Small nitpick.
Land markets are generally distorted by default: improvements in the immediate area generate 'privately captured positive externalities' for land-owners in the form of increased unimproved land-value: in other words, pure economic rents that are capitalised into increased private land values. Taxes (like LVTs) that transfer some of this value from private to public hands reduce this distortion: they actually enhance allocative efficiency.
It's a fascinating dynamic, and IMHO this uncorrected distortion is a major driver of boom-bust cycles in the macro-economy. Mark my words: the economic depression that will occur in the next 5 years will be started by bubbles popping in residential property markets (China's first, most likely). Consequently, we'll be looking at financial system collapse when this is transmitted to banks via insolvent residential property speculators (to whom they've loaned significant amounts of money).
This ain't going to be pretty.
On the hopeful side, countries like the US, Ireland and Iceland who 'took their medicine' during the GFC (sustained heavy property price declines or significant bank collapses), will be closer to fundamental values already. So they may have less distance to fall, even though there will probably be some overshoot. Also, OPEC flooding the world market with oil (to try and kill the US shale oil industry in the crib) and the likelihood that China will run down its foreign currency reserves to pay for stimulus (depreciating the US dollar) will mean US export industries (excluding oil and natural gas) become very competitive indeed.
Countries like China, Australia, Canada and the UK on the other hand, who staved off significant property market corrections during the GFC (especially Australia), are in for a very bad time (http://www.economist.com/blogs/dailychart/2011/11/global-hou... ). Like worse than 1920s depression bad time (closer to 1890s depression).
On government response, it's hard to predict. Frankly, in both the US and Australia, our legislatures are now controlled by even crazier and stupider politicians than during the GFC, so I don't hold out much hope for sensible fiscal responses. There's also less room to move fiscally, as we used up most of our powder during the GFC and won't be able to fire as strong a shot this time around. The thing that truly worries me is that government underwriting of financial system liabilities will therefore be less credible, so there is an increased probability of bank-runs causing a complete financial system collapse.
Our central banks also have less room for more traditional responses (i.e. reducing the cash rate), as they'll be starting from a much lower initial rate (and so will hit the zero lower bound much quicker). QE will therefore be deployed more rapidly and in greater quantity. Even though the Fed Reserve may have appeared confident re: QE, I'll bet they were privately shitting themselves because QE was (and still is) uncharted and risky territory. This time around they'll have to go much harder and earlier. At this point, I really have no clue what could happen.
On the bright-side, at least we'll be able to settle the question of whether theorised 'liquidity traps' truly exist...
All this is just my best guess. A more positive but still plausible theory is that China will manage their economy into a 'slow-melt', and will experience a long period of economic stagnation similar to what Japan has gone through in the last two decades. In this scenario, the damage might be contained and the US could come out relatively unscathed. I think Australia's screwed either way though...
That isn't the actual problem. Its the problem the author imagines.
The real problem with land [and property taxes] is the fact it tends to flow into the cost of rent and homeownership. Everyone in this country is impacted, it is just a question of degree. Similarly, the vast majority sees an item in their basket of purchases goes up by $X and gets angry.
Case in point: The gasoline tax. The vast majority of economists thinks it should go up to cover infrastructure but there is no political will to do so precisely because of how angry it makes their constituents.
People are far less rational than you think they are and if their entire tax burden was shifted into the rent for their house, they'd flip the fuck out.
The price of property and rent in popular places will be what the market will bear. So with tax, the rent would stay the same. Price of apartments would go down, because buyers need to pay the tax, so they cannot afford as much.
Apartments in space efficient towers would be grow in value relatively, because they don't need to pay so much tax, so there would be incentive to build more densely.
This means more apartments and cheaper prices.
You are ignoring that capital flows to the most efficient RoI it can find.
If rents remained the same, the RoI would drop [due to the tax increase] and it would lead to land abandonment. Land abandonment is one of the largest practical issues with a land value tax.
Increasing housing density isn't efficient when the practical value of the land is low. Yes, it'd be great in SF. But what about Athens, GA? It'd be a terrible idea there. Building upwards isn't free, either.
Yes, its popular with a certain class of economist who makes certain assumptions but the real world behavior of landlords isn't what you think it is.
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Let us say, for the sake of argument, that you are correct.
$800 rent, tax burden increased by $600 a year.
So everyone unloads their real estate holdings because they are no longer profitable. Prices of land plummet as its abandoned as unprofitable, reducing tax revenue.
If you build alot of high density housing, you need less land, so as such housing finishes...everywhere that is "far" from the new high density area drops in value again. The cycle repeats until the new normal is stable. You've suddenly restructured every major city in the affected area.
