A popular tax among neoliberals is a land-value tax. This is a tax on the value of land minus the value of any improvements. The most common critiques of the tax are about the practical difficulty of measuring land value, but I think there are deeper conceptual problems that remain even if you assume perfect measurement.
The basic case for LVT is that the value of land is an economic rent, meaning it is a “payment to a factor of production in excess of what is required to keep that factor in its present use”. Because land will not go away if it is taxed, it would therefore be efficient to tax away 100% of the value of the land. This would exclude the value of improvements like buildings, which would allow property owners a return on capital for the improvements they make, but no excess returns due to increases in the value of the land.
LVT proponents argue that part of what gives land it’s value is public goods, and that this value belongs to wider society rather than individuals. Ironically, it’s this close relationship between land value and public goods which I think makes a 100% LVT problematic.
To understand the problem with land value taxes, start by asking: why does land value differ so much? A big part of the answer is the value of amenities, and many of these amenities are privately provided. If you take an empty city block and fill it with dense, beautiful buildings, nice restaurants and bars and other sources of entertainment then the value of the land will go up.
This reflects the reality that there are a significant amount of spillovers in local real estate investment. Land value is not just capitalized value of publicly provided public goods, but of nearby privately provided positive spillovers. It’s widely recognized that when individuals clean up a property, or open a popular business, there are often spillover values in the neighborhood. Urban economists recognize that the collective value of these spillovers is huge, and in fact makes up a significant amount of land value.
You can see how important the positive spillovers of desirable real estate are in, for example, in Kolko, Glaeser, and Saiz’s paper “The Consumer City”:
This paper argues that there are four particularly critical urban amenities. First, and most obviously, is the presence of a rich variety of services and consumer goods. The Internet, and before it the revolution in catalog sales in the 1980s, means that manufactured goods really are national goods. However, restaurants, theaters and an attractive mix of social partners are hard to transport and are therefore local goods. Cities with more restaurants and live performance theaters per capita have grown more quickly over the past 20 years both in the U.S. and in France…
Further evidence of the importance of spillovers can be seen in the literature showing residential foreclosures have a negative impact on nearby house prices.
The fact that private amenities have positive spillovers suggests that they will be underprovided by competitive markets. However, by allowing some of the value of spillovers to be captured, higher land values provide real estate developers, businesses, and even households with incentives to create them.
Anecdotally, it’s easy to see how this is an important dynamic. Real estate developers who move into neighborhoods with high vacancies, low demand, and high crime are often hoping that positive spillovers from their investment will spur additional investments from others, which will in turn make their investment more valuable. In commercial developments the concept of finding an anchor tenant to help draw in other commercial tenants is widespread. When a commcerial property owner brings in an anchor tenant and can thereby charge higher rents for their other nearby properties, should that value be taxed away? These dynamics are fundamental to how the business of real estate investment is done in the real world today, so 100% LVT proponents need to make a case why the world would be better without them.
Even if you assume you could perfectly measure anything you wanted, this conceptual issue raises a problem of what exactly would you want to measure? LVT proponent Fred Foldvary argues that land value should be measured as:
“My analysis here is based on an assessment or estimate of what the plot-devoid-of improvements would rent for in a market or auction.”
But given how important spillovers are, the specifics of the “devoid-of-improvements” counterfactual matter. Is it the value of the land if the improvement had never been made, or the value of the land if the improvement was taken away today? Even if you think you have rock solid argument for choosing one of these over the other, the fact that they can diverge significantly shows the economic importance of spillovers in real estate. Taxing away the incentive for creating spillovers that can be so large seems problematic.
Let me close by saying that the fundamental case for some land value taxation remains intact. Property remains relatively immobile making property taxes relatively efficient. And because land is more mobile than property, it’s better to weight it towards that. However, given the importance of spillovers in urban real estate, a 100% land value tax would be a problem even we had perfect measurement. The fact that we don’t have perfect measurement makes it even more problematic.