The Wrong Way to Tax

(Originally published here.)

A good rule of thumb is that the more you tax something, the less of it there is. People don’t work too hard when they can’t keep most of the fruits of their labor. This suggests that governments should only tax things that are bad for society, such as pollution. In practice, however, pollution or similar taxes aren’t sufficient to cover the financing needs of most governments.

This is why many economists have long been in love with land taxes. As Lex Luthor of Superman comic-book fame noted, the great thing about land is it’s the one thing they aren’t making any more of. It also happens to be the one thing that can’t disappear when the tax man shows up. No wonder the International Monetary Fund, the Organization for Economic Co-operation and Development and The Economist’s Zanny Minton-Beddoes have all argued in favor of higher property taxes in exchange for lower taxes on incomes and consumption.

This sounds great in theory, but I am skeptical of how well it would work in practice. There are good reasons why property taxes are small relative to national income in almost every country.

Minton-Beddoes makes the best case in favor of land taxes, quoting an unsigned Economist column:

“Taxing land and property is one of the most efficient and least distorting ways for governments to raise money. A pure land tax, one without regard to how land is used or what is built on it, is the best sort. Since the amount of land is fixed, taxing it cannot distort supply in the way that taxing work or saving might discourage effort or thrift. Instead a land tax encourages efficient land use. Property developers, for instance, would be less inclined to hoard undeveloped land if they had to pay an annual levy on it.”

The unsigned column also notes that a land tax “is likely to be progressive” because poor people generally don’t own real estate.

I agree that governments generally give an unfair advantage to landowners by making property an artificially attractive source of collateral for consumer spending. Since wealthier people tend to own more land, this usually acts as a subsidy for the rich. In the U.S., for example, both interest payments and local property assessments can be deducted from federal income taxes. Bloomberg View’s editorial board has criticized these unfair and distorting loopholes for many of the same reasons that Minton-Beddoes favors a land tax.

This doesn’t mean that land taxes are a good idea. The problem is that land taxes are paid by the people who own the land, not the land itself. If the property-tax rate goes up, those people must either sacrifice a higher share of their incomes to the state, or, if their incomes are too small, they must draw on savings. That could involve selling financial assets or even taking out loans. Many property owners could be forced to sell their land for cash if their incomes are too low. That would depress prices.

A regime of high property taxes and low income taxes would force most people — especially retirees who have paid off their mortgages and are living on savings and pensions — to sell their land to top earners, who would be the only people capable of holding onto it. This might be desirable if you agree that high land taxes will force people to make more improvements. Most people, however, wouldn’t choose to live in a world where all of the land is owned by a handful of magnates.

This debate has practical implications, especially for Europe. In April, the European Central Bank released a study purporting to show that Italians (and Spaniards and other southern Europeans) were richer than Germans. The research had some major flaws, but it did highlight an important fact: Many Italian families pass down their property for generations. As a result, almost 70 percent of Italians own their own home — more than in the U.S. — and less than 11 percent of Italians have any mortgage debt outstanding.

Some have mistakenly concluded from this that the Italian state should tax Italy’s physical wealth more aggressively. Mario Monti, the prime minister imposed upon the people of Italy in 2011, was ousted at the polls earlier this year in part because his property assessments were so unpopular. That isn’t a surprise. Italians may seem wealthy, but they don’t have much income to support an increased tax burden. The unemployment rate is almost 12 percent and rising. Real gross domestic product was lower in Italy in this year’s first quarter than it was in 2000. How, exactly, could any Italian land owner afford to pay a new assessment without cutting consumption, taking out new debt or selling?

A cynic might argue that the “troika” of the IMF, ECB and European Commission finds an Italian land tax attractive precisely because it would be an unbearable burden. After all, forcing Italians to sell their lands to a new class of German rentiers could potentially help facilitate “rebalancing” within the euro area. That doesn’t seem like a particularly persuasive case to make to the people of Italy, however.

(Matthew C. Klein is a contributor to the Ticker. Follow him on Twitter.)


About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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