However, you've created so much abandoned land that is converted to farming that your tax revenues have dropped. So you have to raise taxes, the cycle repeats.
If you assume that it just captures a fraction of the profit, then the existing stock would remain, because it's still profitable. New build rentals would be affected, and would probably push towards more land-efficient form factors.
Take your example, with the added assumption that the landlord is netting out $200/mo after expenses, repairs, vacancy, etc. If the land tax was 100/mo, he'd still be taking home $100/mo. ROI is cut in half, but it's still positive, so it will probably stay a rental. Certainly some of the marginal units will get turned into for-sale housing, but not all of them, and probably none would be abandoned.
Many, many landlords in this country are single property landlords or landlords that own a small number of "single family homes" [1-4 unit homes].
The gross cash flow of such properties is ~1% of the property value in cash flow. A 1% property tax equivalent increase wipes out all cashflow and guarantees an overall negative return given real estate stays about even with inflation, barring bubbles/speculation.
However, the positive per-unit cashflow is about $100/month/unit in the real world if you picked a good investment. $100. You raise the tax burden by $1200/year/unit, the unit is worthless and must be sold. Pretty much all "land value tax" proposals require that much of an increase as they replace other revenue streams.
> ROI is cut in half
You've basically admitted the problem. If you cut ROI in half, you are better off investing in the market.
Real estate investing is very, very narrow in its advantage over other forms of investment [if you are good at it and can find good deals] to the tune of fractions of a percentage point. Perhaps as much as a whole percentage point.
If this wasn't the case, everyone would plow their money into real estate instead of stocks/bonds/etc.
Also, since you define the tax increase as 1% of property value, then your math is correct. But I believe the proposition is to charge it on the value of the land, not including the value of the improvements, which is typically a much lower number. For single family homes it would still be a hit, but not as severe as your math indicates. For higher density developments it would be even less onerous - which is pretty much the point.
Tangentially, I believe your estimate on ROI from rentals is inaccurate. Long term average stock returns are in the range of 7%, it's not uncommon to find rentals about 10%. As they should be, given the illiquidity, lack of diversification, various extra risks, and the work involved. All of which explains why stocks are more popular.
Let me put it this way, we both agree there are extra risks. I think, after those risks, RE is worth +.5%-1% on equivalent assets in a different asset class. [e.g. Stocks]
You think its worth the "paper value" of 10%.
Fair enough. I just am never going to agree that RE is worth the risk at -1% of what the current real returns is vs. Stocks.
> Many consider the "1% Rule" as the minimum bar. You're probably right that there are a lot rentals around that level, but those are the marginal rentals that I mentioned would likely become for-sale housing.
Yes. Its also the bar used for relatively safe real estate investments. Generally, when you hit 2%+ you are engaging in a greater level of risk. I believe the market prices assets accurately in regards to risk v. reward for the capital.
That being the case, greater than "1% rule" returns are gained through taking on larger risks.
> Also, since you define the tax increase as 1% of property value, then your math is correct. But I believe the proposition is to charge it on the value of the land, not including the value of the improvements, which is typically a much lower number. For single family homes it would still be a hit, but not as severe as your math indicates. For higher density developments it would be even less onerous - which is pretty much the point.
In major metro areas with heavy zoning, the land is worth more than the improvements on it. Literally every piece of residential real estate I have rental income from, this is the case. Sometimes its as high as 2:1 [land:improvement].
In situations where land is the "lower number", you have to recoup the losses from removing improvements from the equation which effectively makes the "tax on real estate" equivalent to the government as a source of revenue. You can't say "Well, we'll just take in 33% of the revenue we did before because the land is only worth 1/3rd of the value of the improvement." You've got to keep the tax revenue roughly the same, so its a tax swap.
Yes, you'll get better returns under a land value tax with highly dense construction...however, if you double the density of a city, that means the land outside that denser urban center is going to lose value and that compaction is going to require higher land taxes to recoup the loss from the less valuable land.
Ultimately, even the proponents of a LVT agree that land abandonment is a concern [although they in theory can fix this with a properly designed LVT regimee] when introducing into an area that previously only had a property tax and/or the LVT is used to replace other taxes. [e.g. income, sales]
So...I get you don't agree but until someone proves me wrong in practice, I don't have faith in it.
What to do then? Subsidize construction? Force higher densities?
"A tax upon ground-rents would not raise the rents of houses. It would fall altogether upon the owner of the ground-rent, who acts always as a monopolist, and exacts the greatest rent which can be got for the use of his ground."
