • Politics has been rather cruel to the people of Ireland. Invasion after invasion, then centuries of domination by “rack-renting” absentee landlords residing in London. Then, with home rule and sovereignty, Ireland’s political leaders decided to emulat British landlordism rather than create the basis for economic and social democracy.

    If any people in this world ought to understand the destructive power of land monopoly and land speculation it ought to be the people of Ireland. You have been its victims for longer than many of the rest of us.

  • Glencoppagagh

    Surely Ireland more than any other country should want to curb enthusiasm for property as an asset. Removing all fiscal incentives for property ownership would be a good start to be followed by robust taxation of all capital gains from property ownership, including those of owner occupiers. The only case for exemption is agricultural land which is a productive asset.

  • Alias

    The problem is how to value the property that is constructed on the land rather than how to value the land. Land itself will abide by the two-thirds rule, e.g. the value of the plot is worth about a third of the value of the property that is constructed on it (the other two thirds are the cost of the building and the developer’s profit).

    Banks value property using the mark-to-market accounting model which assumes that a buyer is either going to live in the property or let it to a third party who will pay the buyer rent to live in the property. That model is defective because it doesn’t account for a third class of buyer will neither live in the property nor rent it to somebody who will.

    That third class is the problem because his economic model is purely to acquire the property at a lower price that the price than he can sell it for at a later time, hence Ireland now has several hundred thousand empty properties that produce no income to repay the mortgage.

    When you set interest rates at nominal levels as the ECB disastrously did then you create the third class of buyer because you allow him to hold a property that produces no income for a longer period of time than would otherwise apply. If, however, you set interest rates at, say, 6% then the buyer would be less likely to afford to hold the property for a long period of time without finding a tenant to repay the mortgage as the longer he holds it at the higher interest rate the lower his potential profit will be from any increase in value. You also solve the other problem which is lending to buyers who do not have a tenant and do not live in the property and, ergo, you do not end up with several hundred thousand empty properties.

    Do you think it is unbelievable that banks do not account for the third class of buyer? It is unbelievable but it is also universal practice. All banks use the defective mark-to-market accounting model which specifically excludes that buyer from their calculations.

  • Alias

    Just to make that first paragraph a bit cleaner: the value of the land is worth a third of value the number of properties that can be constructed on it, e.g. if a developer can get permission to build 20 properties on it with a value of 500k each then the value of the plot is 6.6 million. So the value of the land will be determined by the value of the properties and not vice versa.

  • Alias

    Err, 3.33 million…

  • aquifer

    Taxing land is necessary to defuse the bankers’ tendency to believe it is the safest asset of all and overvalue it. Tax land and bankers will have to understand productive business or the tax will not be paid.

    You are onto something.Mack.

  • You wrote:
    “The problem is how to value the property that is constructed on the land rather than how to value the land. Land itself will abide by the two-thirds rule, e.g. the value of the plot is worth about a third of the value of the property that is constructed on it (the other two thirds are the cost of the building and the developer’s profit).”

    Ed here:
    The value of any building is reasonably easy to determine: replacement cost less actual depreciation. Any good property appraiser can come up with the value of a building with current construction cost data and depreciation schedules.

    For the last four or five years before land markets began to crash around the globe, appraisals in the most speculation driven markets would have shown land-to-total value ratios well above 50% — 80% or so for locations where the buildings had not been upgraded and modernized in recent years.

    A developer who has not been land-banking (i.e., acquiring land or options to purchase land at a stated price years in advance of any intention to construct) will only pay the asking price for a land parcel if the minimum selling price once constructed is at least four times land acquisition cost. High land cost is one very practical reason why developers seek variances on density or the height of a building.

    This is the consequence of a fundamentally dysfunctional and speculation-prone land tenure system virtually everywhere around the world.

  • Alias

    “The value of any building is reasonably easy to determine: replacement cost less actual depreciation.”

    That is the method for determining the amount to be paid by an insurance company if a building is destroyed and a claim is made by the insured party. It has nothing whatsoever to do with determining the market value of the building. The insurer only pays the cost of replacing a property, not the market value of it. The market value is not determined by an indemnity policy but via the mark-to-market model, e.g. what a buyer is willing to pay for it.

    Banks assume that the buyer is either going to live in the property or let it to someone who will live in it. They don’t assume that a property is being built that will never be occupied, e.g. that there is no market demand for it. The third class of buyer that I referred to above distorts the law of supply and demand as predicated on the mark-to-market model because he creates an artificial demand for the property that forces up its value. That is how he profits. There is no economic value attached to the property via occupying in the property or renting it so the real value of the property is determined when this class of buyer stops buying. He only stops buying when he believes that his economic model is no longer viable, i.e. when the bubble is about to burst.

    The legacy of this third class of buyer is a surplus of properties that produce no income to pay the mortgage. The supply then outstrips the demand, the price of the property falls and the lenders are left with assets that are wrote considerably less than the money they advanced to the borrower (who now has an asset that he cannot sell and which he cannot rent even if he decided to rent it so he has no means of repaying the lender since his model depended on him securing the money to repay the lender from selling the asset at a higher price than he paid for it).

