Bryan Caplan  

A Search-Theoretic Critique of Georgism

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Conversation with David Weinbe... Problems with Henry George's S...
Economist Henry George famously advocated a 100% (or near 100%) "Single Tax" on the unimproved value of land.  Many modern tax economists, most notably Joseph Stiglitz, conclude that George's logic was sound: Since the unimproved value of land is perfectly inelastic, even an expropriatory tax is non-distortionary.  Economists' main objections to Georgism are merely that (a) it is difficult to implement in practice, and (b) politically impossible.

My co-author Zachary Gochenour and I have a new working paper arguing that the Single Tax suffers from a much more fundamental flaw.  Namely: A tax on the unimproved value of land distorts the incentive to search for new land and better uses of existing land.  If we actually imposed a 100% tax on the unimproved value of land, any incentive to search would disappear.  This is no trivial problem: Imagine the long-run effect on the world's oil supply if companies stopped looking for new sources of oil.

I can explain our argument with a simple example.  Clever Georgists propose a regime where property owners self-assess the value of their property, subject to the constraint that owners must sell their property to anyone who offers that self-assessed value.  Now suppose you own a vacant lot with oil underneath; the present value of the oil minus the cost of extraction equals $1M.  How will you self-assess?  As long as the value of your land is public information, you cannot safely self-assess at anything less than its full value of $1M.  So you self-assess at $1M, pay the Georgist tax (say 99%), and pump the oil anyway, right?

There's just one problem: While the Georgist tax has no effect on the incentive to pump discovered oil, it has a devastating effect on the incentive to discover oil in the first place.  Suppose you could find a $1M well by spending $900k on exploration.  With a 99% Georgist tax, your expected profits are negative $890k. (.01*$1M-$900k=-$890k) 

You might think that this is merely a problem for a handful of industries.  But that's probably false.  All firms engage in search, whether or not they explicitly account for it.  Take a real estate developer.  One of his main functions is to find valuable new ways to use existing land.  "This would be a great place for a new housing development."  "This would be a perfect location for a Chinese restaurant."  And so on.  As Gochenour and I explain:
Note we have not complicated the models by differentiating between improvements and the land's "unimproved" value. Information about the land can be considered an improvement in its own right. Some of the land's qualities have very low search costs to discover: is it arable, will it support any type of building, is it in the middle of a city or rural area, etc. Discovery of other potential uses may require significant search and/or investment in other technologies. An entrepreneur brings these qualities to market - they do not bring themselves. Until he does so, the value of the land is undefined.
Georgists might be tempted to reply: "Fine.  We'll limit the Single Tax to existing real estate, and exempt new development entirely."  But in the real world, such offers lack credibility.  Past expropriation is a strong signal of future expropriation:
Previous attempts at land reform have more often failed than not, sometimes with terrible consequences. Consider the case of Uganda, where in 1971 dictator Idi Amin expelled approximately 60,000 Indian immigrants and expropriated their land (Jorgensen 1981). The idea was simple: expel the immigrants and redistribute their holdings among the native population to curry favor without affecting future output. In years to come, lack of foreign investment crippled the country, and even non-Indians mistrusted the government. In 1998, when the expelled citizens and their heirs were offered the opportunity to return and take back their businesses, (understandably) very few accepted the offer. Once a government shows a willingness to drastically alter their respect for certain types of property rights for certain types of citizens, everyone updates their expectations to account for this change.
The big puzzle for me: Why do tax economists spend so much time discussing mere curiosities like lump-sum taxation, excess profit taxation, and land taxation, when the completely realistic option of taxes on negative externalities is right in front of their noses?



COMMENTS (25 to date)
david writes:

Shhh, we don't want the non-economists to realize that the economists' notion of taxing negative externalities doesn't actually necessarily imply compensating those the externalities affect, only that the degree to which they are affected is efficient.

david writes:

Anyway, the really clever Georgist might want to observe real-life examples of high effective unimproved-land taxes and conclude that, like Singapore and Hong Kong, the way to go is not to tax all unimproved land at x% but to own x% of the land. The Georgist revenue stream as landlord rather than universal tax assessor.

If you think there is some heretofore unacknowledged location/mineral/etc. benefit, you buy it from the state-linked corporation (and the state proxy uses the cash to buy some other land, maintaining its x%). Given that Singapore maintains its x% through a layer of sovereign wealth funds merely owning vast amounts of otherwise private real-estate conglomerates, it has both the benefits of implicitly claiming some of the landlord's rent plus market efficiency.

