While working in the cities of pre-reform China in the 1980s and the former Soviet Union in the 1990s, I was astonished by inefficiencies in urban land use. I observed rusty containers stored in the center of Tianjin and coal depots in the center of Moscow. Both countries’ Marxist ideologies prevented users from selling the land they occupied at market value, causing inefficiencies. In a market economy, the option of selling land to the highest bidder is the mechanism that moves land users from an expensive place to a cheaper location when their economic activity does not justify the price of the ground they occupy.
The periodic recycling of land by the users themselves is a vital mechanism. It submits cities in market economies to a Darwinian process as they adapt to changing economic conditions and technologies. But some forms of land taxation could inadvertently hinder land recycling.
Municipalities are always looking for financial resources to provide new infrastructure and social services. Property taxes recovered yearly on the market value of land represent a common, legitimate way to finance the operation and maintenance of cities. However, since the economist Henry George published Progress and Poverty in 1879, advocating a tax confiscating the total incremental value of urban land, cash-strapped municipalities have been tempted to implement his theory of capturing what they call “unearned land value.”
This idea—capturing the entirety of the increase in land value over its undeveloped state—has long seduced policymakers. During the fall of the Soviet Union in 1990, the American economist Nicolaus Tideman sent a letter to Mikhail Gorbachev, then president of the Soviet Union, urging him not to privatize land. “Users of land should not be allowed to acquire rights of indefinite duration for single payments,” Tideman wrote. Thirty Western academics signed the letter, including four Nobel Prize winners in economics.
Suppose we accept that the incremental value of land is the motor of land-use recycling, which maintains efficiently used land. What would be the potential consequences of Henry George’s type of taxation? Imagine a recently retired couple living in New York City who own an apartment they bought 30 years ago. The current market value of their home is about four times what they paid 30 years back. This price increase owes partly to inflation and partly to a rise in population and income in Gotham during this period. The couple may want to move to a quieter, warmer climate and a less expensive place for retirement. Selling their home at the current market price would easily finance their move and a new home; it would probably even allow them an extra retirement income if they moved to a small town that charges lower taxes.
This couple may like the New York neighborhood where they live, but the large amount of money they would get by selling their New York house would constitute a powerful incentive to move. The buyer of their home would likely be younger and an active worker in New York looking forward to living closer to work and New York amenities. If the sale occurs, the seller and buyer will benefit significantly from the transaction. The city will also benefit, as an active person replaces a non-active couple. The government will be able to collect more income tax that it can use (ideally) to improve public services, in addition to the increase in property tax reflecting updated market value collected.
What would happen, however, if New York introduced a tax on real-estate properties? The tax collected when the original owner sells would represent a large part of the value of the lot, as the house is unlikely to have changed much. Such a tax would leave the sellers with the value of their home as it was 30 years before. It would be insufficient to cover the move or even to allow buying a house in their preferred community. The retired couple would lack the means to move and would stay in their current home until they died. The city, the elderly couple, and the younger worker—all would lose.
The same logic would apply to commercial or industrial property. The increased land value will create a major incentive for landowners to move commercial or industrial installments from a central urban location to a larger lot in a far suburb or a smaller town.
A recent paper by economist Rachelle Alterman summarizes the international experience in Georgian taxation worldwide, for those intrigued by it. As she concludes, “the rationale for direct betterment capture may be convincing on paper, but it has not caught on widely across the world.” As usual, the devil is in the details.