A Rule called George:
Fixing the Property Tax System
David Robinson
[7 June, 2002. David Robinson is a Professor of
Economics at Laurentian University]
This month we begin what we hope will become an ongoing INORD series.
We will be presenting simple, but not widely understood ideas from
economics and other social sciences that Municipal Councilors can use
to make our communities better.
Introduction
When the Ontario Fair Tax Commission handed its report to Floyd
Laughren in December of 1993, it reported that "Local government
finance issues were raised more often in the commission's public
consultation process than all other tax issues combined." They
went on to say,"The system of local government finance is so
complex and arcane that it is incomprehensible to most Ontario
resident " It is fair to say that after almost a decade of
reforms the situation is only a little better.
Part of the problem is that the existing system was designed the
wrong way from the ground up. Most reforms are aimed at making the
wrong approach less harmful.
The secret of a good property tax system has been discovered,
however. Meet George. If you understand George, you'll understand some
of the key problems in municipal government. You also understand how
to solve those problems.
George is actually the Henry George Rule, a little known but
extremely powerful principle for running local governments. The
principle is that local governments should try to maximize the
property values. The value of a piece of property depends on the
community and what the community does. The local government is doing
its job when it makes the largest possible contribution to property
values.
There is one tricky point that you have to get clear to really
understand George. The relevant value of land is price plus the value
of all the future taxes. Why should taxes be counted as part of the
value of the land? The cost of using a piece of land has two parts -
the price of the land PLUS the tax bill. When there is a free market
for land, sales only happen when the benefits are at least equal to
the price plus the taxes.
This insight leads to a simple rule for city council.
Never OK a project unless it increases the value of the
land and future taxes by more than it costs.
That is all there is to the Henry George Rule.
Of course there is an equally important POSITIVE version of the rule:
OK a project if it increases the value of the land and
future taxes by more than it costs.
The positive version is harder to implement. City Council doesn't
have enough money for all the projects that this rule says it should
do. The nature of property taxes gets in the way. Increases in the
market price of the land go to the owners. Property owners collect the
benefits that city council pays for.
When Toronto builds a subway, the landowners get rich, but the rest
of the city pays the bills.
The result is that City Councils invest less than they should in
their cities because they don't get paid for the benefits the projects
would produce. Local governments are usually inefficient because they
can't collect fair value for what they produce.
Now you know the Henry George rule. The rest this article provides
examples and more explanations. It also provides a little bit of
history and some information about Henry George the man.
The Henry George Rule is one of the principles of a well-run city.
The Henry George Rule is one of the basic principles for a well-run
city. Economists have proven that if a city follows the rule it will
maximize the wealth of the community.
The Henry George Rule is not a very radical proposition. Local
governments serve the local population. It is true that not everyone
owns property, but it is fairly easy to show that the property values
actually reflect the interests of tenants too.
The Henry George Rule has two major problems.
- Almost no one knows about the rule
- Existing tax laws are set up a different way
- Property taxes are charged on buildings as well as land.
- Property taxes are set to cover services like water or
garbage collection that are not part of the property value
- Property taxes are used to pay for services that are not
related to property value.
>Who was Henry George and why are they keeping him in the closet?
Henry George died on Oct 27, 1897, in the middle of his second
campaign to become Mayor of New York City. He had lost by a narrow
margin in 1896 and probably would have won in 1897.
George was also the author of Progress and Poverty the most
popular Economics book ever written.
Born Sept 2, 1839 in Philadelphia, George left home at 16. He worked
as a sailor, joined the California gold rush, became a typesetter,
journalist, editor, and eventually one of the founders of the San
Francisco Post.
George was generally seen as a socialist, and his approach was seen
as an alternative to Marxian socialism. George's radical reputation is
one of the reasons that his ideas have been ignored.
The core of George's prescription was the single tax. He wanted to
eliminate all other taxes and finance all public activities through a
tax on land. Remember that this is before there was an income tax (It
was Karl Marx who was calling for an income tax, by the way). Henry
George's ideas were one of the streams that led to the creation of the
British Labour Party and the CCF in Canada.
