Taxing Land Rents for Urban Livability and Sustainability

H. William Batt

[A paper presented at the 11th Global conference on Environmental Taxation, Bangkok, Thailand, 3-5 November 2010. Reprinted from GroundSwell, November-December 2010]

In most cities of the world today ambience and livability are plagued with two problems: traffic congestion and sprawl development. Yet public bodies seem at a loss in solving them, even though at least from a technical point of view they are demonstrably solvable. Governments have at their command two means by which to address them—two arrows in their quiver, so to speak: constitutionally known as police powers and tax powers. More commonly referred to as command-and-control approaches and fiscal approaches, they are the only legitimate tools that the public has at its disposal.

All this must be borne in mind when designers of government policy consider the efficacy of public programs, particularly with reference to their scope, domain, and weight. Scope involves all those matters or interests in which government concerns itself; the domain is the area or number of people over which it has exercise; and the weight, or intensity, is the degree to which a people or an area feels itself imposed upon, heavily or only lightly. If a government in some way over-extends itself, or imposes itself too much upon people, it will prove to be ineffectual, illegitimate, and have a difficult time maintaining itself. One can find instances in all governments where what limited police powers are available are squandered, and where laws are flouted or circumvented. It is even more the case for taxing powers, where estimates are that as many as half the population believes it is legitimate to cheat if they can do so. This is the case in the United States; and it is higher in many other nations. Poor design of government administration has the effect of undermining the legitimacy of public authority and is costly in every sense of the word. Authors David Osborne and Ted Gabler have such concerns in mind when they exhort policy makers to employ measures that rest lightly on society, that don't require so much "muscle," what they call "Catalytic Government: Steering Rather than Rowing." Skillful design husbands the resources of government.

What makes the challenges of public administration even more difficult is the realization that both tools are better at circumscribing, or even stifling, behavior it opposes rather than promoting it. Bear in mind that any public policies typically have costs—either in the public resources required to administer them or by reducing general welfare. Care must therefore be taken to ensure that their design should be considered and explained. Examples abound where policies, typically with commendable goals, have been implemented, but with consequences that are unanticipated and often harmful and expensive. Often too it is the symptoms of problems that are addressed rather than the underlying causes, the result being that they momentarily or provisionally supply answers but which further exacerbate situations in due course.

With respect to the two problems at hand, traffic congestion and sprawl, most governments have failed to adequately deal with their challenges because they have taken little pain to fully understand their genesis and root causes.With respect to traffic, for example, the solution has too often been to build more roads, or else to widen them. Yet it has long been understood that such policies usually foster greater traffic congestion. Among students of systems theory this has come to be known as Braess's Paradox, after the brilliant German mathematician who first explicated it. So it eventuates that most city thoroughfares of the world are plagued with overuse that is the direct consequence of foolish and counterproductive public policies. Other illustrations of transportation mismanagement could also be offered, but this example illustrates the point.

With respect to the matter of the centrifugal forces of sprawl development, it is more directly a result of economic misunderstanding. But the solutions seldom employ economics; rather policy makers look to command-and-control approaches like zoning and urban growth boundaries (UGBs). The earliest UGB was instituted decades ago in Portland, Oregon, advocated mostly by farmers whose land was threatened by the growing incursion of housing sprawl. A girdle of protected greenspace was drawn around the city's perimeter, intended to prevent development in identified areas and presumably beyond it as well. In time, however, development leapfrogged the UGB and led to more commuter traffic and congestion beyond the girdle. Those property owners inside the perimeter were overjoyed with the arrangement because the scarcity enhanced their site values. Since locational values are a function of access and are reflected in capitalized transportation costs people had the choice either of paying more in site rent for the privilege of location or else in travel costs from areas with more modest costs.

Ultimately the disequilibrium pressures of the site values inside and outside the UGB became so disparate that the system burst. Political forces reached a point wherein the disparities could not be maintained and the UGB could not hold. Other cities have also attempted to delimit their suburban growth but have in one way or another faced similar problems. California's Bay Area outlined a growth boundary demarcated so far from urban cores that the projected infill would take a century. Political resistance made it impossible to impose it closer in where it would have greater bite. It encompasses an area larger than that of the US states of Connecticut and Rhode Island combined! So it is a meaningless pretense. Melbourne, Australia, has just reported a similar failure to curtail sprawl development, having relied upon a UGB pattern that has now been shown to have encouraged land speculation.

