Thursday, 14 October 2010

LVT - a cart and horse inverse juxtaposition?

Perhaps the greatest mystery about Land Value Tax is the absolute certainty with which those who support it voice the benefits that will accrue. Land prices will fall and then be kept stable, the cost to business of employing staff will be reduced thereby leading to greater employment, there will be no speculative expectation pressure on land prices, malaria will be no more and England will win the World Cup until the end of time, and so the list goes on.

In my last missive I asked how LVT will cause or contribute to a fall and then stabilisation of land prices and received some jolly interesting comments, none of which made a case I find in the least bit persuasive. A number of points made deserve a more detailed answer than comments allow, so I'll do my best to explain my continued puzzlement.

The first puzzle is: how does LVT cause prices to fall? One way this question can be addressed is by asking whether LVT would have prevented the house-price bubble engineered by Gordon Brown from about 2000 onwards. My first line of enquiry must be to ask what actually caused the bubble and then to ask whether LVT would have negated that cause. My view, which I have stated before at tedious length, is that the bubble is exclusively (or almost exclusively) the result of lenders advancing unaffordable loans, a state of affairs encouraged by the government despite the knock-on effect it had on the value of the lenders' assets. The entire state of tits-uppedness in which many banks and other lending institutions found themselves a couple of years ago (and still but they don't mention it now) was the result of making bad investments - specifically, making bad loans to prospective house purchasers. Although it is to state the bleeding obvious, if Mr & Mrs Ordinary suddenly find they can borrow £200,000 rather than £150,000 there is more money chasing the same goods and prices rise. Value doesn't rise, but prices do. We saw exactly the same thing happen in the mid and late 1980s (although it didn't cause a banking crisis because securitisation and credit default swaps did not get out of hand). How was the crisis solved in 1989? Simple, by letting the market adjust naturally. Borrowing became more expensive sbecause interest rates were set to a level that was appropriate to risk so that good loans paid for bad loans and, in consequence, prices fell dramatically. LVT didn't cause prices to fall because there was no LVT. What deflated the bubble was to withdraw the very hot air that inflated it in the first place. Would LVT have prevented "liar loans"? Will LVT remove that hot air from the current bubble? I don't see how it could or can unless it is set at such a high level that people can no longer afford to pay both their mortgage and their LVT.

And that is the core difficulty I have with the argument that LVT will cause prices to fall. Because LVT is recycled through the Citizen's Dividend it can only ever increase the cost of housing by less than the additional tax charged, because part is repaid to the taxpayers themselves through the Dividend. What level of LVT is sufficiently high to cause prices to fall below current levels? No one seems able to tell me. To my mind it is a false argument. To reduce a bubble you have to look at how the hot air got into the balloon and address that, seeking to deflate it by reference to something else entirely might work but it can only do so circuitously and will, inevitably, have other consequences that might or might not be beneficial.

It is then said that LVT will keep prices stable. How it will achieve this is the second puzzle. One argument is that it will remove the prospect of speculative profit and that this will mean people won't pay over-the-odds now in order to secure a windfall gain later, but this assumes the very stability it seeks to cause. In other words it is a consequence of stability and a factor that maintains stability but it cannot be a cause of stability, so how does LVT cause that stability in the first place?

There can only be one answer because only one factor can prevent price bubbles, namely the dampening of demand. That can happen in a number of ways. You can increase supply of housing to reduce the price pressure on each individual property, you can limit the amount potential purchasers can borrow or you can reduce the income of purchasers so that they can only afford to service a smaller loan. What is unavoidable is that LVT can affect only the third of these factors and it can only do so by being set at a rate which is more expensive to the landowner than the aggregate of the amount he saves through the abolition of taxes on his income and the amount he receives by way of Citizen's Dividend.