    There are several hundred thousand vacant properties in Ireland that were purchased by this third class of buyer, and yet the banks will deny this class of buyer even exists. They will tell you that they lent money to the two classes of buyer that are covered by their accounting model (mark-to-market), e.g. to someone who either intended to live in the property or rent it to somebody who would live in it. That economic model was utterly defective, and I point you to those several hundred thousand vacant properties as the proof of it.

    Mark-to-market will assume that the third class of buyer cannot exist because nobody would borrow money to buy a property that could not generate income to pay the mortgage or meet the buyer’s personal accommodation needs wherein rent is displaced from another property (that they buyer would otherwise be paying) and converted into a mortgage payment. Setting interest rates at nominal amounts destroys the mark-to-market model by creating the third class of buyer.

  • John East Belfast

    Mack

    A few points on this.

    Land is already taxed – via Rental Income on any income derived therefrom, via capital gain on any realised increase in value and via inheritance (excluding business assets and agricultutural) once passed at death.

    Non productive land will yield no tax true – but nor does non productive labour but then land does not expect to be supported by the welfare state either.

    Having a flat tax on land will only be passed onto tenants via higher rents.
    A flat tax may force a landowner to put the land to use if it no longer becomes economically viable to sit on it but is that fair ? Also the fact that the landlord is not using it is usually for a good reason – ie the market doesnt want or need it. Hence forcing him/her to use it may not be desirable either.

    Flat land taxes – ie what we have in the UK as Domestic Rates – is a way of raising local income tax and that is a totally different matter.

    There is no argument in my opinion for taxing non productive land and property and the Govt doing so will only make matters worse by such interference in the market.

    We also shouldnt pick on land and property because of the events of recent years. Collective madness set in with banks, developers and regulatory bodies that allowed a crazy bubble and that can be prevented by better future practices and not more tax

  • JimRoche

    The economic case for a property tax is well established. But the political reality is that this government do not have the moral authority to introduce it. Their own back-benchers would revolt and the government would fall.

    Will Fine Gael and Labour put it in their manifesto? No. So where does the mandate come from. The failure to introduce property tax is a symptom of the crisis in the political system and addressing that is the most urgent priority. Without a credible political class there will be no economic reform.

    Lowering taxes on wages would reduce the cost of employment without squeezing take-home pay and living standards. Raising taxes on property, meanwhile, would leave less value to be capitalised into bank loans, thus guarding against future indebtedness.

    That is not what the government proposed. There was no corresponding reduction in payroll taxes. This was an over and above tax which would suck money out of the real economy and reduce the future tax take from everything else.

  • Alias, you wrote:
    “The market value is not determined by an indemnity policy but via the mark-to-market model, e.g. what a buyer is willing to pay for it.”

    Ed Dodson here:
    However, the task of the appraiser is to ignore the motivation of the buyer and look at what the most probable value would be should the property be put back on the market (by the lender, in the event of a default and foreclosure). I do concur that if the housing unit is unique in a positive way (e.g., has historical significance, was designed by a famous architect), then the house will likely sell for a premium over its actual replacement cost. However, for most properties this is not the case. What a buyer pays a premium for is locational advantage.

  • On Vincent Browne on Thursday night, Leo Varadkar stated his support for a land tax in principle, but also that introducing it now while the market is still dropping and owner-occupiers are vulnerable would be a recipe for disaster. You won’t see it in any manifestos at the next election, but the time may be right when (if?) the property market starts to recover.

  • Andrew Gallagher wrote:

    On Vincent Browne on Thursday night, Leo Varadkar stated his support for a land tax in principle, but also that introducing it now while the market is still dropping and owner-occupiers are vulnerable would be a recipe for disaster. You won’t see it in any manifestos at the next election, but the time may be right when (if?) the property market starts to recover.

    Ed Dodson here:
    Of great importance is to use language that consistently refers to the impost as a tax on “land value.” Ideally, the amount of the tax should approach but not exceed the annual rental value of the land parcel owned.

    Yes, property values have fallen and continue to fall, in some places falling steeply from highs that any rational person realized could not be sustained. Property prices were climbing much faster than household incomes.

    Any property owner faced with significant mortgage debt may potentially default and lose their property if the lender forecloses. Under widespread conditions of economic recession, the issue for government is whether to impose some level of moratorium against foreclosures and evictions (based on the assertion that the loss of ability of people to remain current on their loans is beyond their control).

    Lenders (and/or the investors who purchased mortgage-backed securities) are already faced with losses if properties are foreclosed and then resold at current market prices.

    A restructuring the how property is taxed to partially or totally exempt property improvements and to tax some percentage of the assessed value of land is not likely to result in the reduction in land values more than they have already fallen. Obviously, the effect depends on the accuracy of assessments (i.e., to what extent all land parcels and assessed at the same percentage of actual market value, which is an essential requirement to acheive equity and fairness).

  • Mack

    Andrew, this encapsulates the problem

    but the time may be right when (if?) the property market starts to recover.

    Property is still overvalued. Taxing land speculation of the type we’ve seen is thoroughly desirable and with banks effectively wards of the state and NAMA in progress now is the time to do that at least. Home owners and even property investors and land owners could be taxed lightly via annual land tax – for now, but a big tax on capital gains from land speculation should be put in place immediately.