“Power is a lot like real estate. It’s all about location, location, location. The closer you are to the source, the higher your property value.”

—Francis Underwood (“House of Cards” lead character in episode 1)

Two very often heard arguments for a land value tax are:

“Land was not made/produced by anyone and therefore no one has a right to own it.”“A land value tax is a great tax because it cannot be avoided (e.g. through grey economy transactions, or by hiding property in tax havens).”

These arguments are unfortunately a little weak—each in its own way. After explaining why, I’ll suggest two better arguments.

Weak Argument #1: Land has not been produced by anyone

The first argument is based on a fairly arbitrary ethical rule (i.e., a “deontological” argument). It takes it for granted that the right to ownership depends on the owner having made the object of ownership: that people have a right to the products of their work and nothing else.

Such a rule might be intuitively enticing. However, stating such a rule does not yet make a convincing case that following such a rule would guarantee a just and efficient economic system. Someone might still argue that the private, exclusive ownership of such unproduced assets could be useful or necessary for ensuring that the resource is used efficiently and preserved responsibly.

This is a “natural rights argument” similar to the “homesteading” principle worshipped by many libertarians: They insist that a person should be allowed to own exclusively anything that they have first taken into use (i.e., homesteaded)–including land and any vital natural resources. As Ludwig von Mises puts it:

“The arguments advanced by average politicians and writers against socialism are either silly or irrelevant. It is useless to stand upon an alleged ‘natural’ right of individuals to own property if other people assert that the foremost ‘natural’ right is that of income equality. Such disputes can never be settled.” – Ludwig von Mises, Human Action (1963, p. 284-285)

Weak Argument #2: LVT cannot be avoided

Let’s admit that this argument is a useful one. When taxes can be avoided, there is an incentive to put effort into that tax avoidance game, which is pure waste from the perspective of the whole economy.

Also, our current paradigm focused on taxing transactions has reduced democracy into an arm wrestle where interest groups try to get others to pay taxes while leaving the appropriate loopholes for themselves.

Having land value taxation with a fair valuation system would remove the need for such scheming and political rent seeking. The main question would no longer be “who pays taxes”–but ”for what do we pay taxes”.

However, the problem with this argument is that it is more likely to turn many people against land value taxation–especially those right-wing or libertarian-leaning people who do not trust the public sector to make beneficial decision.

Many people would rather minimize the amount of money on which the public sector can get its hands. For them, it would be a catastrophe if the state had in its toolbox a tax that (a) could not be avoided and, “worse” yet, (b) one that would not be subject to the “Laffer curve effect”, which applies to transaction taxes: higher tax rates reduce total revenues. When a tax has no harmful incentive effects, it is harder to argue for reducing such a tax and hence downsizing the state. The right wing likes to be able to do so on grounds of “economic efficiency”.

What is missed is that such non-harmful tax revenues could also

allow reducing harmful transaction taxation, and/orbe paid out to citizens as a “basic income” or “citizens’ dividend”.

In those cases, they would not increase the relative size of the public sector or its power in the economy.

In a twisted way, it is in the interests of the political right to keep all taxation as harmful to the private sector economy as possible – just to prevent the left from getting a better negotiation position. It is all well and good to call out such an agenda and to question it. However, rooting for “a tax that cannot be avoided” is not necessarily the best way to phrase LVT to a state-hating libertarian or republican.

Strong Argument #1: LVT is a Pigovian Harms Tax on the Inefficient Use of Valuable Locations

The main arguments for the private, exclusive ownership of anything are the claims that it:

encourages people to take good care of things, andit encourages keeping things in as productive use as possible

The trouble with the private, untaxed ownership of location is that it doesn’tlead to efficient use of locations!

Location is one of those few asset types that can rise in value without any additional real investment in them, i.e., work done to improve them. Moreover, merely this expected rise in value of real estate can provide enough of a return to cover for the capital costs (that is, profit requirements) of owning that piece of land, especially under low interest rates.

Real estate owners have in fact a significant incentive to underutilize their resources.

Firstly, there are significant risks involved in leasing out an apartment or facility to a tenant. At low capital costs, it’s a safer investment to just possess high-end real estate. In China, there is even a widespread belief (or cultural attitude?) that the value of an apartment is eroded by people living in it.

Secondly, a large real estate investor or a de facto cartelized construction sector can maintain higher revenues by purposefully sustaining an apartment deficit. Accommodation has a fairly low price elasticity of demand, which means that people’s ability and willingness to pay for living in a certain metropolitan area does not fall very rapidly with the rise in rents. Therefore, keeping a few hundred more apartments empty in a city can significantly raise the rents that can be asked for the occupied apartments in that city. This applies even more so to office buildings.

For the accommodation and facility markets to work efficiently, there needs to be a cost to holding valuable locations. If such a cost was imposed via a LVT, that would make it very unprofitable to keep apartments and other facilities in central locations unoccupied.

Unnecessarily lowered population density decreases the efficiency and potential of the whole urban economy (see Conclusions). A LVT acts practically as a Pigovian harms tax on the negative externalities of inefficient land use resulting from unoccupied apartments and underdeveloped real estate.

Strong Argument #2: Untaxed Landownership is Extremely Non-Optimal Allocation of Risks

As for taking care of a resource, the owner of a piece of real estate has very minimal chances to affect the location value of that piece of real estate.

He can surely take care of the building and is in charge of decisions to invest in improving those buildings, within the limitations of zoning and construction permits. But the location value of the piece of real estate instead depends on:

changes in zoning and city plans,public infrastructure investments,other locally available public services,available local private services,large structural shifts between regions,the overall macroeconomic situation,monetary policy, as well asunique geographic features.

None of these are in any way in the hands of an individual real estate owner! It is hence highly non-optimal that the owner of an apartment or office building has to carry the risk of variations in this location value.

Actually, the whole function of the financial market is to price risks and to allocate those risks onto those who are in the best position to carry them.

A government charging a Land Value Tax is effectively the government holding a “land value derivative”. Real estate owners paying this tax (“issuing the derivative”) are practically hedged against these systemic risks over which they have hardly any control.

It would be a win-win solution for the government to raise land value taxes significantly (e.g. to 10-15 %) and compensate real estate owners 80-90 % for the resulting fall in the market value of the real estate. The government would effectively be “buying” a majority of the land value of all real estate.

It would make sense to make this kind of investment/acquisition even with new government debt. The government would not become more indebted in net. It would simply be purchasing a valuable asset (the future land rents in the form of the land taxation right) with debt leverage.

As there would no longer be so much private debt (e.g. mortgages) with volatile land value as its main collateral, financial crises would be evaded and mitigated. The economy would become far more robust to most kinds of shocks.

Conclusion

A land value tax would fix a number of significant market inefficiencies and make the whole economy more productive and robust.

Urbanization has played a big role in mankind’s material prosperity. And the whole point in urbanization is bringing people closer together to allow new types of trade, more specialization, as well as the collision and evolution of ideas. As proximity matters, location matters. Owning location is the right to charge others for participating in an economy – and for local public services.

More good arguments and counterintuitive economic phenomena are presented in my new book Paradox Economics, which is available in print and for Kindle.

If you want, as a real estate owner, to thank all us taxpayers for helping you build your wealth, this shirt might come in handy: “Your taxes pay for the infrastructure that makes my land more valuable!” (link to US shop, link to European shop).