Toward Rent Recovery

Roy Langston

[Reprinted from a Land-Cafe online discussion, 27 April, 2007]

Please take the following more as a practical political recommendation rather than economic theory. Feedback appreciated.

Implementing a system to recover publicly created land rent for the purposes and benefit of the public that creates will be difficult, but will be easier and ultimately more successful if the people implementing it follow a sound plan based on economic and political realities. The problem of how to obtain the political power to implement land rent recovery is unique to each jurisdiction, and there is no one-size-fits-all solution. Size matters: politics in a smaller jurisdiction may be easier to influence, and rent recovery advocates can select a good candidate jurisdiction based on how the reform will affect the majority of voters there. On the other hand, a small jurisdiction typically lacks the authority to make all the desired policy changes, especially to reduce other taxes (though the efficiency gains with LVT imply some reduction of other tax liabilities, especially income and sales taxes, as prices decline relative to wages). Where power lies is also important. In the jurisdictions politically dominated by large landowners where land reform is needed most, rent recovery will be difficult, perhaps impossible to implement until other events destabilize the power structure. So we will likely enjoy more success in jurisdictions where land reform is already on the table, and landowners' financial interests have less influence on policy than other considerations -- places like Cuba, Venezuela, Bolivia, China, Israel, and perhaps others where sheer desperation may prompt those in power to seek a genuine solution to refractory economic and social problems, like Zimbabwe (or indeed almost any country in Africa), North Korea, or Haiti. The most promising candidates for land rent recovery where landowner privilege is well established are likely to be places where the majority of voters are not landowners, like Detroit, NYC, and Washington DC in the USA, and numerous cities in other countries. Where private landowning is not established (e.g., China), or is already being challenged by the government (e.g., Venezuela), the critical features of a sound system to recover the rent of public land will be to:

1. Provide secure tenure and freedom of productive use -- generally including a limited subletting right -- so as to maximize the lease amounts users willingly pay while preventing misuses that could reduce future rents;

2. Establish site rents through free and transparent market bidding for exclusive use and tenure of duration suitable to the expected and designated use -- this might range from less than 10 years for pasture or forest land where no significant improvement is anticipated, to 50 years where construction of high-density fixed improvements with a long useful life is anticipated;

3. Index the rents to local GDP as available statistical data permit;

4. Limit lease terms to 50 years before another market-based recalibration of the rent, and index the recalibrated rent to local GDP again;

5. In the event that a user becomes unwilling or unable to pay the rent (including by dying, etc.), permit him (or his estate, etc.) to sell the improvements and transfer or sublet the land, with the new user responsible for paying the land rent under the terms of the existing lease;

6. If the current user is unable to find a new user willing to pay him for the existing improvements and assume his lease obligations, place the land and improvements on the market for lease bids again; when the high bidder is identified, the land authority should dispossess the current user only after a reasonable grace period (say three months), pay him the depreciated value of the improvements less any loss of site value his use of the site may have caused, and transfer the land to the new user.

7. Provide a universal, flat, per capita personal land rent exemption equivalent to about 20% of per capita land rent revenues, applicable to any land the recipient uses for his own work or residence, whether the recipient is the direct landholder or a sublet tenant.

Where private landowning is an accepted institution and its abolition not politically feasible, it also usually accounts for the bulk of the monetary (debt money) system and thus of the banking and financial structure. Great care must be taken not to trigger a monetary contraction and consequent financial panic and economic depression by recovering too much land rent too quickly, especially in jurisdictions that have no authority to reform the financial, banking, or monetary systems concurrently with land reform. In addition, political resistance from landowners and others sympathetic to their interests will be minimized if losses of their asset value can be kept modest and gradual. Removing a large fraction of land value suddenly through taxation alone will provoke much more resistance than removing the same amount gradually and intermittently, through a variety of means, over the course of several years.

Political prudence requires great sensitivity to the interests -- real and perceived -- of the often large numbers of small landowners. Evil on the scale of landowner privilege cannot persist in a democracy without co-opting its victims. The inherent contradictions of being co-opted mean that co-opted victims are often highly irrational about their situations, and will typically defend their oppressors with ferocious loyalty in order to avoid knowing facts that imply both a practical necessity and a moral obligation to resist their oppression by force (a kind of Stockholm Syndrome?).