Phil writes:

"Information about the land can be considered an improvement in its own right."

That's your objection in one sentence, right?

Mike Hammock writes:

I'v been puzzling over the lack of interest in pollution taxes (in place of taxes on labor) for years. Why is there so little talk of the double dividend? It seems like a political winner, too: "Tax the polluters" sounds like it would be a viable slogan.

I don't like taxes, but we have to tax something. I'd rather tax pollution and congestion than labor. Why isn't this at the top of every economist's list for tax reforms?

Justin Ross writes:

No other big objection, except to this last point I think requires some clarification:

The big puzzle for me: Why do tax economists spend so much time discussing mere curiosities like lump-sum taxation, excess profit taxation, and land taxation, when the completely realistic option of taxes on negative externalities is right in front of their noses?

Discussing to whom? If the answer is the academic community, then I am sure it is far more lucrative area of research to study a carbon tax or anything other than land/poll taxes. I would bet the volume of publications in "real" taxes is much greater on an annual basis than the volume of research on land/poll taxes.

If discussing to students, then it is helpful to illustrate where excess burden actually comes from when dealing with Hicksian demand. So it warrants some attention in the classroom disproportionate to its usefulness in much the same way that perfect competition models warrant attention in teaching industrial organization.

Tom writes:

Mike Hammock: Because some clown will come along call something like CO2 pollution. We'd be one step away from the proverbial taxing the air you breathe. We can tax the air you exhale.

Bryan,

If you haven't already, you might want to look at Steve Landsburg's intermediate micro textbook. He makes a point that is, at the very least, similar to yours.

I don't have the most recent edition (8th) at hand, but here is a key passage from the 7th edition's discussion (p. 292, chapter 9):

"The fly in the Fabian ointment is that land is not equally valuable in all uses, and Jennifer Lopez is not equally valuable in all movies."

Regards,
Craig

Ellie K writes:

The case against the Georgist tax seemed like a gambit to resurrect an earlier theme, namely, taxing externalities. So I bit, clicked the URL above, was transported back to 2007, and a discussion of Pigouvian pro's and con's. The comments were the best part, and only served to highlight the impracticality of implementing an externality tax.

Actually, there ARE externality taxes in place to some extent now. In Arizona, where I live, violent crime is heavily taxed in certain circumstances. (In a manner that has nothing to do with illegal immigration). Like many of the policies in Arizona, it is probably condemned by many as an infringement on civil rights, a heavy handed action by an out of control police state.

My point is not that Arizona is a wonderful place, a secret Libertarian utopia, nor that externality taxes are necessarily ineffective. Rather, I think they are impractical. As I read the comments, particularly from here to the end (which were very funny, though sincere, and thoughtful), I was left with an even stronger sense of blue sky style abstraction.

Oddly enough, a research paper that was the focal point of a Farnam Street blog post just this morning 14-Feb-2012, Status quo bias in decision making (the research paper was published in 1988, but that doesn't mean it is invalid now), about resistance to change, particularly in matters of public policy and taxation, led to an auto-suggest by SpringerLink to this uncannily relevant item: Mises’ democracy–dictatorship equivalence theorem: A critique by none other than... Bryan Caplan (!), see The Review of Austrian Economics, Vol. 21, #1 DOI 10.1007/s11138-007-0028-y Now this was relevant, despite the Nov 2007 publication date!

I have a few reasons for mentioning that article. I don't want to sound dismissive and critical of Bryan Caplan, because I'm not! I think his other research is more interesting than Georgist arguments and counter-arguments. Maybe this is a not a failure of economic theory. Non-specific resistance to change.... an enduring obstacle (due to human nature) when implementing public policy and governing in general. I don't have any constructive ideas about how to address that, though.

Ryan P writes:

Michael Hammock (and to some extent, Bryan),

A lot of economists like negative externality taxes, and a lot of them especially like them for the "double dividend" idea. For at least some economists, however, the reason the double dividend argument isn't at the top of the list is because it's at best an oversimplification and at worst a fallacy. When you tax pollution, you're taxing labor too, because the point of labor is to be able to buy goods and some goods become more expensive because of the pollution tax. In general, this will actually be a less efficient way (in deadweight loss terms) to collect revenue, because you're concentrating the tax on fewer goods. It only makes sense because of the beneficial effect of reducing the externality (i.e., it's only the one dividend in general)

Ryan P writes:

@Bryan,

Does the problem go away if you do the "clever Georgist" regime of self-valuation, but then allow a 100% tax deduction for the cost of search? You may say this is hard to implement, but I'm asking theoretically.