The distribution of costs and benefits.
Say City Council builds a new park, which raises the quality of life.
Tenants are willing to pay more to live in the area. The landlord
raises the rent. In theory the tenants might be no better off in the
end. All the extra value accrues to the landlord.
Or say you build a sewer in the South end of Sudbury. Because the
developers say that no one will buy their land if they have to pay the
whole cost of servicing the land, City Council pays for some of the
sewer with money collected form downtown residents.
The project is the right size, so it maximizes total wealth.
Unfortunately, the downtown residents are made poorer and the
developers are made richer in the process. Part of the motive for the
project is to transfer wealth from one part of the community to
another.
The key point is that there is a simple rule.
Local governments control the supply of local public goods. No one
else can do this job well. Local public goods influence the value of
the surrounding land. In fact, the benefits from local public goods
appear as increases in the total property value.
LOCAL GOVERMENTS SHOULD SUPPLY LOCAL PUBLIC GOODS TO MAXIMIZE THE
PROPERTY VALUES. In other words. LOCAL GOVERNMENTS SHOULD ACT AS IF
THEY OWNED THE LAND AND MAXIMIZE THE VALUE OF THEIR PROPERTY.
The economics of the back fence
This example shows how the technical terms are used.
Imagine that your real estate agent tells you that you could get a
higher price if you rebuilt your fence. In other words, the benefit of
the fence appears in the value of the property. This is the principle
behind the Henry George Rule.
Rent and capitalized value
When someone buys the house they will get some benefit from the
fence. The benefit will be spread out over years. The potential buyer
is willing to pay the capitalized value or "present value"
of that long stream of benefits in addition to the value they get from
the rest of the property.
Costs vs Benefits
How would you decide whether you should build the fence? You ask
yourself "will it cost less than the increase in the value of the
property."
The basic principle is expressed this way: invest in the fence up to
the point where the "marginal benefit is equal to the marginal
cost". This is the essential rule of cost benefit analysis.
Local Public Goods
What if your neighbour's property value also goes up? When there are
spillover effects we say the fence is a local public good. Local
governments provide many local public goods, including roads and
parks.
Financing Local Public Goods
"Publicness" causes problems. You can't get the whole
capitalized value of your fence back when you sell your house because
some of the benefits are going to your neighbour. Even though the
fence is worth building, you might decide not to build it.Why? Because
you only get half the benefits and half the benefits may not be enough
to make you want to go ahead.
The need for a public sector
Sometimes it makes sense to have a local government to pay for public
goods.
Example: The Toronto subway
This is one of the tragedies of Ontario municipal finance, the
Toronto Subway system.
Here is the question: how far out should the subway line be built?
Answer: only so far as there is enough ridership to pay for it. Right?
Wrong!
The right answer begins with the fact that the subway will increase
the property values around every new station. If the total increase in
property value is enough to pay for the line and the station then the
station should be built.
This is an application of the Henry George Rule. If you don't follow
this rule your municipality is not being run efficiently. You have to
follow the Henry George Rule to have economic efficiency.
There are a few interesting qualifications to this rule. You should
include the fares. Fares should be set to maximize overall rents. But
the basic rule would lead to a much larger subway system than Toronto
has right now. In other words, Toronto is being run inefficiently.
What stands in the way of an economically efficient subway system?
Why can't you go to your councils and say, "Here is a very
simple rule. You should follow it"?
The answer is simple but depressing. If you run an economically
efficient municipality the way the rules are set up right now,
you will go bankrupt.
There is no way that the City of Toronto can use the wealth it
creates by building the subway to pay for the cost of the subway. The
benefits are there, but they go to the owners of the land as capital
gains. They go to land speculators in many cases.
Example: Selling Central Park
New York City has a famous park. Central Park is known around the
world for a variety of activities that go on there.
New York City is having financial problems.
There is a proposal that Central Park be sold to developers for one
billion dollars.
No reasonable user fee will ever collect that much money. Would you
advise New York City Council to sell the park?
