Tuesday, 12 October 2010

Some observations on LVT

As a dedicated reader of the meanderings of my friend Gerard I have become familiar with some of his views on tax. In particular, I am aware that he believes it desireable to abolish Income Tax, Value Added Tax, National Insurance, Capital Gains Tax, Inheritance Tax and others and replace them with a Land Value Tax. His position is perhaps explained most clearly here.

The central principle seems to be that tax will be levied at so-many percent a year on the value of land (the value being assessed by reference to sale prices actually achieved in the area). Numerous alleged benefits of Land Value Tax (LVT) have been identified in the many posts Mr Wadsworth has made on the subject (collected here), including that LVT will contribute to the prevention of future land price bubbles and that it will not be as damaging to enterprise as the existing tax regime. I have long had reservations about both these claims, so I thought I'd say why.

Take LVT as a contributor to preventing price bubbles. The obvious first question to ask is how it will have this effect. And the obvious answer is that it will make it undesireable for prices to rise because any rise will cost landowners more in tax. To an extent it is hard to dispute this, but I cannot see how it goes very far.

Does it put any pressure on government to adopt policies that encourage stability or even a fall in land values? No, it does exactly the opposite. If land values fall so do LVT receipts and no government has ever seemed keen on reducing its tax revenues. Whereas a rise in land values will boost the Treasury coffers. On the face of it one would expect government to encourage a rise in land values.

Of course there is another side to this. A general rise in prices leads to a rise in LVT which everyone will have to pay either because they are landowners or because they rent from landowners who have to increase rents in order to cover their extra costs. When everyone is being screwed for more tax simply for the privilege of living in the same place they lived in for a lower cost last year, we can reasonably expect more than a few to cough a polite "ahem" and question the fairness of this windfall accruing to the Treasury. Perhaps the most obvious result will be the need for regular reductions in the percentage in order to keep the overall tax-take roughly the same; yet we can be confident that any such reduction will involve an element of drag so that more tax is taken year-by-year but not quite as much as it would be without a reduction in percentage.

Whether or not that is a correct inference to draw, how could LVT cause or contribute to a fall in land prices? The only way, it seems to me, is for LVT to be so expensive that it makes a significant difference to how much people are prepared to pay for any particular property. At the moment I think it reasonable to suggest that the main factor affecting how much people are prepared to spend on housing is the cost of servicing the loan they take out to buy somewhere. If they think ahead they would be well-advised to build-in a margin for the risk of interest rates rising in the future but in any event they will look at their finances and say "we can afford £20,000 a year", or whatever figure is appropriate to their circumstances. The wise ones will also take into account likely running costs including costs of insurance, repairs and utilities, so their thinking might actually be "we can afford £25,000 for housing, comprising £5,000 for running costs and £20,000 for paying for the place". The matter that determines how much they are prepred to pay is how much they can borrow in return for repayments of £20,000 a year. For sake of example, let's assume they can borrow £300,000. They do not approach the issue by saying "this house costs £300,000, how will we pay for it" but by saying "we can pay £300,000, what can we get for that sum?"

For LVT to have any appeciable effect on prices it must affect the amount people can afford to borrow. LVT can affect how much people can afford to borrow in one way only, and that is as a running cost that forms part of the overall household budget. Using the example I have just given, those with £25,000 to pay for housing would alter their analysis to something like: "we can afford £25,000 for housing, £5,000 will be needed for running costs, something for LVT and the balance to pay towards a loan". If the amount left to repay the loan is less than £20,000 that is fair enough, LVT could reduce prices. But, by definition, those very people are no longer paying Income Tax, NI or VAT, so their disposable income has increased. Say they paid £10,000 in IT & NI and £2,000 in VAT. Instead of starting with £25,000 to pay for housing they now have £37,000. So LVT would have to exceed the cost of the taxes it replaces (£12,000 in my example) for it to be able to make any difference at all.