A marginal increase won't have any more effect than increases in other bills, a few quid or even a few hundred quid a year won't necessarily do it, people adjust because they save on matters they consider less important. For existing homeowners it will be an inconvenience like recent rises in prices for food, electricity and gas. They are not suggested by anyone to have had any significant effect on house prices, so why should a tax unless it really bites into their income? And it is not enough that it makes life more expensive for existing homeowners, it must be sufficiently expensive to deter potential purchasers from paying what they otherwise might be prepared to pay. So, how high would it have to be? I have no idea but it is, I think, reasonable to suggest that it would be so much that the whole thing would be politically impossible to implement.

Warning to those of a delicate disposition - the following paragraph appears to be nonsense from beginning to end and has been retained to remind me to read what I write before hitting the "publish post" button.
My puzzlement doesn't end there. The whole exercise assumes a transfer of money from landowners to non-landowners because of the Citizen's Dividend that stands alongside LVT to prevent the government making a windfall gain. The non-landowners receive a double benefit. They no longer pay Income Tax, National Insurance or VAT and they receive the Citizen's Dividend that increases as the take from LVT increases. One would think the natural result of them having so much more in their pockets and of their landlords being hit by LVT is that their rent would go up. Assuming that to be the case the acquisition of houses and flats to rent would appear to be an even more attractive business than it is now. There's no income tax to pay and your customers suddenly have many thousands of pounds a year more in their pockets, it sounds like a wonderful arrangement for landlords; all the more so because Capital Gains Tax is to be abolished too. They only need to raise rents by the difference between existing taxes and LVT and they are quids in, after all their tenants will be in profit by a lot more than that. And the effect on property prices? It hardly sounds like a downward pressure to me.

Much more puzzles me, but that's enough for today.


16 comments:

Mark Wadsworth said...

As I've said, the whole thing is slightly circular (which is good news, because it makes it more difficult to 'get it wrong').

Maybe capital selling prices would go down (which would be unpopular in some quarters and popular in others) and maybe they wouldn't.

If we can convince people that low and stable prices are A Good Thing (which is our first battle) then it's easiest to see LVT like a higher interest rate on mortgages, which inevitably pushes prices down.

So if selling prices don't go down as much as expected, the rate can be nudged up until selling prices of land and buildings are more or less equivalent to the replacement cost/value of the buildings alone, i.e. the tax soaks up most or all of the location rent (i.e. the consumption of collective efforts for which the consumer otherwise does not pay).

We can short circuit the circularity and divert some of the receipts back out of the loop by using them to repay national debt, which even on a conservative estimate is £1,000 billion. Even with a swingeing super-LVT, it will still take us ten or twenty years to pay that off, by which stage we'll know exactly what we are doing.

The alternative riposte is of course to point out that IF selling prices are unaffected, this is a clear sign that people can easily afford to pay their LVT bills, which demolishes the whole 'what about ability to pay' nonsense.

Mark Wadsworth said...

"The whole exercise assumes a transfer of money from landowners to non-landowners."

Nope. Everybody lives somewhere, and even tenants 'consume' land. Their total rent will of necessity include the LVT (give or take a bit) exactly as now, only currently the LVT is privately collected by the landlord (but subejct to income tax) and under LVT it is a straight flow through from tenant to state and back to citizens.

As I have explained before, LVT is a transfer of money from people who consume a lot of land value to those who don't consume much land value. There's no more to it than that.

How you can square this statement with your following assumption:

"... the acquisition of houses and flats to rent would appear to be an even more attractive business than it is now."

... is a complete mystery to me. It's either one or t'other, surely? If you say that landowners and landlords are being clobbered (not true) then why would it suddenly become more attractive to be a landowner/landlord (not true either)?

Anonymous said...

"One would think the natural result of them having so much more in their pockets and of their landlords being hit by LVT is that their rent would go up. Assuming that to be the case the acquisition of houses and flats to rent would appear to be an even more attractive business than it is now."