Because you know the Henry George Rule, you will naturally ask "
if we sell the park what effect will it have on the property values
for the whole city. After all, it will cut tourism, reduce the
attractiveness of the city to people who use the park, and even to
those who think they might use the park.
If selling the park reduced property values in the city by 1% and if
the total value of the property in New York City were two trillion
dollars - not an unreasonable estimate - by the way - selling the park
would do more harm than good.
So what advice would you give? The right answer (if my numbers
happened to be correct), "buy some of the neighbouring land
and expand the park!!!" And keep doing it until the increase in
total value of the land left outside the park reaches a peak.
Who wrote the Henry George Rule?
Henry George didn't invent the Henry George Rule. John Stuart Mill
had already suggested capturing all the capital gains on land. Mill's
proposal was actually implemented for crown lands in Britain in 1909
and was applied to all plots of land in the British Town and Country
Planning Act of 1947.
George didn't even prove the rule is correct. The first proof was
developed in 1974 by Flatters, Henderson and Mieszkowski. It is
sometimes called the Henry George Theorem and sometimes called the "Golden
Rule." It is actually a general principle derived from standard
economic theory.
Taking a Position
Municipalities have to be able to say, "we produced that
increase in land value, so we are entitled to levy a charge against
the property for the value we created. But how do you know what the
effect of a particular project is? Economists have developed some
fairly sophisticated techniques for assessing the impact of local
public goods. Econometric methods are finally up to the challenge.
Even 15 years ago the technical problems were insurmountable. They are
not any more.
There are two gaps.
First Gap: There has to be a complete and continuously updated
property value database for the province. I say for the province for
three reasons.1) Logically we have to have data for a large group of
communities. 2) The responsibility for providing the administrative
machinery is constitutionally at the provincial level. 3) the obvious
way to develop such a database is to build it around an automated
provincial land registry and there are major economic gains form
moving in this direction.
Second Gap: Who will pay for the system? The answer is that the
municipalities would be happy to pay for such a system. What we are
really talking about is a major improvement in the billing and
collection machinery for local governments. Any business makes the
billing and collection part of the price of doing business. Right now
the system is so bad that local governments can't collect for what
they produce.
What do Economists Think about the Henry George Rule?
George's Progress and Poverty was an all time best seller. But how
much influence has George's theory had? The Henry George Rule has won
new support from economist in the last quarter century.
The Encyclopaedia Britannica, "few economists of reputation
supported" his specific remedy - the single tax. "Nevertheless...
his systematic economic analysis provided a stimulus to orderly
reform."
W.E. Kuhn, an economist at the Federal Reserve Bank of Chicago,
wrote, " What little recognition was given this self-taught
economist by the profession, uneasy when stirred out of its
complacency, was grudging, and certainly not a fair measure of his
analytical competence." (The Evolution of Economic Thought,
p155).
Mark Blaug, possibly the most influential historian of economic
thinking, called Progress and Poverty a "wonderful example of
old-style classical economics" , but he also said " it was
thirty years out of date the day it was published."
Flatters, Henderson and Mieszkowski produced the first proof that
George was right in 1974.
Pines and Weiss (1976) showed that Henry George was right for a
slightly different case. The marginal increase of the land rent in an
open and small region correctly reflects the marginal benefit of a
public project.
Arnott and Stiglitz also found that Henry George was right. For an
optimally run community, the aggregate land rent equals the total
expenditure on public goods. The result applies exactly only when the
community has the optimal population.
Kanemoto (1980) showed that if a profit seeking company owned all the
land in town, developed only the land that was profitable, and set the
rental prices to maximize its profits, it would follow the Henry
George Rule.
Even more interesting, in Kanemoto's company town, the company would
also maximize the welfare of the people living in the town. A mining
company, for example, building a townsite on its own land would
maximize the total product of the city minus the cost of maintaining
the utility level required to attract a workforce. The community that
it built would tend to have the same distribution of housing as a
planned city or a city that grew up on its own. The result is also
the same as if all the land in the city is owned by absentee
landlords.
Summary: Economists now know that George was correct. The debate is
about whether it is practical to implement the correct approach.
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