– Adam Smith, Wealth of Nations
"A tax on rent would affect rent only; it would fall wholly on landlords, and could not be shifted to any class of consumers. The landlord could not raise his rent, because he would leave unaltered the difference between the produce obtained from the least productive land in cultivation, and that obtained from land of every quality."
– David Ricardo, On the Principles of Political Economy and Taxation
In a world where there are significant search and movement frictions, where subsidized housing exists, where landlords and their tenants have relationships beyond renter/rentee, where a home/building has value beyond its ability to be slept in, these theories will not hold.
My hypothesis is that if an LVT was levied in SF, rent would go up by at least 50% of the value of the LVT as a direct effect of the tax.
In reality, housing/rent is very sticky. If my landlord had his taxes raised, he would simply raise my rent by a corresponding amount. And I would pay, because it would be too much of an issue for me to put my life on hold while I find another place to live. Nobody is paying 100% of their income as rent - there is always room to squeeze more margin out of renters.
The problem is, in practice, this hasn't really worked.
The housing market is far from a self-regulating, equilibrium-seeking free market. It is very heavily regulated. Landlords would love to increase SF density so they could pack more people in while extracting NY-level rents. They can't because it's currently illegal.
And I 100% agree on land-market regulations. It seems to be a similar story in most first-world economies: regulations are artificially constraining land supply, and also causing inefficient use of existing land.
That's simply not true in the case of rent payments to landlords if we're talking about a land-value tax (i.e. taxing a proportion of the unimproved value of land). Land-supply is effectively fixed in the short-run (and pretty damn inelastic in the long-run thanks to over-regulation, zoning etc.). Therefore, tenant rents are determined solely by what the demand-side of the market will bear, meaning landlords can't pass LVT on (so they bear the economic incidence of the tax). Just to clarify terminology, by land-value tax (LVT), I mean taxing the proportion of unimproved land value that represents capitalisation of future economic rents (unearned profits) from land.
It's plausible a LVT would actually decrease rents paid by tenants, as it would increase the elasticity of dwelling supply in the long-run (land-owners would have stronger incentives to use land more productively). A properly designed LVT only taxes economic-rents (unearned profits) that currently accrue to private land-owners: if the local council builds a park near some land, the increased amenity for the surrounding area translates to increased economic rents, as the increased amenity is captured in the form of increased unimproved land values.
As for home-owners (existing land-owners), theoretically if people are unable to move houses then LVT would increase the cost of home-ownership: directly from increased tax and indirectly from decreased value of their land holding (as future economic rents from land is capitalised into land values). However, this is an unlikely scenario. More likely, the revenue raised from LVT would hopefully be used to cover reductions in property transfer taxes (i.e. ad valorem/stamp-duty taxes), which have absurd efficiency costs. This would reduce the cost of home-ownership overall.
People would pay less transfer tax over their lifetime, and property and land prices would fall due to increased allocative efficiency: reduced transaction taxes mean more efficient allocation of existing housing and land stock, as the tax disincentive to reallocate is reduced or eliminated. Also, under an LVT existing land would also be used more efficiently (e.g. medium-high density inner-city dwellings) as there would be higher opportunity costs of using high-value land unproductively (e.g. building a 1 bedroom shack on a big plot of land in the CBD).
In my opinion, the real problem is that these dynamics aren't immediately evident, are difficult to explain, and it's very easy to (mistakenly) conflate legal incidence with economic incidence of taxation. It's interesting you bring up gasoline taxes as this is the classic example: the Carter administration attempted to increase gas tax and hand the revenue back out through tax-cuts. It didn't happen because many thought it was simply taking with one hand and giving with the other.
In actual fact, given the aim was to reduce US oil consumption, it was pretty sound policy. Even though people would have ended up with the same amount of money (neutral income effect), gasoline consumption would have been reduced due to substitution effects: gas would have become relatively more expensive in comparison to every other consumption possibility, meaning people would substitute away.
You know, neoliberal corruption of government isn't Written in Stone by the Three Fates. We can actually fight it, especially when there's $2 trillion at stake.
>[1] Perhaps this paper assumes that there is an infinite supply of highly-skilled tech workers who have taken jobs elsewhere due to high costs of rent? Seems a bit far-fetched to me.
I don't know about infinite, but I sure as hell know that I personally choose not to live in the Bay Area, despite its having loads of tech opportunities and the nicest climate on the planet, because of its high housing costs and suburban sprawl.
You should give us another look. Our long term plan to reduce the number of rainy days per year is finally paying off!
