A big benefit of land-value taxation is that after the transition, the typical landowner has no tax burden, because the tax replaces what would otherwise have been mortgage interest, as LVT reduces the price of land to provide a normal return on the remaining asset value. But this land-value reduction stirs up opposition to the tax shift. That raises the issue of compensation for losses and how to deal with mortgaged landowners.
First of all, compensation for the loss of land value is not morally required. The typical landowner has been receiving an implicit subsidy from the government, as public goods generate higher rent and land value. One could argue that justice requires the title holder to pay back the past subsidies. The situation is similar to that of slavery; would liberation require compensation to the slave owners? They had been unjustly taking the wages that would otherwise have been paid to the slaves. Rather than get compensated for the loss of the value of the slaves, one could argue that they should pay back the wages stolen from the slaves.
With land bought prior to the transition, but recent to it, the capitalized value of the subsidies would have been paid to the previous owner. Should all previous owners or their heirs pay compensation for their past subsidy gains? One can see that this becomes a tangled mess.
When income or sales taxes are increased, nobody talks about compensation. The reason this comes up with a land-value tax is that there is a significant change in asset value. But in reality, a higher income tax reduces an asset: the present value of the worker’s future income. The loss of value is more stark and evident with tangible property.
While compensation is not morally required, a payment for net losses would make the transition more politically feasible. The cases we can examine are 1) owner-occupied long-held debt-free land; 2) a landlord long-held debt-free land; 3) an owner-occupier holding recently bought debt-free land; 4) an owner with totally mortgaged land.
- Suppose a person inherited land 50 years ago and now owns and uses it with no mortgage and no tax. The price of the land is $100,000, the interest rate is five percent, and the implicit rent is $5,000 per year. LVT is enacted at a rate of forty-five percent of the price. The price of land after the transition is $5,000/.5 = $10,000. The tax amount is $4,500.Suppose also that the landowner has a wage of $100,000 per year, taxed at 25 percent, and spent $50,000 a year on taxable goods with a sales tax of 10 percent. His annual tax bill was $25,000 + $5,000 = $30,000. The present value of a perpetual payment of $30,000 at five percent is $600,000. His gain is $600,000 and his loss is $90,000; the man is a winner, with no compensation needed.But suppose that the man had no taxable income and no taxable spending (his income was tax-free municipal bond interest, and his spending was on tax-free services and food). He would receive a compensation of $90,000 for the loss of land value and of the implicit $5,000 rent. We can see that this is a highly unusual case, and such compensation would be rare.
- Now suppose the same data, but there is a landlord renting to a tenant. The landlord receives $5000 in rent income per year. This income is capitalized as the price of land at $100,000. The loss of asset value is the same, $90,000. The difference is that the $5,000 in explicit rent is income taxed, and the spending from that income is sales taxed. Suppose the total tax is $1,000. That $1,000 would be subtracted from any compensation.
- The recent buyer spent $100,000 of his own money for the land. The interest he could have earned from that amount in bonds is $5,000. He now gets an implicit interest of $500 on the $10,000 remaining land value. His loss is $4,500 in implicit interest, capitalized to $90,000 asset value. So the situation is the same as in case #1.
- A person borrows the entire $100,000 to pay for the land, which afterwards has a value of $10,000. He pays mortgage interest at $5,000 annually. Now he also has to pay a $4,500 land value tax. One possibility to have the lender pay the tax, but in a competitive industry, the financial institution was already making only normal profits, any interest income beyond costs going to the depositors, who would pull out if they don’t receive the prevailing interest. So the lender should not be taxed. As in case #1, the $4,500 tax payment has to be compared to the gain from untaxing the other sources of income, and compensation is made for any net loss.
Because most taxpayers, households and enterprises, would have net gains, relatively few landowners would get compensated for a net loss. And as the removal of market-hampering taxes would result in greater employment, income, and growth, over time, the government debt that paid for the one-time compensation could be paid off. There would be no more deficits, so that the governmental debt would eventually disappear.
Thus is the transition to land-value tax not a moral problem, and is financially and politically feasible.
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