The economic policy dilemma

Tim endorses business rates as a "close approximation to a Land Value Tax, the least distorting of all taxes."

He omits to add that they are also very unpopular - which is one reason why they raise only 1.6% of GDP*. Their domestic equivalent, rates, were, remember, abolished in 1988 and (eventually) replaced with the less onerous council tax. This tells us that there is very little support for Land Value Tax.

This reflects a widespread problem in economic policy-making, which I express through the medium of a Venn diagram thusly:

This doesn't just apply to land taxes, but to numerous other things: immigration; Keynesianism (Osborne's policy is more popular than Labour's); a citizens' basic income; worker democracy; drug liberalization; fiscal union in the euro area. And so on; feel free to add others.

In saying this, I'm not taking a left-right stance. Marxists have long thought public opinion warped by false consciousness; the libertarian Bryan Caplan has challenged what he calls the "myth of the rational voter", and the Democrat-supporting Alan Blinder has said (pdf):

Ideology seems to play a stronger role in shaping opinion on economic policy issues than either self-interest or knowledge...The contrast with homo economicus—who is well informed, nonideological, and extremely self-interested—could hardly be more stark.

However, I fear that blaming public stupidity is only part of the problem. It's also the case that economists' association with the charlatanic practice of forecasting has helped to discredit the profession even where it has useful things to say.

Whatever the cause, the fact is that there is a sharp trade-off between democracy and good economic policy-making.

* Table 4.6 of this pdf.

Comments

[John H]

Genuine question: why are you so sure that "policies that are equitable" and "policies that are efficient" can be identified in this way?

Is the question I was going to ask after seeing your post in Google Reader, which still has the original version of your Venn diagram. And now I see you've changed it, you cheat. ;-)

[Duncan Stott]

I think there's more to it than this. Take the Mansion Tax. This is surely a rich man's LVT. All the polls I've heard about point to it being popular with voters. Yet the Tories decide to veto it.

[Anonymous]

How well correlated would LVT be with income? If highly so, then I suggest it would be both a popular and a good tax.

I suggest business rates (Tim's LVT proxy) are unpopular because their relationship with income and the ability to pay is tenuous.

As far as I can tell, until a high correlation can be proved between income (ability to pay) and LVT then such a tax is a non-starter

A pity really, because LVT does have merits.

[Ralph Musgrave]

Land value tax on those with over say £1m of land would be popular, wouldn't it?

[chris]

@ John H - I changed the chart for simplicity's sake.
Natch, there'll be some disagreement about what policies are efficient and equitable (and what these terms mean). But this isn't really my point.
Instead, my challenge is: can you think of significant policies which you can argue would be efficient and equitable - by reasonable lights - and which are also popular but which do not presently exist? I doubt there are many.
@ Duncan etc - a mansion tax wouldn't raise very much, so it's hardly transformative, and it runs into the IMO misplaced objection that it would be hard on "asset rich, cash poor" pensioners, so might be be very popular.

[Anonymous]

@Ralph

LVT, if it truly has merit, would be payable by anyone and everyone, just like income tax. It would replace council tax, business rates and possibly income tax. So even households would be liable to it.

The problems, as I see them, include the following:

- Who pays, land owners or occupiers?
- Will it be related to ability to pay?
- Will it raise enough to pay for public services?
- Valuations may not capture economic reality
- Who will the winners and losers be?
- Will it promote economic efficiency as suggested by its proponents?

[Jim]

"How well correlated would LVT be with income?"

Very well correlated, in the long term. Because the only thing one can pay it with is cash, and apart from a small amount of people paying it out of capital (which is not a long term solution), it will have to come out of a person's cash income. Ergo everyone will eventually be living in a house that has a LVT bill that their income can sustain. It will just take a decade or so for everyone to move to a house with a suitably affordable LVT bill.

In the long term LVT is a tax on income, because property values are linked to income levels. As GDP rises, property values rise, LVT would rise also. Its just that LVT is a tax based on the general level of income in society, not any one individuals specific income. Hence its inflexibility, and why property taxes are universally disliked.

[Keith]

May I suggest that Jims argument has a exception: the supply of Land affects its price as does population density. The appeal of a Land Tax arises from the belief that these two factors produce an unjust enrichment of land owners and that taxing land is a correction for this injustice. For example the "dukes" as David Lloyd George used to say become richer by the day even though they are lying in bed being waited on by their servants as the industrious create more national wealth.

If the land owner is maxamising his monopoly income from land and it is the land lord who pays then the state will have succeeded in extracting some of his unjust income. But what the state does with the revenue may or may not be a social good. If the land lord pays in cash but has unused monopoly power he can transfer some of the incidence to his tenants by increasing the rent. So the gain is only partly at his expense or even entirely at the expense of his tenants. If the land belongs to an owner occupier they will probably have to sell up and down size so they can match income to tax liability. Only if you get a large income from renting out your land can you avoid this result. For most people property taxes and capital taxes on say land are just an income tax badly matched to ability to pay.

