Taxes for Land Acquisition

John McClaughry

[Reprinted from The People's Land, A Reader on Land Reform in the United States, edited by Peter Barnes, for the National Coalition for Land Reform, printed by Rodale Press, 1975]

The ideal way to use taxes as an instrument of reform is to link them directly to desired objectives - for example, land redistribution. In the following selection, John McClaughry outlines several imaginative ways to tie land-related taxes to land reform. The statement was presented to the First National Conference on Land Reform. McClaughry, a Republican, is a former Vermont legislator and White House aide who currently directs the Institute for Liberty and Community in Concord, Vermont.

Various intricate tax provisions may be used to encourage donors to convey lands to a land trust program, but in general, any program for acquiring and conveying land, or holding it in trust for specified uses, requires some source of financing.

Perhaps the most logical and possibly most lucrative source of revenue to finance a land reform program is the increment value tax, sometimes called the "unearned increment tax" or "capital gains tax". This tax is based on the theory that much of the increase in value of undeveloped land is due to society, and not to the efforts of the land's owner.

This is arguably true in two senses. Where there is a public investment - a highway, airport, sewer line - adjacent land increases in value because of it. Even where there is no specifically identifiable public investment, the changing preferences of consumers, such as urban residents seeking a country home, may drive up the price for land. Since the increment is "unearned" by the land owner, "society" has a right to claim the value of the increment through taxation.

The classic argument for the site value tax, advocated by Henry George in his Progress and Poverty (1879), is equally applicable to the land increment value tax. The difference is that George's argument applied to the total value of the land; the increment value tax applies only to the rise in value experienced during the time the land has been held by the current owner, and is imposed only at the time of transfer.

There are several important considerations to be understood in connection with increment value taxation. First, allowance must always be made for the value of actual improvements made by the landowner, such as drainage, clearing, access roads, etc., which create "earned" increments of value.

Second, there is the troublesome question of the "value" of risk accepted by the owner of undeveloped land. When a speculator purchases a parcel of land, he satisfies the needs of the previous owner who wishes to exchange illiquid land for a liquid asset, money. The speculator converts his liquid assets and credit to an illiquid asset, land. He holds the land hoping to become a seller later on at a profit. This is not an inconsiderable service. In some cases the speculator may take a beating, as when a glue factory or junkyard locates near his parcel. How to set a price on this "earned" service of the speculator in creating liquidity for a seller and absorbing risk has never been satisfactorily dealt with. Much of the oratory condemning land speculation fails to recognize that the speculator does perform a service for which he is entitled, in fairness, to some reward.

Third, it should be noted that increment values are customarily taxed annually in every property tax system. This is because land that has increased in value will be reappraised (sooner or later) to the higher value, increasing the amount of taxes payable annually on it. The increment value tax in effect double taxes this increment, by imposing a second tax on it at the time of transfer.

Finally, there is a question of fairness involved in moving from a system based on landowners right to increment value to a system based on the right of society to that value. Whether or not the .present system is deemed proper and just, it exists, and many present system is deemed proper and just, it exists, and many people have acted in the reasonable expectation that it will continue. If a wholly new system, such as the public right to enjoy "unearned increment," is to be substituted, in fairness those who have acted on the basis of the previous system should, at least in the early years of the new system, receive some allowance from the public.

These considerations are not offered to discredit the idea of an increment value tax on land, but merely to suggest that the practical implementation of such a tax contains some serious difficulties that deserve to be addressed.

Mabel Walker of the Tax Institute of America reports in the August, 1971 Tax Policy that a land increment value tax has been tried in Austria (1822), imperial China (1890), imperial Germany (1911), Denmark and Taiwan, with varying results, but has rarely been the subject of even serious study in the United States. In 1973, however, the state of Vermont became the first jurisdiction in the country to enact an increment value tax on land. The Vermont law imposes a tax based on both the amount of gain and the length of time the land was held by the seller. The tax does not cover buildings or improvements, and also exempts up to five acres necessary for a dwelling if the dwelling is the principal residence of the seller. The taxis paid by the seller at the time of sale. The basis (tax cost) of the land is that determined under the federal Internal Revenue Code.

Two examples will help make this clear. Suppose, a speculator bought a 100-acre parcel of unimproved country land in 1974 for $20,000. Without making any improvements in the land, he sells it in 1977 for $40,000. Having held the land for three years and having sold it for a gain ($20,000) equal to 100 percent of the basis, he would be taxed at 22.5 percent of the gain, or $4,500.

A second example: A speculator buys a 100-acre parcel in 1974 with a residence upon it for $40,000. In 1979 he sells the entire property for $90,000. If half the original basis is allocated to the residence and five acres, then the amount of gain on the remaining 95 acres would be $25,000, or 120 percent of basis. The tax would be, for 120 percent gain and five years ownership, 7.5 percent or $1,875.

These are somewhat overly simplified examples, as they ignore certain exemptions, commissions and sales expenses, and many complications of determining the original basis under IRS rules, but they give a general idea of how the tax is calculated. The tax goes to zero if the property has been held for six years or more.