I'm tempted to point out that the US tax code tries, at least sometimes, to do something very like this with taxes on resource extraction.

Zac Gochenour writes:

@Ryan P, that would definitely help, but natural resources aren't the only thing you could search for.

As we say in the paper, there are ways of getting around the problem by (correctly) classifying more and more things as "improvements." What you're left with is that everything is an improvement.

From the paper: "In the long run, there is no such thing as a 'rent,' only returns on initial endowment, effort, and luck."

Isegoria writes:

So, a tax on the unimproved value of land doesn't work when things that dramatically increase the value of land — finding it in the first place or finding better uses for it — aren't treated as improvements and do end up taxed. OK.

Actually, isn't the real problem that the State receiving these tax revenues isn't a profit-maximizing firm? An enlightened sovereign would pay geologists to locate oil on his land, after all.

Mark Wadsworth writes:

"Imagine the long-run effect on the world's oil supply if companies stopped looking for new sources of oil."

This is feeblest argument of all. I don't even need logic to defeat this one, I can do this with hard facts. And as a matter of hard fact, most governments operate a fairly Georgist system with oil exploration and extraction, or just about any mining activities, i.e. they auction off licences to explore and extract.

The winning bid for the licence must, by definition, be approx. equal to the rental value of the site (or the rights to do certain things at the site). And the winning bid, if calculated correctly, will leave the company with a good profit on its operations in future, and as a matter of fact, most mining companies and most oil companies make profits, end of discussion, there is no disincentive for exploration at all.

Or do you think that when Western oil companies rock up in Saudi Arabia, that the Saudis don't make them pay every cent for the value of the land/natural resources? The Western oil companies just get to keep the additional profits made by extracting, refining, shipping the stuff.

Ryan P writes:

That's a really good point. The easy retort is, ok, but the gov't's goal here is to tax the hell out of initial endowment (and, I'd argue, luck) ... but as you point out, that's really hard to get at, especially when "initial" is inherently poorly defined. Thanks for the reply!

Mark Wadsworth writes:

"A tax on the unimproved value of land distorts the incentive to search for new land and better uses of existing land."

No it doesn't.

There is no 'new land', it's all on maps somewhere and it's all under the control of states and therefore it is all owned already.

"If we actually imposed a 100% tax on the unimproved value of land, any incentive to search would disappear."

a) Again, nope. This is about incremental improvements. Imagine the landlord rents out ten identical shops or factory units for their market rent. Every tenant has the incentive to maximise his profits from that site, so the ones that put their own sites to its most efficient or best use will keep all the extra profits. Those who put it to inefficient use won;t be able to pay the rent and get booted out.

b) Or imagine that somebody has bought a home or a commercial building with a 100% mortgage, he is effectively paying Land Value Tax, only he is paying it to the bank instead of the government. He will still try to get the best use out of the building.

c) Or imagine that the government gives people land for free, but charges them Land Value Tax. How is that in any way different from A or B?

All the truly earned income (about three quarters of their gross income) accrues to the tenants, and the value of the location (about a quarter of their total income), which is generated by society as a whole or 'the good governance of the state' (to quote Adam Smith when he explained why LVT was the only good kind of tax) goes back to society. Surely, it is better for this value to go back to society than to a bank or a landlord?

Daniel Klein writes:

David Henderson followed up on Bryan's post, and I left a comment there, and referred to Bryan's.

Greg writes:

sorry, but even for me, who is studying economics at graduate level, this is a REALLY obscure topic to write a paper on.

you give economists a bad name Caplan!!!

Isegoria writes:

I don't know how much "new land" is still out there for the taking, but much of the English-speaking world was "new land" not so long ago — at least as far as tax-collecting governments were concerned.

Now, if we want to compare and contrast (a) a leasehold, (b) a freehold with a mortgage, and (c) a freehold with a land value tax, we need to think about how the "rent" is determined and how it changes.