The exact figures do not matter for this purpose. What does matter is that LVT will have to take more from household incomes than the taxes that are to be abolished for it to be able to have any effect on purchase prices at all. That is why I said it would have to be expensive. In order to have an appreciable effect it would have to be very expensive. In my example it would have to exceed £12,000 a year on a property costing £300,000. That is only 4%, so would 5% be enough, 7%, 10%? Whatever figure is chosen above 4% would provide the Treasury with a phenomenal windfall before any influence on prices fed through.

As to it not being as bad for enterprise as existing taxes, I am, again, unconvinced. The most stifling factor on enterprise is cost. Whether that cost is tax, wages, materials or fuel, the more expensive it is to start a new business or expand an existing business the less likely it is that the start or expansion will happen. VAT, Income Tax and National Insurance Contributions are the most stifling taxes because the first forces a business to make a profit just to break even and the other two increase the cost of hiring staff. Were all three abolished, enterprise would undoubtedly be rewarded ... or would it?

Abolishing Income Tax raises a particular problem because salaries are agreed gross not net. Someone on a headline salary of £30,000 is entitled to £30,000 from his employer whether or not part of that sum is paid to the Treasury as Income Tax. Get rid of Income Tax and employees' NI Contributions (which are also deducted from gross wages) and on the face of it, the employee would still be entitled to £30,000, there would be no saving to the employer. Employers' NI Contributions would be a saving, as would VAT. In their place would come LVT on the employer's premises. Who is to say whether this would be more or less than the saving in VAT and NI? I see no reason why substituting one tax on an employer for another should necessarily reduce his overall costs of doing business.

Maybe it will, maybe it won't, but unless the total tax take is reduced all that can ever happen is that the burden of tax is shifted onto someone else. Perhaps the victims will be landowners generally, both domestic and commercial, but it seems to me to be little more than guesswork (or perhaps nothing more than guesswork) to suggest that LVT will reduce business costs to any significant extent. It cannot be ignored that any sizeable increase in the cost of living of employees accompanied by a reduction in costs of employers will lead to calls for higher wages to return the balance to what it was before. And it is hard to resist the inference that employers would accede to those calls, at least in part, either voluntarily or after facing a revolt from the shop floor.

In this regard there is a difference between employees being hit by higher taxes from the government and employees being taxed more in order to make things cheaper for their bosses. In the former case the boss has an answer: "I've got no extra money, sorry" whereas in the latter it is necessarily the case that that excuse does not arise.

Once LVT has come into effect and the running costs of a household are increased accordingly it is unavoidable that some will not be able to increase their incomes and will find their homes unaffordable out of current income. The only answer given by LVT-ists is that such people will have to trade down to something they can afford, whether it be a cheaper rented place or a cheaper owned place. In itself that raises a serious policy issue. Is it right that taxation policy should force people to move from a home they could previously afford? This is illustrated most acutely by those on modest incomes who own a "high-value" property. The existing tax arrangements allow them to retain their home whereas LVT makes it unaffordable so they are forced to sell and move to something cheaper.

The usual justification given is that these people are not putting the land they occupy to efficient use and the benefit accruing from it being freed for more efficient use outweighs, as a matter of public good, the cost and inconvenience to the displaced individuals. I find this a most unattractive argument. In many parts of London and the South East the supposed justification cannot be assumed to be correct in fact. Even small properties command prices existing occupiers / owners could not afford were they buying a home today. Forcing out existing residents of one or two bedroomed flats and houses will not lead to the properties being used more efficiently, it will result in them being used by pretty much the same number of people but the new occupants will just happen to have higher disposable incomes than their predecessors.

Even where a couple moves out of their three-bedroomed home to something smaller in an area they might or might not know in order to allow one or two additional people to occupy their old house, the more efficient use of their former home hardly justifies the eviction. The occupation of land is not just an economic exercise; sentiment, including family history, are important aspects of life. People have a reasonable expectation, entirely separate from any windfall capital gain that will accrue on sale, that public policy will not render unaffordable the home they own. Of course they could remain in those homes and pay LVT out of capital by allowing their LVT liability to be charged against their home and redeemed when they sell or die. It is arguable that their homes are actually affordable on this basis because LVT simply sucks-up the equity they have acquired (but not earned) while house prices have soared. It is still a most unattractive policy to my mind because it then places these people in debt when they have arranged their affairs specifically to avoid debt. That the debt is to be paid out of a profit they have not earned is no answer except in an accountant's ledger. If you want to divest them of unearned profits wait until they are dead and apply Capital Gains Tax, don't worry them while they are alive.