It's utterly beautiful most of the year, and only gets slightly uncomfortable for a few weeks during summer.
I live 8 miles from the Pacific and this week's forecast is almost sublime, compared to the continental climate I grew up in. Boiling hot summers? No. Sweaty, muggy, mosquito fests from July through late September? No. Freezing winters from late October through early March? No.
San Diego would be uninhabitable without environmentally destructive and ill-conceived federal irrigation of the southwest.
> Freezing winters from late October through early March? No.
Some of us find freezing cold and snow to be pros rather than cons.
I do like the cool nights in the winter that we get in SB.
I think, in general, regulation works best as a threat (clean up your act, or we will). But for a threat to be credible, you need to follow-through on it from time-to-time.
The recent issue with the FCC and Comcast et. al. is an example of this. 20 years from now, we are going to regret that the FCC has increased authority over ISPs, but the actions of the cable oligopolies left little choice.
Is The Economist starting to support Georgism?
"Or they could heed the advice of Henry George, an American follower of Ricardo who in the 1880s made the case for a land-value tax. It has many theoretical virtues. Most taxes dampen, distort or displace economic activity by changing incentives on the margins. But a land tax cannot reduce the supply of land, and it would stimulate economic activity by penalising those whose land is unproductive. And your tax base is always right there—a city lot cannot be whisked off to Luxembourg.
The mayor of New York City, Bill de Blasio, hopes that taxing vacant lots by value will help deal with urban blight in the Bronx and elsewhere. But there are practical problems with a land tax—perhaps the largest of which is that by its very nature it hits the well-connected rich hardest. Even fiscally purist Estonia, which adopted a land tax in 1993, has complicated it with multiple bands, including an exemption for homeowners."
As criticism goes, that is so weaksauce it's a 0 on the Scoville scale.
This is the idea of "nature deficit disorder", the idea that exposure to natural environments helps be be more happy/creative/healthy/etc. Governments should subsidize undeveloped land ownership rather than taxing it out of existence.
When your revenue is driven by ads, which are driven by views, you are incentivized to publish inflammatory articles that play to mass-approved tropes, such as "burn the 1%" and "the police are all evil/out of control". Not to say that these pieces are unmerited, but I've observed their quantity and quality to be moving in opposite directions.
I think Bloomberg Businessweek is killing it right now. They've onboarded some of the best talent (Paul Ford, Matt Levine) and revamped the style of their publication to appeal to the young, ADD, super-exuberant tech/finance crowd (myself included). I believe they are heavily subsidized by Bloomberg's other business ventures, so this seems to be a more viable way to fund and disseminate high quality content.
How are those incentives less perverse than those engendered by current funding models? I don't imagine reporting on stories that show those other business ventures ina negative light may not been seen favorably at some level of management.
Of course, I have no idea how closely the other branches of Bloomberg's empire tie into BusinessWeek, but from many of the articles I have read, I get the feeling that Bloomberg LP is holding off on pushing some annoying agenda until they absorb enough market share from The Economist, The Wall Street Journal, Business Insider, etc.
According to a recent study, if the Bay Area got rid of its building/density regulations, the local economy would be able to support 5x the area's current population, which would boost the US' yearly GDP by $2tn. In 2009, the US GDP was 13.5% lower than it otherwise could have been if land-use regulation had been abolished in 1964. [1]
The solution? Dissolve land-use regulation, pay residents to allow developers to build new structures, and distort the market in favor of the renters by levying a land-value tax. Theoretically, this would allow for an increased supply of housing while penalizing the owners of the least-productive parcels of land, such as those who squat on empty plots in New York.
The author hints at the political problem of adopting a land tax near the end: But there are practical problems with a land tax — perhaps the largest of which is that by its very nature it hits the well-connected rich hardest. So we may very well never see this regulation brought up or passed given the current, money-greased machinations of the political machine.
I was disappointed that the author of an otherwise well-researched and informative article did not get to the heart of the issue: who owns the land? Yes, it is obvious that urban landlords are making a killing in this market, but who exactly are these landlords? What percent of real estate in London, SF, NY is owned by actual residents vs. holding companies vs. foreign interests vs. the government? Is it a small, concentrated number of buyers in each city? Is collusion possible?
Also, how are we going to induce growth in sectors other than tech, consulting, and finance? Or do we not care if young talent continues to accrete in these fields, driving the (currently extortionate) growth of the city? Is this the best plan for long-term growth and prosperity?
[1] Perhaps this paper assumes that there is an infinite supply of highly-skilled tech workers who have taken jobs elsewhere due to high costs of rent? Seems a bit far-fetched to me.