Taxes on the Sale Value of Land
A tax on the sale value of land, or
"ad valorem" tax, is a recurring (e.g., annual or monthly) tax
proportional to the price at which the land would
sell. Ad valorem taxes on
land have been praised by many economists for the fact
that they do not impair incentives to use land
productively. The characteristic of an ad
valorem tax that keeps it from impairing incentives
to produce is that, when such a tax is properly
administered, the amount of the tax is independent of any
action taken by the taxpayer. Whatever course of action
maximizes the wealth of a taxpayer before a tax is levied
also maximizes his or her wealth after the tax is levied
(apart from income effects, which do not entail
allocative distortions). A taxpayer can reduce the taxes
he or she pays by selling the land, but the new purchaser
will acquire a tax burden of the same magnitude. The
total of taxes to be paid is independent of any
reshuffling of land titles among taxpayers. For this
reason, ad valorem taxes on land, like taxes on
the rental value of land, are capitalized into the
purchase price of land and entail no economic
distortions.
A tax on the sale value of land is
very much like a tax on the rental value of land, but
with a somewhat different incidence. If land is
not taxed, its sale value in a market in which the
participants foresee the same opportunities can be
described as the present value of future net returns,
discounted at the market interest rate, r, when the land is used in such a way as to
maximize those returns. The effect of an ad valorem tax
at an annual rate of t is to
increase the annual holding cost of a dollar's worth of
land from r to r + t. Thus the value of a site in the
presence of a tax at a rate of t is computed by
discounting future returns at a rate of r + t. The sale
price of a site with a net return of x per year falls
from x/r to x/(r + t), so the tax takes the fraction t/(r
+ t) of the pre-tax value. Thus for land that is not
changing in value, an ad valorem tax at a rate of t is
equivalent to a tax at a rate of t/(r + t) on the rental
value of the land.
If the net return from the use of a site is not
constant but rather grows from an initial value of x at a
rate of g, then the sale value of the site in the absence
of a tax is x/(r - g). When the tax raises the annual
holding cost to r + t, the sale price becomes x/(r + t -
g). The fraction of value that is taken by the tax is
t/(r + t - g). For example, if the tax rate is 4% and the
interest rate is 8%, then the tax takes 1/3 of the value
of a site that is not growing, but 40% of the value of a
site whose return is growing at 2% per year. When paths
of returns through time cannot be expressed as simple
growth rates, it continues to be true that, other things
being equal, a site with relatively more attractive
future prospects will bear a higher proportion of current
taxes under a tax on the sale value of land than under a
tax on the rental value of land. Thus an ad valorem tax
falls more heavily on land that might be the object of
speculation than on other land. It thus tends to
discourage speculation more than a tax on the rental
value of land does. Otherwise, its effects are the same
as those of a tax on the rental value of land. There is
an upper limit of 100% on the feasible rate of a tax on
the rental value of land. There is no such upper limit on
the feasible rate of an ad valorem tax on land.
The tax could be 10% per year or 10% per day or 10% per
hour, with the sale value falling as the rate rose. In
the limit as the tax rate of an ad valorem tax
approaches infinity, the tax approaches a tax that takes
100% of the rental value of the land.
An ad valorem tax is administered by having
assessors who estimate the sale value of land. When tax
rates are modest, it is easy enough for assessors to do
this by monitoring sales of land that is vacant or has
only structures that are about to be demolished. However,
if the rate of an ad valorem tax is very high,
then the influence of inherent value of land will be
overwhelmed in prices by idiosyncratic features of
transactions between particular buyers and sellers.
Assessors would need to rely on processes in which sale
prices were linked directly to taxes. These could be
either auctions, where
participants knew that the auction result would be used
to set the tax for a specified period, or options, where potential uses of land offered
specified payments for any site meeting certain
standards. Because ad valorem taxes on land have
no distorting effects, they neither retard nor advance
the timing of land development in a world of perfect
information. This has been denied by Shoup (1970, p.
38-39), Bentick (1979, pp. 861-63; 1982) and a variety of
other writers who have followed them. The tax that Shoup
and Bentick analyze, however, is not an ad
valorem tax, but rather a tax whose base is the
present value of the future net income that is expected
to result from the plans for a site. Thus a change in the
plan produces a change in the tax bill, generating an
incentive for inefficient changes in plans (Tideman,
1982). ...
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