What, I wonder, will be the position once LVT is in place and all those with homes they cannot afford have been forced to move to something they can afford. It is when we look at that position that we see the essential circularity of reasoning that underlies and undermines LVT. Where will people live? Answer: in homes they can afford. What is affordable? Answer: that which you can pay for out of income or by reducing your capital. What will be the most common form of affordability? Answer: paying out of income. No doubt some would choose to stay put and diminish capital for the privilege of remaining in the home they occupied since long before LVT moved the goal posts, I would suggest it is reasonable to infer that the vast majority will pay for their housing (including LVT) out of income. The inescapable conclusion is that LVT will be linked directly to income in the vast majority of cases. So, a tax brought in to prevent taxes being based on income (because that is potentially damaging to enterprise) will itself be based on income a few years down the line. And at every stage of the adjustment from current taxes to LVT the government will trim things so as to increase the total tax-take - I mean any government of any political hue.


19 comments:

Mark Wadsworth said...

Very fair summary, just a couple of points:

1. "Whereas a rise in land values will boost the Treasury coffers."

Ultimately, the tax is on rental values, not capital values. How can a government boost rental values? By reducing crime, having nicer public parks, better transport services or roads etc.

2. "What does matter is that LVT will have to take more from household incomes than the taxes that are to be abolished for it to be able to have any effect on purchase prices at all."

That is possibly true, but you are compeltely missing out what the government does with all that money. The intellectually coherent flip side of LVT is a Citizen's Dividend. So in the final analysis, a person who occupies below average property is a net recipient, and somebody in an above average property is a net taxpayer.

3. "The inescapable conclusion is that LVT will be linked directly to income in the vast majority of cases."

Of course! That's the whole point - as there is a very high correlation between the value of the location you occupy and your income. So it is not a particular radical tax shift (and I am not a radical in any sense of the word). But it is an entirely voluntary tax on consumption of common resources rather than a punitive tax on hard work and enterprise.

Mark Wadsworth said...

And obviously, for this to fly politically, there would have to be exemptions, discounts or deferments for pensioners, possibly combined with higher state pension.

Mark Wadsworth said...

4. "Is it right that taxation policy should force people to move from a home they could previously afford?"

Ask yourself whether it is right for people's income to be reduced by income tax and for that tax to be spent on things that benefit an area, so that young people have to pay for the COST of things out of income tax but then pay again for VALUE of those things?

(Or ask yourself whether it is right for Ferrari to set their prices such that 99% of the population can't own a Ferrari.)

Thus young people end up with about half as much housing as would otherwise be the case, entirely because of THE FORCE exercised by THE STATE.

This argument is about as dull as politicians bailing out banks and homeowners to "prevent the nightmare of repossession" (about which you know more than most!). One man's repossession is another man's opportunity to buy a house at a reasonable price.

Anonymous said...

Good post - one of the more balance analysis.

The question remain how are land value calculated. If it is still based on zoning, then government can indeed continue to restrict zoning to ensure land price goes as high as possible!

Secondly, I think the parasit (er heem... highly value add) industry such as the investment bank will love the arrangement. These corporations occupy not a lot of space but make huge profit by skimming off wealth crated by others. So, how much would a hedgefund based in 20th floor (high rise = low lvt per unit) and occupy a 500 sqf space pays in LVT?

LVT should be implemented hand in hand with other taxes (but ensuring no net tax increase).

Paul Lockett said...

Anonymous: "The question remain how are land value calculated. If it is still based on zoning, then government can indeed continue to restrict zoning to ensure land price goes as high as possible!"