Each of these examples reflects poorly conceived public policies, in the first instance an attempt to invest in greater infrastructure and essentially "buy" a way out of the problem, and in the second case a misuse of a police-power-based command-and-control approach that simply postponed and amplified the problem. A better sense of economics, especially land economics, could have successfully addressed the challenge. Proper use of constitutionally permitted tax powers, or fiscal approaches, can not only correct the distortions that result from market disequilibriums; they can also raise revenue for the support of public services and obviate reliance upon revenue streams that have more negative impact and downside consequences. In exploring the problems at hand, the best solutions are in institution of a variant of the conventional property tax, what is most commonly known as land value taxation.

A Better Solution is a Tax on Land Values Alone

The conventional real property tax as known in most English-speaking countries is really two separate taxes from an economic point of view: a tax on land values and a tax on improvement values. Each has very different dynamics and each influences behavior in a different way. Any tax on improvements, essentially buildings, penalizes upkeep and construction initiatives. Titleholders maintaining and improving property to the full extent that sites warrant are penalized with a higher tax. Owners that let property go to wrack and ruin are rewarded with lower assessments and hence lower taxes. Just as taxing wages discourages work, as taxing interest discourages savings, and taxing sales discourages consumption, taxing improvements to real estate rewards the wrong behavior. There are long histories of tax folly from the time trees were taxed effecting deserts, when taxing windows led to darkness, and taxing lot frontage led to outlandish "shotgun houses" in the old American West.

On the other hand, the tax on the assessed value of the land component of a parcel encourages investment and development. The higher the tax the more the owner is encouraged to build on the site so as to recover his carrying costs. Heavier taxing of underused and vacant parcels generates improvements, especially in high value urban cores. This development then fosters the necessary density to make localities walkable and less vehicle dependent. What vehicles then service the areas tend to be public transit. The tax on land values and the tax on improvement values are like a train with an engine on each end: they work in opposite ways and negate what powerfully beneficial effects a tax on land value alone has.

Since the primary concern of this conference is environmental policy and the use to which revenue streams can be put to accomplish sound environmental goals, I will return to this line of thought shortly. It is important, however, to recognize that a tax on land values comports perfectly with all the principles of sound tax theory. Among them are efficiency, neutrality, equity, administrability, stability, and simplicity. An ideal tax is neutral and efficient with respect to markets and progressive in so far as those who have fewer resources will pay less. A soundly based land tax is also easily administered, simple to understand, and provides a stable and reliable revenue stream. It is certain in the face of any attempts at evasion. One can't escape a land tax by taking it to the Isle of Man or the Cayman Islands. Many students hold the view that all taxes have downside attributes so that any revenue system must necessarily make compromises and trade-offs. This claim is very much open to challenge. It is important here only to emphasize that taxes impact behavior in ways that go far beyond their purposes of supporting public services. To this extent, their architecture needs to be carefully designed and understood.

Tax principles as enumerated above have been recognized in various ways since first set forth by Adam Smith. But in recent years there are considerations above and beyond those relevant to revenue design itself. Environmental concerns are equally important, particularly as they address land use configurations. Taxing land parcels according to their market value fosters land use patterns that best suit the demands of the community as a whole. Those sites that reflect where people want to be command the highest land values; those sites that are of marginal use or concern from a pricing perspective are taxed less and reflect less pressure to improve. Business and commercial parcels tend to cluster in high value areas, residential parcels develop at the edges, and agricultural and forest property is relieved of pressure to develop and consume land.

Taxation of Natural Resource Rents

The market value of land parcels reflects what classical economists called rent, also called ground rent or economic rent. Although originally thought of as applying to the productivity of farmland, rent is today identified far more with urban space. This is a different meaning of the word rent than when paying someone for the use of some property, whether for things like tools or for real estate purposes. Land rent is a flow of value through any natural resources that command a market price on account of their demand. Classically, rent is the market price any such commodity beyond what is needed to bring that factor into use. It applies as much to air or water or mineral and petroleum resources as it does to locations. Any items that have a market price not created by human hands or minds can have rental value—even airport timeslots, electronic signals, and satellite orbits. Because their value results not from any human efforts, resource rents can be understood as socially created wealth; they are the mutual result of common enterprise and such rents flow through property more than they are generated by it.

