Market-priced Land Taxes

published

2019-11-10

The puzzle

I've been living in the Bay Area for 5 years now which has given me some time to reflect on the housing problem here. All along I've wanted to fully understand why this problem exists. In general, I think rushing to implement solutions without a solid understanding of the causes is likely to be ineffective or counterproductive. So I tried to find the root cause, which initially seemed simple, but turned out to be more subtle than I expected.

Whenever I see a serious problem or inefficiency in the economy, the first thing I do is look for a corresponding government policy that infringes on liberty and consequently hinders the natural process of optimization. This almost always explains the problem, and it initially appeared to explain the Bay Area housing problem too. The local governments of the Bay Area have strict housing policies that limit increases in the housing supply. As the population grows and demand for housing increases, the supply can't keep pace and prices rise. So the government policy infringes on the liberty of property owners who would like to increase housing density, and we see market inefficiency as a consequence.

Although this may be a valid explanation of the current situation, I wasn't content that this was the full understanding. My concern arose from questioning whether it's possible to claim in general that restrictive housing policy is always an infringement on liberty. What if everyone in the community unanimously agreed to the policy, then who's liberty is being infringed? This was the puzzle I had to figure out.

As an example, imagine that a group of people decide to start a new city from scratch in the wilderness. They buy a large tract of land and divide it up into parcels and distribute it amongst themselves subject to covenants that they all unanimously agree to. Let's say the covenants place housing density limits on the land and forbid an owner from selling to anyone unless the next owner agrees to sign the covenant. This effectively sets up the same housing policy issue that much of the Bay Area has but in a purely voluntary non-coercive way. If it's all totally voluntary, then we shouldn't expect the government to interfere with their private contracts. But if the land in that area becomes very valuable in the future and a lot of people try to move there, you would still end up with a housing problem.

Some people might argue that it's not really a problem; the city founders got there first, took the risk, and invested in the land so they deserve to capture the benefits of their work for as long as they wish. This perspective makes sense when the value of the land itself is very small relative to the value of the improvements because they are just earning dividends on their efforts.

But what if the value of the land exceeds the value of their improvements, perhaps because of exponential population growth around the world? The founders didn't make the land and it doesn't really make sense to award them a permanent monopoly on a valuable natural resource that they did nothing to create. Up to a point it might be reasonable to ignore this consideration and let some landowners get away with unearned benefits, but as land becomes more scarce this approach becomes increasingly detrimental to non-owners. When you reach the point where all land is owned and most people are born without a land inheritance, land owners accrue substantial economic rent at the expense of non-owners, which can lead to economic oppression.

It's also possible that the value of the land derives largely from proximity to the economic activity that the city founders created. In this case one could argue that even the land value represents the fruits of their labor and so a monopoly on this value is not unearned. This perspective becomes less justifiable when there are renters contributing to the local economy, which is almost always the case. Even if there aren't any renters, under modern conditions there's no good reason to assume a correlation between the size of land owned and contribution to the economy. Therefore it seems overall more reasonable in general to consider land values an unearned value than the opposite.

So our current system of land ownership awards an unearned privilege to land owners: the ability to capitalize on the value of a natural resource they did not create.

But is this an infringement on liberty? Our current system would say no because if you don't own land then you have no right to exist unless you can convince someone with land to sell you some or rent to you. I'm sure some of our founding fathers would have argued along similar lines that owning slaves is not an infringement on anyone's liberty because slaves are property, so they don't have any liberty to infringe in the first place. It's futile to discuss principles of liberty within a political framework that is flawed in its foundations.

We can still see the housing problem as arising from a government policy issue, but it's perhaps not within the bounds of an infringement on liberty; it's deeper than that. There are multiple ways that governments can create problems: 1. Poor enforcement of the law 2. Lack of good laws 3. Laws that infringe on liberty (and hinder optimization) 4. Laws that establish a bad definition of liberty (and optimize the wrong thing) I believe land ownership issues fall in the last category.

Geolibertarianism

There is a political theory called geolibertarianism that addresses this issue with land ownership. It's a combination of libertarianism and Georgism (the political theory of Henry George). The general idea is to consider all land and other natural resources "unowned" while still allowing individuals to obtain exclusive rights over natural resources if they pay compensation for the damages they are causing by excluding others from that resource. The compensation would be distributed as a citizen's dividend, which could provide a basic income for all adult citizens. The tricky part is determining the amount of compensation required for each parcel of land and unit of other natural resources.

In the book Radical Markets, Eric Posner and Glen Weyl propose a system where every property owner publicly lists a price for each piece of property they own and stands ready to sell at that listed price to any buyer. Then a fixed percentage of that listed value is the property tax payment required. This very clever idea seems more fair and accurate than either allowing the government to set property tax rates or only reseting rates when a sale is made, which is how property taxes are currently handled.

Although I was very impressed by the idea of determining tax rates using a decentralized market-based mechanism, I think there are some serious problems with the details of their proposal. The first problem is that they suggest that all forms of property should be subject to the same system as opposed to just natural resources, even things like your refrigerator or shoes. Not only would this be very complicated and create huge practical overhead, but the philosophical argument for a system like this only applies to natural resources because people should be entitled to the fruits of their labor.