Any actual Land tax would have to have an income relief for owner occupiers and so is a income tax with a property element to it.

I suspect the popularity of LVT arises from the unrealistic assumption that you could actually raise huge amounts of money in some painless way. There is no realistic way to raise substantially more money except increasing income tax since all tax payments come from some ones income eventually. The popularity of some ideas comes from them being impractical day dreams no one has thought through.

[shtove]

The Venn diagram underlap makes a change from gratuitous pics of honeys to adorn these posts.

But if you have your page three specs on ...

[Metatone]

Worth noting that part of the problem with business rates is that the valuations are not particularly flexible and it seems, not actually correlated with any meaningful definition of value.

For example, on a shopping street near me there is a premises that has been empty for a year. Yet there has been no reduction in the business rates you'd have to pay if you opened up in there. Worse, the landlord gets a big discount while it is empty...

So in fact, Business Rates bring small businesses none of the advantages of LVT and all of the disadvantages...

(As a final aside, Tim assumes incidence of Business Rates on Starbucks, but in other cases he would assume incidence on consumers or employees... interesting...)

[Anonymous]

@shtove

Bring the honeys, I say. My beer goggles are not that good :)

[FromArseToElbow]

@Keith, LVT is popular not because it would produce a lot of revenue painlessly but because it is almost impossible to avoid, so it has the virtue of effectiveness. You cannot easily hide or disguise your land or physically move it offshore.

It is also easy and cheap to administer, relative to other schemes such as income tax or business rates, so it also has the virtue of efficiency.

The idea that owner-occupiers would have to downsize to pay their tax bill would only make sense if you assume that LVT would produce a net increment in that person's total tax. It is more likely that an LVT would substitute for existing taxes, such as the council tax and perhaps a portion of income tax, so the average home-owner would see little if any change in their tax burden.

There are many ways an LVT can be implemented, but the most suitable in the UK context would probably be a combination of a tax on the unimproved value of land (so urban land is taxed at a higher rate due to roads, sewers and other amenities) plus the market price. The former would penalise builders who hold land banks (particularly brown-field sites), while the latter would, over time, act as a drag on property prices.

[Anonymous]

@FromAtoE

LVT still fails on the ability to pay test. For example, pensioners who may be asset rich but cash-income poor. The LVT tax liability may well exceed their ability to pay from their income.

As Keith says, all tax ultimately derives from income and so income is probably the best tax base.

Taxing income, at least if it is progressive, ensures that people pay according to the value or benefit they extract from society. It acts as a sort of rent- the more luxury society affords an individual, the higher their rent (tax liability)

Also taxing income progressively keeps money in circulation - money which would be otherwise removed from circulation if income tax was low. It is better that surplus incomes are not parked in savings accounts but instead are re-distributed via income tax to low income people with higher propensities to spend. The economy as a whole functions better under this arrangement because one person's spending is another's income.

A progressive income tax also addresses a political problem, which is that the electorate will not stand for a tax that is not based upon ability to pay.

Then there is also the social justice element, "From those according to their ability, to each according to their need". Progressive income tax complies with this maxim.

LVT is unlikely to match income tax in achieving these objectives and so it seems we are stuck with the latter, supplemented with a mish-mash of indirect taxes. Despite what classical economists may say LVT in truth has little going for it save for its immovability and visibility.

[john b]

Anon:
The pensioner point is massively overblown. It would maximise efficiency if people rattling around in million pound houses without tenpence to rub together sold up and moved to a bungalow somewhere. But since this would fall foul of your "electorate wouldn't stand for it" point (see the diagram above), the obvious alternative is simply to allow pensioners to roll up LVT until death. Presto: problem solved.

The rest is nonsense. Ability to pay and circulation of money are based on wealth, not income (which is a measure of your annual change in wealth). Wealth taxes like LVT are just as socially fair as income tax, without the negative effect on economic output that income tax has.

[FromArseToElbow]

@Anon, John B says the pensioner point is overblown. I'd go further: it's a myth. There simply aren't lots of little old ladies living in mansions on a paltry pension. This particular propaganda trope originated with the Tories' ideological campaign against the old rates in the 80s, which led to that unfortunate business with the poll tax.

I'm wholly in favour of a progressive income tax, but I think there is a role for an LVT as well. Income tax is too easy for the wealthy to avoid.

[Anonymous]

@JohnB

As you correctly imply, a wealth tax would tax past income retrospectively, in cases where wealth is the accumulation of unconsumed income. In principle, if wealth was just accumulated unconsumed past income then a wealth tax would produce a more socially just outcome than income tax provided it were progressive and designed to redistribute wealth. I'd be all for that.

However, wealth is often held in the form of future income at its present value (shares for example). Although the sale of shares to pay a wealth tax liability may not impact on real productive activity, selling manufacturing plant piecemeal to meet a wealth tax demand may have adverse impacts.

So a wealth tax may produce the same negative effect on economic output that you allege for income tax.