The purpose of this increment value tax in Vermont was to raise money to fund a property tax relief program totally unrelated to land reform. Governor Salmon promised that under this program no Vermonter would have to pay more than five percent of his income on property taxes on his house and its surrounding acre of land. The Governor also offered considerable oratory to the effect that the increment value tax would stamp out the serpent of land speculation.

As was pointed out by his critics, the Governor can not have it both ways. If the tax is successful in stamping out the serpent of land speculation, there will be no revenue for tax relief. If there is to be tax relief money, land sales must not be taxed out of existence. This is a dilemma that must be faced whenever revenue and social impact are said to be offered in one package.

In practice, the increment value tax considerably dampened sales of land. In fiscal year 1973, for instance, the one-half of one percent Vermont property transfer tax yielded $2,027,000. In the first ten months of fiscal 1974, despite generally higher prices for land, this tax yielded only $1,358,000. If one assumes that transfer of property exempt from the increment value tax continued at their recent trend, the reduction in sales of land subject to the increment value tax must have been extremely pronounced to have produced such a shortfall.

It is most unfortunate that the proceeds of the increment value tax, originating from land transfers, has been tapped for the non-land-related purpose of general property tax relief. It would have been far preferable to use these revenues to fund a Vermont Land Trust, a measure introduced by the writer in the 1972 General Assembly.

As it is, the continual clamor for general tax relief will probably prevent any future diversion of the increment value tax revenues into a land reform or environmental preservation program. This suggests that advocates of land reform in other states should make a strong effort to relate an increment value tax to land reform programs, before competing interests seize upon those revenues to fund their special programs.

A second source of financing for land acquisition is what in Great Britain is known as the betterment levy. This tax, in force in Britain from 1967 to 1971, was applied to the increment in value due solely to a change in zoning status. It bore no relation to the length of time the land was held prior to the change, and was subject to a host of adjustments.

Here is, again, an overly simplified example: A hundred acre parcel of open land has been zoned "agricultural conservation". Its value, based on what it should bring on the market for agricultural conservation uses only, is $50 per acre, or $5,000. The owner sees an opportunity to make a profit by converting this parcel to garden apartments, providing he can obtain a change in zoning to "low density residential." He appeals to the planning board for the zoning change, arguing the need for additional garden apartments in the area and the suitability of his parcel for this use. The board agrees and rezones the land "low density residential." For this use, the value of the land now becomes $500 per acre, or $50,000. Leaving aside the numerous adjustments, the owner would be subject to a 40 percent tax on the $45,000 "betterment", or $18,000.

It should be noted that the betterment levy was a not too important part of an extremely strong program of state zoning in Great Britain. According to Professor C. Lowell Harriss, the levy strongly discouraged any increase in land use intensity, and its revenues were small in relation to the administrative costs involved. Its repeal, says Harriss, does not support a rejection of land increment value tax proposals for the United States, especially since repeal came after the adoption of an overlapping capital gains tax in Great Britain.*

It should be noted, too, that when originally conceived in the 1940s in Great Britain, the betterment levy was seen as a source of revenues to compensate landowners whose land values had been reduced by restrictive zoning. That is, when the planning boards increased the value of certain lands by permitting intensive development, and denied the same opportunity to other landowners, the lucky landowners should be taxed to compensate the unlucky ones. This is a complicated subject, but there does seem to be some merit to the argument.

To summarize, the betterment levy might produce some revenues for a land reform program, provided the tax rate is not so high that it only discourages development; that the administrative complexities are held to a minimum; and that the revenues are not automatically allocated to a compensation fund for landowners whose development rights have been limited by zoning regulations.

A third possible source of tax revenues for land reform is the property transfer tax, in effect in Vermont since 1963. The Vermont tax, estimated to produce about $1.9 million in 1974, is levied on the sale price of all real estate at a rate of one half of one percent. Originally this tax was levied to provide funds for tax mapping of the state, but the proceeds were soon diverted into the general fund and the tax mapping was never seriously undertaken. This is unfortunate, because any serious effort at land reform requires a precise tax mapping to ascertain who owns land, where it is, and what it is worth.

The law requires each seller to file a property transfer tax form at the time of transfer, indicating the sale price and other pertinent data. This form is invaluable in helping the state tax department determine tax equalization factors among the various towns, required by Vermont's school aid formula, which is based on real estate wealth per pupil in each town. There have been no administrative complications with this tax.

One unfortunate effect of the property transfer tax has been its disproportionate burden on lower income families. The tax is absorbed in the sale price, which means the poor man must pay the same rate on a modest home as a rich man pays on a chateau. This could be remedied by exempting the first $10,000 from the tax, and making the tax one percent on everything over $10,000, or otherwise graduating the tax.

These possibilities for raising revenues for a land reform program vary in efficacy and must of course be considered within the particular tax structure of each state. Obviously, adoption of one may preclude adoption of one or more of the others, so careful thought must be given as to the most advantageous method.


* Harriss, C. Lowell, "Land Value Increment Taxation: Demise of the British Betterment Levy," 25 National Tax Journal, 567 (December, 1972).