Deadweight Loss
The loss of economic welfare when a tax drives the quantity traded below its efficient level, preventing mutually beneficial transactions. Because land's supply is fixed, a tax on land value causes no such loss — the core efficiency argument for taxing land.
Definition
Deadweight loss (also called excess burden or allocative inefficiency) is the reduction in total economic welfare — the sum of producer and consumer surplus — caused by a market intervention that shifts the equilibrium quantity away from the socially optimal level.
In the context of taxation, deadweight loss arises when a tax on a good or factor of production causes the quantity supplied or demanded to fall below what it would be in the absence of the tax. The lost transactions would have been mutually beneficial; the tax prevents them from occurring.
Why Most Taxes Create Deadweight Loss
A tax on wages reduces the net return to working, causing some people to work less than they otherwise would. A tax on capital returns reduces the net return to investment, causing some investment not to occur. In each case, the productive activity that would have happened (and would have benefited both the worker/investor and their counterparts) is forgone. This forgone activity is the deadweight loss.
The size of the deadweight loss depends on the elasticity of supply and demand. The more elastic (responsive to price changes) either supply or demand, the greater the deadweight loss from a given tax.
Why Land Value Tax Has Zero Deadweight Loss
Land is unique in being perfectly inelastic in supply: its quantity is fixed regardless of price. No matter how high the tax on land, there will be the same amount of land. There is therefore no quantity of land that is "lost" to the tax; no productive use of land that is forgone because the tax made it unprofitable. The entire incidence of the tax falls on the landowner, with no reduction in the quantity or use of land supplied.
This is the core efficiency argument for LVT that has been accepted by economists across the ideological spectrum, from Henry George to Milton Friedman to the authors of the Mirrlees Review.
The Excess Burden of the Current Tax System
Every dollar raised through labour income taxes, capital gains taxes, sales taxes, or corporate taxes carries with it a deadweight loss — an additional cost to society beyond the revenue raised. Estimates of this excess burden typically range from 20 to 50 cents per dollar of revenue, depending on the tax and the economy. LVT is the one major revenue source with no excess burden.
See Also
- Objection: the public-choice critique — the Leviathan inversion: why "no deadweight loss" is, on one reading, a public-choice cost
- Tideman & Plassmann, Losses of Nations (1998) — the movement's G7 excess-burden calculation (stub, pending full read)
- Pigouvian Taxation
- Land Value Tax — the zero-deadweight-loss tax
- Economic Rent — the base that LVT targets
- ATCOR — the stronger theorem about tax incidence
Sources
- James Mirrlees et al. (2011), Tax by Design (the Mirrlees Review), Institute for Fiscal Studies — used for the authoritative statement that recurrent land/property taxes are the least distorting (A/B-claims). IFS · wiki summary
- Standard public-economics treatment of excess burden under inelastic supply — used for the textbook mechanism (A-claim; any intermediate public-finance text states it).