The pure transition from any tax to land-value taxation is basically simple. A pure shift changes the tax base without changing the total tax revenue. In general, reduce the existing tax rates while increasing the tax on land value or rent by a revenue-neutral amount.
The implementation of a pure tax shift, however, is complex because of the timing. Shall the shift be sudden, or else gradual? Let’s first consider a gradual shift in federal or national taxation. Suppose the tax shift is to take ten years.
Consider a linear shift over ten years, such that the amount of tax shifted is the same each year. Suppose there is a flat-rate income tax of 50 percent. As an example, posit a wage income of $100,000. The tax amount is $50,000. Each year, reduce the tax rate by five percent. The first year, the tax amount is $45,000. The next year, the tax rate becomes 40 percent, and the tax amount is $40,000. In the next-to-last year of the shift, the tax rate is five percent, and the tax amount is $5000. The last year of the transition, and forever after, the tax rate on wage income and the amount are zero.
On the land-value side, calculate the tax rate from the amount of revenue to be obtained. For that, we need the percentage of rent to be taxed. Suppose we set it at 80 percent. $50,000 in tax revenue requires the rent to be $62,500. Consider an initial property tax rate of zero. We want a tax revenue of $5000 from rent in the first year of transition. Suppose the tax base is the economic rent.
A tax amount of $5000 on rent of $62,500 results in a tax rate of $5000/$62,500 = eight percent. The next year we want $10,000 in LVT, for a rate on rent of 16 percent. In the final year, we want $50,000 in revenue and a tax rate of 80 percent of the rent.
Suppose instead that there is already a state property tax. The rent is split among the revenue to the state government, revenue to the federal government, and the portion kept by the titleholder. In that case, increase the federal tax rate on the rent by eight percent per year until the sum of the federal and state tax rates on rent equals 80 percent.
If the tax base is land value instead of rent, the tax amounts are the same, but the calculations are more complicated, because as the tax amount rises, the rent stays the same, but the land value falls. The price p of land equals the annual rent r divided by the sum of the tax rate t (on land value) plus the relevant interest rate i, hence p = r / (i+t). The relevant interest rate is the average ratio of the rent to the price of land, r / p. This is also called the “capitalization rate.”
Suppose we observe the ratio r/p to be four percent. For rent of $62,500 and zero tax, the price of the land is p = $62500 / .04 = $1,562,500. We want a tax amount (t times p) of $5000. Since this is eight percent of the rent, use the formula .08 = t/(i+t). We get .08(i+t) = t; .08*i + .08*t = t. Hence .08*i = .92 * t; 8*.04 = 92*t; .32 = 92*t, t = 3.5 percent of the land value that is now r/(i+t) = $833,333. For each year of transition, increase the tax amount by $5000, calculate the percentage of rent taxed (x), and use the equation x = t/(i+t). After the transition, the tax amount is $50,000, and the tax rate on the land value is .8 = t/(i+t). We get .8(i+t) = t; .8*i + .8*t = t. Hence .8*i = .2 * t; .8*.04 = .2*t; .32 = .2*t, t = 16 percent of the land value that is now r/(i+t) = $312,500, one fifth of the zero-tax price.
The tax shift could be implemented suddenly rather than gradually. In that case the tax on wages would suddenly fall to zero, and the total tax rate on land value would be 16 percent in this case.
A complication in a tax shift from income taxes to land-value taxation is that much of land value was bought with borrowed funds, and has a mortgage. Much of the rent is already being paid to mortgage interest. If the lender, such as a bank, pays the LVT, that would greatly reduce the bank’s asset value, as if the loan had gone bad. Thus it is better to tax the titleholder, but only on the net rent, after paying the mortgage.
So for example if the land value with no tax is $1,562,500, and the new titleholder borrows 80 percent of the land value, the mortgage is $1,250,000. For an interest rate of four percent, the titleholder pays $50,000 in interest, equal to the amount that would be collected by LVT, and the tax amount is zero.
That $50,000 interest is paid by the bank to a depositor, so one solution could be to tax the interest income that comes from land rent, in a gradual transition. Over time, the loans would be paid off, and new buyers would pay a lower price for land as the tax rate increases, and there would be no more taxes on rent-based interest.
A shift to LVT would not be simple, and there would be transition costs, but after the shift, forever after the economy would grow rapidly, poverty would diminish, and the real estate and business cycles would become less severe. The costs of transition are trivial compared to the great benefits from a shift from taxing all income to taxing only land rent.
Copyright 2010 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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