But of course that's correct, by simplifying the tax system far fewer people need waste their lives administering the mess that it is, so all those people could then find productive employment producing goods as services that people actually want, rather than the "service" of administering tax. Such an increase in productivity would push up GDP, which inevitably would increase peoples spending power which would flow on to increased land values. Greater productivity is why land is more valuable in the middle of London than in the middle of Lagos.

Andrew W

Mark Wadsworth said...

AW: "Greater productivity is why land is more valuable in the middle of London than in the middle of Lagos."

Exactly.

And can Lagos compete away these profits? Nope.

This is a clue that land ownership is in fact a monopoly. Even if the Duk of Westminster divided up all his land between dozens of relatives, each of them would just own a smaller share in the same monopoly.

There is no reason to assume that land values in central London would fall as a result of chopping ownership up into smaller blocks.

Anonymous said...

"There is no reason to assume that land values in central London would fall as a result of chopping ownership up into smaller blocks."

That is a good explanation as to why land in central London is not under monopolistic control, its value is determined by market forces, not by its owners.

From Wiki: "In economics, a monopoly (from Greek monos / μονος (alone or single) + polein / πωλειν (to sell)) exists when a specific individual or an enterprise has sufficient control over a particular product or service to determine significantly the terms on which other individuals shall have access to it."

On this one its Mark Wadsworth vs All Economists.

Anonymous said...

That was me.

Andrew W

Mark Wadsworth said...

Andrew, I knew you'd say that.

I am perfectly aware of the Wiki definition, which is why I referred to the fact that a symptom of a monopoly is that "the monopolist can make monopoly profits which cannot be competed away".

Or why I gave the example of e.g. a water company, which for practical reasons has a monopoly in any area (barriers to entry nigh insurmountable), but is publicly quoted so there are lots of owners of that monopoly.

The shares are of course freely traded, but the different share owners are not in any way competing with each other, the value of the monopoly and hence the company is much the same whether one man buys up all the shares himself or whether they are still held by a million Sids owning 100 shares each.

Similarly, can you address the question. let's assume the Duke of Westminster owns the whole of Central London (I don't know if he does, but let's assume) so he is by and large a monopolist and can make monopoly profits.

Would the total value of the land in Central London change significantly, or would rents drop, if he were divide up all this land between dozens of relatives?

If the answer is "no", and it is of course, then the conclusion is that land is a natural monopoly. The price you can charge in rent bears little relation to the costs of production, it depends purely on demand, and cannot be competed away.

Mark Wadsworth said...

Andrew, am I allowed to quote another famous economist, Adam Smith?

“The rent of land, therefore, considered as the price paid for the use of the land, is naturally a monopoly price. It is not at all proportioned to what the landlord may have laid out upon the improvement of the land, or to what he can afford to take; but to what the farmer can afford to give.”

So at least I've got him on my side. Oh look, what's this?

"Thus, Ricardo viewed land as a monopoly."

If you want I can trawl through all proper economists and tell you what the final score is. Suffice to say, I read their stuff first before saying anything.

Anonymous said...

"Ricardo viewed land as a monopoly."

But the whole passage actually says:

"Rent in the nineteenth century was not controlled or restricted by free competition because land did not change hands. Thus, "Ricardo viewed land as a monopoly."

Here's another for you: [John Stuart] Mill also applied the term to land,.."

But if we read on: "..which can manifest a natural monopoly by virtue of it being the only land with a particular mineral, etc.."

That is, as I said earlier, in circumstances where there is no other comparable land.

Mark, perhaps you could avoid quoting out of context.

I'd also not accept your Adam Smith quote without the context being clear.

Andrew W

Anonymous said...

"let's assume the Duke of Westminster owns the whole of Central London (I don't know if he does, but let's assume) so he is by and large a monopolist and can make monopoly profits."

Under those circumstances yes, in my opinion a monopoly could exist.

Andrew W

Anonymous said...