Therefore, subtler, less direct implementation strategies are called for -- strategies that will effectively wean both small landholders and financial institutions off land rent and land value increases before any attempt is made to substitute land rent recovery for unjust and economically destructive taxes on production. It is absolutely crucial to remove as much of the speculative premium as possible from land values BEFORE implementing a program of LVT rate increases, in order to minimize the probability of a price crash and credit contraction. The key is to first make landowning less profitable by other means:

1. Increase the property tax rate, but give a flat, uniform, per capita exemption, applicable to both owners and tenants, taking care to ensure that the great majority of small landowners who own only their own residences end up with lower net property tax bills. Make the change revenue neutral. This measure will substantially increase the tax cost of, and thus discourage, holding land out of use, releasing more land for use, thus reducing land prices which will again discourage speculation. Making the exemption available equally to renters and owners is easier to defend politically, and will remove some of the small holders' financial incentive to own rather than rent. It is hard for people to resent a reduction in their property value that results from a reduction in their net property taxes.

2. Shift the property tax off improvements and onto land. This can and should be done fairly quickly, but the timing will depend to some extent on election cycles. In jurisdictions where there is a ceiling on residential rent increases, the tax shift should match the rent increase ceiling: if tenants can be required to pay increases at that rate to keep their homes, why not owners? And of course most owners, having significant improvement value, will experience smaller property tax increases than the ceiling rent increase for tenants. Where there is no rent increase ceiling, completing the tax shift over ten years on most properties is a reasonable goal, as long as individual homeowners are protected by a real tax increase ceiling of about double the long-term average real land appreciation rate. Before implementing this tax shift, care should be taken to ensure that landlords cannot spitefully increase rents in response, as a stratagem to foment tenant opposition to the shift. This can be deterred by increasing the supply of vacant housing. Planning permissions for densified residential development should be expedited at least a year before the tax shift is begun (minimizing planning delays is a good idea in any case). A residential vacancy rate increase of 1%-2% during the tax shift is a reasonable target -- although in the few places where vacancy rates are already over 5%, an increase in vacancies to accompany the tax shift is probably neither needed nor desirable.

3. To discourage speculation and reduce expectations of land value appreciation while providing fiscal capacity to reduce taxation of improvements and economic activity, local governments should aim to recover effectively all the land value increments resulting from their densifications of designated use. A simple, efficient, and politically palatable way to do this is simply to stop rezoning privately owned land and giving the resulting value increments away to the private landowners. Instead, local governments should buy up low-density land (especially land within easy walking distance -- 500m, say -- of public transit stations) at the current market price, greatly increase the density of the designated use, and then either sell the land back into the market or lease it to users while retaining it in public ownership (see above for guidelines on leasing public lands).

Assembly of small parcels to facilitate high-density development can also greatly increase the total land value recovered by this method. A reasonable rule of thumb would be to retain half the land thus redesignated and sell the other half to finance additional purchases and redesignations. Taking advantage of the positive feedback of such a system, astute local governments could quickly put themselves in a position to recover almost all the rent of hundreds of acres of prime high-density commercial and residential land, without expropriating any land or increasing anyone's property taxes. The resulting development boom would also help create economic conditions favorable to the subsequent re-election of the land reforming administration, including a mandate for more ambitious reforms.

4. Where feasible, legal frameworks should be amended to make it at least as difficult and time consuming for mortgage lenders to dispossess delinquent debtors as it is for governments to dispossess delinquent residential taxpayers. This will discourage mortgage lending, thus reducing speculative price premiums and financial institutions' reliance on land rent. Numerous other legal and fiscal reforms to deter mortgage lending are also possible.

5. Ensure that valuations are kept current and accurate. All real estate sales data should be incorporated into a computer model of site values, all site values and property tax assessments updated annually, and all relevant information made freely available to the public.

6. Property tax rate differentials for different types of owners, properties and uses should be gradually reduced and then eliminated. Likewise other abatements. The only property tax abatement should be the flat, uniform, universal personal property tax exemption, equal to about 20% of per capita property tax revenues. As that may not be sufficient to secure the homes of the politically sensitive elderly widows, local jurisdictions should also provide a low-cost consulting service to help those who find themselves without the means to pay their land taxes arive at suitable solutions. In addition to seeking accommodation more suited to the applicants' needs and means, such solutions might include reverse mortgages, lease-back sales, liquidation of other assets (especially real estate, of course), taking in tenants or boarders, renting out parking, storage or garden space, etc.

These measures should reduce land values, but also increase total improvement value by stimulating construction and renovation. It is politically prudent not to reduce land values faster than improvement value is added by the increase in construction, and also to ensure that at least in the early stages of land rent recovery, net property tax liabilities for the great majority of taxpayers increase more slowly than the historical average rate of increase -- or even decline. Make sure this sort of information is widely disseminated. Few policies are more politically salable than tax reductions.

