California's Proposition 13 has had a wide range of
undesirable effects. Among them is the tendency for people
to remain in homes that are too big for or otherwise
unsuited to their current needs, while others who seek such
homes must build them somewhere on the fringe. Also, people
who no longer need to be close to their work are
incentivized to remain in those choice sites, while those
who do need access to those workplaces must commute long
distances. If the market were permitted to work, housing
prices in California would be much lower and more people
would live closer to their work.
While it is often true that the
prospect of earning capital gains is what induces new
investment to be made, applying further rate cuts to real
estate gains cannot be expected to spur much new
construction activity under present fiscal institutions.
Clearly a “capital” gains tax cut cannot
cause the production of more land; land (as distinct from
capital improvements) is made by nature, not by the
landowner. As to buildings, more of the tax benefit would
go to speculators in existing capital than to investors
in construction and renewal. We also doubt that a further
rate reduction is likely to accelerate real estate
turnover by reversing a “lock-in effect.”
Turnover is strongly affected by depreciation rates. In
periods of rapid write-offs -- most strikingly during the
1980s, when real estate could be written off faster than
in any other period -- buildings tend to be sold as
soon as they are depreciated. The 1986 reforms reduced
the incentives for this rapid turnover, but the principle
is clear: When depreciation rates are high, there is a
powerful tax-induced incentive to sell a building when it
is fully depreciated.24 The basic motivation at work, of
course, is to avoid taking investment returns as taxable
income. Investors prefer to declare as much of their
income as possible in the form of capital gains, which
are taxed later and at a lower rate. Read
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Normal yearly turnover in the
U.S. land market is 3-4 percent of parcels, and much less
than 3 percent of value (because small parcels turn over
faster). Most of even that small turnover is
zero-sum, buyers being financed by sales of what they
owned before. Net movement of money in or out of land is
a small percentage of total value turned over, and a
minuscule share of total land value.
...
There would be no land gains if
land rent were to be 100 percent socialized, and if the
market expected it to remain so. In practice those
circumstances are unlikely, and some would consider them
undesirable: the easiest and most accurate way to
appraise rent is by monitoring the market in land
titles.
When land and/or minerals are "ripening" over
an extended period of ownership, a property tax during
the ripening period can be shown to collect exactly the
proper share of the increment, but only under ideal
conditions. First, the market and the foresight of market
agents must be so perfect that value rises roughly along
a curve of compound interest. Second, tax assessment must
follow that perfect market closely.
In practice even rough perfection is, alas,
rare. A gains tax is a good way of "mopping up" excess
rent that escapes the basic rent tax. It can also be very
productive of revenue: in Taiwan the land gains tax
raises four times as much as the basic land tax, partly
because the gains tax is always based strictly on current
sales data. The land tax should be based on current sales
data as well, to be sure, but in Taiwan and many other
jurisdictions it often is not.
This writer recommends announcing at time of
privatization, and regularly thereafter, that landowners
should expect a high tax rate, 80 percent or more, to be
imposed on land gains. It should be contrary to public
policy for land to attain a value based on expected
future resale. Possessory interest with allocation to
highest and best current use, and not land speculation,
is the desired emphasis.
Instead of being made illegal, resale gains
should be closely monitored to audit the system of rent
collection. Gains are evidence that basic rent taxes are
too low or that market agents expect them either to fall
or to fail to keep up with rising rent. A rise in gains
is an early warning to view the land tax administration
with alarm and move swiftly to correct it. Experience
shows that buyers quickly acquire a mental vested
interest in collecting rent and avoiding taxes based on
what they paid, or others are now paying, for land
titles.
A problem with gains taxes is the "lock-in
effect." Holders with surplus land may refuse to sell to
avoid tax. A gains tax may be very high, however, without
a serious lock-in effect, when coupled with a high
ongoing rent tax. The latter compels owners to dispose of
surplus lands. Indeed, the "ripening cost" theorists
believe it forces premature sales for conversion to new
uses. If there is any merit to their rationale we should
favor strengthening the lock-in effect. So should they,
as a litmus test of their rational consistency and
constructive purpose.
The greatest cause of the lock-in effect of the
capital gains tax in the U.S., however, is not the tax
itself but one of its major loopholes: the ability to
avoid it via the step-up of basis at time of death. There
should of course be no such provision, which is a kind of
negative inheritance tax mainly benefitting heirs who
have done nothing to deserve it. Legacies, devises, gifts
and other transfers without arm's length consideration
should trigger valuation and tax. So should death itself,
when property has to be valued anyway.
Land gain should be defined as the excess of
net sales price over depreciated cost basis. An
administrative problem to note and solve is the manner of
recording capital outlays and their depreciation, in the
(presumed) absence of a general income tax.
A supplemental tax on land transfers is
desirable as a tool of disclosure. It should be based on
gross value of lands transferred (not just gain, and not
just equity). Many American states have such taxes, at
very low rates, simply to supply data for land
assessment. While rates should be nominal, penalties for
perjury should be severe: the public has a right to know
how much others are getting for its property....
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