From Wealth Of Nations (via Wiki)

Chapter 10, part ii, motivates an understanding of the idea of feudalism.

Of the Rent of the Land: Rent, considered as the price paid for the use of land, is naturally the highest the tenant can afford in the actual circumstances of the land. In adjusting lease terms, the landlord endeavours to leave him no greater share of the produce than what is sufficient to keep up the stock from which he furnishes the seed, pays the labour, and purchases and maintains the cattle and other instruments of husbandry, together with the ordinary profits of farming stock in the neighbourhood. This is evidently the smallest share with which the tenant can content himself without being a loser, and the landlord seldom means to leave him any more. Whatever part of the produce, or, what is the same thing, whatever part of its price, is over and above this share, he naturally endeavours to reserve to himself as the rent of his land, which is evidently the highest the tenant can afford to pay in the actual circumstances of the land. Sometimes, indeed, the liberality, more frequently the ignorance, of the landlord, makes him accept of somewhat less than this portion; and sometimes too, though more rarely, the ignorance of the tenant makes him undertake to pay somewhat more, or to content himself with somewhat less, than the ordinary profits of farming stock in the neighbourhood. This portion, however, may still be considered as the natural rent of land, or the rent for which it is naturally meant that land should for the most part be let.

As a NZ farmer, and former NZ sharemilker I can tell you that that is not representative of the modern farming situation (at least not on this side of the world, is British farming still feudal?) where people can pick and choose whose land they work and negotiate the conditions of their contracts.

Andrew W

Mark Wadsworth said...

AW.

1. Can you explain why landowners can make profits far in excess of their costs? Is there any other explanation apart from "their profits cannot be competed away?"

2. Can you tell me whether a water utility which is publicly quoted and has lots of small shareholders is, in your eyes, a monopoly or not?

3. Let's imagine you own all the land in Central London. Is there any way for me as an outsider to enter the market and become a supplied of "land in Central London" short of buying the monopoly right from you?

4. If interest rates fall, then the price of things produced by competing producers does not rise. They stay the same or get less. But the price of monopoly items rise.

Consider: if interest rates fall, then car manufacturers can afford more equipment to build more cars, so they build more cars for the same price and (hopefully) make more money. If interest rates rise again, they reduce output to maintain margins.

However, if interest rates fall, then land prices rise. Lower interest rates do not lead to more land being produced or more land coming on the market, because land is in fixed supply, whoever happens to own it at the time that interest rates fall is analogous to the small shareholder in the water company, they are all monopolists.

(the reverse holds on the way down again, of course. if you have bought a house with a mortgage and interest rates and prices fall, you cannot reduce supply to maintain margins, you are just stuck with it).

Do you not notice that land exhibits all the signs of being a monopoly?

5. I was a homeowner and BTL landlord, I made splendid profits which could not be competed away. Sure, somebody else could buy into the monopoly, but only to the benefit of incumbents who were cashing in.

In which other market - apart from a moopoly -can you earn money in your sleep (or indeed lose money in your sleep) without doing anything (or without being able to do anything about it), all underwritten by the government?

Mark Wadsworth said...

Or you appear to accept that were one person to own all the land, "Under those circumstances yes, in my opinion a monopoly could exist."

Would the cost of land and buildings, or rents. in Central London change materially if that one person were to divide up his holding between dozens of relatives?

To the outside world, to prospective purchasers or tenants, nothing has changed. So why do you think it makes a difference whether the monopoly is owned by one person, or a large number of shareholders, or dozens of smaller blocks etc?

james c said...

LVT would force down the price of property, as the cost of ownership will increase substantially.

Rents would stay the same (assuming no reduction in supply of rented property).

The landlord, though, will not keep all of the rents, as a big part will be used to pay his LVT bill.

abdul said...

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landlord building insurance

Mark Wadsworth said...

TFB, I've just noticed your red edit at the end. You have just gone up a lot further in my estimation for that.