Site rent can also be construed as capitalized transportation costs. Sites with high market value are easily accessible; by whatever mobility means are at hand. Land sites reflect all such costs—those borne by individual members of society as well as those borne collectively. Site rents and transportation costs in a metropolitan area are essentially reciprocal: parcels in urban cores have high access and rental value whereas parcels in remote areas have high transportation costs and low rental value. One way or another the people have to pay for access to market exchanges, whatever sort or style they have: one pays either for the privilege of occupying a location or for the cost of getting there. But since transportation costs reflect the use of materials and energy, it makes sense that they be efficiently consumed, important for a well-designed locality.

German economic geographer Heinrich von Thunen worked out this theory almost two centuries ago. He calculated the costs of bringing farm goods to market and as they related to the most suitable distance from the market on which to grow them. The reciprocal of this was his understanding the value of the market sites themselves. He appreciated that locations in urban cores had site prices many times those in agricultural areas. He further understood the relationship between site rents and access. When von Thunen lived there was little use of fossil fuels for transportation purposes; he died before the carbon age was fully upon us and before transportation costs became for the moment almost inconsequential. We live today in a time of temporary luxury when it comes to energy consumption, an age which most believe will soon pass. Given how intractable land use configurations are once set in place, societies are foolish to develop a permanence that make them far less livable once the petroleum age largely passes.

Returning once more to the matter of the flow of ground rents through locations, one needs to understand that if the public does not recapture the socially created rent it is capitalized in lump-sum market prices. For titleholders to such sites this constitutes windfall gains, what John Stuart Mill called an "unearned increment." This is surplus wealth reflecting social productivity that becomes effectively frozen and unavailable as resource capital. It

is a leaden drag on economic enterprise so long as this wealth is not put back in circulation. Moreover, if this flow of ground rent is not taxed and restored to the economy, the public then is forced to rely on other taxes that have more downside impacts. As earlier noted taxes on wages and goods discourage economic vitality, distort market choices, and are administratively expensive to collect and enforce. Lastly, when entrepreneurs or households make real estate investments they are usually forced to pay artificially inflated prices for locations where value is fed by speculative practices. Members of society pay twice as a result, first for real estate investment loans and then again in taxes to support public services. The only winners are speculators and bankers.

It needs to be emphasized once more that when land sites are artificially inflated in price by speculators keeping them off the market waiting for a gain, those who would elect to use those sites if they were available are forced to choose second-best and sub-optimal locations instead. Rather than market-clearing efficiencies assuring the rational development of social spaces, one finds leapfrog and haphazard unfolding settlement. All this adds to extra costs in infrastructure—roads, utility services, public amenities and community services—that are also less than optimal in their provision. Spatial arrangements thereby impose their social costs several times over, all of which lead to community well being that is far below what could be optimally obtained. Its costs are reflected especially in the consumption and waste of natural resources and human effort.

Chances for private capture of socially created rental value of land arose only during the past four centuries of the "great land rush." From roughly 1650 on, natural resources that earlier were regarded as part of the public commons were turned into a marketable commodity and privatized for selfish gain. Although it has been best chronicled in the history of the Americas, this was a worldwide phenomenon. Moreover it was rationalized and justified in numerous arguments and judicial decisions. The world is only now beginning to appreciate the implications of this rush to privatization. The loss of natural resources consequent upon treating them either as "free goods" or commodities captured by whatever parties have secured legal titles has resulted in the impoverishment of everyone, and even jeopardizes the sustainability of the earth.

We are now far down the road to privatization of the common natural resources of the earth, a process that has been traced to what is known as the "enclosure movement" first initiated in the early Tudor era of English history. It is difficult now to recapture and restore much of this property to the public realm, A more promising solution is to collect the rent from land parcels based upon their market price, treating land not as a commodity to be owned by title in fee-simple but rather as a usufruct. As earlier explained, since economic rent is a socially created product, there is every moral ground for its public recapture. This policy not only encourages the economy to perform far more efficiently, it also restores a sound moral basis to the economy and offers a clear theory of distributive justice. That which is rightfully the public's is returned to the public; that which is created by one's own mind or body is one's own to possess. The commons and the private realms are restored to a comprehensible moral framework.