I don't think that, in generally, zoning can achieve the increase in land prices you imply.

It can obviously increase the value of some specific plots of land, but only by restricting the uses of other plots, thereby forcing their values down. Increases in the value of some plots of land don't automatically translate into an increase in total land value.

Mark Wadsworth said...

Anon, PL has answered your first point, so I'll deal with your second.

It wasn't the investment banks as such that caused the financial crisis, it was all the reckless mortgages on overpriced land and buildings that were recycled as mortgage backed securities and all that cr*p.

If you keep land prices low and stable, hey presto, no more liar loans and no more MBS cr*p, so the investment banks can focus on channelling money into productive businesses (after taking their traditional handsome cut, such is life).

Paul Lockett said...

To address some of the points in the post:

For LVT to have any appeciable effect on prices it must affect the amount people can afford to borrow.

Not necessarily. You also need to allow for the speculative element of the housing market. Most people who stretch themselves to the maximum when borrowing to buy a house do so because they expect a long term gain from it. Reduce that potential and a house becomes a consumer durable, like a car and in general, people don't view maxing out their lending in order to buy the most expensive car possible to be a smart investment; there isn't a Kirstie Alsopp equivalent in the motoring world.

As to it not being as bad for enterprise as existing taxes, I am, again, unconvinced. The most stifling factor on enterprise is cost. Whether that cost is tax, wages, materials or fuel, the more expensive it is to start a new business or expand an existing business the less likely it is that the start or expansion will happen.

That's true, but given that a new business will have to rent or buy premises and thanks to Ricardo's Law of Rent, we know that LVT can't increase rents, LVT won't increase costs for new business and therefore solves the issue that you highlight being a factor with other taxes.

The occupation of land is not just an economic exercise; sentiment, including family history, are important aspects of life.

They are, but by the same token, many people have an emotional attachment to their car, but it doesn't necessarily mean that skewing the tax system to make it easier for people to keep running a gas guzzler is the right idea.

People have a reasonable expectation, entirely separate from any windfall capital gain that will accrue on sale, that public policy will not render unaffordable the home they own.

They may have that expectation, but I don't think it's reasonable. There is a common argument that if people have owned a house for many years, they would have paid much less for it than it is now worth, which is true, but the flip side is that, if they've been in the house that long, at the time of purchase, domestic rates would have been in place, so they wouldn't have had any reason to believe that property taxes as a proportion of the total tax take, or as a percentage of property values, would fall.

Anonymous said...

My two cents worth.

The two most important features a non-discriminatory tax (one not intended to punish non PC activities) needs is that it be broad, and that it be simple to administer.

To improve on the "broad" over a land tax I'd go for a tax on all trade-able assets, including things like art, copy right and brand names.

To make its administration simple I'd let people place whatever value they thought appropriate on each of their (trade-able)assets, but allow the government (and perhaps others) to buy them at that valuation.

Very simple and self policing.

Andrew W

Mark Wadsworth said...

Andrew, the idea behind LVT is to tax people on the benefits of state-protected monopolies.

That includes copyrights and patents (or the extra value that arises from being able to sue infringers, not the value of the creative idea itself); cherished number plates; possibly brand names (i.e. registered trade marks); land slots at airports, radio spectrum; fishing and oil drilling rights in the North Sea or round the Falklands; mining rights on mainland.

I don't see how this extends to art works. A painting is a physical object created by the artist. It has nothing to do with the state; it does not owe its existence to the state or society in general; it can be taken abroad or physically destroyed; it can be replicated or duplicated; its value may fall because it goes out of fashion etc; and a tax on art works must ultimately act as an income tax on artists.

Therefore such a tax is a bad tax. But this is quite different to the legal right of the owner of a painting to prevent other people from printing copies of that painting (which is a copyright matter) which would exist even if the painting were destroyed. Thus a tax on the value or the copyright (or even simpler, on the copyright royalties) is a justifiable tax.

Anonymous said...