Only when the above measures have been in place for a few years will it be prudent to begin a systematic, ambitious program of replacing economically destructive taxes by increased land rent recovery. Care should be taken to ensure that the great majority of taxpayers experience a reduction in net taxes, and to prove and publicize this fact widely and often. Because property tax (and LVT) liabilities are associated with ownership of an asset while other tax liabilities typically are not, there is an illusory loss of asset value (personal "wealth") associated with increased LVT, in addition to the tax liability. This illusion must be dispelled with extreme prejudice at every opportunity. To illustrate the problem as simply as possible, assume a society where $1G is raised in sales tax each year, there are no other taxes, and total land value is $20G at a discount rate of 5%. Shifting the tax burden entirely to land still raises the same $1G in tax revenue, but now there is no land value at all, so $20G in asset value has disappeared! LVT thus seems to impose an immense loss of "wealth" on society in addition to the taxes people pay. This phenomenon is an artifact of how asset value is determined, and the fact that because people cannot be owned, the future tax liabilities associated with their actions rather than with anything they own do not show up as a reduction in the value of any asset. If putatively Georgist organizations were actually interested in promoting LVT, they would support and publish research, books, etc. explaining this trade-off between the value of land and the value of people's future actions. It's one thing to be told, "Your total tax bill will decline by $10K/yr, but the value of your land will decline by $100K," and quite another to be told, "The value of your land will decline by $100K, but the value of your future will increase by $200K.") There is no doubt that reducing the value of people's assets is always going to provoke significant resistance, especially from those who have -- and thus lose -- the lion's share of such assets. It is therefore important to shift the burden of taxation further off production and onto land rent only when taxation of improvement value has been eliminated and other methods of recovering land rent have been implemented, and not to shift the burden so quickly that land values undergo a sudden and significant decline.

Fortunately, because land rent recovery is so economically stimulative, land values may well rise in response to increased land taxation, at least until the land value tax rate is comparable to the growth rate. So resistance to greater recovery of land rent is more likely to be provoked by large percentage increases in tax amounts than by losses of asset value. It will therefore be prudent to keep year-on-year increases in tax amounts modest where possible, especially in a low-inflation environment. Sudden, large increases in tax liabilities are virtually guaranteed to provoke intense resistance. That is another reason it is better to densify the designated uses only of publicly owned land, not private land. Redesignation of private land results in large land value increases that must then in fairness be taxed. The fact that much more value has been given to the owner than is being recovered by the tax will reliably be ignored by the media.

One can derive a serviceable formula for LVT rate increases to balance the conflicting goals of shifting the burden of taxation onto land rent as quickly and smoothly as possible and not provoking financial disruptions or taxpayer and voter resistance. The most important factor to keep in mind is that land tax rate increases must exceed the economic growth rate, or the tax burden will not be shifted onto -- and may even shift OFF -- land rent. Secondly, the tolerable increase in tax rate will be not much more than the growth rate, because larger increases will begin to trigger disruptively rapid declines in land value. The third factor is that tolerable rate increases will be roughly proportional to the current tax rate, but very low rates imply a very small tax amount, and correspondingly less resistance to a given percentage increase -- taxpayers will not resent an increase of $100 on a $200 tax as much as an increase of $1000 on a $5000 tax. The fourth factor is that low LVT rates should be increased more rapidly than high ones to reduce problems associated with widely disparate rates.

Taking all these factors into account, a simple, reasonable compromise formula for calculating the next year's LVT rate (r2), given a current tax rate of r1 and previous year's growth rate g, all expressed as fractions, might be:

r2 = r1 (1 + r1 + g) + 0.001

Application of this formula will typically yield annual percentage increases in the LVT rate in the low double digits: a tolerable pace of increase that is unlikely to depress land values much but will nevertheless build up quickly as r and g rise, producing a doubled rate in 4-5 years. The announced intention of the rate increases should be to stabilize nominal land prices by eliminating speculative premiums and to reduce and eliminate unfair and economically damaging taxes. Should land prices increase despite the tax rate increases, increase the tax rate by another mil. Should land prices decline, it should be taken to indicate that speculators are leaving the market as intended, prices are more accurately reflecting true value, and a modest reduction in the planned rate increase can be made. Only in the case of a precipitous decline in prices should the rate increase be reduced to less than the GDP growth rate. It is absolutely crucial to stick with a systematic plan for rate increases, and not to adjust the rates up or down to match a budget projection. If a revenue surplus is obtained, buy up suitable low-density land for redesignation and rent recovery, with the stated aim of using the additional revenue to further reduce unfair and economically damaging taxes.