The concept of usufruct ownership, in contrast to fee-simple title, is a term that needs to be restored to contemporary discourse. It constitutes the legal right to use and benefit from property, typically natural resource property, that other persons, institutions, or the general public have formal title to, at least so long as the property is not damaged or degraded. The English word usufruct derives from the Latin expression usus et fructus, meaning "use and enjoyment," cognate to English "use and fruits." The concept of usufruct goes back to ancient times, and has been far more evident in societies of the world than the notion that elements of nature can be owned as commodities. Just as the terms usufruct and fee-simple are typically opposites, so are the terms leasehold and freehold. Thomas Jefferson wrote, citing John Locke, that "the land belongs in usufruct to the living," a quote that Henry George often repeated, as in his noted speech, "The Crime of Poverty." George also held that private capture of that which was God-given constituted theft, pure and simple: "Thou Shalt Not Steal!" he told the Anti-Poverty Society of New York in 1887. Native American people put the same principle differently: we do not inherit the earth from our ancestors; we borrow it from our children. Even in American society where private property in land and nature is a sacrosanct hallmark of capitalism, the law doesn't talk about it in such terms. Rather it talks about property ownership as a "bundle of rights."

Prior to the enclosure movement and the advent of "the great land grab" and its privatization, the use of land was typically paid for in various forms of rent. One can trace the origins of such payments to earliest times and show that such practices were almost universal prior to the modern era. Payments were made to society, or to nobility acting in its name, in rent whether it be in the form of tribute goods, labor, or in yields from the land itself. Fee simple ownership of land in any form was unique to the rise of Western civilization and its spread. One could argue from an economic perspective that the leasehold arrangements that characterized classic civilizations were equal to or better equilibrated than are the tax regimes employed in nations today.

Land Rent in a Modern Economy

There is growing appreciation among some economists, urbanologists, tax theorists, and land use planners that the disregard or trivialization of land as a factor of production has had profound consequences for many aspects of social and economic evolution. Failure to recognize the significance of the flow of rents from land and other natural resources has led to distortions in many realms of society and their economies. It was possible to overlook this distortion so long as there lacked the means by which to identify and quantify it; rent was posited and discussed largely in economic theory, and what tools were available to identify and quantify it were for the most part derivative and inferential. Computer power and the availability of quantifiable data now offer greater opportunity to redress this failing, and evidence of its existence and impact mounts.

One first needs to ask how much rent is there in a modern nation's economy. Is it a significant enough surplus that taxing it to support government would be adequate? With all the advantages to be had by financing government from the taxing of rents, and removing rent from the markets, how much of a productivity surplus does it constitute? Estimates are difficult, because even with the advent of computers and data mainstream economists have not pressed governments for the financial data compilation that would allow us to adequately measure it. The US National Income and Product Accounts puts the figure at roughly 1 or 2 percent of GDP, a figure that we know is ridiculous. Even back-of-the envelope calculations suggest that it is many times this. If taxes on labor and capital goods could be supplanted by taxes on rents, economic performance would be substantially improved.

Capturing socially created resource rents ultimately restores to liquidity elements of the economy that are otherwise "frozen capital;" this can improve market efficiency. We know also that absent taxes on labor and goods the amount of rent would be much greater: after all their shifts through the economy, all taxes ultimately come out of rent. This is an axiom that has come to be known by the acronym ATCOR. Sometimes it is explained it a bit differently, in one case by the acronym ATAAER: All taxes are at the expense of rent. Put still another way, total rent is that remaining net of taxes. Moving beyond contemporary attempts at its identification, one finds ample references counting rent payments in other societies and times. Historically rent payments were usually a proportion of a farmer's yield or a specified number of days of corvée labor. Based on practices of the period, classical economic theory took largely as a given that rent surplus constituted about a third of a society's economy. An old English nursery rhyme reflects this common practice in feudal arrangements:

Bah, Bah black Sheep, Have you any Wool?
Yes Sir, Yes Sir, Three Bags full.
One for my Master, One for my Dame,
One for the little Boy That lives down the lane.

One quick study, based on the potential of a full land tax but excluding the rents from pollution rights, the spectrum, landing slots, corporate charters, internet addresses, and other sources, suggests that this rent alone amounts to about 28 percent of GDP, and a far more detailed and sophisticated study of the total land rent in Australia estimates that the total is well above thirty percent of GDP. It concluded that "the 'bottom line' reinforces the overall conclusion … that land-based tax revenues are indeed sufficient to allow total abolition of company and personal income tax." A full enumeration of sites where additional rents situate would take enormous work, but Mason Gaffney has suggested fifteen major sources as a start, all of which by their private capture now reduce economic productivity. When all is said and done, he suggests that "The Hidden Taxable Capacity of Land [is] Enough and to Spare" in supporting government and supplanting all present taxes.

