We are living in an age when house prices have risen to unprecedented levels and the rise shows no sign of abating. Experience from across the globe shows that its impact on the economy and its participants, have been varied and interesting. Unlike other economic processes, asset bubbles add to the incomes of the owners with them not having contributed anything to it. It is a simple case of being at the right place at the right time. Economists call it a "free-rider problem", wherein the beneficiaries partake of a windfall from an event, at no cost to them. In the instant case, the positive externalities generated by specific developments in an area causes all land values to rise..
David Ricardo, the nineteenth century British economist had said that land has a rental value, which is an unearned increment endowed on the owner, and hence can and should be taxed. Ricardo's Law of Rent, postulates that a substantial portion of the wealth generated through any economic activity ends up in increased land values, which benefits only the landowners, who ironically enough do not contribute anything whatsoever to this increase in value.
Unlike other endowments, land and natural resources confer benefits on the owner by the mere fact of being owned, without the need for any value addition to be done by the owner. Further, the rise in value of land or of any natural resource is generally independent of the amount of effort or value addition done by the owner, and is dependent on various exogenous variables. But the full value of the rise is captured by the owner, without the need for sharing or parting with any part of this increase. Land values rise in leaps and bounds due to community activity like new roads, transport links, commercial developments etc. In fact, all these activities, called public goods, generate large amount of positive externalities, most of which are captured by the land owners in terms of increases in land values.
In fact one of the major economic benefits and economic consequence of increased economic and commercial development in an area is captured by way of increased land values, all of which accrue to the land owner, with nothing being shared with the community. We therefore have a situation wherein the landowners become richer at the expense of taxpayers whose incomes are used to generate the positve externalities that causes the rise in land values. And the unkindest cut is that the taxpayer does not get any share of this massive wealth generation, achieved using his taxes.
A typical story goes like this. Mr Realtor buys land in Realtyland I. The Government announces its decision to set up a Software Park in the vicinity of Realtyland I. Land prices in Realtyland I immediately doubles. The Software Park is completed, and infrastructure facilities including roads, water and sewerage, transport links, schools, hospitals, commercial centers and residential enclaves come up around Realtyland I. In three years, the land prices goes up by another five times. What is Mr Realtor's contribution to this growth? None. But Mr Realtor and his ilk are the largest beneficiaries of this boom! He then sells off a part of his land and goes to Realtyland II and buys another 5 acres. The Government then announces the setting up of an Special Economic Zone (SEZ) near Realtyland II, and land values double. The story goes on. There are any number of real world examples like the aforementioned. Replace any part of the new Hyderabad or Visakhapatnam with Realtyland, and the numerous land owning nouveau riche (and this is an increasingly substantial number) with Mr Realtor, and you have a glimpse of this boom economy.
One of the central concerns of economics is about reconciling the principles of individual freedom with social justice, without distorting the market incentives. Surely, no one can deny the right of any individual to own land. But by any yardstick, the principles of natural justice demands that tax payers get value from the expenditures incurred by their taxes in atleast some proportion. It is thus the poor subsidising the rich to become richer still. It is a form of private appropriation of public value, embedded in land rents or increased land values.
Further, there are inherent structural conditions in our economy that favors the already well endowed. These conditions play a major role in widening the income gap between them and the not so fortunate people. Land and natural resources confer on its owners substantial advantages, that are denied to those not possessing it. Given that the amount of these resources available in the world is limited and increasingly scarce, those in possession of the same have considerable advantages, which persists throughout their lifetime.
Social and economic justice is not the only concern arising from rising land values. It distorts other economic incentives also. Experiences from across the globe shows that rising land prices have led to huge increase in household debt as people borrow massively to invest in the real estate market. It results in a drop in savings as people lulled by the "wealth effect" induced by higher land values, stop saving altogether (witness America this decade). The attraction offered by rising land values leads to a crowding out of investment in more productive enterprises, as the short term returns from it far outweigh other investment options. So much so that even financial and manufacturing sector firms start investing in real estate! High land prices have its impact on housing rents, thereby inhibiting internal mobility within a country, as people find it difficult to find affordable housing in cities.