Mark, we appear to have different understanding of the word "monopoly", we also seem to have different definitions of what makes a tax good or bad.
"Good", as I've said, is broad and simple.

Your arguments against an assets tax that would include things like paintings to my mind would also include land, but a block of land is not a monopoly as long as there are comparable blocks of land around, a copy right on a romance novel is also not a monopoly as long as other similar romance novels exist.
If a developer subdivides a farm into residential sections, as I read your comment, a land tax on those properties would be an income tax on the developer and therefore "bad".

Could I also point out that a tax on land and not on other assets would see flight of investment into those other assets, making such a land tax discriminatory.

Andrew W

TheFatBigot said...

Interesting comments all, thank you.

I still see nothing to explain how LVT will "keep land prices low and stable". In any event, you first have to have low prices in order to keep them low. How does LVT cause the 40-odd% devaluation that would take prices down to something approaching realistic levels?

It can only do so, it seems to me, by increasing the running cost of housing (after taking into account that householders no longer have to pay Income Tax, NI or VAT) to such an extent that buyers cannot afford to offer current sale prices in the future because the cost of running the property will be too high. That would require a massive annual tax to be levied.

The tax then has to be kept high to prevent people "over-paying" in the future.

Yet I am told the total tax-take is to be no higher than it was already (and, ideally, to be less). So, as LVT goes up so does the Citizen's Dividend, thereby giving back the very money that has been taken (less wasteful beaurocratic charges, of course) albeit not exclusively to the same people.

I really don't see the necessary cause-and-effect in this scenario.

You can call it a tax on State-protected monopoly rights if you want, but that goes nowhere towards showing how it will actually causes prices to be low and stable.

Anonymous said...

"I still see nothing to explain how LVT will "keep land prices low and stable"."

The absence of a tax on land can push up the price of that land because of expectations of future tax free capital gains.

Andrew W

Paul Lockett said...

Andrew W: Could I also point out that a tax on land and not on other assets would see flight of investment into those other assets, making such a land tax discriminatory.

That would almost certainly be the case, but I don't see any reason to view it as a problem. In fact, it's part of the benefit of an LVT. If, taking your art example, people started moving money into art, you would expect to see a general increase in the amount of art being produced. On the flip side, as money moves out of land, then due to the fact that land is a fixed quantity, it won't show a comparable reduction.

fraggle said...

Your wonderment about how it keeps prices low comes about because you're looking at the prices nominally. The money that can be spent on land tenure is hard-limited by what people take home from work. If taxation reduces that amount below the market rent for a piece of land, then less money will be paid. If land is able to be bought and sold as perpetual title, then bank lending enters the equation (hence the current bubble), but even that has limits based on income. If said taxation is removed, then the rents would rise to their actual market level, but never by more than the take home income rose, and if the amount that income rose was above the amount needed for rents to reach true market level, then anything above that stays with the labourer. In other words, rents may rise, but never more and probably less than take home pay does.

That's if they rise at all. There is also a downward pressure on land prices once LVT kicks in. Once it's not possible to buy land once and then claim the land-rent forever, there's no speculative nature to the valuations. Demand for land as an investment stops.

So one downward pressure on land prices (taxation lowering income) is removed but so is an upward pressure (speculative valulation). Exactly what would happen in nominal terms cannot be known, but *relative to labour*, rent would go down.

So that's the low part. The stable part is again to do with the speculative valuations. Land generally does not depreciate in a physical sense. So in general a loan secured on it can always be repaid, even in default. However, the ability to hold perpetual title (as mentioned above) causes people to *overvalue* land because in the long run, they'll be able to get the money back by no longer having to pay (or even get other people to pay). This causes swings in land prices in excess of how prices would normally change (with changes in population or economic development). By removing the incentive to speculate on land, land prices are based on their current usefulness rather than future imaginiations.

fraggle said...