This is a significant finding, because we know from various studies how much the deadweight loss from the current taxes is. Harvard economist Martin Feldstein estimated that the burden from the income tax alone is more than 30 percent of the yield, and about 50 percent if social security taxes are added. The sales tax is in all likelihood just as inefficient. Looked at another way, substantial proof has now been developed to show, as George himself originally argued, that

In every civilized country, even the newest, the value of the land [i.e. the amount of taxable rent] taken as a whole is sufficient to bear the entire expenses of government. In the better-developed countries it is much more than sufficient. Hence it will not be enough merely to place all taxes upon the value of land. It will be necessary, where rent exceeds the present government revenues, commensurately to increase the amount demanded in taxation, and to continue this increase as society progresses and rent advances.

In the past thirty years, economists of major stature have demonstrated the validity of what claim has come to be called the Henry George Theorem. Gilbert Tucker, a self-taught student of Henry George, foretold the case decades earlier in a short book titled The Self-Supporting City. In it, he boldly begins by arguing, Municipal taxation as now levied can and should be a thing of the past: the American city can be a self-supporting corporation, meeting its expenses from its rightful income. Taxation is unnecessary, because the city has, in its physical properties, acquired through the years, by the expenditure of its people's moneys, a huge capital investment from which it collects only a very small part of the return earned.

The virtue of taxing rent is that it captures unearned income that is otherwise windfall gains to households and businesses. It is typically the wealthier elements of the population that have title to property resources, so that to them the capture of untaxed but socially-created rent constitutes a "free lunch." The component of the population that owns no land of any sort, typically the poorest elements of society, pay no rent taxes at all for the reason that resource rents, coming from sources with inelastic supply, cannot be passed forward. This makes the taxation of land rents highly progressive, besides their possessing all the other attributes of a sound tax structure.

Most of the literature exploring the nature and sources of economic rent tends to focus on what flows through surface locations of the earth, what is known as ground rent or land rent. Very little attention has been given to rent sources from other elements of nature, since ground rent now seems to be the largest single component. But a significant additional source of resource rent is generated from minerals and fossil fuel extraction. Consider also the wealth of the world's oceans, mostly used today as a source of fish. The electromagnetic spectrum, the frequencies on which radio, television, mobile phone and other signals travel in today's world, all yield economic rents. And especially now, the air sink itself must be recognized for its rental value to the extent that it is used for pollution emissions, and to the extent that it is capable of absorbing them. The air, after all is rightfully the birthright of all humanity, and its sale to polluters to use as a dump is the penultimate travesty in the privatization of the commons.

A Technical Detail: Assessing Price and Value

An objection is often raised concerning the ability of assessors to assign a value to the base of any resource that might be targeted for its taxable rent. For those resources that are fungible, their value can be auctioned off on a regular and periodic basis. This applies to mining sites, fishing grounds, petroleum fields, spectrum frequencies, and air pollution sinks. As to land parcel values, especially since cities are where most of the land value lies, concern is often expressed that one cannot know with confidence how much of an improved parcel is land value and how much value lies in the improvement. This is because land parcels are much less fungible and because sales are far less frequent. Fortunately, computer technology is quickly overcoming this obstacle, even though many assessors have always held the view that the valuing land sites is far easier than valuing buildings.

Much of the earlier difficulty seems to be explained by the inertia of the economics to taxation approaches and to the fact that sales records contain the price of land and improvements totaled together. Since improved parcels are sold far more frequently than unimproved land parcels, these have become the benchmark of valuation quality. Residential parcels change ownership frequently, as often as once every five years, whereas industrial, commercial, and agricultural parcels tend to have very stable ownership. Therefore the standard of valuation for non-residential parcels is far more relaxed.

Handbook of The International Association of Assessing Officers (IAAO) states that "the chief measure of uniformity [in aggregate analysis] is the coefficient of dispersion (COD), which, depending on the nature of the properties involved, should not exceed 10.0-15.0 for residential properties, 15.0-20.0 for commercial properties, and 20.0 for vacant [i.e., rural] land." The limitations of this "eyeball method" have left property owners believing that property taxation is based on subjective judgments and is therefore questionably equitable. In contrast, triangulation algorithms being developed for computer applications, especially when coupled with available aggregate sales data and regression calculations, now allow a higher degree of confidence in the assignment of bills for land use than other tax regimes are able to claim.

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