It is therefore natural and just that landowners share a part of the increase in value of their assets with the community or the Government, that is responsible for the activity responsible for causing the rise in value. There is a school of thought, with origins in the ideology of David Ricardo, that argues for taxing ownership and exploitation of natural resources, instead of taxing human effort and enterprise. This tax would be a tax on un-earned income and therefore would not distort the market incentive structure. Adam Smith had argued that such a tax would "not distort the people's incentive to work, save and invest". Unlike labor and capital, the quantity of land is fixed, and hence taxation would not lead to any change in the amount of land available in the market. However, if this were done, it would reduce the incentive for hoarding land. Land ownership would be therefore spread out more evenly. This is equitable, and stands the Rawlsian test, in so far as it promotes equality in access to basic economic opoortunities.
There are many ways of assessing a land tax. One approach is to tax land transactions. This is already being done in a small manner, by way of stamp duty and suffers from substantial evasion and pilferage. Such a tax would be a deterrent on a valuable economic activity, and encourage people to evade detection of the transaction or report lower transaction values. Another method is to tax the capital value of the land on an annual basis. Still another model is to tax the annual economic rent, or the amount of money the land would generate if leased out for a year. These two approaches minimizes market distortions. Besides they are easier to levy and collect, since you cannot parcel away your land to some tax haven like Cayman Islands or to hide it someway.
But there are other important issues to be addressed. Do we levy the land value tax on all lands or only on vacant lands? Do we levy tax on the land value or on the increase in land value or the capital gains? Do we levy tax only on vacant lands or also on developed lands?
A land value tax has many advantages. It will bring more land into circulation and therefore reduce land prices, thereby making it affordable for more people to own land. This will ensure more economically and socially beneficial use of land, by way of construction or agriculture, which would add value to the economy and promote development. The extra supply of land would reduce urban land and building rents, and thereby the accommodation costs for houses and businesses. This would also help reduce urban sprawl. An unused vacant land is a drag on the economy and is an unproductive investment. Such a tax will also help the Government reduce its reliance on other forms of taxation that penalise enterprise and effort. Finally, since land assets are fixed and scarce, and economic efficiency demands that we make the most optimum use of scarce resources, it is only appropriate that we incentivize land development and disincentivize hoarding of land.
The critics of any land value taxation plan will point out that while land values may rise without any value addition by the owner, land is a store of economic value like any other asset. It can be an attractive source of investment for those who earn their incomes through entreprenuership and effort. So would it not be against the principles of economic justice to tax such land owners. My argument against this would be that, even accepting this, are we not right in incetivizing these investors to invest their wealth in other more productive avenues? All of us would agree that there are ceratinly other more productive sources of investment which generate jobs, which are in need of the scarce savings available in the economy.
Land tax is already under implementation in different forms in some countries. Many towns and local councils in Denmark, Australia, South Africa, New Zealand, and some US states, have different variants of land value tax. In Hong Kong, there is no private ownership of land. All land is owned by the State and is leased out. Alsakan oil welath is similarly taxed and its proceeds paid out as a dividend to its citizens.
Interestingly, under the Hyderabad Municipal Corporation Act, there is a provision for imposing an annual vacant land tax amounting to 0.25% of the capital value of the land. This is intended to discourage hoarding of land and incentivize land development. There are also available provisions in Town Planning related rules and orders, for imposing an impact fees to capture the value addition on lands due to external developments like road widenings, land use changes, or other development notifications issued by the Government.
Instead of being a Federal government tax, any land value tax should be a decentralised one. Since all land taxation is generally vested with the local bodies, it is only appropriate that any land value tax be levied and collected through them. Such tax revenues can be used to finance local infrastructure expenditure, and can be a substantial source of revenue for the local bodies. In fact, the local bodies can even dispense with the Property Tax levied on buildings and can impose land value tax on the land housing the building.
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