In the case of a leasehold, with literal rent, the lessee has no incentive to improve the site, because the owner will reap the benefits; the owner can increase the rent to reflect its new higher value.

In the case of a freehold with a mortgage, the nominal owner has every incentive to improve the site, because he owes the bank a fixed amount; he can sell or rent at the increased value.

In the case of a freehold with a land value tax, it depends how we compute the land value. Any improvements that aren't exempted push us toward the leasehold case. If carving a new homestead out of the wilderness means you have to pay full rent on the newly arable land, no one will do the work of homesteading. If discovering oil means you have to "rent" the site of a potential well, then no one will go to the effort to discover oil.

These problems aren't insurmountable; they're just issues that come up if you propose a simple land value tax without simultaneously proposing a few complications.

Kj writes:

Isegoria:
If discovering oil means you have to "rent" the site of a potential well, then no one will go to the effort to discover oil.

I invite you to check out the world of actual oil and mineral exploration, this happens all the time. Very seldom will a party of oil/minerals exploration not have to negotiate with a private/government party who will extract as much rent as they can, and the stuff still gets out of the ground with a profit for the exploration party.
The author mistakes 100% of the rent for being 100% of the value of, in this case, oil. It's not, it's what the exploring party will bid to profitably extract it.

Kj writes:

I assume since this is a working paper, there will eventually be presented a good case for why the example of Idi Amin's expropriation of Indian immigrants is relevant to the discussion of the Single Tax. Political uncertainty is a problem in any tax-regime, why is this the single tax/lvt worse in this respect? I'd also be interested in case-histories to substantiate the statement: some countries have experimented with very high land taxes to tremendous detriment

Isegoria writes:

That was my point, Kj: it depends how we compute the land value. If we naively grant the tax authority the entire value of any discovered resource without granting it leeway to negotiate deals, the simple land tax doesn't work — but these aren't insurmountable problems.

Kj writes:

That was my point, Kj: it depends how we compute the land value. If we naively grant the tax authority the entire value of any discovered resource without granting it leeway to negotiate deals, the simple land tax doesn't work — but these aren't insurmountable problems.

Agreed.

Isegoria writes:

One problem with using Georgist language is that it raises the philosophical question of just what unimproved means — which we can debate endlessly — when what we really want is a tax (or rent, or mortgage) scheme that aligns incentives efficiently.

It doesn't really matter what the unimproved value of the land under Manhattan or Tokyo is — or what that even means — when what we really want is a negligible marginal tax rate on improving existing lots — or creating new lots, however that might be done.

Kj writes:

One problem with using Georgist language is that it raises the philosophical question of just what unimproved means — which we can debate endlessly — when what we really want is a tax (or rent, or mortgage) scheme that aligns incentives efficiently.

IMO a benchmark would be that after the tax is applied, all sites should still have a positive capital value before the cost of bringing it into use (empty lot in the city, fallow land in an arable area), even if just a fraction of what it would be if the tax was not applied.

It doesn't really matter what the unimproved value of the land under Manhattan or Tokyo is — or what that even means — when what we really want is a negligible marginal tax rate on improving existing lots — or creating new lots, however that might be done.

It does matter, because Tokyo and Manhattan are the types of places where most revenue would be collected, for good reason. Neglible taxations of improvements is the whole point of land value tax. So we want to have new uses with higher value being applied to sites making a profit from that better use.
All this doesn't mean the land value tax as a function of the value of surrounding property will never catch up even if I manage to apply a more profitable use of a site for a while.
As for the whole mineral rights/new uses bit, I agree there needs to be principles applied so that there are incentives for property owners for applying a higher value use. But this is an area where most of the not-totally-inept governments of the world manages to do, eploration is done, rent is collected (more or less) and profitable extraction is done.
In the real world search costs aren't discounted for under private collection of land rents either. I would most likely not get a reduction in rent/capital purchase price of a restaurant for the market research involved in deciding that it'd be a chinese restaurant.

ricketson writes:

Are you saying that raising/adjusting a real estate tax amounts to showing "a willingness to drastically alter their respect for certain types of property rights for certain types of citizens,".

In case you haven't noticed, real estate taxes are pretty common in the USA.

And the "clever Georgist" of this example may illustrate some theoretical point nicely, but he has nothing to do with real-world Georgists who typically start with the existing system of real estate assessments (not self-valuation)

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