More importantly, I think Posner and Weyl's price-setting system is problematic. For example, let's say you buy a house for $200,000 and live there for a decade and the market value hasn't changed much, but during that time you've grown attached and you wouldn't be happy to move for less than $1,000,000. In Posner and Weyl's system, to be safe you would have to pay 5x higher property taxes as a defensive measure even if nobody was interested in buying your house at anywhere near that value.

Their system puts the option to execute in the hands of the buyer rather than the seller, which is a big disadvantage to the seller. This is great for big corporations that want to acquire a bunch of land for a new railroad (as in their Hyperloop example), but isn't so good for the individuals who just want to feel secure in their homes. It optimizes GDP over the well-being of individuals. My proposal is to shift the option to execute to the owner.

The Proposal

My proposal is to implement geolibertarianism with market-priced land taxes. Market-priced land taxes go up in proportion to the market demand for the parcel. You pay compensation based on what the market thinks your land is worth.

Buyers place bids on land parcels through a government-regulated exchange. Owners have the right at any time to sell their land to the highest bidder. The buyer cannot back out after their bid is executed. If the owner wishes to remain on their land, they pay a tax based on a fixed percentage of the time-averaged highest bid for their land on the exchange.

The exchange would require that buyers deposit funds into escrow before they could place a bid. Each bid would be fully backed by escrowed funds to make it impossible for a buyer to back out of a bid after it gets executed, though bids could be cancelled at any time prior to execution. Multiple bids could be collateralized with the same escrowed funds; when one bid executes all under-collateralized bids would be automatically cancelled by the exchange.

If an owner defaults on their land taxes, it is treated as equivalent to the owner accepting the highest bid; the bidder is forced to pay the bid price to the owner and the owner is expected to vacate the land. Defaulting on land taxes is not a crime and it doesn't affect your credit score because it isn't a debt, but the defaulting former owner will be treated as a trespasser if they don't vacate before the deadline.

Note that there are no taxes on a parcel that has no bids. This is fair because the owner isn't depriving anyone of a valuable natural resource since the market doesn't put a value on it. There could also be a personal exemption where the first $1000/year of land taxes are waived for each citizen so that you could always have the option of moving to a low-demand area and not pay any taxes at all and just collect citizen's dividends.

Owner's are free to remove or destroy any improvements to the land prior to yielding their parcel to a bidder. This means that bidders have to place their bids under the assumption that all they will get is the land and not any improvements. Even though this sounds potentially wasteful it is important that property tax rates are set according to the land value and not the improvement value so as not to discourage improvements. And practically it would be very rare that an owner would agree to sell a developed property for the bid price because the bid price would be based just on the land value. Even if they were unable to afford the land taxes they would most likely sell the property on the real estate market just as they would in the current system. In this case, the sale contract would set the terms of what improvements would come with the property.

As an example, imagine that a buyer wants to buy a house in a certain neighborhood where the land is valuable but there aren't any properties listed on the real estate market because the owners aren't very interested in selling. Let's say the properties all have existing bids for around $100,000 and there is a 5% land tax rate, so each owner is paying $5000/year. The buyer can deposit $200,000 into escrow and place a bid on all the properties in the neighborhood for $200,000. The owners are notified that their land taxes will be doubling to $10,000/year for as long as the bid stands. If any owner is willing to sell, they can try to negotiate a normal market sale with the new bidder. Perhaps they will sell for $200,000 because the bidder is willing to pay more to guarantee that they will receive the home with the land. If this happens, everyone's land tax reverts to $5000/year. If nobody wants to sell, then everyone in the neighborhood will have to pay $10,000/year while the bid stands, which applies continuous pressure to incentivize someone to sell.

For owners who don't want to be exposed to the risk of such fluctuations in their land taxes, insurance providers can provide land tax insurance to stabilize the rate for the owner.

Note that the 5% number used above is arbitrary and doesn't necessarily represent what the actual percentage would be. The actual number would be set by congress in response to the needs of the public. However a key principle is that the percentage applies equally everywhere, so if it's high then everyone will get a larger citizen's dividend that will offset land tax costs.

It's also important to note that a system like this would liberate a lot of land that is currently privately owned but un-utilized because it would become uneconomic to just hold land for the purpose of speculation or hoarding. This would increase the supply of land and housing and make it cheaper to live.

This system elegantly resolves the issue of the community with density-restricting covenants. Outsiders who want to use the land continue bidding for the properties until some of the existing owners can no longer afford to pay the land taxes. Then the owners will try to find buyers who are willing to sign the covenant so they can do normal sales. But if they can't find buyers who are willing to sign the covenants, they will default on their land taxes and the land will transfer to the bidders who never signed the covenant, which allows the parcel to escape the covenant and higher density housing construction can begin. This would also encourage owners to make covenants with some kind of escape clause to avoid the risk of being forced to sell at the land value of their properties.

Although I used the term "land tax" here for ease of communication, technically it isn't a tax if you accept that nobody actually owns natural resources because nobody made them or has any justifiable claim to them. It's more like a fee for renting a public space than a tax because you aren't forced to pay it. So this system has the potential to provide increased economic efficiency and a universal basic income along with the elimination of all taxation, especially if supplemented with assurance contracts and fees for government enforcement of contracts.