Non-distortionary taxes

From an article in today's Scotsman comes this nugget:

... [house] prices north of the Border are continuing to rise – due in part to the oil price spike fuelling the Aberdeenshire market ...

Which set me thinking about "least-bad" taxes...

When they first discovered oil under The North Sea, the government did not hand out free drilling licences willy-nilly; it basically auctioned them off. Oil companies (who are experts in these matters) made estimates of future oil prices, extraction costs, added a profit margin; worked out the net present value thereof; and submitted bids. And the best bids won. (The full story is of course far more complicated than this, but let's just go with it for now).

Alternatively, the government could have given away the licences for free (to Party donors and in exchange for offers of directorships for ex-Ministers, no doubt).

Those are your two basic options - auction off licences for "market value" and use the revenues to cut other taxes, or trade them for money and favours. To me, the auction must be the preferred method for allocating the licences - it raises money for the Treasury without depressing economic activity, i.e. without reducing the amount of oil extracted*.

This sort of auction is a "non-distortionary tax".

Now, to extract oil, you don't just need a drilling licence, you need a shedload of money for oil rigs, boats, pipes, helicopters and for employees to run the show. And those employees have to live somewhere. So they all bought or rented near e.g. Aberdeen, so the secondary beneficiaries were local landowners, who could sell for higher prices or let out for higher rents. So the employees need higher salaries, so the profits of the oil companies, who are taking all the financial risk, go down.

Now, if you are agreed so far that auctioning off the licences is a non-distortionary tax, why not go one further and skim off a land value tax from local landowners? A large part of that land value relates to the value of the oil - but while the oil companies have to stump up for drilling licences and take all the financial risk, the local landowners just sit there and make capital gains.

Wouldn't a land value tax on such landowners also be a "non-distortionary tax"? The selling prices or rents that they can achieve will go up whether there is a tax or not - it's not like a landlord could tear down his building to avoid the tax (as it is a tax on land values, so the tax would be due either way). And so landlords would be keen to let out as much space as possible, and other people in the area (who don't work in the oil industry) would be more amendable to selling up their houses and moving elsewhere (to avoid the higher land value tax); this would depress rents and house prices, so oil workers wouldn't need such high wages so the auction value of the drilling licences (next time they came up for auction) would be even higher, and so on.

A sort of negative Laffer-curve effect, if you will - it's like a balloon with water in it. If you squash it on one side, the water (in this case the unearned profits) just go to the other end - what you have to do is squash in at both ends simultaneously (but not so hard that it bursts, obviously).

* A smartarse would no doubt say "If the oil companies didn't need to spend money on licences, they'd have more money to spend on oil rigs". Superficially true, yes. But oil companies do not have a fixed amount of money - as long as profitable opportunities are there, they can raise as much capital as they need. Similarly, would a smartarse apply this argument if oil were discovered under his own back garden? I doubt it. So if the North Sea oil belongs half to the United Kingdom (and half to Norway) would smartarse approve if the oil were just given away to multinationals? I hope not.