(this had to be split because of the char limit)

A similar consideration can be made with regards to employers. The first thing to understand is that the initial effect on Income Tax is to burden *employers*. As a tax is imposed, workers still want the same take-home pay (as that's what matters to them), so employers end up 'overpaying' in order to take the tax into account. If the tax contines to rise, a point is reached at which the employees are more able to take the hit than the employer. Then, by competition, the employee's take home pay will reduce. Because of the nature of contracts this process takes a bit of time, but ultimately it happens one way or the other. The important thing to remember is that any tax on employment is ultimately shared in some way between both the employer and the employee.

Similarly, once the tax is lifted, employees find themselves quids in...for a while. Remember, by definition they were being 'overpaid' before, so this state of affairs cannot last, contract or no contract. One way or the other, the take-home of the employee will reduce to what it would have been in the first place had there been no Income Tax. That level, however will still be higher than what it was after Income Tax was applied.

For the employer, they will get whatever share they contributed in the first place when the tax was introduced. If employers had taken more of the burden of the tax than they will get more of the benefit. It may take a while to get through the system (again, because of the contracts) but it will happen.

The main reason though that LVT is better for business is because taxes on employment are just that - a punsihment on the act of employing someone. Once it's no longer punishable to employ someone, a lot more of it can happen.

The point that LVT ends up being based on income is, to my mind, quite true. But surely that's a good thing. It makes LVT generally progressive, but it does it without punishing employment (which is the only other way to make a tax progressive) and it does it without costly and bothersome assessments of people's business dealings. Assessing land is much cheaper and less bothersome.

Mark Wadsworth said...

Andrew W, I love a bit of hair splitting, so I'll respond to this:

"a block of land is not a monopoly as long as there are comparable blocks of land around"

Not actually true.

1. Analogy: a water company supplying the whole of London is a monopoly. Let's assume that company is publicly quoted so lots of different people can buy and sell shares in that monopoly.

The fact that ownership of the monopoly is divided up into smaller blocks and these blocks are freely tradeable does not stop it being a monopoly.

2. Monopoly profits cannot be competed away. Your land in the city centre is worth £10 million/acre.

There is no way that i can replicate that by buying an acre of farmland in the middle of nowhere and, even if I could get planning permission, by plonking exactly the same buildings on it as you have built on your acre, because my acre doesn't have hundreds of thousands of potential workers or consumers round it, it has no railway station or local radio station, no hospitals or schools, no sewage works etc.

So your extra rents cannot be competed away, which is a sure fire sign of a monopoly.

Anonymous said...

Mark, I can only suggest you check out what the definition of monopoly is on the web.

Overall we're probably not so far apart in that we'd both like to see a simplification of the tax system. You however do seem to see a LVT as a way of changing behaviour, while I don't think that taxes should be anything other that a method of revenue collection.

Andrew W

Anonymous said...

Land and property prices are high for one reason and one reason only. The government (previous especially) engineered year on year rises to increase income from stamp duty, and inheritance tax, whilst ensuring the minds of the population were employed in making ends meet (although still enjoying the feel good factor of an appreciating asset). Bank mortgage lending was encouraged by this policy, that’s how it worked!
To promote a tax that gives the 650 complete control over land values, and the income from them, is insanity!
Currently you can pay your income tax and choose how much VAT you spend by monitoring your outgoings. This is freedom. Not much freedom but some.
If the obsession with the ‘80% of the country green belt’ were to be abandoned housing prices could be kept at sensible rates. Don’t hold your breath.

Paul Lockett said...

Anonymous,

while government policies have had an impact on land values, to claim that they are the only reason they are high doesn't explain why land value bubbles have occurred for as long as the current system of land tenure has existed. As for:

To promote a tax that gives the 650 complete control over land values, and the income from them, is insanity!

It doesn't. The underlying land value is what it is. The only thing that would change is the proportion paid in LVT and the proportion rolled up into a capital value.

Currently you can pay your income tax and choose how much VAT you spend by monitoring your outgoings. This is freedom. Not much freedom but some.

Just as you would be able to choose how much LVT you pay by choosing where to live based on the rate payable. In fact, you would have far more freedom, because you could choose to pay no LVT at all by choosing to rent a home, rather than buy.